10-K 1 v371549_10k.htm FORM 10-K

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

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

 

For the fiscal year ended December 31, 2013

 

or

 

¨TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _____________ to ________________

 

Commission file number: 001-34445

 

LIHUA INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   14-1961536
(State or other jurisdiction of   (I.R.S. Employer Identification No.)
incorporation or organization)    
     
c/o Lihua Holdings Limited    
Houxiang Five-Star Industry District,
Danyang City, Jiangsu Province, PRC
  212312
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (86) 511 86317399

 

Securities registered pursuant to Section 12(b) of the Act: Common Stock, par value $0.0001 per share

 

Name of each exchange on which registered: NASDAQ Capital Market

 

Securities registered pursuant to Section 12(g) of the Act:  None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  ¨   No  x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes  ¨  No  x

 

Indicate by check mark whether the registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 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 (§229.405 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 disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

 

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

 

Large accelerated filer  ¨ Accelerated filer    x
   
Non-accelerated filer  ¨ Smaller reporting company  ¨

 

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

 

The aggregate market value of the voting and non-voting stock held by non-affiliates of the Registrant as of June 30, 2013 was approximately $79,222,316.

 

The number of shares outstanding of the Registrant’s common stock as of March 13, 2014 was 30,032,116.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

None.

 

 
 

 

LIHUA INTERNATIONAL, INC.

 

Annual Report on Form 10-K for the Year Ended December 31, 2013

 

FORWARD LOOKING STATEMENTS 1
       
PART I      
       
  ITEM 1. BUSINESS 2
    ITEM 1A.     RISK FACTORS 23
    ITEM 1B.     UNRESOLVED STAFF COMMENTS 38
       
  ITEM 2. PROPERTIES 38
       
  ITEM 3. LEGAL PROCEEDINGS 38
       
  ITEM 4. MINE SAFETY DISCLOSURES 39
       
PART II     39
       
  ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 40
       
  ITEM 6. SELECTED FINANCIAL DATA 41
       
  ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 42
    ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 55
       
  ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 56
       
  ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 56
    ITEM 9A. CONTROLS AND PROCEDURES 56
    ITEM 9B. OTHER INFORMATION 57
       
PART III     58
       
  ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE 58
       
  ITEM 11. EXECUTIVE COMPENSATION 65
       
  ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS 72
       
  ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE 74
       
  ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES 75
       
PART IV     76
       
  ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 76

 

i
 

 

FORWARD LOOKING STATEMENTS

 

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. These statements relate to future events or our future financial performance. We have attempted to identify forward-looking statements by terminology including “anticipates”, “believes”, “expects”, “can”, “continue”, “could”, “estimates”, “expects”, “intends”, “may”, “plans”, “potential”, “predict”, “should” or “will” or the negative of these terms or other comparable terminology. These statements are only predictions. Uncertainties and other factors, including the risks outlined under Risk Factors contained in Item 1.A. of this Form 10-K, may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements.

 

A variety of factors, some of which are outside our control, may cause our operating results to fluctuate significantly. They include:

 

·changes in end-user demand for the products manufactured and sold by our customers;

 

·general and cyclical economic and business conditions, domestic or foreign, and, in particular, those in China’s copper industries;

 

·the rate of introduction of new products by our competitors and customers;

 

·the rate of introduction of enabling technologies by our suppliers;

 

·changes in our pricing policies or the pricing policies of our competitors or suppliers;

 

·changes in the market price of copper;

 

·our ability to compete effectively with our current and future competitors;

 

·our ability to manage our growth effectively, including possible growth through acquisitions;

 

·our ability to enter into and renew key corporate and strategic relationships with our customers and suppliers;

 

·foreign currency exchange rate fluctuations;

 

·adverse changes in the securities markets; and

 

·legislative or regulatory changes in China.

 

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Our expectations are as of the date this Form 10-K is filed, and we do not intend to update any of the forward-looking statements after the filing date to conform these statements to actual results, unless required by law.

 

We file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy and information statements and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended. You may read and copy these materials at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the public reference room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding us and other companies that file materials with the SEC electronically. You may also obtain copies of reports filed with the SEC, free of charge, via a link included on our website at http://www.lihuaintl.com.

 

1
 

 

PART I

 

ITEM 1.BUSINESS

 

Company Overview

 

Business Overview

 

We are a vertically integrated company in China which develops, designs, manufactures, markets and distributes low cost, high quality refined copper products including copper anode, copper rod, pure superfine copper wire, and copper-clad aluminum superfine wire (“CCA”), which is an alternative to pure superfine copper wire. We also use recycled scrap copper as a raw material to produce refined copper products including copper anode and copper rod.  Copper anode is the raw material for copper cathode, which is the fundamental building block for pure copper products. We use the copper rod we produce as raw material for the production of pure copper wire. Primarily because of its high electrical conductivity, pure copper wire is used in many components in a wide variety of motorized and electrical appliances such as dishwashers, microwaves and automobiles. In most instances, our CCA wire and refined copper rod and wire products are an excellent, less costly substitute for pure copper cable and wire products.

 

We sell copper anode primarily to a few large copper cathode producers in China. We sell our rod and wire products to down stream manufacturers including fine and superfine wire processors and small and micro electronic motor manufacturers who in turn sell to the consumer electronics, white goods, automotive, utility, telecommunications and specialty cable industries. Our track record and reputation for producing high quality products in large quantities has paved the way for expansion of our customer base. In the PRC, the market for copper products is large and growing. As a result, there is solid demand for all of our products. Essentially all of our product sales are made to domestic customers in the PRC.

 

Prior to 2009, our business focused primarily on CCA. Our CCA business consisted of acquiring CCA with a line diameter of 2.60 mm from our suppliers as a raw material, and then reducing the diameter of the CCA by drawing it and then annealing and coating it. Our final CCA product typically has diameters from 0.03 mm to 0.18 mm, depending on customer specifications.

 

Over the past several years we have worked to develop and produce a new form of CCA wire using our own proprietary binding technology which has better performance characteristics than the CCA wire that is currently available to us from third party suppliers. In 2013, we completed product and industry standard testing of this new CCA product. In the second half of 2013 we added five copper and aluminum binding machines in order to supply this new CCA product as the raw material for new superfine CCA products, which share the improved performance characteristics of the new CCA raw material, including better conductivity. Due to these improved performance characteristics, the new CCA superfine wire can be used in more sophisticated applications such as audio and visual equipment.

 

In the first quarter of 2009, we began production of copper rod from recycled scrap copper. The copper rod we produce meets the national purity standard for pure copper cable and wire. In August 2010, we began production and sales of copper anode, another refined copper product produced from recycled scrap copper, and increased our refined copper smelting capacity to 50,000 tons per annum.  In October 2011, we completed capacity efficiency improvements to our two smelters and thereby increased annual production capacity of copper anode and copper rod to 35,000 tons and 50,000 tons, respectively. In mid 2012, we focused on copper anode production capacity expansion and completed construction of two new copper anode smelters on the 30-acre plant site, giving us a total of 3 anode smelters. In December 2012, we dismantled the oldest copper anode smelter as a result of consolidating and upgrading our production site. In the first quarter of 2013, we completed construction of a third copper anode smelter. The new copper anode smelters constructed in 2012 and 2013 each have an annual production capacity of 25,000 – 30,000 tons, giving us total copper anode refinery capacity of 75,000 – 90,000 tons per annum. We started construction of a fourth copper anode smelter in early 2013, however we have delayed the further construction due to reconfiguration of the dust collection system. The construction will resume upon completion of the dust collection system and a better near term economic outlook. To the extent our down stream wire-drawing capacity allows, we process our copper rod into copper wire.  Until the first half of 2010, because our output of copper rod exceeded our capacity to process it into copper wire, we sold our excess copper rod to other wire manufacturers for further processing.  In the third quarter of 2010, we completed an expansion of our wire drawing capacity expansion and reached 20,000 – 25,000 tons of annual drawing capacity for wires with diameters ranging from 0.03mm – 1.60mm, we started using our copper rod output exclusively for internal copper wire drawing. With the October 2011 copper rod capacity expansion to 50,000 tons per annum, in the fourth quarter of 2011, we again began selling excess copper rod to the open market.

 

2
 

 

Because copper anode is the raw material for copper cathode, which is the fundamental building block for pure copper products, copper anode is an upstream product, and the end market for copper anode covers most of the copper consumption market in the PRC.  Our markets for our other three main products overlap to a degree, and are characterized by their breadth and depth, with a number of current and potential customers for each product category. Our refined copper products, copper anode and copper rod, which are manufactured from recycled scrap copper, compete directly with the same products made from “virgin” (e.g. newly mined) copper. Since we produce our copper products with bulk scrap copper, we believe it provides us with a cost advantage in the market. Our copper anode customers are large domestic copper cathode manufacturers.  Most of our copper rod customers 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 undergo 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 new CCA wire product offers conductivity performance characteristics that are comparable to those of pure copper wire, which means they are attractive in a wide variety of product applications such as audio and video equipment, most household appliance, automotive, consumer electronics and telecommunications applications. Demand for each of our product lines is solid, due both to consistent demand in the PRC for overall copper consumption and all types of basic wire raw materials and the relative cost advantages our product lines carry over “virgin” copper competitive products.

 

We believe that we are well positioned to continue capturing further market share in the larger copper consumption market and the copper wire industry.  We generated sales of $900.7 million, $853.8 million, and $637.1 million for the years ended December 31, 2013, 2012 and 2011, respectively. We achieved net income of $56.2 million, $57.9 million and $53.1 million for the years ended December 31, 2013, 2012 and 2011, respectively. In 2013, we had a $8,369 non-cash loss on extinguishment of warrant liabilities and non-cash charge of $106,536, 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 warrant related non-cash charges, net income for 2013 was $56.3 million, down 3.0% from the same period last year of $58.0 million, which excluded aggregate non-cash charges of $50,709 related to gains on extinguishment of warrant liabilities and changes in the fair value of warrants.

 

Currently, our ability to increase production and sales of our copper anode, copper rod, copper wire (drawn from copper rod) and CCA wire products is limited by the capacity of the equipment we have installed to produce these products. Our refined copper products 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 with total annual scrap copper refining capacity of 125,000 – 140,000 tons. Three of the smelters are copper anode smelters which are capable of producing a total of approximately 75,000 – 90,000 tons per year. In October 2011, we completed efficiency improvements to the copper rod smelter and increased the copper rod production capacity to 50,000 tons per annum, after adding a vertical smelter on top of the original horizontal one. As of December 31, 2013, we operated approximately 80 high speed wire drawing machines, which draw larger diameter copper rod or CCA rod into much finer diameter wire, with a total capacity of 6,000 – 8,000 tons per annum of superfine CCA wire and 20,000 - 25,000 tons per annum of superfine copper wire, with a diameter range of 0.03mm to 1.60mm. We also have four fine wire drawing machines with aggregate annual drawing capacity of 50,000 – 100,000 tons of fine wire products with a diameter range of 1.65mm – 2.60mm. 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 the PRC.  We are not dependent on any single custom equipment manufacturer for the fabrication of our drawing lines.  In 2012, we completed construction of a new production and warehousing facility adjacent to the current plant, which houses our three copper anode smelters. We began construction of the fourth copper anode smelter in early 2013 but delayed construction completion due to the reconfiguration of the dust collection system for the smelters. The decision to complete construction of the fourth anode smelter is dependent on better near term economic outlook and the completion of the dust collection system. We have completed construction of all the production and warehouse facilities on site to house production equipment for our new CCA cable and wire product, as well as warehousing of materials.

 

3
 

 

We continuously pursue technological innovations and improvements in our manufacturing processes. We have obtained two patents in the PRC. In 2013 we submitted 16 patent applications relating to the production technology of the new CCA product we have developed. We have formed research and development (“R&D”) partnerships with Shanghai Electric Cable Research Institute and Beijing Modern Recycle Economy Research Institute. We believe that our emphasis on technological innovations and production efficiency has contributed significantly to our leading industry position in the PRC and will continue to do so for the foreseeable future. Further, significant capital requirements make it difficult for newcomers to successfully compete with our scrap copper refinery and superfine wire businesses. With respect to our scrap copper refinery business, our proprietary smelting process enhances scrap copper purity, and enables us to produce high purity refined copper products, which meet the industry standard for pure copper product.  With respect to CCA, during the process of drawing, annealing and coating CCA, it is challenging to maintain the integrity of copper and aluminum weight and volume distribution without breakage, especially for finer diameter wires. Our knowledge and experience in successfully generating high quality CCA fine and super fine wires put us at a significant advantage over would-be competitors. With respect to pure copper wire, our proprietary recycling technology offers us a unique ability to produce high quality pure copper wire from scrap copper. This enables us to have a lower raw material cost base compared to pure copper wire produced from “virgin” copper sourced from copper mines. Our experience and technology allow us to offer products that are, in most instances, more cost-effective to those that our potential competitors can produce. Because we are already an approved vendor for many of our customers and qualifying new vendors can be time-consuming, we believe we are further advantaged vis-à-vis potential competitors.

 

To minimize exposure to copper commodity risk, we seek to minimize our raw material inventory. In addition, we charge a fixed dollar processing fee for most of our products thus enabling us to pass most of the underlying raw material price exposure to our customers, and minimize our exposure to copper price fluctuation. The processing fee is adjusted periodically based on market condition, which includes supply demand dynamics, competitive landscape changes, and copper price fluctuation. We further confirm raw material purchase orders for scrap copper or CCA with suppliers only when the applicable sales order has been received. On the other hand, our principal CCA and scrap copper suppliers usually dedicate portions of their inventories as reserves to meet our manufacturing requirements. We have built a network of reliable suppliers that deliver high quality raw materials, and accordingly, are not dependent upon any one supplier.

 

We believe that our experienced management team will continue to leverage our leading technologies and increase capacity to manufacture, produce, market and distribute cost-effective, high quality refined copper and superfine copper and CCA wire products. If worldwide demand for alternatives to pure copper grows as we anticipate, and we continue to innovate and improve our processes, we believe we will be well positioned to compete in the copper consumption and copper wire market on a global scale.

 

Our Strengths

 

We believe that the following strengths have contributed to our competitive position in China:

 

Leading market position and early-mover advantage.   We are one of the few scrap copper refineries in China that can produce high purity refined copper products with a purity level as high as 99.96%, which meets the national pure copper cable and wire standard.  We believe we were one of the first companies in China to produce CCA superfine wire on a commercial scale, and currently we are one of the leading CCA superfine wire producers in China, as measured by our current annual CCA superfine wire production capacity of 6,000 – 8,000 tons.

 

The early-mover advantage coupled with our reputation for high quality products enabled us to establish a wide array of customer and supplier relationships and to expand our relationships with our existing customers. We believe we are well positioned to leverage our increasing production scale and to expand our customer base and product portfolio, to meet China’s demand for copper products.

 

Proprietary automated and efficient production facility that can be scaled to meet increased demand.   To cope with increased demand, we continue to expand our production facility organically: our CCA wire production capacity increased from 2,200 tons per annum in 2006 to 6,000 – 8,000 tons per annum as of December 31, 2013. In March 2009 we launched scrap copper refinery production and have since built refined copper production capacity to 125,000 – 140,000 tons per annum. In 2010, we increased pure copper superfine wire drawing capacity (for diameter range 0.03mm – 1.60mm) to 20,000 – 25,000 tons per annum.

 

4
 

 

Efficient proprietary production technology.   We continually pursue technological improvements to our manufacturing processes via our strategic partnerships with leading research institutes. We have obtained two patents related to our production technology and production processes. In 2013 we submitted 16 patent applications relating to the production process of the new CCA product we have developed. In addition, we have entered into technology cooperation agreements with research institutes to develop new products as well as new techniques and processes. Our research and development (“R&D”) efforts have generated technological improvements that have been instrumental in controlling our production costs and increasing our operational efficiency. The combination of our trade secrets and our proprietary production technology enables us to use lower-cost recycled copper feedstock and to produce high quality copper alternative products.

 

Rigorous quality control standards.   Consistent with our continuing commitment to quality, we impose rigorous quality control standards at each stage of our production process. Since January 2007, our plant has maintained ISO9001:2000, a certification of quality management systems maintained by the International Organization of Standardization and administered by certification and accreditation bodies, which is subject to annual review. In addition, our plant has obtained ISO14001 environmental management standard certification.

 

For copper magnet wire, we obtained a National Industrial Production License in January 2009 and satisfied the UL standard in October 2008. According to a test report dated April 17, 2008 by China’s Machinery Industry Quality Supervision and Test Center For Electrical Material and Special Wire and Cable, a government inspection and testing agency, recycled copper rod produced by us satisfied the national standard for electrical copper wire, GB/T3952-1998. We believe these testing results demonstrate our commitment to producing high-quality products as well as provide us with a competitive advantage over certain domestic competitors in the event China implements stricter quality standards in the future.

 

Strong technology improvement and R&D capabilities.   Our technology improvement and R&D infrastructure includes a team of more than 30 professionals focusing on quality assurance, equipment maintenance, process maintenance and improvement, and new product and process R&D. We have formed R&D partnerships with Shanghai Electric Cable Research Institute and Beijing Modern Recycle Economy Research Institute. We absorb most of the technology related expenses in our production costs, and thus have only incurred R&D costs at very low levels in past years. We were granted two patents relating to our production process. We believe our knowledge and experience in R&D are the key reasons why we were able to become one of the earliest and leading manufacturers in China in both the CCA and high purity refined copper products. Our scrap copper refinery operation utilizes a proprietary smelting process, which enables us to smelt scrap copper into high purity copper rod product, which meets the national industry standard for pure copper. As a result, we have been able to take advantage of this emerging market opportunity given the growth in China’s copper consumption.

 

Experienced management and operations teams with local market knowledge.   Our senior management team and key operating personnel have extensive management skills, relevant operating experience and industry knowledge. Mr. Zhu and Ms. Wang, our co-founders, Chairman & CEO and COO, have extensive experience managing and operating companies in the copper manufacturing industry. We believe our management team’s in-depth knowledge of the Chinese copper market will enable us to formulate sound expansion strategies and to take advantage of market opportunities.

 

Our Strategies

 

We will continue to strive to be a leading supplier of copper replacement products in the PRC, while maximizing shareholder value and pursuing a growth strategy that includes:

 

Developing market driven new products and processes.   We consistently pursue technological improvements to our manufacturing processes and new product development through our strong in-house technology development team. Our R&D efforts have generated technological improvements that have been instrumental in controlling our production costs and increasing our operational efficiency. Our combination of trade secrets and proprietary production technology enables us to use lower-cost feedstock and to attain higher product quality. We have formed R&D partnerships with Shanghai Electric Cable Research Institute and Beijing Modern Recycle Economy Research Institute. Through innovation and further production efficiencies, we believe our emphasis on R&D will enable us to maintain our position as a leading copper alternative and replacement product supplier in the PRC.

 

5
 

 

Reliable supplier network for low cost raw materials.   We maintain long-term supply relationships with several key suppliers. We believe many of our suppliers prefer to sell raw materials to us due to our track record for prompt payment as well as our ability to accept large quantities of raw materials. Our long-standing supplier relationships provide us with a competitive advantage in China, and we intend to broaden these relationships to parallel our efforts to increase the scale of our production facilities, thereby maintaining a diverse supplier network while leveraging our purchasing power to obtain favorable price and delivery terms.

 

Production capacity expansion.   In order to accommodate the rapidly increasing demand for our products, we have expanded, and plan to continue to expand, our manufacturing capacity. An increase in capacity has a significant effect on our results of operations, both in allowing us to produce and sell more products and achieve higher revenues, and in lowering our manufacturing costs resulting from economies of scale. We have expanded rapidly since we launched our CCA wire production in 2006. The following table sets forth information on the historical development of our production facilities:

 

    Plant 1   Plant 2   Plant 3
Location   Danyang, Jiangsu   Danyang, Jiangsu   Danyang, Jiangsu
             
Began construction   March 1999   March 2008   November 2010
             
Began production   January 2006   March 2009  

2 new copper anode smelters – June 2012;

3rd copper anode smelter – January 2013;

4th copper anode smelter – construction started in early 2013;

Completed construction of production factories and warehouses

             
Capacity as of December 31, 2013 (metric tons per year)   None.  For new product test run only.   Copper rod – 50,000 Fine Copper wire – 50,000-100,000   Copper anode – 75,000-90,000
             
            *Superfine copper wire – 20,000–25,000
*CCA superfine wire – 6,000-8,000
             
Site area (square meters)   11,000   66,000   119,988

 

* Production equipment moved from Plant 2 to Plant 3 in the third quarter of 2013.

 

We believe our expansion strategy will enable us to increase market share in the copper market in the PRC.

 

6
 

 

Selectively pursue acquisition opportunities.  Although we have not identified a potential acquisition target(s), we may in the future look to acquire businesses or assets that may enhance our market position.

 

Strengthening our relationships with key customers and diversifying our customer base.  We intend to strengthen our existing relationships with key customers while further expanding our customer base. We plan to continue providing high-quality and cost-competitive products to our existing customers and use our existing customer network and strong industry reputation to expand geographically to strategic locations across China. We plan to increase our sales service personnel to further expand our supplier and customer base and to provide increased coverage of the market. To assist our efforts, we intend to continue to use customer feedback to improve our service quality and strengthen our long-term customer base.

 

Competition

 

The PRC is the world’s largest country for copper products consumption and is also the largest producer and market for cable and wire. Our sales are predominantly in the PRC, and as a result, our primary competitors are PRC domestic companies. To a lesser degree we face competition from international companies.

 

We believe we are the leading CCA superfine wire manufacturer in China in terms of market share, and we are one of the leading scrap copper recyclers in the nation, based on our current scrap copper refinery capacity.

 

We believe being located in the PRC provides us with a number of competitive advantages within our industry, such as:

 

·Pricing.   Low cost of shipping from being geographically close to our customers and low cost of labor provide us with cost and pricing advantage;

 

·Technology.   Developed proprietary technologies from being in the PRC copper industry and knowledge of the supply and demand trend in the local market; and

 

·Barriers to entry.   Strong customer relationships and superior product quality benefiting from our proprietary technology, as well as access to capital from being a public company.

 

Competition in the bimetallic and scrap copper recycling and refinery industry, particularly in the PRC, can be characterized by growth and a concentration of manufacturers. We believe we differentiate ourselves by being an early mover in the industry, and by offering superior product quality, timely delivery and better value. We believe we have the following advantages over our competitors:

 

·the performance and cost effectiveness of our products;

 

·our ability to manufacture and deliver products in required volumes, on a timely basis, and at competitive prices;

 

·superior quality and reliability of our products;

 

·our after-sale support capabilities, from both an engineering and an operational perspective;

 

·excellence and flexibility in operations;

 

·effectiveness of customer service and a seasoned sales force to assist our customers; and

 

·overall management capability.

 

 

Corporate Structure

 

The following diagram illustrates our corporate structure as of December 31, 2013.  All of our subsidiaries are owned directly by us.

 

 

 

7
 

 

Manufacturing Process

 

Copper recycling

 

Our copper recycling pre-treatment process involves manually or mechanically sorting, stripping, shredding and magnetically separating the scrap copper. The scrap copper is then compacted and then smelted and fire refined in a furnace. The furnace refining process commences with loading the furnace with the pre-treated metal, smelting it, and then refining and reducing it. Thereafter, the molten copper is continually belt cast and further treated, and the refined copper product is ultimately molded or shaped for further processing or sale.

 

8
 

 

Wire processing

 

Our fine and superfine wire drawing process utilizes either our recycled copper rod or CCA and involves drawing the wire to the desired final diameter. Whether using recycled copper rod or CCA, the drawing process entails multiple steps, including heat treating, annealing, baking, cooling, quenching and spooling, as may be necessary to achieve the desired wire diameter and other customer specifications. The CCA drawing process, however, is more complex than the process for using recycled copper rod, and utilizes our proprietary trade secrets to ensure that the wire maintains the original bimetallic bond from the raw material. The fine or superfine wire is either sold to customers or is coated and further processed to become magnet wire.

 

The following illustration is a simplified outline of our process:

 

 

Products

 

We were one of the first vertically integrated companies in the PRC to develop, design, manufacture, market and distribute low cost, high quality refined copper products.  Our products consist of high purity copper products refined from scrap and bi-metallic copper products.

 

Copper Anode

 

An anode is an electrode through which electric current flows into a polarized electrical device.   Copper anode is the raw material for the production of copper cathode, which is the fundamental building block of pure copper products.  The copper anode we produce is in a very heavy, dull looking copper pallet form.

 

In July of 2010, we completed the construction of a scrap copper smelter dedicated to the production of copper anode.  We started manufacturing and selling copper anode in August of 2010, mainly to larger copper entities, which produce and sell copper cathode to copper products manufacturers.

 

9
 

 

Copper Rod and Copper Wire

 

In March 2009, we launched the manufacturing of copper rod for fire refining, melting and rod casting. We use scrap copper as the raw material for the refined pure copper rod. We use copper rod produced internally as raw material for pure copper wire.

 

Cable and magnet wire are copper rod based products that have the following end uses: 

Cable

 

·Used for:
·telephone drop wire and conductors;
·electric utilities; transmission lines, grid wire, fence and structured grounds;
·industrial drop wire, magnet wire, battery cables, automotive wiring harnesses; and
·electronics: radio frequency shielding.

 

Magnet wire

 

·Used in electronic motors, transformers, water pumps, automobile meters, energy, industrial, commercial, and residential industries.

 

The superfine pure copper wire we manufacturer is stretched from the copper rod we produce from the scrap copper refinery.  We produce and distribute pure copper superfine wire in the following forms:

 

·Fine wire.   Fine wire is sold to smaller wire manufacturers for further processing;

 

·Magnet wire.   Magnet wire can be fine or super fine and is the basic building block of a wide range of motorized appliances and is mainly used for its electrical conductivity; and

 

·Tin plated wire.   Tin plated wire is mainly used for the transmission of audio and visual signals.

 

We produce in accordance with customer orders and we customize our products based on customer specifications.

 

Copper Clad Aluminum (CCA) Superfine Wire

 

CCA is an electrical conductor consisting of an outer sleeve of copper that is metallurgically bonded to a solid aluminum core. This structure is set out in the following CCA illustration:

 

 

 

Note: The illustration is not drawn to scale.

 

Since approximately 2005, CCA in China has become a viable and popular alternative to pure copper wire. In comparison with solid copper wire, CCA raw material costs are generally 35% to 40% lower per ton. CCA and pure copper raw materials are purchased based on weight. Our CCA products are a cost effective substitute for pure copper wire in a wide variety of applications such as wire and cable, consumer electronic products, audio and visual equipment, white goods, automotive parts, utility applications, telecommunications, and specialty cables.

 

10
 

 

We produce CCA wire with the line diameter in the range of 0.03 mm to 0.18 mm. We produce and distribute wire in the following forms:

 

·Fine wire.   Fine wire is sold to smaller wire manufacturers for further processing;

 

·Magnet wire.   Magnet wire can be fine or super fine and is the basic building block of a wide range of motorized appliances and is mainly used for its electrical conductivity;

 

·Tin plated wire.   Tin plated wire is mainly used for the transmission of audio and visual signals.

 

We produce our wire products in accordance with customer orders and we customize our products based on customer specifications. Customer specifications vary depending on the end use of the CCA wire, but are primarily determined based upon two measurements, the thickness of the copper layer on the aluminum core and the diameter of the CCA wire.

 

Quality Control

 

We apply rigorous quality control standards and have implemented safety procedures at all phases of our production process. Since January 2007, our plant has maintained ISO9001:2000, a certification of quality management systems maintained by the International Organization of Standardization and administered by certification and accreditation bodies. In addition, our plant has obtained ISO14001 environment management standard certification.

 

Quality assurance efforts have been made on various lines of products in the following ways:

 

·Copper magnet wire.   We strictly follow the mandatory national product standard in China, and obtained National Industrial Production License for copper magnet wire in January 2009 and satisfied UL standards in October 2008.

 

·Scrap copper refinery.   According to a test report dated April 17, 2008 of China’s Machinery Industry Quality Supervision and Test Center For Electrical Material and Special Wire and Cable, a government inspection and testing agency, our copper rod satisfied the national standard for electrical copper wire, GB/T3952-1998.

 

  · CCA wire.   We strictly follow the industry recommended standards.

 

We believe the testing results we have obtained demonstrate our commitment to producing high-quality products and provide us with a competitive advantage over certain domestic competitors in the event China implements stricter quality standards in the future.

 

Raw Materials and Suppliers

 

For the superfine CCA wire product, we primarily use CCA wire with a line diameter of 2.60 mm, produced in house and to the extent needed, supplemented with CCA raw wire from our bimetallic wire suppliers, to manufacture superfine CCA wire. Our raw material procurement policy is to use only long-term suppliers who have demonstrated quality control, reliability and maintain multiple supply sources so that supply problems with any one supplier will not materially disrupt our operations. In order to avoid copper price volatility exposure, we do not maintain raw material inventory of CCA. We confirm raw material purchase orders with suppliers only when the relevant sales orders are received from our customers. On the other hand, because of the long-term relationship that we have maintained with our suppliers, our principal suppliers usually dedicate portions of their inventories as reserves to meet our manufacturing requirements. Suppliers are generally paid with a credit term of 30 days. We use pure copper rod produced internally as raw material for the pure copper wire product.

 

For our scrap copper refinery, we primarily use No. 1 and No. 2 scrap copper in our production of two types of recycled copper products: copper anode and copper rod, which is the raw material for our pure copper wire product. We purchase the materials through dealers and the scrap metal market. We have a scrap copper raw material warehouse in one of China’s largest scrap metal markets. Scrap copper is generally purchased with cash on delivery terms. In addition, we periodically purchase scrap copper from one or two venders which require partial prepayments. We believe that we will have access to an adequate supply of scrap copper on satisfactory commercial terms due to the numerous scrap dealers located throughout Guangdong Province in the PRC.

 

11
 

 

For each of the fiscal years ended December 31, 2011, 2012 and 2013, our five largest suppliers accounted for 73%, 49% and 50% of our total purchases, respectively, and our single largest supplier accounted for 38%, 24% and 16% of our total purchases, respectively.  We believe that we will have access to an adequate supply of raw material on satisfactory commercial terms for the foreseeable future.

 

Sales, Marketing and Distribution

 

Chinese domestic market sales account for a majority of our revenue. We target our sales efforts primarily in the coastal provinces of Guangdong, Fujian, Zhejiang, Anhui and Jiangsu, as well as the Shanghai region, where the majority of our customers are located. We have a sales staff of approximately 42 employees. We maintain ten sales offices in the PRC, including five in Guangdong, two in Zhejiang, one in Fujian, one in Shandong and one in Anhui. We participate in industry exhibitions in which we showcase our products and services and from which we obtain new customers.

 

We have a small fleet of trucks that deliver merchandise to customers located within three hours of our production facilities. In addition, we contract with independent third-party trucking companies to deliver our products when necessary.

 

Customers

 

We sell our products in China either directly to manufacturers or through distributors in the wire and cable industries and manufacturers in the consumer electronics, audio and visual equipment, white goods, automotive, utility, telecommunications and specialty cable industries. Our customer base in the wire category has been very diversified with 170 customers in total as of December 31, 2013.  Since we started offering copper anode in August 2010, we have experienced customer concentration. We have five anode customers as of December 31, 2013. Copper anode customers are typically large domestic copper cathode producers.

 

For the years ended December 31, 2013, 2012 and 2011 our five largest customers accounted for 52.4%, 50.8% and 49.0% of our total sales, respectively, and the single largest customer accounted for 25.5%, 31.7% and 25.3% of our total sales, respectively. We generally extend unsecured credit for 30 days to large or established CCA wire customers with good credit history. In terms of the refined copper products, we typically do not extend credit terms for more than 15 days. Historically, the Company has not experienced customer payment delays or delinquencies, however management reviews its accounts receivable on a regular basis to determine if adequate allowance for doubtful accounts should be created.

 

Research and Development

 

Our scrap copper recycling and superfine wire manufacturing technology were developed and refined via strategic partnerships with leading research institutes and in-house by our technology improvement and R&D team. Our in house professionals focus on quality assurance, equipment maintenance, process maintenance and improvement, and new product and process R&D.

 

We absorb most of the development technology related expenses in our production costs, and thus have only reported R&D costs at very low levels in the past years. For each of the fiscal years ended December 31, 2013, 2012 and 2011, we reported R&D costs of $1,305,379, $1,779,018 and $954,299. The reduction in 2013 R&D costs from the prior year is mainly the result of the completion in R&D for our new CCA cable and wire product we developed in partnership with Shanghai Electric Cable Research Institute.

 

We believe our commitment to, and knowledge and experience in, R&D are the key reasons why we are able to remain an early mover advantage in the copper alternative and replacement manufacturing industry in China. This expertise has enabled us to expedite the launch and expansion of our superfine copper wire production as well as scrap copper refinery production.

 

12
 

 

We plan to continue our R&D efforts, to maintain and strengthen our leading position in China, and to expand into new products and markets.

 

In 2011, Lihua Electron entered into several research and development agreements with Shanghai Electric Cable Research Institute for the research and development of new CCA products. In late 2013, we successfully completed this project and passed industry standard tests. We are currently in batch production mode and expect the gradual ramp up in production and sales of this new product in 2014. Lihua Copper has also cooperated with Beijing Modern Recycling Economy Research Institute in the development and planning of new copper recycling technology.

 

Financial Information About Segments

 

For financial information regarding our segments, please refer to Note 22 to our financial statements included in this Annual Report, which is incorporated herein by reference.

 

Intellectual Property

 

Our manufacturing processes are based on technology substantially developed via partnership with leading research institutes and in-house by our R&D and engineering personnel. We rely on a combination of patent, trademark, domain names and confidentiality agreements to protect our intellectual property. We require all members of our senior management and our key R&D personnel to sign agreements with us which stipulate, among other things, confidentiality obligations and restrictions on the assignment of intellectual property.

 

We were granted a utility model patent (patent no.: 1182192) by the State Intellectual Property Office of the PRC for our “Oxygen-free copper rod pressure cut off device,” patent issued on March 4, 2009. The term of this patent is 10 years from the effective date. We were also granted a patent (patent no.: 707494) by the State Intellectual Property Office of the PRC for our “CCA magnet wire paint and related production process,” patent issued on December 8, 2010. The term of this patent is 10 years from the effective date. We have no foreign patents. We are currently using the trademark “Mei Lihua” for all our products.  We have applied to register the trademark “Mei Lihua” in the PRC. We are not aware of any material infringement of our intellectual property rights. In 2013, we submitted 16 patent applications relating to the production process of our new CCA product.

 

Employees

 

As of December 31, 2013, we had 402 full time employees.

 

Insurance

 

We maintain various insurance policies to safeguard against risks and unexpected events. In protecting against work-related casualties and injuries, we purchase accidental injury insurance policies for our employees. In addition, we provide social security insurance including pension insurance, unemployment insurance, work related injury insurance and medical insurance for our employees. We also maintain insurance for our plants, machinery, equipment, inventories and motor vehicles. We do not have product liability insurance for our products. All of our products have met the relevant regulatory requirements under PRC laws and we have not been subject to any material fines or legal action involving product non-compliance.

 

Financial Information About Geographic Areas

 

We produce and sell all our products to PRC based customers.

 

13
 

 

Industry and Market Overview

 

Copper

 

Copper ranks third in world consumption of metals after iron and aluminum, and is broadly used in a variety of industries and applications. According to preliminary data from the International Copper Study Group (ICSG), global mines produced over 16.7 million tons of copper in 2012; copper smelter production reached approximately 16.7 million tons and refinery production rose to over 20.1 million tons in 2012. The global demand for copper continues to grow due to expanding industries such as electrical and electronic products, building construction, industrial machinery and equipment, transportation equipment, and consumer and general products.

 

 

A malleable and ductile metal, copper is an excellent conductor of heat and electricity that is corrosion resistant and antimicrobial while maintaining exceptional strength. Copper’s chemical, physical and aesthetic properties make it an attractive choice for a wide range of applications including electronics and communications, construction, transportation, and industrial equipment.

 

The chief commercial use of copper is based on its electrical conductivity, which is second only to that of silver among all metals. Electrical uses account for the majority of copper consumption, including power transmission and generation, building wiring, telecommunication, and electrical and electronic products. Copper is an essential component of energy efficient generators, motors, transformers and renewable energy production. Renewable energy sources such as solar, wind, geothermal, fuel cells and other technologies are all heavily reliant on copper due to its excellent conductivity. Copper is also heavily relied upon as a raw material in construction, transportation, industrial machinery and equipment and consumer products and white goods.

 

14
 

 

 

The following chart shows the global consumption of refined copper, for the years 1960, 1980 & 2012, by geographic region.

 

 

According to Platts, a leading global energy, petrochemicals and metals information provider, in 2012, the PRC consumed nearly 7.68 million tons of refined copper, accounting for nearly 40% of worldwide copper consumption. Even with its relatively low per capita consumption, China consumes significantly more copper than any other country. In 2012, China accounted for nearly 43% of the 20.5 million tons of refined copper used worldwide. Accordingly, China is, by a large margin, the world's largest importer of copper. However, the copper China imports is used for both its domestic needs and a rapidly expanding manufacturing industry. Thus, China has also become the world's second-largest exporter of semi-fabricated copper products, after Germany.

 

15
 

 

The PRC’s consumption of copper continues to outpace its production of copper, making it among the largest importers of the non-precious metal. In 2012, the PRC was the world’s leading importer of refined copper, copper ore and copper concentrates. The shortfall in production was satisfied through recycling of scrap copper as well as copper imports, which are more expensive due to freight costs. We believe that the PRC’s continued urbanization should continue to drive strong copper consumption within the PRC. In addition, under China’s 12th Five-Year Plan, the central government has expedited large infrastructure projects and invested significantly in continued infrastructure development. In September 2012, the government announced a policy of accelerating $156 billion in infrastructure spending. Three large users estimate that China’s refined copper consumption might rise 5 to 6 percent in 2014. This would take consumption to around 8.6 million tons, based on 8.1 million tons estimated for 2013 by State-backed research firm Beijing Antaike Information and Development Co.

 

The following chart shows the global consumption of copper in 2012, by geographic region.

 

16
 

 

2012 World Copper Consumption

 

Basis: Copper content, thousand metric tons

Source: International Copper Association

 

 

Source: ICSG, World Copper Factbook 2013

 

Refined Copper

 

The dynamics of constrained supply and growing demand in the PRC have contributed to the continued search for cost effective alternatives to pure copper. Manufacturers in the cable and wire industry have begun pursuing and adopting alternative technologies, including the use of scrap copper. According to ICSG, refined copper usage (usage by semi plants or the first users of copper) accounted for 19.5 million tons in 2013 (through November). China was also the largest consumer of refined copper in 2012 with apparent usage of over 8.8 million tons.

 

Copper is also one of the most recycled of all metals. Recycled copper (also known as secondary copper) represents scrap copper that has been fire-refined, or that has been converted to anode at the smelter level and then electrolytically refined. The recovery process for recycling and refining scrap copper is divided into four separate operations:

 

·Scrap pre-treatment: the pre-treatment process includes the cleaning and consolidation of scrap in preparation for smelting.

 

·Smelting: Smelting consists of heating and treating the scrap for separation and purification of specific metals.

 

·Alloying: Alloying involves the addition of other metals to copper to obtain desirable qualities characteristic of the combination of metals.

 

17
 

 

·Casting: In the casting process, the molten metal is poured into molds for being turned into different shapes.

 

We use recycled scrap copper as raw material to produce our refined copper products including copper anode and copper rod.  To produce pure copper superfine wire products, we primarily use copper rod. These products provide a cost effective alternative to newly mined copper products and lower raw material costs, while meeting the requirements of pure copper products based on the employment of our proprietary recycling technology.

 

 

Source: ICSG, World Copper Factbook 2013

 

A price spread between refined copper and scrap copper, reflecting the profit for the recycling process, fluctuates in relation to the movement of copper prices, as well as scrap consumption. To minimize our exposure to copper commodity risk, we maintain minimal raw material inventory and charge a fixed-dollar processing fee for most of our products. In doing so, we are able to pass through most of the underlying copper price exposure to our customers.

 

18
 

 

 

Source: ICSG, World Copper Factbook 2013

 

The PRC is a net importer of copper and has deficient copper reserves. In recent years, the PRC has significantly grown its refining capacity. To meet increased demand, the PRC has been importing raw materials including scrap copper to fill the gap.

 

In 2013, the PRC’s scrap copper imports was 4.37 million tons, a 10.1% decrease compared with 2012. The PRC government has established industrial policies to encourage the use of scrap copper. In 2007 the import duty on scrap copper in the PRC, historically 1.5%, was removed. China’s 11th Five-Year (2006 – 2010) Plan encouraged the greater use of scrap metals to help alleviate a shortfall in supplies and set the target consumption of secondary copper at 35% of total national copper consumption. China’s 12th Five Year Plan (2011-2015) places an emphasis on internal markets and domestic demand including industrial structures that emphasize added value, including a focus on energy, environmental and next generation telecom equipment industries, all of which bode well for higher copper demand and consumption.

 

19
 

 

 

 

Source: smc®, November 2013

 

Copper Clad Aluminum (“CCA”) Wire

 

CCA bimetallic materials are an ideal substitute for pure copper, a major raw material component of magnet wire, and a prime alternative to satisfy China’s demand. Bimetallic materials have been in existence for decades, but until recently they have only been selectively adopted due to higher production costs and historically low copper prices. However, as the price of copper increased in recent years, companies have started to use CCA bimetallic materials as an alternative.

 

CCA wire is composed of an inner aluminum core and outer copper cladding. CCA wire has a significant cost advantage over copper because its main constituent, aluminum is a cheaper metal. In addition to the cost advantages, the properties of CCA wire include:

 

·Lighter than pure copper wire;

 

·Higher conductivity and strength than pure aluminum wire; and

 

·Better solder ability than aluminum, due to the lack of an oxide layer, which prevents solder adhesion when soldering bare aluminum.

 

However, CCA wire has a high fabrication cost, as the cladding process is more complex than conventional wiredrawing. As a result, developed economies have not widely used CCA since the higher fabrication costs offsets the lower cost of raw material.

 

As a result of the changes in the market conditions in recent years, PRC-based companies perceived a potential market opportunity and added capacity for production of CCA wire. This has in turn resulted in improvements in the production process and made increased production volumes of CCA wire available from the PRC. As a result of the increased production capacity, the PRC has become leading global supplier in the CCA market.

 

20
 

 

Our Corporate History and Background

 

From the date of our incorporation until October 31, 2008, we were a “blank check” company with nominal assets. We were originally incorporated in the State of Delaware on January 24, 2006 under the name of Plastron Acquisition Corp. for the purpose of raising capital to be used to merge, acquire, or enter into a business combination with an operating business.

 

Ally Profit was incorporated in the British Virgin Islands on March 12, 2008 under the Business Companies Act of 2004. In June 2008, Ally Profit became the parent holding company of a group of companies comprised of Lihua Holdings, a company organized under the laws of Hong Kong and incorporated on April 17, 2008, which is the 100% shareholder of each of Lihua Electron and Lihua Copper, each a limited liability company organized under the existing laws of the PRC. Lihua Electron and Lihua Copper were incorporated on December 30, 1999 and August 31, 2007, respectively. We changed our name from Plastron Acquisition Corp. to Lihua International, Inc. on September 22, 2008.

 

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

 

As of December 31, 2013, details of our subsidiaries 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 products

 

 

Government Regulation

 

Overview

 

Manufacturing

 

Our manufacturing operations are subject to numerous laws, regulations, rules and specifications relating to human health and safety and the environment. These laws and regulations address and regulate, among other matters, waste water discharge, air quality and the generation, handling, storage, treatment, disposal and transportation of solid and hazardous wastes and releases of hazardous substances into the environment. We are in compliance with all material aspects of such laws, regulations, rules, specifications and have obtained all material permits, approvals and registrations relating to human health and safety and the environment. Third parties and governmental agencies in some cases have the power under such laws and regulations to require remediation of environmental conditions and, in the case of governmental agencies, to impose fines and penalties. We make capital expenditures from time to time to stay in compliance with applicable laws and regulations.

 

21
 

 

Environmental Matters

 

Given the nature of our business, we generate waste water, exhaust fumes and noise during our production process. We have implemented a comprehensive set of environmental protection measures to treat emissions generated during our production process to minimize the impact of our production process on the environment. These measures include the following:

 

·Waste water.   Waste water processed by our facilities meets the Chinese standard for discharge. To conserve water resources, we also recycle and reuse waste water generated during our production process, which decreases our consumption of water and reduces the discharge of waste water into the environment;

 

·Exhaust fumes.   We generate exhaust fumes during our production process. Exhaust fumes generated during our production process are filtered to reduce dust, sulfur dioxide, total suspended particulate, nitrogen oxide and organic elements. In each case, exhaust fumes are treated to comply with national air quality standards; and

 

·Noise.   We generate noise through the operation of our heating, ventilation and pumping systems. We typically reduce the noise generated by these activities to a range of 60 decibels to 80 decibels by employing various noise reduction measures that comply with applicable law.

 

Foreign Investment in PRC Operating Companies

 

The Foreign Investment Industrial Catalogue jointly issued by MOFCOM and the National Development and Reform Commission (“NDRC”) in 2007 classified various industries/business into three different categories: (i) encouraged for foreign investment; (ii) restricted to foreign investment; and (iii) prohibited from foreign investment. For any industry/business not covered by any of these three categories, they will be deemed industries/business permitted to have foreign investment. Except for those expressly provided restrictions, encouraged and permitted industries/business are usually 100% open to foreign investment and ownership. With regard to those industries/business restricted to or prohibited from foreign investment, there is always a limitation on foreign investment and ownership. The reason that our business is not subject to limitation on foreign investment and ownership is as follows:

 

(i)        our business falls under the class of “manufacturing of materials for processing beryllium copper straps, lines, pipes and rods”, which is open to 100% foreign investment and ownership;

 

(ii)       our business does not fall under the industry categories that are restricted to, or prohibited from foreign investment; and

 

(iii)      whether a business is subject to foreign investment restriction is subject to interpretation by MOFCOM and/or the NDRC, restructuring of each of our operating entities into a wholly foreign owned enterprise, each of which has been approved by the local MOFCOM, can also directly evidence no limitation on foreign investment and ownership to our business.

 

Share Exchange

 

Restructuring

 

In June 2008, Magnify Wealth, a British Virgin Islands holding company, which was 100% owned by Mr. Chu, developed a restructuring plan (the “Restructuring”). At that time, Magnify Wealth was the parent company and sole shareholder of Ally Profit, which was the parent company and sole shareholder of Lihua Holdings. The Restructuring was accomplished in two steps. The first step was the PRC Subsidiary Acquisition. After the PRC Subsidiary Acquisition, the second step was for Magnify Wealth to enter into and complete a share exchange transaction with a US public reporting company, whereby the US company would acquire Ally Profit, Lihua Holdings and the PRC Operating Companies.

 

22
 

 

PRC Subsidiary Acquisition

 

The PRC Subsidiary Acquisition was structured to comply with PRC M&A Laws. Under PRC M&A laws, the acquisition of PRC Operating Companies by foreign companies that are controlled by PRC citizens who are affiliated with the PRC Operating Companies, is strictly regulated and requires approval from MOFCOM. However, such restrictions do not apply to foreign entities controlled by foreign persons. These restrictions apply only at the time that PRC Operating Companies are acquired by a foreign entity. In our case, this was July 10, 2008 when the PRC Operating Companies were acquired by Lihua Holdings, which was ultimately beneficially owned by Mr. Chu, a Hong Kong citizen, as the sole shareholder of Magnify Wealth.

 

Lihua Holdings acquired 100% of the equity interests in the PRC Operating Companies from companies owned by our current CEO, Mr. Zhu, and the Minority Shareholders of the PRC Operating Companies. In addition to being the sole shareholder of Magnify Wealth, Mr. Chu was also a 45.5% owner of Lihua Electron, prior to the consummation of the PRC Subsidiary Acquisition. The aggregate consideration payable by Lihua Holdings to the shareholders of Lihua Electron was $2,200,000, and the aggregate consideration payable by Lihua Holdings to the shareholders of Lihua Copper was $4,371,351.

 

The Share Transfer Agreement enabled Mr. Zhu to receive consideration for selling his interest in the PRC Operating Companies to Lihua Holdings by allowing him to earn back an indirect interest in the PRC Operating Companies without violating PRC laws. At the time of the PRC Subsidiary Acquisition, Mr. Zhu did not have any equity interest in Lihua Holdings. As a PRC citizen, Mr. Zhu would not have been permitted to immediately receive shares in Lihua Holdings or in Magnify Wealth in exchange for his interests in the PRC Operating Companies. Subject to registering with SAFE prior to the exercise and issuance of the Option Shares under the Share Transfer Agreement, which is an administrative task, there is no prohibition under PRC laws for Mr. Zhu to earn an interest in Magnify Wealth after the PRC Subsidiary Acquisition was consummated, in compliance with PRC laws. Pursuant to the original terms of the Share Transfer Agreement, Mr. Chu granted to Mr. Zhu the option to purchase all of the 3,000 ordinary shares of Magnify Wealth then held by Mr. Chu at the nominal price of $1.00 per share, subject to the achievement of certain net income targets. Since our consolidated net income targets were reached, as of February 14, 2011 all of the Options Shares were vested and are fully exercisable.

 

Also on October 22, 2008, Mr. Chu and Europe EDC entered into subscription agreements to purchase shares in Magnify Wealth at a nominal price of $1.00 per share. Pursuant to these subscription agreements, Mr. Chu and Europe EDC will be issued the shares of Magnify Wealth for which they subscribed in tranches on February 14, 2009, 2010 and 2011 of 25%, 25% and 50%, respectively, which are the same dates the Option Shares are exercisable. The number of subscription shares issuable to Mr. Chu and Europe EDC in the aggregate, are 632 shares and 32 shares, respectively, and was determined based on the proportion of capital contributed by each of them in the PRC Operating Companies. As of February 14, 2010, Mr. Chu was issued 316 shares of Magnify Wealth and Europe EDC was issued 16 shares of Magnify Wealth, which equals 50% of the shares of Magnify Wealth which have been issued as per the subscription agreements. The subscription agreements enable Mr. Chu, a Hong Kong citizen, and Europe EDC, a Dutch company, to receive an interest in Magnify Wealth in consideration for the sale of their respective interests in the PRC Operating Companies to Lihua Holdings. Because Mr. Chu is a Hong Kong Citizen and Europe EDC is a Dutch company, there is no prohibition or restriction under PRC laws against non-PRC residents or citizens acquiring shares in Magnify Wealth in consideration for the sale of their respective interests in the PRC Operating Companies to Lihua Holdings.

 

ITEM 1A.RISK FACTORS

 

Investing in our securities involves a great deal of risk. Careful consideration should be made of the following factors as well as other information included in this annual report before deciding to purchase our common stock. You should pay particular attention to the fact that we conduct all of our operations in the PRC and are governed by a legal and regulatory environment that in some respects differs significantly from the environment that may prevail in other countries. Our business, financial condition or results of operations could be affected materially and adversely by any or all of these risks.

 

23
 

 

THE FOLLOWING MATTERS MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL CONDITION, LIQUIDITY, RESULTS OF OPERATIONS OR PROSPECTS, FINANCIAL OR OTHERWISE. REFERENCE TO THIS CAUTIONARY STATEMENT IN THE CONTEXT OF A FORWARD-LOOKING STATEMENT OR STATEMENTS SHALL BE DEEMED TO BE A STATEMENT THAT ANY ONE OR MORE OF THE FOLLOWING FACTORS MAY CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN SUCH FORWARD-LOOKING STATEMENT OR STATEMENTS.

 

Risks Related to Our Business

 

We have a limited operating history.

 

Our limited operating history and the early stage of development in the CCA industry and the scrap copper recycling industry in which we operate makes it difficult to evaluate our business and future prospects. Although our revenues have grown rapidly, we cannot assure you that we will maintain our profitability or that we will not incur net losses in the future. We expect that our operating expenses will increase as we expand. Any significant failure to realize anticipated revenue growth could result in operating losses.

 

We will continue to encounter risks and difficulties in implementing our business model.

 

We believe that our business model will allow us to become a leader in the CCA and the scrap copper recycling industries in which we operate. However, we cannot assure you that our business model will be effective. We are susceptible to risks, including the failure to create awareness of our products, protect our reputation and develop customer loyalty, the inability to manage our expanding operations, the failure to maintain adequate control of our expenses, and the inability to anticipate and adapt to changing conditions in the markets in which we operate as well as the impact of any changes in government regulation, mergers and acquisitions involving our competitors, technological developments, and other significant competitive and market dynamics. If we are not successful in addressing any or all of these risks, our business may be materially and adversely affected.

 

Our quarterly operating results may fluctuate.

 

Our quarterly results of operations may fluctuate as a result of a number of factors, including fluctuation in the demand for and shipments of our products and changes in the prices of copper which directly affect the price of our products and may influence the demand for our products. Therefore, quarter-to-quarter comparisons of results of operations have been and will be impacted by the volume of such orders and shipments. In addition, our operating results could be adversely affected by the following factors, among others, such as variations in the mix of product sales, price changes in response to competitive factors, increases in raw material costs and other significant costs, increases in utility costs (particularly electricity) and interruptions in plant operations resulting from the interruption of raw material supplies, narrowing of the price spread between our raw material price and average sales price of our products, and other factors. Our operating results are also impacted during the summer months and first few months of each year, when production at our factory declines due to the hot weather in Southern China, and Chinese New Year vacation, respectively.

 

Fluctuating copper prices and the price spread between pure copper and scrap copper impact our business and operating results.

 

Copper prices declined sharply from 2008 to early 2009 before seeing a rapid upturn until early 2011, and have experienced a downturn from 2011 to 2013. Such prices may continue to fluctuate significantly in the future because the copper industry is highly volatile and cyclical in nature. This affects our business both positively and negatively. For example, since our products are a substitute for pure copper wire, higher copper prices usually increase demand for our CCA products, while lower copper prices can decrease demand for CCA products. Numerous factors, most of which are beyond our control, influence copper prices. These factors include general economic conditions, industry capacity, utilization, import duties and other trade restrictions. We cannot predict copper prices in the future or the effect of fluctuations in the costs of copper on our future operating results. Consequently, fluctuations in copper prices and the narrowing of price spread between pure copper and scrap copper can significantly affect our business and operating results.

 

24
 

 

We may encounter substantial competition in our business and our failure to compete effectively may adversely affect our ability to generate revenue.

 

The CCA and scrap copper recycling industries are becoming increasingly competitive. Our competitors may have greater market recognition and substantially greater financial, technical, marketing, distribution, purchasing, manufacturing, personnel and other resources than we do. Furthermore, some of our competitors have manufacturing and sales forces that are geographically diversified, allowing them to reduce transportation expenses, tariff costs and currency fluctuations for certain customers in markets where their facilities are located. The principal elements of competition in the refined copper and bimetallic industry are, in our opinion, pricing, product availability and quality. In order to succeed in the bimetallic industry, we must be competitive in our pricing, product availability and quality. If we fail to do so, we will not be able to compete effectively and will lose market share. In such case we may be forced to reduce our margins to retain or acquire that business, which could decrease our revenues or slow our future revenue growth and lead to a decline in profitability. Further, to the extent that, whether as a result of the relative cost of copper, the relative strength of the Chinese currency, shipping costs or other factors, we are not able to price our products competitively, our ability to sell our products in both the Chinese domestic and the international markets will suffer.

 

We may not be able to effectively control and manage our growth.

 

If our business and markets grow and develop it may be necessary for us to finance and manage expansion in an orderly fashion. In addition, we may face challenges in managing expanding product offerings. Such circumstances will increase demands on our existing management and facilities. Failure to manage this growth and expansion could interrupt or harm our operations and cause production backlogs, longer product development time frames and administrative inefficiencies.

 

Shortages or disruptions in the availability of raw materials could harm our business.

 

We expect that raw materials of CCA and recycled copper will continue to account for a significant portion of our cost of goods sold in the future. The prices of raw materials fluctuate because of general economic conditions, global supply and demand and other factors causing monthly variations in the costs of our raw materials purchases. The macro-economic factors, together with labor and other business interruptions experienced by certain suppliers, have contributed to periodic shortages in the supply of raw materials, and such shortages may increase in the future. If we are unable to procure adequate supplies of raw material to meet our future production needs and customer demand, shortages could result in a material loss of customers and revenues and adversely impact our results of operations. In addition, supply shortages or disruptions or the loss of suppliers may cause us to procure our raw materials from less cost effective sources and may harm our business, revenues and results of operations.

 

We depend on a few suppliers for a significant portion of our principal raw materials and we do not have any long-term supply contracts in excess of one year. Interruptions of production at our key suppliers may harm our results of operations and financial performance.

 

We rely on a limited number of suppliers for most of the raw materials we use. Interruptions or shortages of supplies from our key suppliers of raw materials could disrupt production or impact our ability to increase production and sales. We do not have long-term or volume purchase agreements in excess of one year with most of our suppliers. Identifying and accessing alternative sources may increase our costs. Interruptions at our key suppliers could negatively impact our results of operations, financial performance and the price of our common stock.

 

25
 

 

Material prepayment for raw material purchases may increase risk of loss resulting from non-delivery of goods by our suppliers

 

We periodically make prepayments to a few scrap copper suppliers. Material prepayment we make for raw materials increases our exposure to loss resulting from potential non-delivery of goods by suppliers.

 

Any increases in raw materials prices will increase our need for working capital.

 

As the prices of raw materials increase, our working capital requirements increase. Increases in our working capital requirements can materially adversely impact our results of operations, our cash flow and our available liquidity to fund other business needs. Furthermore, there is no assurance we would be able to finance additional working capital requirements or finance such working capital requirements on favorable terms. If we were unable to obtain financing on favorable terms, our business and results of operations may be adversely affected. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations —Liquidity and Capital Resources”.

 

Any increases in raw materials prices may increase credit and default risk with respect to our customers.

 

Any increases in the price of our products, as raw material prices may rise, may place additional demands on the working capital and liquidity needs of our customers. Accordingly, our customers’ cash flow may be negatively impacted which may have an adverse effect on the timing and amount of payment on our accounts receivable, which would in turn, harm our results of operations.

 

If the scrap copper recycling or CCA industry does not grow or grows at a slower speed than we project, our sales and profitability may be negatively impacted.

 

We derive most of our profits from sales of our products in China. The continued development of our business depends, in large part, on continued growth in the copper consumption market in China. Although China’s copper consumption market has grown in the past, it may not continue to grow or grow at a lower rate in the future. Any reduced demand for our products, any downturn or other adverse changes in China’s copper consumption market or related industries could severely harm the profitability of our business.

 

Potential environmental liability could harm our operations and financial condition.

 

As a manufacturer, we are subject to various Chinese environmental laws and regulations on air emission, waste water discharge, solid wastes and noise. Although we believe that our operations are in compliance with current environmental laws and regulations, and our plant has ISO14001 environmental management system certification, we may not be able to comply with these regulations at all times as the Chinese environmental legal regime is evolving and becoming more stringent. Therefore, if the Chinese government imposes more stringent regulations in the future, we may have to incur additional and potentially substantial costs and expenses in order to comply with new regulations, which may negatively affect our results of operations. Further, no assurance can be given that all potential environmental liabilities have been identified or properly quantified or that any prior owner, operator, or tenant has not created an environmental condition unknown to us. If we fail to comply with any of the present or future environmental regulations in any material aspects, we may suffer from negative publicity and be subject to claims for damages that may require us to pay substantial fines or have our operations suspended or even be forced to cease operations.

 

We may be unable to retain key employees who are essential to growing our business.

 

Mr. Jianhua Zhu, Ms. Yaying Wang and Ms. Daphne Huang, along with Ms. Junying Zhu, and Mr. Yingchun Han, are essential to our ability to continue to grow our business. Each of these key employees has established relationships within the industries in which we operate. Each of these employees has agreed to non-solicitation and non-compete restrictions during the course of their employment with us, however, these restrictions only extend for a one year period from termination. Further, we do not maintain, or intend to maintain, key person life insurance for any of our officers or key employees. If any of them were to leave us, our growth strategy might be hindered, which could limit our ability to increase revenue. In addition, we face competition for attracting skilled personnel. If we fail to attract and retain qualified personnel to meet current and future needs, this could slow our ability to grow our business, which could result in a decrease in market share.

 

26
 

 

We have derived a material portion of our revenues from a small group of customers. If we were to become dependent again upon a few customers, such dependency could negatively impact our business, operating results and financial condition.

 

As a result of our copper anode product offering in 2010, our customer base has become more concentrated since we currently produce and sell to a few large copper anode customers. For the year ended December 31, 2013 and each of the fiscal year ended December 31, 2012, 2011, 2010 and 2009, our five largest customers accounted for 52.4%, 50.8%, 49.0%, 36.5% and 6.9% of our total sales, respectively, and the single largest customer accounted for 25.5%, 31.7%, 25.3%, 12.7%, and 1.6% of our total sales, respectively. As our customer base may change from year-to-year, during such years that the customer base is highly concentrated, the loss of, or reduction of our sales to, any of such major customers could harm our business, operating results and financial condition.

 

We may need additional financing, which may not be available on satisfactory terms or at all.

 

Our capital requirements may be accelerated as a result of many factors, including timing of development activities, underestimates of budget items, unanticipated expenses or capital expenditures, future product opportunities with collaborators, future licensing opportunities and future business combinations. Consequently, we may need to seek additional debt or equity financing, which may not be available on favorable terms, if at all, and which may be dilutive to our stockholders.

 

We may seek to raise additional capital through public or private equity offerings, debt financings or additional corporate collaboration and licensing arrangements. To the extent we raise additional capital by issuing equity securities, our stockholders may experience dilution. To the extent that we raise additional capital by issuing debt securities, we may incur substantial interest obligations, may be required to pledge assets as security for the debt and may be constrained by restrictive financial and/or operational covenants. Debt financing would also be superior to our stockholders’ interest in bankruptcy or liquidation. To the extent we raise additional funds through collaboration and licensing arrangements, it may be necessary to relinquish some rights to our technologies or product candidates, or grant licenses on unfavorable terms.

 

If we fail to adequately protect or enforce our intellectual property rights, or to secure rights to patents of others, the value of our intellectual property rights could diminish.

 

Our success, competitive position and future revenues will depend in part on our ability to obtain and maintain patent protection for our products, methods, processes and other technologies, to preserve our trade secrets, to prevent third parties from infringing on our proprietary rights and to operate without infringing the proprietary rights of third parties.

 

To date, we have two approved patents filed with the State Intellectual Property Office of the PRC. However, we cannot predict the degree and range of protection patents will afford us against competitors. Third parties may find ways to invalidate or otherwise circumvent our proprietary technology. Third parties may attempt to obtain patents claiming aspects similar to our patent applications. If we need to initiate litigation or administrative proceedings, such actions may be costly whether we win or lose.

 

Our success also depends on the skills, knowledge and experience of our scientific and technical personnel, consultants, advisors, licensors and contractors. To help protect our proprietary know-how and inventions for which patents may be unobtainable or difficult to obtain, we rely on trade secret protection and confidentiality agreements. If any of our intellectual property is disclosed, our value would be significantly impaired, and our business and competitive position would suffer.

 

27
 

 

If we infringe the rights of third parties, we could be prevented from selling products, forced to pay damages and compelled to defend against litigation.

 

If our products, methods, processes and other technologies infringe proprietary rights of other parties, we could incur substantial costs, and may have to obtain licenses (which may not be available on commercially reasonable terms, if at all), redesign our products or processes, stop using the subject matter claimed in the asserted patents, pay damages, or defend litigation or administrative proceedings, which may be costly whether we win or lose. All of the above could result in a substantial diversion of valuable management resources.

 

We believe we have taken reasonable steps, including comprehensive internal and external prior patent searches, to ensure we have freedom to operate and that our development and commercialization efforts can be carried out as planned without infringing others’ proprietary rights. However, we cannot guarantee that no third party patent has been filed or will be filed that may contain subject matter of relevance to our development, causing a third party patent holder to claim infringement. Resolving such issues has traditionally resulted, and could in our case result, in lengthy and costly legal proceedings, the outcome of which cannot be predicted accurately.

 

One shareholder owns a large percentage of our outstanding stock and could significantly influence the outcome of our corporate matters.

 

Currently, Magnify Wealth beneficially owns approximately 44% of our outstanding common stock. Mr. Zhu, our Chairman and CEO, is the sole director of Magnify Wealth. As the sole director of Magnify Wealth, Mr. Zhu has the sole power to vote the shares of our common stock owned by Magnify Wealth, and as a result, is able to exercise significant influence over all matters that require us to obtain shareholder approval, including the election of directors to our board and approval of significant corporate transactions that we may consider, such as a merger or other sale of our company or its assets. Additionally, pursuant to the Share Transfer Agreement, Mr. Zhu has a fully vested option to purchase up to 3,000 shares of Magnify Wealth from Mr. Chu (the “Option Shares”). At such time as Mr. Zhu exercises and acquires all of the Option Shares, he will own shares representing 81.9% of Magnify Wealth’s issued and outstanding shares. Once the Option Shares are exercised, Mr. Zhu will then also have a controlling equity interest in Magnify Wealth. This concentration of ownership in our shares by Magnify Wealth will limit the other shareholders’ ability to influence corporate matters and may have the effect of delaying or preventing a third party from acquiring control over us.

 

If we are unable to maintain appropriate internal financial reporting controls and procedures, it could cause us to fail to meet our reporting obligations, result in the restatement of our financial statements, harm our operating results, subject us to regulatory scrutiny and sanction, and cause investors to lose confidence in our reported financial information.

 

Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud.  As a public company, we have significant additional requirements for enhanced financial reporting and internal controls. We are required to document and test our internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, which requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent registered public accounting firm addressing these assessments. The process of designing and implementing effective internal controls is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to expend significant resources to maintain a system of internal controls that is adequate to satisfy our reporting obligations as a public company.

 

We cannot assure you that we will not, in the future, identify areas requiring improvement in our internal control over financial reporting. We cannot assure you that the measures we will take to remediate any areas in need of improvement will be successful or that we will implement and maintain adequate controls over our financial processes and reporting in the future as we continue our growth. If we are unable to establish appropriate internal financial reporting controls and procedures, it could cause us to fail to comply with Sarbanes-Oxley and meet our reporting obligations, result in the restatement of our financial statements, harm our operating results, subject us to regulatory scrutiny and sanction, and cause investors to lose confidence in our reported financial information.

 

28
 

 

Due to lower profit margins associated with the sale of refined copper products, we expect our overall gross profit margin to decline as we continue the capacity expansion in the scrap copper refinery segment. However, the ramp up in production and sales of our new CCA product may result in an increase in our average gross profit margin since we expect this product to have a higher profit margin than our refined copper products.

 

Our gross margin is affected by our product mix. As a result of significant costs associated with production in our scrap recycling business, copper anode and rod contribute a lower gross profit margin compared to our finished wire products. As we continue to expand the capacity of our scrap copper refineries, we expect that as the sales of the refined copper products increase over time, there will be a decline in our gross margin, unless we are able to add additional processing capacity of higher margin products such as CCA and increase its sales percentage in the product mix.

 

Risks Associated With Doing Business In China

 

Our operations and assets in China are subject to significant political and economic uncertainties.

 

Changes in PRC laws and regulations, or their interpretation, or the imposition of confiscatory taxation, restrictions on currency conversion, imports and sources of supply, devaluations of currency or the nationalization or other expropriation of private enterprises could have a material adverse effect on our business, results of operations and financial condition. Under our current leadership, the Chinese government has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the Chinese government will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice.

 

We derive a substantial portion of our sales from China and a slowdown or other adverse developments in the PRC economy may materially and adversely affect our customers, demand for our services and our business.

 

Substantially all of our sales are generated from China. We anticipate that sales of our products in China will continue to represent a substantial proportion of our total sales in the near future. Although the PRC economy has grown in recent years, we cannot assure you that such growth will continue. The industry which we are involved in the PRC is relatively new and growing, but we do not know how sensitive we are to a slowdown in economic growth or other adverse changes in the PRC economy which may affect demand for our products. A slowdown in overall economic growth, an economic downturn or recession or other adverse economic developments in the PRC may materially reduce the demand for our products and materially and adversely affect our business.

 

Currency fluctuations and restrictions on currency exchange may adversely affect our business, including limiting our ability to convert Chinese Renminbi into foreign currencies and, if Chinese Renminbi were to decline in value, reducing our revenue in U.S. dollar terms.

 

Our reporting currency is the U.S. dollar and our operations in China use their local currency as their functional currencies. Substantially all of our revenue and expenses are in Chinese Renminbi. We are subject to the effects of exchange rate fluctuations with respect to any of these currencies. For example, the value of the Renminbi depends to a large extent on Chinese government policies and China’s domestic and international economic and political developments, as well as supply and demand in the local market. Since 1994, the official exchange rate for the conversion of Renminbi to the U.S. dollar had generally been stable and the Renminbi had appreciated slightly against the U.S. dollar. However, on July 21, 2005, the Chinese government changed its policy of pegging the value of Chinese Renminbi to the U.S. dollar. Under the new policy, Chinese Renminbi may fluctuate within a narrow and managed band against a basket of certain foreign currencies. It is possible that the Chinese government could adopt a more flexible currency policy, which could result in more significant fluctuation of Chinese Renminbi against the U.S. dollar. We can offer no assurance that Chinese Renminbi will be stable against the U.S. dollar or any other foreign currency.

 

29
 

 

The income statements of our operations are translated into U.S. dollars at the average exchange rates in each applicable period. To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currencies denominated transactions results in reduced revenue, operating expenses and net income for our international operations. Similarly, to the extent the U.S. dollar weakens against foreign currencies, the translation of these foreign currency denominated transactions results in increased revenue, operating expenses and net income for our international operations. We are also exposed to foreign exchange rate fluctuations as we convert the financial statements of our foreign subsidiaries into U.S. dollars in consolidation. If there is a change in foreign currency exchange rates, the conversion of the foreign subsidiaries’ financial statements into U.S. dollars will lead to a translation gain or loss which is recorded as a component of other comprehensive income. In addition, we have certain assets and liabilities that are denominated in currencies other than the relevant entity’s functional currency. Changes in the functional currency value of these assets and liabilities create fluctuations that will lead to a transaction gain or loss. We have not entered into agreements or purchased instruments to hedge our exchange rate risks, although we may do so in the future. The availability and effectiveness of any hedging transaction may be limited and we may not be able to successfully hedge our exchange rate risks.

 

The application of PRC regulations relating to the overseas listing of PRC domestic companies is uncertain, and we may be subject to penalties for failing to request approval of the PRC authorities prior to listing our shares in the U.S.

 

On August 8, 2006, six PRC government agencies, namely, MOFCOM, SAIC, CSRC, SAFE, the State Assets Supervision and Administration Commission, and the State Administration for Taxation, jointly issued the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (the “New M&A Rules”), which became effective on September 8, 2006. The New M&A Rules purport, among other things, to require offshore “special purpose vehicles”, that are (1) formed for the purpose of overseas listing of the equity interests of PRC companies via acquisition and (2) are controlled directly or indirectly by PRC companies and/or PRC individuals, to obtain the approval of the CSRC prior to the listing and trading of their securities on overseas stock exchanges. On September 21, 2006, pursuant to the New M&A Rules and other PRC Laws, the CSRC published on its official website relevant guidance with respect to the listing and trading of PRC domestic enterprises’ securities on overseas stock exchanges (the “Related Clarifications”), including a list of application materials regarding the listing on overseas stock exchange by special purpose vehicles. Based on our understanding of current PRC Laws and as advised by our PRC counsel, because (i) the CSRC currently has not issued any definitive rule or official interpretation concerning whether our offering is subject to the New M&A Rules and Related Clarifications; (ii) we were and are not a special purpose vehicle formed or controlled by PRC individuals; and (iii) conversion of Lihua Electron and Lihua Copper from a joint venture to a wholly foreign owned enterprise was and is not subject to the New M&A Rules in accordance with Rule 55 of the New M&A Rules and Guidance Manual on Administration of Entry of Foreign Investment issued by the Department of Foreign Investment Administration of the MOFCOM in December 2008, we were and are not required to obtain the approval of CSRC under the New M&A Rules in connection with this offering.

 

However, there are substantial uncertainties regarding the interpretation, application and enforcement of these rules, and CSRC has yet to promulgate any written provisions or formally to declare or state whether the overseas listing of a PRC-related company structured similar to ours is subject to the approval of CSRC. Any violation of these rules could result in fines and other penalties on our operations in China, restrictions or limitations on remitting dividends outside of China, and other forms of sanctions that may cause a material and adverse effect to our business, operations and financial conditions.

 

The new mergers and acquisitions regulations also established additional procedures and requirements that are expected to make merger and acquisition activities by foreign investors more time-consuming and complex, including requirements in some instances that the Ministry of Commerce be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise that owns well-known trademarks or China’s traditional brands. In addition, PRC national security review rules which became effective on September 1, 2011 require acquisitions by foreign investors of PRC companies engaged in military related or certain other industries that are crucial to national security be subject to security review before consummation of any such acquisition. We may grow our business in part by acquiring other businesses. Complying with the requirements of the new mergers and acquisitions regulations in completing this type of transactions could be time-consuming, and any required approval processes, including CSRC approval, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.

 

30
 

 

We have granted stock options to three of our past and current PRC employees and our CEO, Mr. Zhu, who has options to purchase shares in our majority shareholder, Magnify Wealth, which may require registration with SAFE. We may also face regulatory uncertainties that could restrict our ability to issue equity compensation to our directors and employees and other parties who are PRC citizens or residents under PRC law.

 

In December 2006, the People’s Bank of China promulgated the Administrative Measures of Foreign Exchange Matters for Individuals, which set forth the respective requirements for foreign exchange transactions by individuals (both PRC or non-PRC citizens) under either the current account or the capital account. In January 2007, SAFE issued implementing rules for the Administrative Measures of Foreign Exchange Matters for Individuals, which, among other things, specified approval requirements for certain capital account transactions such as a PRC citizen’s participation in the employee stock ownership plans or stock option plans of an overseas publicly-listed company. In February 2012, SAFE promulgated the Notices on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plans of Overseas Publicly-Listed Companies, or the Stock Option Rules, which replaced the Application Procedures of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Ownership Plans or Stock Option Plans of Overseas Publicly-Listed Companies issued by SAFE in March 2007. Under these rules, PRC residents who participate in the stock incentive plan of an overseas publicly-listed company are required to register with SAFE or its local branches and complete certain other procedures. Participants of a stock incentive plan who are PRC residents must retain a qualified PRC agent, which could be a PRC subsidiary of such overseas publicly-listed company or another qualified institution selected by such PRC subsidiary, to conduct the SAFE registration and other procedures with respect to the stock incentive plan on behalf of its participants. Such participants must also retain an overseas entrusted institution to handle matters in connection with their exercise of stock options, the purchase and sale of corresponding stocks or interests and fund transfers. In addition, the PRC agent is required to amend the SAFE registration with respect to the stock incentive plan if there is any material change to the stock incentive plan, the PRC agent or the overseas entrusted institution or other material changes. We have adopted an equity compensation plan and have begun to make option grants to some of our key employees, three of whom are PRC citizens. If we or our PRC recipients of such options fail to comply with these regulations, we or our PRC option grantees may be subject to fines and other legal or administrative sanctions. In that case, our ability to compensate our employees and directors through equity compensation would be hindered and our business operations may be adversely affected.

 

PRC SAFE Regulations regarding offshore financing activities by PRC residents have undertaken continuous changes which may increase the administrative burden we face and create regulatory uncertainties that could adversely affect our business.

 

Recent regulations promulgated by SAFE regarding offshore financing activities by PRC residents have undergone a number of changes which may increase the administrative burden we face.  The failure by our stockholders and affiliates who are PRC residents, including Mr. Zhu, who has sole voting power with respect to shares held by our majority shareholder, Magnify Wealth, to make any required applications and filings pursuant to such regulations may prevent us from being able to distribute profits and could expose us and our PRC resident stockholders to liability under PRC law.

 

In 2005, SAFE promulgated regulations in the form of public notices, which require registrations with, and approval from, SAFE on direct or indirect offshore investment activities by PRC resident individuals.  The SAFE regulations require that if an offshore company directly or indirectly formed by or controlled by PRC resident individuals, known as “SPC,” intends to acquire a PRC company, such acquisition will be subject to strict examination by the SAFE. Without registration, the PRC entity cannot remit any of its profits out of the PRC as dividends or otherwise.  This could have a material adverse effect on us given that we are a publicly listed company in the U.S.

 

31
 

 

Because our principal assets are located outside of the United States and with the exception of one director and one officer, the rest of our directors and officers reside outside of the United States, it may be difficult for you to enforce your rights based on the United States Federal securities laws against us and our officers and directors in the United States or to enforce judgments of United States courts against us or them in the PRC.

 

With the exception of one director and one officer, the rest of our officers and directors reside outside of the United States. In addition, our operating subsidiaries are located in the PRC and all of their assets are located outside of the United States. China does not have a treaty with United States providing for the reciprocal recognition and enforcement of judgments of courts. It may therefore be difficult for investors in the United States to enforce their legal rights based on the civil liability provisions of the United States Federal securities laws against us in the courts of either the United States or the PRC and, even if civil judgments are obtained in courts of the United States, to enforce such judgments in PRC courts. Further, it is unclear if extradition treaties now in effect between the United States and the PRC would permit effective enforcement against us or our officers and directors of criminal penalties, under the United States Federal securities laws or otherwise.

 

We may have limited legal recourse under PRC law if disputes arise under our contracts with third parties.

 

The Chinese government has enacted some laws and regulations dealing with matters such as corporate organization and governance, foreign investment, commerce, taxation and trade. However, their experience in implementing, interpreting and enforcing these laws and regulations is limited, and our ability to enforce commercial claims or to resolve commercial disputes is unpredictable. If our new business ventures are unsuccessful, or other adverse circumstances arise from these transactions, we face the risk that the parties to these ventures may seek ways to terminate the transactions, or, may hinder or prevent us from accessing important information regarding the financial and business operations of these acquired companies. The resolution of these matters may be subject to the exercise of considerable discretion by agencies of the Chinese government, and forces unrelated to the legal merits of a particular matter or dispute may influence their determination. Any rights we may have to specific performance, or to seek an injunction under PRC law, in either of these cases, are severely limited, and without a means of recourse by virtue of the Chinese legal system, we may be unable to prevent these situations from occurring. The occurrence of any such events could have a material adverse effect on our business, financial condition and results of operations. Although legislation in China over the past 30 years has significantly improved the protection afforded to various forms of foreign investment and contractual arrangements in China, these laws, regulations and legal requirements are relatively new and their interpretation and enforcement involve uncertainties, which could limit the legal protection available to us, and foreign investors, including you. The inability to enforce or obtain a remedy under any of our future agreements could result in a significant loss of business, business opportunities or capital and could have a material adverse impact on our operations.

 

We must comply with the Foreign Corrupt Practices Act.

 

We are required to comply with the United States Foreign Corrupt Practices Act, which prohibits U.S. companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business and requires that we maintain adequate financial records and internal controls to prevent such prohibited payments. Foreign companies, including some of our competitors, are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in mainland China. If our competitors engage in these practices, they may receive preferential treatment from personnel of some companies, giving our competitors an advantage in securing business or from government officials who might give them priority in obtaining new licenses, which would put us at a disadvantage. Although we inform our personnel that such practices are illegal, we cannot assure you that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties.

 

Due to various restrictions under PRC laws on the distribution of dividends by our PRC operating companies, we may not be able to pay dividends to our stockholders.

 

The Wholly-Foreign Owned Enterprise Law (1986), as amended and The Wholly-Foreign Owned Enterprise Law Implementing Rules (1990), as amended and the Company Law of the PRC (2006) contain the principal regulations governing dividend distributions by wholly foreign owned enterprises. Under these regulations, wholly foreign owned enterprises, such as Lihua Electron and Lihua Copper, may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. Additionally, Lihua Electron and Lihua Copper are required to set aside a certain amount of their accumulated profits each year, if any, to fund certain reserve funds. These reserves are not distributable as cash dividends except in the event of liquidation and cannot be used for working capital purposes. The PRC government also imposes controls on the conversion of RMB into foreign currencies and the remittance of currencies out of the PRC.  We may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency for the payment of dividends from the profits of Lihua Electron and Lihua Copper.

 

32
 

 

Furthermore, if our subsidiaries in China incur debt on their own in the future, the instruments governing the debt may restrict its ability to pay dividends or make other payments. If we or our subsidiaries are unable to receive all of the revenues from our operations due to the above mentioned government controls, we may be unable to pay dividends on our common stock.

 

We have no current plans to pay any dividends and we plan to retain earnings, if any, for use in the development of the business. Payment of future dividends, if any, will be at the discretion of the Board of Directors after taking into account of various factors, including dividend issuance criteria of the state of the Delaware, where our parent holding company is registered in, current financial condition, operating results, current and anticipated cash needs and regulations governing dividend distributions by wholly foreign owned enterprises in the PRC.

 

Changes in foreign exchange regulations in the PRC may affect our ability to pay dividends in foreign currency or conduct other foreign exchange business.

 

We receive substantially all of our revenues in Renminbi, the Chinese currency, which is currently not a freely convertible currency.  The restrictions on currency exchanges may limit our ability to use revenues generated in RMB to make dividends or other payments in United States dollars.  The PRC government strictly regulates conversion of RMB into foreign currencies.  Over the years, foreign exchange regulations in the PRC have significantly reduced the government’s control over routine foreign exchange transactions under current accounts.  In the PRC, SAFE regulates the conversion of the RMB into foreign currencies.  Pursuant to applicable PRC laws and regulations, foreign invested enterprises incorporated in the PRC are required to apply for “Foreign Exchange Registration Certificates.”  Currently, conversion within the scope of the “current account” (e.g. remittance of foreign currencies for payment of dividends, etc.) can be effected without requiring the approval of SAFE. However, conversion of currency in the “capital account” (e.g. for capital items such as direct investments, loans, securities, etc.) still requires the approval of SAFE. In addition, failure to obtain approval from SAFE for currency conversion on the capital account may adversely impact our capital expenditure plans and our ability to expand in accordance with our desired objectives.

 

The PRC government also may at its discretion restrict access in the future to foreign currencies for current account transactions.  If the foreign exchange control system prevents us from obtaining foreign currency, we may be unable to pay dividends or meet obligations that may be incurred in the future that require payment in foreign currency.

 

The Chinese government exerts substantial influence over the manner in which we must conduct our business activities.

 

We are dependent on our relationship with the local government in the province in which we operate our business.  The Chinese government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership.  Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, environmental regulations, land use rights, property and other matters.  We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of these jurisdictions may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.  Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof, and could require us to divest ourselves of any interest we then hold in Chinese properties.

 

33
 

 

Future inflation in China may inhibit our ability to conduct business in China. In recent years, the Chinese economy has experienced periods of rapid expansion and high rates of inflation.  Rapid economic growth can lead to growth in the money supply and rising inflation.  If prices for our products rise at a rate that is insufficient to compensate for the rise in the costs of supplies, it may have an adverse effect on profitability.  These factors have led to the adoption by Chinese government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation.  High inflation may in the future cause Chinese government to impose controls on credit and/or prices, or to take other action, which could inhibit economic activity in China, and thereby harm the market for our products.

 

We may have difficulty establishing adequate management, legal and financial controls in the PRC.

 

The PRC historically has been deficient in Western style management and financial reporting concepts and practices, as well as in modern banking, and other control systems.  We may have difficulty in hiring and retaining a sufficient number of qualified employees to work in the PRC.  As a result of these factors, we may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet Western standards.  We may have difficulty establishing adequate management, legal and financial controls in the PRC.  Therefore, we may, in turn, experience difficulties in implementing and maintaining adequate internal controls as required under Section 404 of the Sarbanes-Oxley Act of 2002 and other applicable laws, rules and regulations.  This may result in significant deficiencies or material weaknesses in our internal controls which could impact the reliability of our financial statements and prevent us from complying with SEC rules and regulations and the requirements of the Sarbanes-Oxley Act of 2002.  Any such deficiencies, weaknesses or lack of compliance could have a materially adverse effect on our business and the public announcement of such deficiencies could adversely impact our stock price.

 

It may be difficult to protect and enforce our intellectual property rights under PRC law.

 

Intellectual property rights in China are still developing, and there are uncertainties involved in the protection and the enforcement of such rights. We will need to pay special attention to protecting our intellectual property and trade secrets.  Failure to do so could lead to the loss of a competitive advantage that could not be compensated by a damages award.

 

Under PRC law, we are required to obtain permits and business licenses, and our failure to do so would adversely impact our ability to conduct business in China.

 

We hold various permits, business licenses, and approvals authorizing our operations and activities, which are subject to periodic review and reassessment by the Chinese authorities.  Standards of compliance necessary to pass such reviews change from time to time and differ from jurisdiction to jurisdiction, leading to a degree of uncertainty.  If renewals, or new permits, business licenses or approvals required in connection with existing or new facilities or activities, are not granted or are delayed, or if existing permits, business licenses or approvals are revoked or substantially modified, we will suffer a material adverse effect. If new standards are applied to renewals or new applications, it could prove costly to us to meet any new level of compliance.

 

If our land use rights are revoked, we would have no operational capabilities.

 

Under Chinese law land is owned by the state or rural collective economic organizations. The state issues to tenants the rights to use property. Use rights can be revoked and the tenants forced to vacate at any time when redevelopment of the land is in the public interest. The public interest rationale is interpreted quite broadly and the process of land appropriation may be less than transparent. Each of our two operating subsidiaries rely on these land use rights as the cornerstone of their operations, and the loss of such rights would have a material adverse effect on our company.

 

34
 

 

Because we may not be able to obtain business insurance in the PRC, we may not be protected from risks that are customarily covered by insurance in the United States.

 

Business insurance is not readily available in the PRC. To the extent that we suffer a loss of a type which would normally be covered by insurance in the United States, such as product liability and general liability insurance, we would incur significant expenses in both defending any action and in paying any claims that result from a settlement or judgment.

 

We are subject to the environmental protection law of China.

 

Our manufacturing process may produce by-products such as effluent, gases and noise, which are harmful to the environment.  We are subject to multiple laws governing environmental protection, such as “The Law on Environmental Protection in the PRC (1989)”, as amended, and “The Law on Prevention of Effluent Pollution  in the PRC (1984),” as amended, as well as standards set by the relevant governmental authorities determining the classification of different wastes and proper disposal.  We have properly attained a waste disposal permit for our manufacturing facility, which details the types and concentration of effluents and gases allowed for disposal.

 

China is experiencing substantial problems with environmental pollution.  Accordingly, it is likely that the national, provincial and local governmental agencies will adopt stricter pollution controls.  There can be no assurance that future changes in environmental laws and regulations will not impose costly compliance requirements on us or otherwise subject us to future liabilities.  Our profitability may be adversely affected if additional or modified environmental control regulations are imposed upon us.

 

Any recurrence of severe acute respiratory syndrome, or SARS, or another widespread public health problem, could adversely affect our operations.

 

A renewed outbreak of SARS or another widespread public health problem in the PRC, where all of our revenue is derived, could have an adverse effect on our operations. Our operations may be impacted by a number of health-related factors, including quarantines or closures of some of our offices that could leave us without many employees to conduct our business, which would materially and adversely affect our operations and financial condition.

 

The audit report included in this annual report are prepared by auditors who are not inspected by the Public Company Accounting Oversight Board and, as such, you are deprived of the benefits of such inspection.

 

Our independent registered public accounting firm that issues the audit reports included in our annual reports filed with the U.S. Securities and Exchange Commission, as auditors of companies that are traded publicly in the United States and a firm registered with the U.S. Public Company Accounting Oversight Board (United States) (“the “PCAOB”), is required by the laws of the United States to undergo regular inspections by the PCAOB to assess its compliance with the laws of the United States and professional standards.

 

Because we have substantial operations within the Peoples' Republic of China and the PCAOB is currently unable to conduct inspections of the work of our auditors as it relates to those operations without the approval of the Chinese authorities, our auditors are not currently inspected fully by the PCAOB. In May 2013, PCAOB announced that it had entered into a Memorandum of Understanding on Enforcement Cooperation with the CSRC and the PRC Ministry of Finance, which establishes a cooperative framework between the parties for the production and exchange of audit documents relevant to investigations undertaken by PCAOB, the CSRC or the PRC Ministry of Finance in the United States and the PRC, respectively. PCAOB continues to be in discussions with the CSRC and the PRC Ministry of Finance to permit joint inspections in the PRC of audit firms that are registered with PCAOB and audit Chinese companies that trade on U.S. exchanges.

 

Inspections of other firms that the PCAOB has conducted outside China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality.  This lack of PCAOB inspections in China prevents the PCAOB from regularly evaluating our auditor's audits and its quality control procedures.   As a result, investors may be deprived of the benefits of PCAOB inspections.

 

The inability of the PCAOB to conduct full inspections of auditors in China makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our financial statements.

 

Risks Related to the Common Stock

 

Techniques employed by manipulative short sellers in Chinese small cap stocks may drive down the market price of our common stock

 

Short selling is the practice of selling securities that the seller does not own but rather has, supposedly, borrowed from a third party with the intention of buying identical securities back at a later date to return to the lender. The short seller hopes to profit from a decline in the value of the securities between the sale of the borrowed securities and the purchase of the replacement shares, as the short seller expects to pay less in that purchase than it received in the sale.   As it is therefore in the short seller’s best interests for the price of the stock to decline, many short sellers (sometime known as “disclosed shorts”) publish, or arrange for the publication of, negative opinions regarding the relevant issuer and its business prospects in order to create negative market momentum and generate profits for themselves after selling a stock short.  While traditionally these disclosed shorts were limited in their ability to access mainstream business media or to otherwise create negative market rumors, the rise of the Internet and technological advancements regarding document creation, videotaping and publication by weblog (“blogging”) have allowed many disclosed shorts to publicly attack a company’s credibility, strategy and veracity by means of so-called research reports that mimic the type of investment analysis performed by large Wall Street firm and independent research analysts.  These short attacks have, in the past, led to selling of shares in the market, on occasion in large scale and broad base.  Issuers with business operations based in the PRC and who have limited trading volumes and are susceptible to higher volatility levels than U.S. domestic large-cap stocks, can be particularly vulnerable to such short attacks.

 

35
 

 

These short seller publications are not regulated by any governmental, self-regulatory organization or other official authority in the U.S., are not subject to the certification requirements imposed by the Securities and Exchange Commission in Regulation AC (Regulation Analyst Certification) and, accordingly, the opinions they express may be based on distortions of actual facts or, in some cases, fabrications of facts.  In light of the limited risks involved in publishing such information, and the enormous profit that can be made from running just one successful short attack, unless the short sellers become subject to significant penalties, it is more likely than not that disclosed shorts will continue to issue such reports.

 

While we intend to strongly defend our public filings against any such short seller attacks, often times we are constrained, either by principles of freedom of speech, applicable state law (often called “Anti-SLAPP statutes”), or issues of commercial confidentiality, in the manner in which we can proceed against the relevant short seller.  You should be aware that in light of the relative freedom to operate that such persons enjoy – oftentimes blogging from outside the U.S. with little or no assets or identity requirements – should we be targeted for such an attack, our stock will likely suffer from a temporary, or possibly long term, decline in market price should the rumors created not be dismissed by market participants.

 

The market price for our securities may be subject to wide fluctuations.

 

The securities of a number of Chinese companies and companies with substantial operations in China have experienced wide fluctuations in their stock price. Among the factors that could affect the price of our common stock are risk factors described in this section and other factors, including:

 

·announcements of competitive developments, by our competitors;

 

·regulatory developments of our industry affecting us, our customers or our competitors;

 

·actual or anticipated fluctuations in our quarterly operating results;

 

·failure of our quarterly financial and operating results to meet market expectations or failure to meet our previously announced guidance, if any;

 

·changes in financial estimates by securities research analysts;

 

·changes in the economic performance or market valuations of our competitors;

 

·additions or departures of our executive officers and other key personnel;

 

·announcements regarding intellectual property litigation (or potential litigation) involving us or any of our directors and officers;

 

·fluctuations in the exchange rates between the U.S. dollar and the Renminbi; and

 

·release or expiration of the underwriters’ post-offering lock-up or other transfer restrictions on our outstanding common stock.

 

36
 

 

In addition, the securities markets have from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular industries or companies. For example, in September 2008, the volatility and disruption of the capital and credit markets reached extreme levels, developing into a global crisis. As a result, stock prices of a broad range of companies worldwide, whether or not they are related to financial services, have declined significantly. These market fluctuations may also have a material adverse effect on the market price of our securities.

 

We may need additional capital and may sell additional securities or other equity securities or incur indebtedness, which could result in additional dilution to our shareholders or increase our debt service obligations.

 

We may require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If our cash resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity securities or equity-linked debt securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all.

 

Substantial future sales of our securities in the public market, or the perception that these sales could occur, could cause the price of our securities to decline.

 

Additional sales of our securities in the public market or the perception that these sales could occur, could cause the market price of our securities to decline. As of March 13, 2014 there were 30,032,116 shares of our common stock outstanding.  Of that amount, 15,604,421 shares of common stock are freely transferable without restriction upon resale. None of our shares are subject to any lock-up restrictions, although 14,427,695 of them are subject to volume and other restrictions as applicable under Rule 144 under the Securities Act. In addition, we may grant or sell additional options, restricted shares or other share-based awards in the future under our share incentive plan to our management, employees and other persons, the settlement and sale of which may further dilute our shares and drive down the price of our securities.

 

As of March 13, 2014 we had options outstanding to purchase an aggregate of 665,000 shares of our common stock, of which 515,000 are currently exercisable and warrants to purchase 28,456 shares of common stock. To the extent that the options and warrants are exercised, they may be exercised at prices below the price of our shares of common stock on the public market, resulting in a significant number of shares entering the public market and the dilution of our securities.

 

If NASDAQ were to delist our securities from trading on its exchange, such action could limit investors’ ability to make transactions in our securities and subject us to additional trading restrictions.

 

Our common stock is currently listed on the NASDAQ Capital Market. We cannot assure you that our securities will meet the continued listing requirements be listed on NASDAQ in the future.

 

If NASDAQ delists our common stock from trading on its exchange, we could face significant material adverse consequences including:

 

·a limited availability of market quotations for our securities;

 

·a determination that our common stock is a “penny stock” which will require brokers trading in our common stock to adhere to more stringent rules and possibly resulting in a reduced level of trading activity in the secondary trading market for our common stock;

 

·a limited amount of news and analyst coverage for our company; and

 

·a decreased ability to issue additional securities or obtain additional financing in the future.

 

37
 

 

If our shares of common stock become subject to the SEC’s penny stock rules, broker-dealers may experience difficulty in completing customer transactions and trading activity in our securities may be adversely affected.

 

If our common stock were removed from listing with the Nasdaq Capital Market, it may be subject to the so-called “penny stock” rules. The SEC has adopted regulations that define a “penny stock” to be any equity security that has a market price per share of less than $5.00, subject to certain exceptions, such as any securities listed on a national securities exchange. For any transaction involving a “penny stock,” unless exempt, the rules impose additional sales practice requirements on broker-dealers, subject to certain exceptions. If our common stock were delisted and determined to be a “penny stock,” a broker-dealer may find it more difficult to trade our common stock and an investor may find it more difficult to acquire or dispose of our common stock on the secondary market. Investors in penny stocks should be prepared for the possibility that they may lose their whole investment.

 

ITEM 1B.UNRESOLVED STAFF COMMENTS

 

Not applicable.

 

ITEM 2.PROPERTIES

 

Under the current PRC law, land is owned by the state, and parcels of land in rural areas which is known as collective land is owned by the rural collective economic organization “Land use rights” are granted to an individual or entity after payment of a land use right fee is made to the applicable state or rural collective economic organization. Land use rights allow the holder the right to use the land for a specified long-term period.

 

We occupy our properties located in Danyang City, Jiangsu Province, PRC under land use rights for purposes of production, R&D and employee living quarters. We have land use rights, all expiring in 2058, for a total of approximately 77,000 square meters of land for all of our existing plants and plants under construction.

 

On April 12, 2009, Lihua Copper entered into a lease agreement for a cargo yard located at Liangdong Industrial Development Area, LiangQingTang, Dali, Guangdong Province, Nanhai District in China. The lease is for a five year term, which began on May 2, 2009 and terminates on May 1, 2014. From May 2, 2009 to May 1, 2012, the monthly rent is RMB 28,000 ($4,455), from May 2, 2012 to May 1, 2013, the monthly rent is RMB 31,000 ($4,932), and from May 2, 2013 to May 1, 2014, the monthly rent is RMB 33,000 ($5,250). The Company will not renew the lease agreement for the cargo yard upon expiration since it does not need to maintain a warehouse for scrap copper purchased.

 

On November 5, 2010, Lihua Copper entered into a Land Expropriation Contract with Houxiang Township People’s Government, Danyang City, Jiangsu Province, relating to the transfer to Lihua Copper of a 50-year right to use a parcel of land located in Wuxing Village and Jide Village, Houxiang Township, for consideration of $5,154,578 (RMB 32,399,100).  The size of the land being transferred is 119,988 square meters, or 180 mu, and the land will be used for the extension of Lihua Copper’s existing factory buildings. Lihua Copper paid $4,772,890 (RMB30,000,000) as a deposit for the above land use right. Not all the relevant formalities were completed prior to December 31, 2013, and therefore as of year-end Lihua Copper had not yet obtained the legal title to the land use rights of 80 mu of the total 180 mu land leased. For more information on the Prepaid Land Use Rights, please refer to Note 9 to the Financial Statements contained on page F-19 of this report.

 

We believe that our existing facilities and equipment are well maintained and in good operating condition, and are sufficient to meet our needs for the foreseeable future.

 

ITEM 3.LEGAL PROCEEDINGS

 

We may be subject to legal proceedings, investigations and claims incidental to the conduct of our business from time to time. We are not currently a party to any material litigation or other legal proceedings brought against us. We are also not aware of any legal proceeding, investigation or claim, or other legal exposure that has a more than remote possibility of having a material adverse effect on our business, financial condition or results of operations.

 

38
 

 

ITEM 4.MINE SAFETY DISCLOSURES

 

Not Applicable.

 

39
 

 

PART II

 

ITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Our common stock has been quoted on the Nasdaq Capital Market (“Nasdaq”) under the trading symbol “LIWA” since September 4, 2009. The closing price for our common stock on Nasdaq on March 13, 2014 was $5.05 per share.

 

The following table shows by each fiscal quarter and partial period, where applicable, the range of high and low sales prices reported by Nasdaq for each full quarterly period within the two most recent fiscal years, through March 13, 2014.

 

   High   Low 
2014          
First Quarter (through March 13)  $5.85   $5.05 
           
2013          
Fourth Quarter  $6.03   $4.98 
Third Quarter  $5.34   $4.84 
Second Quarter  $6.02   $4.69 
First Quarter  $5.34   $4.23 
           
2012          
Fourth Quarter  $4.45   $3.50 
Third Quarter  $5.47   $3.42 
Second Quarter  $5.85   $4.24 
First Quarter  $6.63   $5.20 

 

Holders of Record

 

At March 13, 2014, there were 30,032,116 shares of our common stock outstanding. Our shares of common stock are held by approximately 34 stockholders of record. The number of record holders was determined from the records of our transfer agent and does not include beneficial owners of common stock whose shares are held in the names of various security brokers, dealers, and registered clearing agencies.

 

Dividends

 

We have no current plans to pay dividends and we plan to retain earnings, if any, for use in the development of the business. Payment of future dividends, if any, will be at the discretion of the Board of Directors after taking into account various factors, including dividend issuance criteria of the state of the Delaware, where our parent holding company is registered in, current financial condition, operating results, current and anticipated cash needs and regulations governing dividend distributions by wholly foreign owned enterprises in the PRC.

 

Performance Graph

 

The graph below charts the cumulative total return of our common stock listed on Nasdaq, the Nasdaq Composite index and the Copper index, for the fiscal year ended December 31, 2013.  Our stock began trading on Nasdaq on September 4, 2009.

 

40
 

 

 

  

Recent Sales of Unregistered Securities

 

None.

 

Purchases of Equity Securities by the Company

 

There were no purchases of equity securities made by the Company in the 4th quarter of 2013.

 

ITEM 6.SELECTED FINANCIAL DATA

 

The following table sets forth selected consolidated statement of financial data as of and for the years ended December 31, 2013, 2012, 2011, 2010, and 2009, which are derived from our audited consolidated financial statements. Our consolidated financial statements are prepared in accordance with U.S. GAAP. Our historical results for any period are not necessarily indicative of results to be expected for any future period. You should read the following selected financial information in conjunction with the consolidated financial statements and related notes and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this annual report.

 

   Year Ended December 31, 
   2013   2012   2011   2010   2009 
   US$   % of
Sales
   US$   % of
Sales
   US$   % of
Sales
   US$   % of
Sales
   US$   % of
Sales
 
   (in thousands, except for percentages, per share and operating data)
(all periods are audited)
 
                                         
Consolidated Statement of Income Data:                                                  
Sales                                                  
CCA and copper wire   359,517    39.9%   393,782    46.1%   335,574    52.7%   243,133    65.6%   109,398    67.7%
Copper anode   472,042    52.4%   381,114    44.6%   287,269    45.1%   97,614    26.3%   —      
Refined copper rod   69,168    7.7%   78,870    9.3%   14,250    2.2%   29,785    8.0%   52,146    32.3%
Total sales   900,727    100.00%   853,766    100.00%   637,093    100%   370,532    100%   161,544    100%
                                                   
Cost of sales                                                  
CCA and copper wire   (317,961)   -35.3%   (345,897)   -40.5%   (285,851)   -44.9%   (192,199)   -51.9%   (78,081)   -48.3%
Copper anode   (430,348)   -47.8%   (343,446)   -40.2%   (262,045)   -41.1%   (89,107)   -24.0%    —     — 
Refined copper rod   (66,019)   -7.3%   (74,875)   -8.8%   (13,483)   -2.1%   (27,124)   -7.3%   (47,230)   -29.2%
Total cost of sales   (814,328)   -90.4%   (764,218)   -89.5%   (561,379)   -88.1%   (308,430)   -83.2%   (125,311)   -77.6%
                                                   
Gross profit   86,399    9.6%   89,548    10.5%   75,714    11.9%   62,102    16.8%   36,233    22.4%
Selling expenses   (3,021)   -0.3%   (2,954)   -0.4%   (2,486)   -0.4%   (2,058)   -0.6%   (1,722)   -1.1%
Administrative expenses   (8,073)   -0.9%   (8,622)   -1.0%   (6,650)   -1.0%   (5,747)   -1.6%   (3,992)   -2.5%
Income from operations   75,305    8.4%   77,972    9.1%   66,578    10.5%   54,297    14.7%   30,519    18.9%
                                                   
Interest income   660    0.1%   548    0.1%   523    0.1%   254    0.07%   174    0.1%
Interest expenses                   (144)   -0.02%   (131)   -0.04%   (335)   -0.2%
Foreign exchange differences   (1)   0.00%   110    0.01%   235    0.04%   (112)   -0.03%    —     
Gain/(loss) on extinguishment of warrant liabilities   (8)   0.00%   73    0.01%   88    0.01%   187    0.05%   (1)   0.001%
Change in fair value of warrants   (107)   -0.01%   (124)   -0.01%   3,062    0.5%   (1,449)   -0.4%   (11,877)   -7.4%
Other income (expenses)   35    0.00%   94    0.01%   115    0.02%   (80)   -0.02%   501    0.3%
                                                   
Income before tax   75,884    8.4%   78,673    9.2%   70,457    11.1%   52,966    14.3%   18,981    11.7%
Income tax   (19,725)   -2.2%   (20,731)   -2.4%   (17,324)   -2.7%   (14,500)   -3.9%   (5,248)   -3.2%
Net income   56,159    6.2%   57,942    6.8%   53,133    8.4%   38,466    10.4%   13,733    8.5%

 

41
 

 

   Year Ended December 31, 
   2013   2012   2011   2010   2009 
   US$   US$   US$   US$   US$ 
   (in thousands, except for percentages, per share and
operating data)
 
Earnings per share                    
—Basic   1.88    1.94    1.78    1.38    0.77 
—Diluted   1.87    1.93    1.77    1.34    0.72 
                          
Other Consolidated Financial Data:                         
Gross profit margin   9.6%   10.5%   11.9%   16.8%   22.4%
Operating profit margin   8.4%   9.1%   10.5%   14.7%   18.9%
Net profit margin   6.2%   6.8%   8.3%   10.4%   8.5%
                          
Consolidated Operating Data:                         
Shipment volume (ton)                         
CCA and copper wire   44,331    46,273    34,743    28,388    15,353 
Copper anode   63,600    48,689    31,943    12,330     
Refined copper rod   9,199    9,994    1,876    3,994    9,630 
Average selling price ($ per ton)                         
CCA and copper wire   8,110    8,510    9,659    8,565    7,126 
Copper anode   7,422    7,828    8,993    7,917     
Refined copper rod   7,519    7,892    7,596    7,457    5,414 
                          
Consolidated Balance Sheet Data:                         
Cash and cash equivalents   203,406    144,300    105,638    90,609    34,615 
Accounts receivable   60,498    45,285    31,082    32,974    10,996 
Inventories   12,141    17,844    15,502    16,156    17,534 
Property, plant and equipment   47,139    47,197    20,566    18,189    18,424 
Total assets   365,533    293,912    238,289    178,285    91,167 
Secured short-term bank loans               2,265    2,197 
Total liabilities   19,533    14,980    18,652    25,127    23,661 
Total stockholders’ equity   346,000    278,932    219,637    153,158    67,506 
Total liabilities and stockholders’ equity   365,533    293,912    238,289    178,285    91,167 

 

ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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 technology and process.

 

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 launched production of copper anode in July 2010, in conjunction with the completion of our second scrap copper smelter, with an initial annual capacity of 25,000 tons. In October 2011, we completed an efficiency upgrade of the smelters and increased the copper anode smelting capacity to 35,000 tons per annum, and the copper rod smelting capacity to 50,000 tons per annum. In mid 2012, we focused on copper anode production capacity expansion and completed construction of two new copper anode smelters on the 30-acre plant site, giving us a total of 3 anode smelters. In December 2012, we dismantled the oldest copper anode smelter as a result of consolidating and upgrading our production site. In the first quarter of 2013, we completed construction of a third copper anode smelter. The new copper anode smelters constructed in 2012 and 2013 each has an annual production capacity of 25,000 – 30,000 tons, giving us total copper anode refinery capacity of 75,000 – 90,000 tons per annum. We started construction of a fourth copper anode smelter in early 2013. However, we have delayed further construction due to reconfiguration of the dust collection system. The construction will resume upon completion of the dust collection system and a better near term economic outlook. Copper anode 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.

 

42
 

 

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 and 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.  In late 2013, we started batch production and sales of a new CCA wire product which was developed in partnership with Shanghai Cable and Wire Research Institute. Compared to the existing CCA wire we produced, the new CCA wire has higher electric transmission and conductivity quality and can be used in more diverse end markets such as audio and visual equipment, computers and mobile phones. 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 the 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, but that 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.

 

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.  For 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. Since we produce our copper products with bulk scrap copper, we believe it provides us with a cost advantage in the market. During 2013, we sold copper anode to a few large copper cathode manufacturers, which use our product to produce copper cathode.  We sold copper rod to customers which are mostly 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. Our new CCA wire product can be used in more diverse applications such as audio and visual equipment, computers and mobile phones.  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 new CCA wire offers conductivity performance characteristics that are equal to or only marginally below those of pure copper wire, which means they are attractive in a wide variety of product applications. The demand for each of our product lines is solid, due both to steady 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.

 

43
 

 

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, we have experienced sales growth in the last three years. We generated sales of $900.7 million, $853.8 million and $637.1 million for the years ended December 31, 2013, 2012 and 2011, respectively.

 

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 number 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 allocated to copper rod and copper anode production. The three copper anode smelters are capable of producing 75,000 – 90,000 tons per year and the copper rod smelter is capable of producing 50,000 tons per year.  In 2013, we sold 63,600 tons of copper anode and 47,111 tons of copper rod and wire.  The fine copper wire products we produce have diameters ranging between 1.65mm – 2.6mm (the “fine wire”) and the superfine wire products have diameters ranging between 0.03mm – 1.6mm (the “superfine wire”). In fiscal year 2013, the sales of fine wire and superfine wire were 55.8% and 44.2%, respectively, of total sales of our copper wire products, and 60% and 40%, respectively, of the volume of our copper wire products sold. As of December 31, 2013, we operated approximately 80 high-speed wire drawing machines which draw CCA rod or larger diameter fine copper wire into much finer diameter wires, with a total capacity of approximately 6,000 – 8,000 tons per annum of CCA wire and approximately 20,000 – 25,000 tons per annum of superfine wire. We also have four fine wire drawing machines with aggregate annual drawing capacity of 50,000 – 100,000 tons of fine wire products. We produce wire products with different diameters depending on customer requirements and thus our actual production of wire products in a particular period fluctuates depending on the orders that we received during that period. In 2013, we sold 6,419 tons of CCA wire and a total of 37,912 tons of fine wire and superfine copper wire products. 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.  In the first half of 2010, we added six high-capacity copper wire drawing production lines, all of which are used to draw copper wire from our copper rod, and increased our annual capacity to 20,000 – 25,000 tons of 0.03mm – 1.60mm diameter range copper wire.  In the third quarter of 2010, we built our first copper anode smelter with 25,000 tons of annual capacity and started copper anode production.  In October 2011 we increased the production efficiency and capacity of the copper rod smelter and increased the smelting capacity to 50,000 tons. As a result, the copper rod production capacity is more than that for superfine copper wire and we sell the excess copper rod produced to external customers. On the new plant construction site, we have added three copper anode smelters with 25,000 - 30,000 tons of annual capacity each.  We have also began construction of a fourth anode smelter but the construction is currently halted pending completion of the dust collection system reconfiguration and a better near term economic outlook. An original cooper anode smelter with a smelting capacity of 35,000 tons was dismantled in December 2012. In the second half of 2013, upon completion of new CCA cable and wire product testing, we have added CCA binding machines and magnet and tin plate machines utilizing new technology and processes we developed.

 

Historically, we have taken a conservative approach in estimating the annual capacity of each main product category. Specifically, in the wire product categories (CCA and copper wire), our historical total annual capacity estimate was based upon the capacity assumption on drawing the thinnest superfine wire, even though we often produced and sold larger millimeters of wire. Since drawing the thinnest diameter of superfine wire (i.e. 0.03 mm) takes the longest time, the estimated annual capacity that we have disclosed assumes only the smallest possible wire production capacity that we could attain.

 

44
 

  

We produce and sell a wide variety of superfine CCA and copper wire products according to customer order specifications. In 2013, the average CCA and copper wire diameters we produced and sold were in the range of 0.03 mm to 2.6 mm. As a result, the actual sales volume of these two products exceeded our estimated production capacity, since such estimate is based upon the thinnest wire diameter production. We are capable of producing annual production capacities for CCA and superfine copper wire in the range of 6,000 – 8,000 tons and 20,000 – 25,000 tons (in the thickness range of 0.03mm – 1.60mm), respectively. We also have four fine wire drawing machines with aggregate annual drawing capacity of 50,000 – 100,000 tons of fine wire products (in the thickness range of 1.65mm – 2.6mm).

 

Given the production capacity estimates are conservative based upon the assumptions that are used, as described above, management does not expect the current CCA and copper wire capacity to limit potential sales. However, such analysis and determination will be performed by us regularly in future years and any changes will be timely disclosed. In 2012 and 2013, we have completed the construction of three new smelters with 25,000 – 30,000 tons of capacity each. In 2013, we have completed the research and development of new products in the CCA cable and wire category, and have passed sample product quality testing. We are in the process of adding production capacity for this new product while actively seeking potential customers. Currently we are planning to ramp up the production and sales gradually throughout 2014. The degree of the ramp up in production and sales is dependent on various factors, including but not limited to: receipt of new customer product qualification and orders, our capital investment plan, as well as working capital needs.

 

Significant Factors Affecting Our Results of Operations

 

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

 

·product mix and implications on 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 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 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 much 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.  The mark up is adjusted periodically based on market condition, which includes supply demand dynamics, competitive landscape changes, and copper price fluctuation.

 

45
 

 

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 the markup, or our gross and net profit in absolute dollar terms, has not been materially affected by the change of copper prices. Shanghai Changjiang Commodity Market, one of the major metal 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.

 

For the year ended December 31, 2013, the average copper price published by the Shanghai Changjiang Commodity Market was $7,363 per ton. During the year, the highest monthly average price was $8,010 per ton (in the month of February 2013), and the lowest monthly average price was $6,973 per ton (in the month of July 2013).

 

For the year ended December 31, 2012, the average copper price published by the Shanghai Changjiang Commodity Market was $7,750 per ton. During the year, the highest monthly average price was $8,072 per ton (in the month of March 2012), and the lowest monthly average price was $7,456 per ton (in the month of June 2012).

 

Production capacity

 

In order to capture the market opportunity for our products, we have expanded, and plan to continue to expand, our production capacity, should the copper product demand in China continue to grow. 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. From 1999 to 2013, the PRC has experienced significant economic growth, achieving a CAGR of 15.3% in gross domestic product, according to National Bureau of Statistics of China. Domestic demand for and consumption of copper and CCA products has increased substantially during the time span as a result of this growth. We believe that economic conditions in the PRC will continue to affect our business and results of operations.

 

PRINCIPAL INCOME STATEMENT COMPONENTS

 

Sales

 

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

 

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.

 

46
 

 

Gross Profit

 

Our gross profit is affected primarily 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. The mark up is adjusted periodically based on market condition, which includes supply demand dynamics, competitive landscape changes, and copper price fluctuation.

 

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 steady 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. We expect that our selling, general and administrative expenses will also increase as a result of 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, 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 Company’s issued and outstanding Series B warrants expired on October 31, 2013. The Company recognized an $8,369 loss as a result of the extinguishment of warrant liabilities. The fair value of the Company’s issued and outstanding warrants issued to placement agents in conjunction with the Company’s initial public offering in September 2009, decreased to $33,262 as of December 31, 2013 and the Company recognized a $106,536 loss, which is a non-cash loss from the change in fair value of these warrants for the year ended December 31, 2013. In future periods, we may experience gains or losses, as the value of these warrants fluctuates in response to changes in our stock price.

 

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.

 

The PRC 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 our subsidiaries in the PRC will not be distributing their earnings to the Company for the years ended December 31, 2013, 2012 and 2011, no deferred tax liability has been recognized for the undistributed earnings of these PRC subsidiaries through December 31, 2013. Total undistributed earnings of these PRC subsidiaries at December 31, 2013 were RMB1,638,688,844 ($268,774,105).

 

47
 

 

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 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 has been 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 2007 to 2013:

 

   2007   2008   2009   2010   2011   2012   2013 
Lihua Electron   12%   12.5%   12.5%   25%   25%   25%   25%
Lihua Copper   25%   25%   25%   25%   25%   25%   25%

 

RESULTS OF OPERATIONS

 

YEAR ENDED DECEMBER 31, 2013 COMPARED TO YEAR ENDED DECEMBER 31, 2012

 

Sales

 

2013 is a transition year for us to lay the foundation for future growth. In 2013, net sales increased by 5.5% to $900.7 million from $853.8 million in 2012. This growth was primarily driven by increased sales of our copper anode products and negatively impacted by the decrease in sales of our wire products and copper rod product. Please see the table below for more details regarding the product sales breakdown by specific category.

 

   Year ended December 31, 
   2013   2012 
In thousands,
except for percentage and average price
  Sales   Volume
(m.t.)
   Average
price
   Sales   Volume
(m.t.)
   Average
price
 
Fine Copper wire  $170,903    22,739   $7,516   $188,810    23,761  $7,946 
Superfine copper wire   135,329    15,173    8,919    144,338    15,574   9,268 
CCA wire   53,284    6,419    8,301    60,634    6,938   8,739 
Copper anode   472,042    63,600    7,422    381,114    48,689   7,828 
Copper rod   69,168    9,199    7,519    78,870    9,994   7,892 
Total  $900,727    117,130   $7,690   $853,766    104,956  $8,135 

 

The overall sales volume increase of 11.6% in 2013 over 2012 is primarily the result of additional copper anode production as a result of the third copper anode smelter added in January 2013. Sales volume of CCA and copper wire in 2013 has decreased by 4.2% from fiscal year 2012 mainly as a result of the production stoppage when we moved the wire drawing equipment from the old plant to the new 30 acre plant site. Sales volume of copper rod has decreased by 795 tons to 9,199 tons in 2013, an 8.0% reduction from the sales volume of 2012, as a result of the suspension of production of a smelter for vertical copper melting furnace reconstruction in December 2013.

 

The average sales price decreased by 5.5% in 2013, primarily as a result of the decrease in copper prices. For the year ended December 31, 2013, the average copper price published by the Shanghai Changjiang Commodity Market was $7,363 per ton, compared to the 2012 average of $7,750 per ton, representing a drop of 5%.

 

We sell our products based on the prevailing market price 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 we sold during the period - the thicker the wire diameter the lower the sale price, and vice versa.

 

48
 

 

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 years ended December 31, 2013 and 2012:

 

   Year ended December 31,
   2013  2012
In thousands, except for percentage  Cost of Sales   % of Sales*  Cost of Sales   % of Sales*
Fine copper wire  $161,176    17.9%  $177,348    20.8%
Superfine copper wire   119,860    13.3%   127,517    14.9%
CCA wire   36,925    4.1%   41,032    4.8%
Copper anode   430,348    91.2%   343,446    90.1%
Copper rod   66,019    95.4%   74,875    94.9%
Total  $814,328    90.4%  $764,218    89.5%

 

   Year ended December 31,
   2013  2012
In thousands, except for percentage  Gross Profit   % of Sales*  Gross Profit   % of Sales*
Fine copper wire  $9,727    5.7%  $11,462    6.1%
Superfine copper wire   15,470    11.4%   16,821    11.7%
CCA wire   16,359    30.7%   19,602    32.3%
Copper anode   41,694    8.8%   37,668    9.9%
Copper rod   3,149    4.6%   3,995    5.1%
Total  $86,399    9.6%  $89,548    10.5%

 

* Percentage of sales of respective product category

 

Average gross profit margin decreased to 9.6% in 2013 as compared to 10.5% in 2012, primarily as a result of increased copper anode sales in the product mix. Our refined copper products typically are the lower profitable products when compared with the wire products. Additionally, gross profit decreased across all product lines as the spread between the Company's scrap copper cost and the market copper price became narrower in 2013.

 

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 Selling, General and Administrative Expenses for the years ended December 31, 2013 and 2012:

 

   Year ended December 31,  Change in 
year ended 
December 31, 
2013
compared to
 year ended 
December 31,
   2013  2012  2012
In thousands, except for percentage  US$   % of Sales  US$   % of Sales  %
Gross profit  $86,399    9.6%  $89,548    10.5%   (3.5)%
Operating Expenses:                         
Selling expenses   (3,021)   (0.3)%   (2,954)   (0.4)%   2.2%
General & administrative expenses   (8,073)   (0.9)%   (8,622)   (1.0)%   (6.4)%
Total operating expense   (11,094)   (1.2)%   (11,576)   (1.4)%   (4.2)%
Income from operations  $75,305    8.4%  $77,972    9.1%   (3.4)%

 

Total selling, general and administrative expenses were $11.1 million for the year ended December 31, 2013, compared to $11.6 million for the same period last year, a decrease of 4.2%.

 

Selling expenses were $3.0 million for the year ended December 31, 2013, an increase of 2.2% compared to the same period last year. 

 

49
 

 

Included in selling expenses were shipping and handling costs of $2.4 million and $2.3 million in 2013 and 2012, respectively, representing an increase of 3.5%, while tons of products sold by us increased 11.6% compared to 2012. The slower growth in shipping and handling costs compared to the sales volume growth of our products is due to: i) The increase in total sales volume was due to an increase in copper anode sales, which is concentrated with a few large customers located in cities that are within close proximity to our production location. ii) Depending on our negotiation with customers on a case-by-case basis, shipping and handling costs for our products may either be borne by us or by our customers; and iii) We own a small fleet of trucks to handle part of the shipping and handling of our products which provides further cost savings compared to outsourcing.

 

General and administrative expenses were $8.1 million for the year ended December 31, 2013, a decrease of 6.4% compared to the same period last year. The main factors which caused this increase was lower research and development costs as we have completed R&D for new CCA products.

 

Income Tax

 

For the year ended December 31, 2013, income tax expense was $19.7 million, reflecting an effective tax rate of 26.0%.  The effective tax rate for the same period in 2012 was 26.4%. Excluding the non-taxable fair value change on warrants and the operating loss of the US entity, the effective tax rate was 25.0% and 25.3% for 2013 and 2012, 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 year ended December 31, 2013 was $56.2 million, or 6.2% of net revenue, compared to $57.9 million, or 6.8% of net revenue, in the same period in 2012. The net income for the year ended December 31, 2013 and 2012 was impacted by a total $0.1 million non-cash charge and $0.05 million non-cash charge, respectively, as a result of the gain/loss on extinguishment of warrant liabilities and change of the fair value of the warrants. Excluding the impact of these non-cash items, net income for the year ended December 31, 2013 was $56.3 million, down 3.0% from the prior year.

 

Foreign Currency Translation Gains

 

During the year ended December 31, 2013, the RMB rose against the US dollar, and we recognized a foreign currency translation gain of $9.6 million.

 

YEAR ENDED DECEMBER 31, 2012 COMPARED TO YEAR ENDED DECEMBER 31, 2011

 

Sales

 

Our business for the year ended December 31, 2012 continued to demonstrate solid growth.  Net sales increased by 34.0% from $637.1 million in 2011 to $853.8 million in 2012. This growth was primarily driven by increased sales of all of our products as a result of capacity addition. The sales growth was partially offset by the decrease in average sales price in 2012 compared to 2011. Please see the table below for more details regarding the product sales breakdown by specific category.

 

   Year ended December 31, 
   2012   2011 
In thousands,
except for percentage and average price
  Sales   Volume
(m.t.)
   Average
price
   Sales   Volume
(m.t.)
   Average
price
 
Fine copper wire  $188,810    23,761   $6,946   $124,062    14,060   $8,824 
Superfine copper wire   144,338    15,574    9,268    149,809    14,347    10,442 
CCA wire   60,634    6,938    8,739    61,703    6,336    9,739 
Copper anode   381,114    48,689    7,828    287,269    31,943    8,993 
Copper rod   78,870    9,994    7,892    14,250    1,876    7,596 
Total  $853,766    104,956   $8,135   $637,093    68,562   $9,292 

 

The overall sales volume increase of 53.1% in 2012 over 2011 is the result of additional production from two new smelters added in June 2012. Sales volume of CCA and copper wire in 2012 has grown 33.2% from fiscal year 2011 as a result of the copper rod smelter annual capacity increase to 50,000 tons in October 2011.

 

Sales volume of copper anode in 2012 has grown 52.4% from 2011 primarily as a result of the additional production from two new copper anode smelters which were completed and started production in June 2012. The 432.7% year over year copper rod sales volume increase was the result of full year production from the increased copper rod capacity in 2012 after the October 2011 rod smelter capacity expansion.

 

The average sales price decreased by 12.5% in 2012, primarily as a result of the decrease in copper prices. For the year ended December 31, 2012, the average copper price published by the Shanghai Changjiang Commodity Market was $7,750 per ton, compared to the 2011 average of $8,767 per ton, representing a drop of 11.6%. In 2011, the Company sold copper rod only in the last quarter, which copper market price was lower than the yearly average of 2012. As a result, the Company recorded an increase in the average price of copper rod in 2012.

 

We sell our products based on the prevailing market price 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 we sold during the period - the thicker the wire diameter the lower the sale price, and vice versa.

 

50
 

 

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 years ended December 31, 2012 and 2011:

 

   Year ended December 31, 
   2012   2011 
In thousands, except for percentage  Cost of Sales   % of Sales*   Cost of Sales   % of Sales* 
Fine copper wire  $41,032    4.8%  $40,328    6.3%
Superfine copper wire   177,348    20.8%   115,662    18.2%
CCA wire   127,517    14.9%   129,861    20.4%
Copper anode   343,446    90.1%   262,045    91.2%
Copper rod   74,875    94.9%   13,483    94.6%
Total  $764,218    89.5%  $561,379    88.1%

 

   Year ended December 31, 
   2012   2011 
In thousands, except for percentage  Gross Profit   % of Sales*   Gross Profit   % of Sales* 
Fine copper wire  $11,462    6.1%  $8,400    6.8%
Superfine copper wire   16,821    11.7%   19,947    13.3%
CCA wire   19,602    32.3%   21,376    34.6%
Copper anode   37,668    9.9%   25,224    8.8%
Copper rod   3,995    5.1%   767    5.4%
Total  $89,548    10.5%  $75,714    11.9%

 

* Percentage of sales of respective product category

 

Average gross profit margin decreased to 10.5% in 2012 as compared to 11.9% in 2011, primarily as a result of increased copper anode and copper rod sales in the product mix. Our refined copper products typically are the lower profitable products when compared with the wire products. Since copper wire is a lower gross margin product than CCA wire, the increase in copper wire sales also contributed to the decrease in average CCA and copper wire gross margin as well as overall gross margin.

 

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 Selling, General and Administrative Expenses for the years ended December 31, 2012 and 2011:

 

   Year ended December 31,   Change in 
year ended 
December 31, 
2012
compared to
 year ended 
December 31,
 
   2012   2011   2011 
In thousands, except for percentage  US$   % of Sales   US$   % of Sales   % 
Gross profit  $89,548    10.5%  $75,714    11.9%   18.3%
Operating Expenses:                         
Selling expenses   (2,954)   (0.4)%   (2,486)   (0.4)%   18.8%
General & administrative expenses   (8,622)   (1.0)%   (6,650)   (1.0)%   29.7%
Total operating expense   (11,576)   (1.4)%   (9,136)   (1.4)%   26.7%
Income from operations  $77,972    9.1%  $66,578    10.5%   17.1%

 

Total selling, general and administrative expenses were $11.6 million for the year ended December 31, 2012, compared to $9.1 million for the same period last year, an increase of 26.7%.

 

Selling expenses were $3.0 million for the year ended December 31, 2012, an increase of 18.8% 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 staffing costs as we continued to expand the sales force during the period.

 

51
 

  

Included in selling expenses were shipping and handling costs of $2.3 million and $2.1 million in 2012 and 2011, respectively, representing an increase of 14.3%, while tons of products sold by us increased 53.1% compared to 2011. Tons of CCA and copper wire and rod products sold increased 53.7% in 2012. The slower growth in shipping and handling costs compared to the sales volume growth of our products is due to: i) Copper anode sales have only been made to two customers, both of whom are located in cities that are within close proximity to our production location. Our wire and rod products are mostly sold to customers located geographically close to us as well; ii) Depending on our negotiation with customers on a case-by-case basis, shipping and handling costs for our products may either be borne by us or by our customers; iii) we own a small fleet of trucks to handle part of the shipping and handling of our products which provides further cost savings compared to outsourcing.

 

General and administrative expenses were $8.6 million for the year ended December 31, 2012, an increase of 29.7% compared to the same period last year. The main factors which caused this increase were (i) higher staff costs associated with our expanded scale of operations; and (ii) higher research and development costs as we have completed R&D for new CCA products and developed R&D partnerships with Shanghai Electric Cable Research Institute and Beijing Modern Recycling Economy Research Institute in 2011.

 

Interest Expense

 

Interest expense was none for the year ended December 31, 2012, compared to $143,779 for the same period last year. The decrease was mainly due to the fact that the Company has sufficient cash and did not borrow any money from banks in 2012.

 

Income Tax

 

For the year ended December 31, 2012, income tax expense was $20.7 million, reflecting an effective tax rate of 26.4%.  The effective tax rate for the same period in 2011 was 24.6%. Excluding the non-taxable fair value change on warrants and the operating loss of the US entity, the effective tax rate was 25.3% and 24.9% for 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 year ended December 31, 2012 was $57.9 million, or 6.8% of net revenue, compared to $53.1 million, or 8.3% of net revenue, in the same period in 2011. The net income for the year ended December 31, 2012 and 2011 was impacted by a $0.05 million non-cash charge and $3.1 million non-cash gain, respectively, as a result of the change of the fair value of the warrants. Excluding the impact of these non-cash items, net income for the year ended December 31, 2012 was $58.1 million, up16.0% from the prior year.

 

Foreign Currency Translation Gains

 

During the year ended December 31, 2012, the RMB rose against the US dollar, and we recognized a foreign currency translation gain of $0.7 million.

 

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.

 

As of December 31, 2013, total cash held in Renminbi and U.S. dollars was RMB 1.2 billion (or $203.4 million based on the conversion rate of US$1 = RMB 6.0969 on the same date). We maintain cash in U.S. dollars in offshore accounts in Hong Kong and in the U.S. to pay for U.S. related expenses such as legal fees and external investor relation firm fees for being a public company in the U.S.

 

As of December 31, 2013, we had approximately $203.4 million in cash, up $59.1 million from $144.3 million at December 31, 2012. The Company has added new production facilities for its new CCA cable and wire product on the new plant site. Total capex in 2013 was $7.8 million. In December 2013, the Company started a facility upgrade of the copper rod smelter, and completed the upgrade at the end of February 2014. Total cost for the copper rod facility upgrade was approximately $3.8 million. The Company expects to incur additional capex for equipment additions for the new CCA product as we intend to ramp up its sales throughout 2014.

 

52
 

 

The following table summarizes our cash flows for each of the periods indicated:

  

   Year Ended December 31 
   2013   2012   2011 
(US$)               
Net cash provided by operating activities  $61,046,939   $48,729,569   $33,377,997 
                
Net cash used in investing activities   (7,796,777)   (9,365,100)   (20,309,900)
                
Net cash (used in) provided by financing activities   590,441    (992,846)   (2,550,960)
Effect of exchange rate on cash and cash equivalents   5,265,327    291,040    4,511,150 
Cash and cash equivalents at beginning of year   144,300,290    105,637,627    90,609,340 
                
Cash and cash equivalents at end of year  $203,406,220   $144,300,290   $105,637,627 

 

Operating activities

 

For the year ended December 31, 2013, cash provided by operating activities totaled $61.1 million compared to $48.7 million and $33.4 million in the same period of 2012 and 2011, respectively. This was primarily attributable to: i) $56.2 million in net earnings; ii) a decrease of $3.0 million in prepayments for raw material purchases, which was primarily caused by the decrease in scrap copper prices; iii) a $6.2 million inventory decrease, as a result of quicker inventory turnover compared with the prior year; iv) a $3.4 million accounts payable increase; v) a $2.0 million increase in other payables and accruals; offset by: vi) a $13.6 million accounts receivable increase, as a result of increase in copper anode sales; and vii) a $1.0 million decrease in income taxes payable.

 

Investing activities

 

For the year ended December 31, 2013, cash used in investing activities totaled $7.8 million compared to $9.4 million and $20.3 million in the same period of 2012 and 2011, respectively. This was primarily attributable to a total net cash outflow of $7.8 million for the purchase of and deposits paid for property, plant and equipment and construction in progress, primarily as a result of the facility upgrade of the copper rod smelter, all being part of our planned expansion.

 

Financing activities

 

For the year ended December 31, 2013, cash provided by financing activities totaled $0.6 million compared to cash outflow of $1.0 million and cash outflow of $2.6 million in the same period of 2012 and 2011, respectively. The $0.6 million cash provided by financing activities in 2013 was from the exercise of share options and Series B Warrants.

 

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 of $0.5 million was paid on January 13, 2012 to Lihua shareholders of record on December 31, 2011 and the second dividend of $0.5 million 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.

 

53
 

 

In January 2011, the Board of Directors authorized management to repurchase stock over a 12-month period with a total value of up to $15 million (the “Repurchase Program”). The Company purchased 264,047 shares in the open market at an aggregate cost of $2.1 million. The initial repurchases were funded with US dollars the Company had in its Hong Kong bank account, and the subsequent repurchases were funded by an aggregate of $1.3 million in loans, denominated in U.S. dollars, from Magnify Wealth, under an up to $4 million demand promissory note entered between Magnify Wealth and the Company on May 19, 2011 (the “Note”). The Company repaid Magnify Wealth in full, in RMB. 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 U.S. dollars, such that the Company had encountered difficulty funding the Repurchase Program with U.S. dollars from cash held by its PRC subsidiaries. The Company explored possible alternative arrangements for funding the Repurchase Program in U.S. dollars with financial institutions, but Company management determined that such alternatives would have been costly or otherwise not appropriate for the Company. The Repurchase Program expired in January 2012.

 

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 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.

 

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 RMB 3.15 million and RMB 5.65 million were repaid, respectively, in RMB, at the average rate of 6.2916 RMB per US dollar, 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 December 31, 2012, there were no outstanding loans under the Note.

 

Capital expenditures

 

Our capital expenditures are principally directed for expansion of production facilities, including construction and purchases of property, plant and equipment. In 2013, 2012 and 2011, we funded our capital expenditures primarily through cash flows from operating activities and the proceeds of bank borrowings, and equity issuance.

 

In 2014, as we accelerate our expansion, we expect to continue capital expenditures for maintaining existing machines and adding manufacturing equipment in our 180 mu new plant site, which is adjacent to our existing plant. We currently have four smelting facilities which can produce a total of 125,000 – 140,000 tons of refined copper products per year.  Since 2012, we have added 75,000-90,000 tons of new anode smelting capacity, while dismantling an older anode smelter with 35,000 tons of annual capacity. With our current capacity of production lines, we can produce 6,000 – 8,000 tons of CCA wire and 20,000 - 25,000 tons of copper wire with the diameter range of 0.03mm – 1.60mm.  We have completed the research and development of a new CCA cable and wire product and have passed the industry standard testing. We began batch production and sales at end of 2013 and plan to ramp up the production and sales of this new CCA product as we continue our efforts to add new customers. 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

 

In 2013, we sold 44,331 tons of CCA and copper wire, 63,600 tons of copper anode and 9,199 tons of copper rod.  In 2012, we sold 46,273 tons of CCA and copper wire, 48,689 tons of copper anode and 9,994 tons of copper rod. As CCA is an emerging product in the PRC, Lihua extends credit terms to some of its larger customers. However, pure copper products, such as our copper anode, copper rod and copper wire, are in higher demand that we don’t 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 wire (and copper rod and anode) purchases are payable upon delivery to the customer, which may occur two to seven days after we ship the product and recognize our revenue. This decision to extend terms or to collect payment upon receipt (essentially a “cash sale”, although due to the shipping time this effectively becomes a very short receivable), 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 payment upon delivery for purchases of copper anode, rod and/or copper wire.

 

54
 

 

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

 

   As of December 31, 
   2013   2012 
         
CCA wire and copper wire  $17,352,415   $13,119,436 
Copper anode   34,793,532    28,586,258 
Copper rod   8,351,833    3,579,229 
Total  $60,497,780   $45,284,923 

 

Off-balance sheet arrangements

 

As of December 31, 2013, we have no off-balance sheet arrangements.

 

ITEM 7A. 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. dollar 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 to 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. dollar. On July 21, 2005, the PRC government changed this policy and began allowing modest appreciation of the Renminbi versus the U.S. dollar. However, the Renminbi is restricted to a rise or fall of no more than 0.5% per day versus the U.S. dollar, 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. dollar 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 in the value of the Renminbi against the U.S. dollar.

 

Any devaluation of the Renminbi against the U.S. dollar 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 December 31, 2013 and 2012, we had cash denominated in Renminbi and U.S. dollar amounting to RMB1.2 billion ($203.4 million) and RMB907.0 million ($144.3 million), respectively.

 

We recognized a foreign currency translation adjustment of approximately RMB 59.7 million ($9.6 million) for the year ended December 31, 2013.

 

55
 

 

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.

 

Interest Rate Risk

 

Should we incur short term bank borrowings, we may be exposed to interest rate risk arising from short-term variable rate borrowings from time to time. Our future interest expense will fluctuate in line with any change in our borrowing rates. We believe our exposure to interest rate risk and other relevant market risks is not material. We did not have short term bank borrowing outstanding as of December 31, 2013. However, we may incur short-term bank borrowings under our working capital revolving line of credit from time to time.

 

Inflation

 

In recent years, the PRC has experienced more material inflation, however 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%, 5.4%, 2.6% and 2.6% in 2009, 2010, 2011, 2012 and 2013, respectively.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Our consolidated financial statements and the notes thereto begin on page F-1 of this Annual Report.

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

Under the supervision and with the participation of management, including our chief executive officer, who is our principal executive officer, and the chief financial officer, who is our principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of December 31, 2013. Based on this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective, as of December 31, 2013, to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our chief executive officer and chief financial officer, to allow timely decisions regarding required disclosures.

 

Management’s Annual Report on Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company.  Using the Integrated Framework adopted by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), our management assessed the effectiveness of the Company’s internal control over financial reporting, as of December 31, 2013, and determined it to be effective.

 

Attestation Report of Independent Registered Public Accounting Firm

 

Our independent registered public accounting firm, Crowe Horwath (HK) CPA Limited, has audited the effectiveness of our internal controls over financial reporting as of December 31, 2013, as stated in their report which appears on pages F-1 of this annual report on Form 10-K.

 

56
 

 

Changes in Internal Controls

 

In addition, no change in our internal control over financial reporting (as defined in Rules 13a-15 or 15d-15 under the 1934 Act) occurred during the fourth quarter of the year ended December 31, 2013, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

ITEM 9B. OTHER INFORMATION

 

None.

 

57
 

 

PART III

 

ITEM 10.     DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

Directors and Executive Officers

 

The following table sets forth information about our directors and executive officers as of March 13, 2014.

 

Name   Age   Position
         
Jianhua Zhu   52   Chief Executive Officer, President and Director
         
Daphne Huang   43   Chief Financial Officer and Treasurer
         
Yaying Wang   51   Chief Operating Officer, Secretary and Director
         
Robert C. Bruce*   51   Independent Director
         
Jonathan P. Serbin*   44   Independent Director
         
Kelvin Lau*   51   Independent Director

 

* Indicates member of Audit, Nominating and Corporate Governance Committee and Compensation Committee.

 

Our directors are appointed for a one-year term to hold office until the next annual meeting of our stockholders or until they resign or are removed from office in accordance with our bylaws. Our officers serve at the discretion of our Board of Directors.

 

Set forth below is information regarding certain significant employees.

 

Name   Age   Position
         
Yingchun Han   44   General Manager of Lihua Electron
         
Junying Zhu   35   VP of Sales and Marketing

 

Set forth below are the respective principal occupations or brief employment histories of each of our directors and the periods during which each has served as a director of the Company, as well as for our named executive officers and certain significant employees.

 

Jianhua Zhu, President and Chief Executive Officer of the Company and the Chairman of the Board of Directors. Mr. Zhu has served as a director of the Company since October 31, 2008. Mr. Zhu has over 20 years of experience in the PRC’s copper industry. From Lihua Electron’s inception in October 1999 and from Lihua Copper’s inception in September 2007 until June 6, 2008, Mr. Zhu served as the sole member of the board of directors. Mr. Zhu currently serves as the Executive Director of Lihua Electron and Lihua Copper. In addition to overall management of the Company, Mr. Zhu is responsible for corporate and product development and governmental regulations. As our founder and CEO, we believe that Mr. Zhu’s extensive experience in the copper industry provides him with significant insights into our business, which make him qualified to be the Chairman of our Board of Directors.

 

58
 

 

Daphne Huang, Chief Financial Officer and Treasurer. Ms. Huang has served as Chief Financial Officer and Treasurer since October 23, 2011 and as Executive Vice President of Finance and Director of Investor Relations since October 2009. From April 2003 through February 2009, Ms. Huang worked at GE Capital Markets, Inc., a broker dealer, where she served as Assistant Vice President and then Vice President of the Debt Capital Markets group and was responsible for debt product structuring and syndication in the U.S. capital markets. From 2000 to 2002, Ms. Huang was an Associate and then a Senior Associate at Fleet Securities, Inc., an investment bank that was acquired by Bank of America. Ms. Huang also served as a Senior Auditor in the Capital Markets Group of PriceWaterhouseCoopers from 1997 to 2000, an Equity Research Analyst at SG Cowen & Company from 1996 to 1997 and a Financial Analyst at Morgan Stanley Dean Witter from 1995 to 1996. Ms. Huang earned an MBA in Finance and Management from the Leonard N. Stern School of Business at New York University, a BBA in Accounting from Baruch College, and holds an inactive CPA license in the State of New York. She is also fluent in Mandarin.

 

Yaying Wang, Chief Operating Officer and a member of the Board of Directors. Ms. Wang has served as a director of the Company, Secretary and COO since October 31, 2008. Ms. Wang has over 20 years of experience in the PRC’s copper industry. Ms. Wang has strong technical knowledge of copper and extensive industry relationships. In addition to her responsibilities as COO, Ms. Wang is responsible for the Sales and Production Departments. We believe that Ms. Wang’s extensive experience in the copper industry provides her with significant insights into our business, which are needed by our Board of Directors.

 

Robert C. Bruce, Independent Director. Mr. Bruce has served as a director of the Company since April 14, 2009. Mr. Bruce is Founder and CEO of Zylo Media, LLC, an early stage digital advertising and marketing company headquartered in Portland, Maine. Mr. Bruce also serves as President of Oakmont Advisory Group, LLC, a financial and operational management consulting firm located in Portland, Maine. Prior to founding Oakmont Advisory Group, from 1999 through 2004, Mr. Bruce served as Chief Operating Officer, Treasurer and Director for Enterix Inc., a privately-held, venture-funded medical device and laboratory services company that was purchased by Quest Diagnostics. He also previously served as Chief Financial Officer for Advantage Business Services (1997 to 1998), a privately-held national payroll processing and tax filing business that was subsequently acquired by PayChex. Mr. Bruce previously served as a member of the board of directors of ImmuCell Corporation (NASDAQ: ICCC) and China North East Petroleum Holdings Ltd. (NYSE Amex: NEP). Mr. Bruce received his MBA from the Yale School of Management, and a Bachelor of Arts degree in East Asian Studies from Princeton University. Mr. Bruce is proficient in written and spoken Mandarin. We believe that Mr. Bruce’s experience as a former director of two other public companies and his extensive finance experience provides him with a unique and valuable perspective from which he helps advise the Board of Directors.

 

Jonathan P. Serbin, Independent Director. Mr. Serbin has served as a director of the Company since April 14, 2009. Mr. Serbin has been the head of Asia Investment Banking of Mesa Global since 2012. Prior to that he was the head of Media and Telecom Investment Banking Asia division for Oppenheimer & Co. from October 2010 until October 2012. From January 2007 until October 2010, he was the Chief Executive Officer of D Mobile, Inc., a seller of mobile content in the PRC. Mr. Serbin holds a B.A. from Washington University, St. Louis, a J.D. from Boston University and an MBA from Columbia University. Mr. Serbin is proficient in spoken Mandarin. We believe that Mr. Serbin’s significant experience in senior management, extensive finance experience and familiarity with working in the PRC provides him with a unique and valuable perspective from which he helps advise the Board of Directors.

 

Siu Ki “Kelvin” Lau, Independent Director.  Mr. Lau has served as a director of the Company since October 20, 2009. Mr. Lau has substantial experience in capital markets, corporate finance, investments and mergers & acquisitions, particularly in the Asia Pacific region. He has worked for a few international and regional investment banks since 1990 and has been providing advisory service to listed and private companies with regard to public listing, corporate takeover, equity fund raising and other corporate activities. From January 1990 to May 1993, Mr. Lau worked for a leading local investment bank in Hong Kong. During May 1993 and May 1997, he worked as a director for a European investment bank, and since May 1997, he has been working for Asian investment banks with global network. Mr. Lau was Managing Director of DBS Asia Capital Limited during April 2002 and December 2008. Since December 2008, he has been working in the Equity Capital Markets and Corporate Finance department of Mizuho Securities Asia Limited, which is a major Japanese investment banking and securities company with global distribution network.  Mr. Lau is a fellow member of the Chartered Association of Certified Accountants of the United Kingdom and a member of the Hong Kong Institute of Certified Public Accountants. He majored in economies. Mr. Lau has language skills in English and Chinese, including Mandarin and Cantonese, and is currently based in Hong Kong and principally covers fund raising and corporate activities of listed and private companies in the Greater China region. We believe that Mr. Lau’s strong exposure in investment banking, corporate finance and corporate governance and his substantial experience of working with PRC corporates provides him with a unique and valuable perspective as an important member of the Board of Directors.

 

59
 

 

Significant Employees

 

Yingchun Han, Vice President. Mr. Han has served as the Vice President of Lihua Electron since July 2013. Mr. Han has over 20 years’ experience working in the cable and wire metals industry in China. He has held executive management positions with a number of cable and wire manufacturers prior to joining our company. Prior to joining Lihua Electron, Mr. Han was the Chief Operating Officer of Jiangsu Huijingyuan Metal Material Ltd. from January 2013 to June 2013. From 2010 to 2012, Mr. Han was the Chief Operating Officer of Changzhou Minhao New Metal Materials Ltd. From 2006 to 2010, Mr. Han was Vice President of Changzhou Suyun Electric Ltd. Earlier in his career, Mr. Han held vice president positions in three companies in the materials and metals manufacturing industry. Mr. Han graduated from Jiangsu Teacher’s University in 1992.

 

Junying Zhu, VP of Sales and Marketing. Ms. Zhu has served as the VP of sales of Lihua Electron since its inception in 1999. Ms. Zhu has more than 10 years working experience in Copper Clad Aluminum magnet wire industry. She had held various executive management positions since Lihua Electron was established, including VP of operations, from 2001 to 2005. During her career, Ms. Zhu has focused on the business development, strategic market planning, key account management, contract negotiation and loss prevention. Ms. Zhu graduated from Changzhou Accounting College with a degree in marketing.

  

Family Relationships

 

Mr. Jianhua Zhu, our Chief Executive Officer, President and Chairman, and Ms. Yaying Wang, our Chief Operating Officer and a director, are married. There are no other family relationships among our executive officers, directors and significant employees.

 

Involvement in Certain Legal Proceedings

 

To the best of our knowledge, there have been no events under any bankruptcy act, no criminal proceedings and no judgments, injunctions, orders or decrees material to the evaluation of the ability and integrity of any director, executive officer, promoter or control person of our Company during the past ten years.

 

Corporate Governance

 

Board Leadership Structure

 

The Board of Directors believes that Mr. Zhu’s service as both Chairman of the Board and Chief Executive Officer is in the best interest of the Company and its stockholders. Mr. Zhu possesses detailed and in-depth knowledge of the issues, opportunities and challenges facing the Company and its business and is thus best positioned to develop agendas that ensure that the Board’s time and attention are focused on the most critical matters. His combined role enables decisive leadership, ensures clear accountability, and enhances the Company’s ability to communicate its message and strategy clearly and consistently to the Company’s stockholders, employees, customers and suppliers.

 

The board has not designated a lead director. Given the limited number of directors comprising the board, the independent directors call and plan their executive sessions collaboratively and, between board meetings, communicate with management and one another directly. In the circumstances, the directors believe that formalizing in a lead director functions in which they all participate might detract from rather than enhance performance of their responsibilities as directors.

 

60
 

 

Risk Oversight

 

The Board of Directors is responsible for the oversight of risk management related to the company and its business and accomplishes this oversight through regular reporting by the Audit Committee. The Audit Committee assists the Board of Directors by periodically reviewing the accounting, reporting and financial practices of the company, including the integrity of our financial statements, the surveillance of administrative and financial controls and the Company’s compliance with legal and regulatory requirements. Through its regular meetings with management, including the finance and internal audit functions, the Audit Committee reviews and discusses all significant areas of our business, including credit policies, inventory management practices, internal controls, accounting policies and procedures and summarizes for the Board of Directors areas of risk and the appropriate mitigating factors.

 

Board Practices

 

Our business and affairs are managed under the direction of our board of directors. The primary responsibilities of our board of directors are to provide oversight, strategic guidance, counseling and direction to our management.

 

Board Committees and Independence

 

The Board of Directors has an Audit Committee, Nominating and Corporate Governance Committee and a Compensation Committee, each of which was formed on April 14, 2009. Our board of directors has determined that Robert C. Bruce, Jonathan P. Serbin, and Kelvin Lau, the members of these committees, are “independent” under the current independence standards of Rule 5605(a)(2) of the Marketplace Rules of The NASDAQ Stock Market, LLC and meet the criteria for independence set forth in Rule 10A(m)(3) under the U.S. Securities Exchange Act of 1934, as amended (the “Exchange Act”). Our board of directors has also determined that these persons have no material relationships with us — either directly or as a partner, stockholder or officer of any entity — which could be inconsistent with a finding of their independence as members of our board of directors.

 

Audit Committee

 

Our audit committee was established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended. The audit committee members consist of Robert C. Bruce, Jonathan P. Serbin and Kelvin Lau. Each of these members would be considered “independent” as defined by Rule 5605 of NASDAQ’s Marketplace Rules, as determined by our board of directors. During the fiscal year ended December 31, 2013, the Audit Committee met 4 times.

 

The audit committee oversees our financial reporting process on behalf of the board of directors. The committee’s responsibilities include the following functions:

 

·approve and retain the independent auditors to conduct the annual audit of our books and records;
·review the proposed scope and results of the audit;
·review and pre-approve the independent auditors’ audit and non-audited services rendered;
·approve the audit fees to be paid;
·review accounting and financial controls with the independent auditors and our internal auditors and financial and accounting staff;
·review and approve transactions between us and our directors, officers and affiliates;
·recognize and prevent prohibited non-audit services; and
·meet separately and periodically with management and our internal auditor and independent auditors.

 

The Audit Committee operates under a written charter, which is available at our website at http://www.lihuaintl.com. Robert C. Bruce serves as the Chairman of our Audit Committee.

 

Our board of directors has determined that we have at least one audit committee financial expert, as defined by the rules and regulations of the SEC and NASDAQ, serving on our audit committee, and that Robert C. Bruce is the “audit committee financial expert”. We have also determined that Robert C. Bruce is “independent” under the current independence standards of Rule 5606(a)(2) of the Marketplace Rules of The NASDAQ Stock Market, LLC and meets the independence criteria set forth in Rule 10A(m)(3) of the U.S. Securities Exchange Act of 1934, as amended.

 

61
 

 

Audit Committee Report

 

The role of the Audit Committee is to assist the Board of Directors in its oversight of the Company’s financial reporting process. As set forth in the Charter, management of the Company is responsible for the preparation, presentation and integrity of the Company’s financial statements, accounting and financial reporting principles and internal controls and procedures designed to assure compliance with accounting standards and applicable laws and regulations. The independent auditors are responsible for auditing the Company’s financial statements and expressing an opinion as to their conformity with generally accepted accounting principles.

 

In the performance of this oversight function, the Audit Committee has reviewed and discussed the audited financial statements for the fiscal year ended December 31, 2013 with management, and has discussed with the independent auditors the matters required to be discussed by Statement of Auditing Standards No. 61, Communication with Audit Committee, as currently in effect. The Audit Committee has received the written disclosures and the letter from the independent auditors required by Independence Standards Board Standard No. 1, Independence Discussions with Audit Committees, as currently in effect, and has discussed with the independent auditors the independent auditors’ independence; and based on the review and discussions referred above, the Audit Committee recommended to the Board of Directors that the audited financial statements be included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013 for filing with the SEC.

 

The members of the Audit Committee are not professionally engaged in the practice of auditing or accounting, are not experts in the fields of accounting or auditing, including in respect of auditor independence. Members of the Committee rely without independent verification on the information provided to them and on the representations made by management and the independent accountants. Accordingly, the Audit Committee’s oversight does not provide an independent basis to determine that management has maintained appropriate accounting and financial reporting principles or appropriate internal control and procedures designed to assure compliance with accounting standards and applicable laws and regulations. Furthermore, the Audit Committee’s consideration and discussions referred to above do not assure that the audit of the Company’s financial statements has been carried out in accordance with generally accepted accounting principles or that the Company’s auditors are in fact “independent”.

 

Based upon the reports, review and discussions described in this report, and subject to the limitations on the role and responsibilities of the Committee referred to above and in the Charter, the Committee recommended to the Board that the audited financial statements be included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, be filed with the Securities and Exchange Commission.

 

The members of the Audit Committee are:

Robert. C. Bruce

Jonathan P. Serbin

Kelvin Lau

 

Nominating and Corporate Governance Committee

 

The Nominating and Governance Committee is responsible for identifying potential candidates to serve on our board and its committees. The committee’s responsibilities include the following functions:

 

·making recommendations to the board regarding the size and composition of the board;
·identifying and recommending to the board nominees for election or re-election to the board, or for appointment to fill any vacancy;
·establishing procedures for the nomination process;
·advising the board periodically with respect to corporate governance matters and practices, including periodically reviewing corporate governance guidelines to be adapted by the board; and
·establishing and administering a periodic assessment procedure relating to the performance of the board as a whole and its individual members.

 

62
 

 

Each of Messrs. Bruce, Serbin and Lau are the members of the Nominating and Corporate Governance Committee. The Nominating and Corporate Governance Committee operate under a written charter, which is available on our website at http://www.lihuaintl.com. Mr. Lau is the Chairman of the Nominating and Corporate Governance Committee. During the fiscal year ended December 31, 2013, the Nominating and Corporate Governance Committee met 4 times and acted by written consent one time.

 

The Nominating and Corporate Governance Committee will consider director candidates recommended by security holders. Potential nominees to the Board of Directors are required to have such experience in business or financial matters as would make such nominee an asset to the Board of Directors and may, under certain circumstances, be required to be “independent”, as such term is defined under Rule 5605 of the listing standards of NASDAQ and applicable SEC regulations. Security holders wishing to submit the name of a person as a potential nominee to the Board of Directors must send the name, address, and a brief (no more than 500 words) biographical description of such potential nominee to the Nominating and Corporate Governance Committee at the following address: Kelvin Lau, Chairman, Nominating and Corporate Governance Committee, Lihua International, Inc., GPO Box 5247, Hong Kong. Potential director nominees will be evaluated by personal interview, such interview to be conducted by one or more members of the Nominating and Corporate Governance Committee, and/or any other method the Nominating and Corporate Governance Committee deems appropriate, which may, but need not, include a questionnaire. The Nominating and Corporate Governance Committee may solicit or receive information concerning potential nominees from any source it deems appropriate. The Nominating and Corporate Governance Committee need not engage in an evaluation process unless (i) there is a vacancy on the Board of Directors, (ii) a director is not standing for re-election, or (iii) the Nominating and Corporate Governance Committee does not intend to recommend the nomination of a sitting director for re-election. A potential director nominee recommended by a security holder will not be evaluated differently from any other potential nominee. Although it has not done so in the past, the Nominating and Corporate Governance Committee may retain search firms to assist in identifying suitable director candidates.

 

The Board does not have a formal policy on Board candidate qualifications. The Board may consider those factors it deems appropriate in evaluating director nominees made either by the Board or stockholders, including judgment, skill, strength of character, experience with businesses and organizations comparable in size or scope to the Company, experience and skill relative to other Board members, and specialized knowledge or experience. Depending upon the current needs of the Board, certain factors may be weighed more or less heavily. In considering candidates for the Board, the directors evaluate the entirety of each candidate’s credentials and do not have any specific minimum qualifications that must be met. “Diversity,” as such, is not a criterion that the Committee considers. The directors will consider candidates from any reasonable source, including current Board members, stockholders, professional search firms or other persons. The directors will not evaluate candidates differently based on who has made the recommendation.

 

Compensation Committee

 

The Compensation Committee is responsible for making recommendations to the board concerning salaries and incentive compensation for our officers and employees and administers our stock option plans. Its responsibilities include the following functions:

 

·reviewing and recommending policy relating to the compensation and benefits of our officers and employees, including reviewing and approving corporate goals and objectives relevant to the compensation of our chief executive officer and other senior officers; evaluating the performance of these officers in light of those goals and objectives; and setting compensation of these officers based on such evaluations;

 

·administering our benefit plans and the issuance of stock options and other awards under our stock plans; and reviewing and establishing appropriate insurance coverage for our directors and executive officers;

 

·recommending the type and amount of compensation to be paid or awarded to members of our board of directors, including consulting, retainer, meeting, committee and committee chair fees and stock option grants or awards; and

 

·reviewing and approving the terms of any employment agreements, severance arrangements, change-of-control protections and any other compensatory arrangements for our executive officers.

 

63
 

 

Each of Messrs. Bruce, Serbin and Lau are the members of the Compensation Committee. The Compensation Committee operates under a written charter, which is available on our website at http://www.lihuaintl.com. Mr. Serbin is Chairman of Compensation Committee. Our executive officers have no formal role in suggesting their salaries. During the fiscal year ended December 31, 2013, the Compensation Committee met one time and acted by written consent one time.

 

Compensation Committee Report

 

The goal of the Company’s executive compensation policy is to ensure that an appropriate relationship exists between executive compensation and the creation of stockholder value, while at the same time attracting, motivating and retaining experienced executive officers.

 

The Compensation Committee has reviewed and discussed the discussion and analysis of the Company’s compensation which appears in Item 11 below with management, and, based on such review and discussion, the Compensation Committee recommended to the Company’s Board of Directors that the above disclosure be included in this Annual Report on Form 10-K for the year ended December 31, 2013.

 

Compensation Committee Interlocks and Insider Participation

 

No member of our Compensation Committee has at any time been an officer or employee of ours or our subsidiaries. No interlocking relationship exists between our Board of Directors or Compensation Committee and the Board of Directors or Compensation Committee of any other company, nor has any interlocking relationship existed in the past.

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, requires our executive officers, directors and persons who beneficially own more than 10% of a registered class of our equity securities to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of our common stock and other equity securities. These executive officers, directors, and greater than 10% beneficial owners are required by SEC regulation to furnish us with copies of all Section 16(a) forms filed by such reporting persons.

 

Based solely on our review of such forms furnished to us and written representations from certain reporting persons, we believe that all filing requirements applicable to our executive officers, directors and greater than 10% beneficial owners were complied with during 2013; except that the following Section 16 reports were filed late in 2013:

 

a) Mr. Robert Bruce filed a late Form 4 to reflect the issuance of options to purchase up to 20,000 shares issued on May 30, 2013;

b) Mr. Jonathan Serbin filed a late Form 4 to reflect the issuance of options to purchase up to 20,000 shares issued on May 30, 2013; and

c) Mr. Kelvin Lau filed a late Form 4 to reflect the issuance of options to purchase up to 20,000 shares issued on May 30, 2013.

  

Code of Ethics

 

We adopted a Corporate Code of Ethics and Conduct on December 31, 2007. The Code of Ethics is designed to deter wrongdoing and to promote ethical conduct and full, fair, accurate, timely and understandable reports that the Company files or submits to the Securities and Exchange Commission and others. A copy of the Code of Ethics is included as Exhibit 14.1 to our Annual Report on Form 10-KSB, filed with the SEC on February 26, 2008. A copy of the Code of Ethics is available on our website at www.lihuaintl.com. A printed copy of the Code of Ethics may also be obtained free of charge by writing to us at our headquarters located at Houxiang Minying Industrial Park, Danyang City, Jiangsu Province, PRC 212312.

 

Meetings of the Board and Committees

 

During the fiscal year ended December 31, 2013, the Board of Directors met 4 times and took action by written consent on two occasions. All of the directors participated in the board meetings. Each director is expected to participate, either in person or via teleconference, in meetings of our Board of Directors and meetings of committees of our Board of Directors in which each director is a member, and to spend the time necessary to properly discharge such director’s respective duties and responsibilities. We do not have a written policy with regard to directors’ attendance at annual meetings of stockholders; however, all directors are encouraged to attend the annual meeting and all directors attended our 2013 Annual Meeting of Stockholders.

 

64
 

 

Communications with the Board of Directors

 

Stockholders can mail communications to the Board of Directors, c/o Hao Du, VP and Board Secretary, Lihua International, Inc., Houxiang Minying Industrial Park, Danyang City, Jiangsu Province, PRC 212312, who will forward the correspondence to each addressee.

 

ITEM 11.     EXECUTIVE COMPENSATION

 

Compensation Discussion and Analysis

 

We strive to provide our named executive officers with a competitive base salary that is in line with their roles and responsibilities.

 

We believe that other peer companies in the PRC which are listed on U.S. stock markets would be the most appropriate to use for salary comparison purposes. However, none of our direct competitors are public companies in the U.S. We have looked at Fushi International (Dalian) Bimetallic Cable Co., Ltd., one of our past suppliers, which, until December 2012, was listed on the Nasdaq Stock Market. The salaries of Fushi’s CEO and CFO were $225,000 and $180,000 per year, respectively. Fushi’s CEO and CFO were each entitled to 100% cash bonuses, according to their compensation plan. In addition, Fushi’s CFO was awarded 30,000 shares of stock and 150,000 stock options. Fushi had lower revenues than we did and therefore, taking this into consideration, we believe that the compensation of our executive officers is appropriate.

 

It is not uncommon for companies with operations primarily in the PRC to have base salaries and bonuses as the sole and only form of compensation. The base salary level is established and reviewed based on the level of responsibilities, the experience and tenure of the individual and the current and potential contributions of the individual. The base salary is compared to similar positions within comparable peer companies and with consideration of the executive’s relative experience in his or her position. Based on an evaluation of available information with respect to the base salaries of executives of our competitors, the base salary and bonus paid to our named executive officers is in line with our competitors. Base salaries are reviewed periodically and at the time of promotion or other changes in responsibilities.

 

On April 14, 2009, the Company adopted the Lihua International, Inc. 2009 Omnibus Securities and Incentive Plan (the “2009 Plan”). The 2009 Plan includes: Distribution Equivalent Rights, Options, Performance Share Awards, Performance Unit Awards, Restricted Stock Awards, Restricted Stock Unit Awards, Stock Appreciation Rights, Tandem Stock Appreciation Rights, Unrestricted Stock Awards or any combination of the foregoing. We will consider other elements of compensation, including without limitation, short and long term compensation, cash and non-cash, and other equity-based compensation. We believe our current compensation package is comparative to our peers in the industry and aimed to retain and attract talented individuals.

 

Summary Compensation Table

 

The following table sets forth the compensation paid or accrued by us for each of the Company’s last three completed fiscal years to our Chief Executive Officer and each of our three other officers whose compensation exceeded $100,000.

 

65
 

 

Name and
Principal
Position
(1)
  Fiscal
Year
   Salary
($)(1)
   Bonus
($)
   Stock
Awards
($)
   Option
Awards
(4)
($)
   Non-equity
Incentive
Plan
Compensation
($)
   Change in
Pension
Value and
Nonqualified
Deferred
Compensation
Earnings
($)
   All
Other
Compensation
($)
   Total
($)
 
                                     
Mr. Jianhua Zhu,   2013    250,000    -0-    -0-    -0-    -0-    -0-    -0-    250,000 
CEO and President (2)   2012    250,000    -0-    -0-    -0-    -0-    -0-    -0-    250,000 
    2011    191,667    -0-    -0-    -0-    -0-    -0-    -0-    191,667 
                                              
Ms. Daphne Huang,   2013    200,000    -0-    -0-    -0-    -0-    -0-    -0-    200,000 
Chief Financial Officer (3)   2012    200,000    -0-    -0-    -0-    -0-    -0-    -0-    200,000 
    2011    116,667    15,000    -0-    334,286    -0-    -0-    -0-    465,953 
                                              
Ms. Yaying Wang,   2013    200,000    -0-    -0-    -0-    -0-    -0-    -0-    200,000 
Chief Operating Officer (2)   2012    200,000    -0-    -0-    -0-    -0-    -0-    -0-    200,000 
    2011    158,333    -0-    -0-    -0-    -0-    -0-    -0-    158,333 

 

(1) Some of our named executive officers reside in the PRC and therefore may receive their annual compensation in RMB.
(2) Mr. Zhu and Ms. Wang entered into new employment agreements with the Company on October 23, 2011. Therefore, their salaries for the fiscal year ended December 31, 2011 are pro-rated in U.S. dollars from based on their salaries received before and after October 23, 2011.
(3) Ms. Huang was named as Chief Financial Officer on October 23, 2011. Therefore, Ms. Huang’s salary as Chief Financial Officer and Treasurer is pro-rated in U.S. dollars from October 23, 2011 through December 31, 2011. Ms. Huang’s compensation also includes those amounts received in her capacity as Executive Vice President of Finance and Director of Investor Relations from October 31, 2009 through October 22, 2011.
(4) Reflects the aggregate grant date fair value of stock awards determined in accordance with ASC Topic 718.

 

Employment Contracts and Termination of Employment, and Change-In-Control 

 

The following employment agreements were entered into by the Company’s PRC subsidiaries and the following executive officers:

 

Jianhua Zhu

 

The Company’s PRC subsidiaries entered into an employment agreement with Jianhua Zhu on June 24, 2008 to serve as Chief Executive Officer and a member of the board of directors for a term of three (3) years. Pursuant to the agreement, Mr. Zhu was to receive annual compensation equal to $180,000. In addition, Mr. Zhu was entitled to participate in any and all benefit plans, from time to time, in effect for employees, along with vacation, sick and holiday pay in accordance with policies established and in effect from time to time. In the event that either of the PRC Subsidiaries terminate the employment agreement without cause (as defined therein), Mr. Zhu was entitled to a severance payment of one year’s salary from the date of termination plus all medical and dental benefits for that time period as well. In addition, if he is no longer employed by the Company, Mr. Zhu had agreed that neither he, nor any of his affiliates shall directly or indirectly employ, solicit, or induce any individual, consultant, customer or supplier who is, or was at any time during the one year period prior to his termination date, an employee or consultant of the Company, a customer of the Company or a supplier of the Company, cause such employee, consultant, customer or supplier to refrain from continuing their relationship with the Company. Mr. Zhu had also agreed to a non-compete clause whereby he shall not engage or assist others to engage in related businesses within Beijing and Danyang, PRC, the prescribed territory, however, he might own up to 5% of the outstanding shares of a company engaged in a similar business if such shares are listed on a national securities exchange. On September 26, 2008, Mr. Zhu entered in an amendment to the Employment Agreement with the PRC Subsidiaries whereby certain clerical errors were corrected.

 

66
 

 

On October 23, 2011, Mr. Zhu entered into a 3 year employment agreement with the Lihua Electron. All of the material terms of this agreement are identical to the prior agreement, except that Mr. Zhu shall receive annual cash compensation of $250,000.

 

Daphne Huang

 

The Company entered into an employment agreement with Daphne Huang on October 23, 2011, to serve as Chief Financial Officer. The agreement is for a one-year term, renewable annually at the Company’s option up to an additional two years. Ms. Huang will receive annual cash compensation of $200,000 and will be awarded a stock option to purchase up to 225,000 shares of common stock at $4.50 per share, which shall vest in equal installments on October 22, 2012, 2013 and 2014, so long as Ms. Huang is serving as CFO at each such time. Additionally, Ms. Huang received a one-time signing bonus of $15,000. Pursuant to the agreement, Ms. Huang must devote all of her time during business hours to the Company and is subject to non-compete, non-interference and non-solicitation covenants during the term of her employment with the Company and for one year subsequent to the termination of her employment with the Company. In the event that Ms. Huang’s employment was terminated by the Company without cause, by Ms. Huang for good reason, or by her death or disability, Ms. Huang would be entitled to continue to receive severance pay equal to her base salary for a period of six months after the termination date, subject to her entry into a separation agreement and general release with the Company.

 

Yaying Wang

 

The Company’s PRC subsidiaries entered into an employment agreement with Yaying Wang on June 24, 2008 to serve as Chief Operating Officer and a member of the board of directors for a term of three (3) years. Pursuant to the agreement, Ms. Wang was to receive annual compensation equal to $150,000. In addition, Ms. Wang was entitled to participate in any and all benefit plans, from time to time, in effect for employees, along with vacation, sick and holiday pay in accordance with policies established and in effect from time to time. In the event that either of the PRC Subsidiaries terminate the employment agreement without cause (as defined therein), Ms. Wang would be entitled to a severance payment of one year’s salary from the date of termination plus all medical and dental benefits for that time period as well. In addition, if she is no longer employed by the Company, Ms. Wang had agreed that neither she, nor any of her affiliates shall directly or indirectly employ, solicit, or induce any individual, consultant, customer or supplier who is, or was at any time during the one year period prior to her termination date, an employee or consultant of the Company, a customer of the Company or a supplier of the Company, cause such employee, consultant, customer or supplier to refrain from continuing their relationship with the Company. Ms. Wang had also agreed to a non-compete clause whereby she shall not engage or assist others to engage in related businesses within Beijing and Danyang, PRC, the prescribed territory, however, she may own up to 5% of the outstanding shares of a company engaged in a similar business if such shares are listed on a national securities exchange. On September 26, 2008, Ms. Wang entered in an amendment to the Employment Agreement with the PRC Subsidiaries whereby certain clerical errors were corrected.

 

On October 23, 2011, Ms. Wang entered into a 3 year employment agreement with the Company’s PRC subsidiaries. All of the material terms of this agreement are identical to the prior agreement, except that Ms. Wang shall receive annual cash compensation of $200,000.

 

Potential Payments upon Termination or Change in Control

 

Assuming the employment of our named executive officers were to be terminated without cause or for good reason, as of December 31, 2013, the following individuals would have been entitled to payments in the amounts set forth opposite to their name in the below table through December 31, 2013:

 

Cash Payments     
Mr. Jianhua Zhu  $250,000(1)
Daphne Huang  $100,000(1)
Ms. Yaying Wang  $200,000(1)

 

67
 

 

(1) Subject compliance with non-solicitation, non-compete, non-disclosure and non-use provisions of the executive’s employment agreement, as well as a general release.

 

Grants of Plan-Based Awards

 

The following table sets forth information regarding each award made to the named executive officers, under the Company’s 2009 Omnibus Securities and Incentive Plan during 2012.

 

2013 GRANTS OF PLAN-BASED AWARDS

 

There were no grants of plan-based awards in 2013.

 

Equity Compensation Plan Information

 

The following table summarizes our plan-based awards as of December 31, 2013.

 

Plan Category  Number of
Securities
To Be Issued
Upon
Exercise of
Outstanding
Options,
Warrants and
Rights
(a)
   Weighted-
Average
Exercise
Price of
Outstanding
Options,
Warrants
and Rights
(b)
   Number of
Securities
Remaining
Available for
Future Issuance
Under
Equity
Compensation
Plans (Excluding
Securities Reflected
in
Column (a))
(c)
 
Equity compensation plans approved by security holders   -0-    -0-    -0- 
Equity compensation plans not approved by security holders:               
Options to purchase common stock   665,000   $5.41    2,338,191(1)
Warrants to purchase common stock   28,456   $4.80    -0- 
Total   693,456   $5.38    2,338,191 

 

(1) Based on 10% of the aggregate number of shares of the Common Stock outstanding as of December 31, 2013, less aggregate options issued and outstanding as of December 31 2013, pursuant to Section 5.1 of the 2009 Omnibus securities and Incentive Plan.

 

Equity Compensation Plans not approved by Security Holders

 

The Company’s Board of Directors adopted the 2009 Plan on April 14, 2009. The 2009 Plan is described in detail under “The Lihua International, Inc. 2009 Omnibus Securities and Incentive Plan” below.

 

The Lihua International, Inc. 2009 Omnibus Securities and Incentive Plan

 

Administration. The 2009 Plan is administered by the compensation committee of the board of directors, which consists of three members of the board of directors, each of whom is a “non-employee director” within the meaning of Rule 16b-3 promulgated under the Exchange Act, an “outside director” within the meaning of Code Section 162(m) and “independent” for purposes of any applicable listing requirements. Among other things, the compensation committee has discretion, subject to the express limits of the 2009 Plan, to determine which directors, employees and independent contractors are to be granted an award under the 2009 Plan, the type of award to be granted, the terms and conditions of each award, the number of shares of common stock subject to each award, the exercise price of each award which is a stock option and base price of each award which is a stock appreciation right (“SAR”), the term of each award, the vesting schedule for an award, whether to accelerate vesting, the value of the common stock, and to determine any required tax withholdings. The compensation committee may amend or modify any outstanding award, provided that the U.S. Participant’s consent to such action is required if the action would materially and adversely impair the rights or entitlements of the U.S. Participant. The compensation committee is also authorized to construe the award agreements, and may prescribe rules relating to the 2009 Plan.

 

68
 

 

Grant of Awards; Shares Available for Awards. The 2009 Plan provides for the grant of stock options, SARs, performance share awards, performance unit awards, distribution equivalent right awards, restricted stock awards, restricted stock unit awards and unrestricted stock awards in an amount not to exceed 10% of the aggregate number of shares of common stock issued and outstanding. If any award expires, is cancelled, or terminates unexercised or is forfeited, the shares subject thereto are again available for grant under the 2009 Plan. The number of shares of common stock for which awards may be granted under the 2009 Plan to a participant cannot exceed 100,000 shares in any calendar year.

 

Currently, there are 8 employees and directors who would be entitled to receive stock options and/or restricted shares under the 2009 Plan.  Future new hires and consultants would be eligible to participate in the 2009 Plan as well. The number of stock options and/or restricted shares to be granted to executives and directors cannot be determined at this time as the grant of stock options and/or restricted shares is dependent upon various factors such as hiring requirements and job performance.

 

Stock Options. Stock options granted under the 2009 Plan are “nonqualified stock options” (“NQSOs”). NQSOs may be granted on such terms and conditions as the Committee may determine; provided, however, that the per share exercise price of an NQSO may not be less than the fair market value of a share of the underlying common stock on the date of grant of the NQSO and the term of an NQSO may not exceed 10 years.

 

Stock Appreciation Rights. A SAR entitles the participant, upon exercise, to receive an amount, in cash or common stock or a combination thereof, equal to the increase in the fair market value of the underlying common stock between the date of grant and the date of exercise. SARs may be granted in tandem with, or independently of, NQSOs granted under the 2009 Plan. A SAR granted in tandem with an NQSO (i) is exercisable only at such times, and to the extent, that the related NQSO is exercisable in accordance with the procedure for exercise of the related NQSO; (ii) terminates upon termination or exercise of the related option (likewise, the option granted in tandem with a SAR terminates upon exercise of the SAR); and (iii) is transferable only upon surrender of the participant’s right to exercise the equivalent portion of the related NQSO. A SAR that is not granted in tandem with an NQSO is exercisable at such times as the compensation committee may specify.

 

Performance Shares or Performance Unit Awards. Performance share or performance unit awards awarded under the 2009 Plan entitle the participant to receive cash or shares of common stock upon the attainment of specified performance goals. In the case of performance units, the right to acquire the units is denominated in cash values.

 

Restricted Stock Awards or Restricted Stock Unit Award. A restricted stock award under the 2009 Plan is a grant or sale of common stock to the participant, subject to the Company’s right to repurchase all or part of the shares at their purchase price (or to require forfeiture of such shares if purchased at no cost) in the event that conditions specified by the compensation committee in the award are not satisfied prior to the end of the time period during which the shares subject to the award may be repurchased by or forfeited to the Company. A restricted stock unit entitles the participant to receive a cash payment equal to the fair market value of a share of common stock, or award under the 2009 Plan one share of common stock for each restricted stock unit subject to such restricted stock unit award, if the participant satisfies the applicable vesting requirement.

 

Unrestricted Stock Awards. An unrestricted stock award under the 2009 Plan is a grant or sale of common stock to the participant that is not subject to transfer, forfeiture or other restrictions.

 

69
 

 

Distribution Equivalent Right Awards. A distribution equivalent right award under the 2009 Plan entitles the participant to receive bookkeeping credits, cash payments and/or common stock distributions equal in amount to the distributions that would have been made to the participant had the participant held a specified number of shares of the common stock during the period the participant held the distribution equivalent right. A distribution equivalent right may be awarded under the 2009 Plan as a component of another award, where, if so awarded, such distribution equivalent right will expire or be forfeited by the participant under the same conditions as under such other award.

 

Change-of-Control Provisions. In connection with the grant of an award under the 2009 Plan, the compensation committee may provide that, in the event of a “change in control” (as defined in the 2009 Plan), any outstanding awards that are unexercisable or otherwise unvested will become fully vested and immediately exercisable.

 

Amendment and Termination. The Board of Directors may amend, suspend or terminate the 2009 Plan, but no amendment will be made that adversely affects any rights of a participant with respect to a previously granted award without the participant’s consent, other than amendments that are necessary to permit the granting of awards in compliance with applicable laws. We have attempted to structure the 2009 Plan so that remuneration attributable to stock options and other awards will not be subject to the deduction limitation contained in Section 162(m) of the Code.

 

Certain Federal Income Tax Consequences of the 2009 Plan.

 

The following is a general summary of the federal income tax consequences under current tax law to the Company and to participants in the 2009 Plan who are individual citizens or residents of the United States for federal income tax purposes (“U.S. Participants”) of stock options which are NQSOs, restricted stock, SARs, dividend equivalent rights, restricted stock units, performance shares, performance units and unrestricted stock awards. It does not purport to cover all of the special rules that may apply, including special rules relating to limitations on the ability of the Company to deduct certain compensation, special rules relating to deferred compensation, golden parachutes, participants subject to Section 16(b) of the Exchange Act or the exercise of a stock option with previously – acquired shares of common stock.  This summary assumes that U.S. Participants will hold their shares of common stock as capital assets within the meaning of Section 1221 of the Code.  In addition, this summary does not address the foreign, state or local income or other tax consequences, or any U.S. federal non-income tax consequences, inherent in the acquisition, ownership, vesting, exercise, termination or disposition of an award under the 2009 Plan, or shares of common stock issued pursuant thereto.  Participants are urged to consult with their own tax advisors concerning the tax consequences to them of an award under the 2009 Plan or shares of common stock issued thereto pursuant to the 2009 Plan.

 

A U.S. Participant generally does not recognize taxable income upon the grant of an NQSO. Upon the exercise of an NQSO, the U.S. Participant generally recognizes ordinary income in an amount equal to the excess, if any, of the fair market value of the shares acquired on the date of exercise over the exercise price thereof, and the Company will generally be entitled to a deduction for such amount at that time. If the U.S. Participant later sells shares acquired pursuant to the exercise of an NQSO, the U.S. Participant recognizes a long-term or short-term capital gain or loss, depending on the period for which the shares were held thereby. A long-term capital gain is generally subject to more favorable tax treatment than ordinary income or a short-term capital gain.  The deductibility of capital losses is subject to certain limitations.

 

A U.S. Participant generally does not recognize income upon the grant of a SAR. The U.S. Participant recognizes ordinary compensation income upon exercise of the SAR equal to the increase in the value of the underlying shares, and the Company will generally be entitled to a deduction for such amount.

 

A U.S. Participant generally does not recognize income on the receipt of a performance shares award, performance units award, restricted stock units award, unrestricted stock award or dividend equivalent rights award until a cash payment or a distribution of shares is received thereby. At such time, the U.S. Participant recognizes ordinary compensation income equal to the excess, if any, of the fair market value of the shares received over any amount paid for the shares thereby, and the Company is generally entitled to deduct such amount at such time.

 

A U.S. Participant who receives a restricted stock award generally recognizes ordinary compensation income equal to the excess, if any, of fair market value of such shares of stock at the time the restriction lapses over any amount paid thereby for the shares. Alternatively, the U.S. Participant may elect to be taxed on the fair market value of such shares at the time of this grant. The Company is generally entitled to a deduction at the same time and in the same amount as the income is required to be included by the U.S. Participant.

 

70
 

 

Outstanding Equity Awards at Fiscal Year-End

 

The following table summarizes the number of securities underlying outstanding plan awards for each named executive officer as of December 31, 2013.

 

   Option Awards   Stock Awards 
   Number of
Securities
Underlying
Unexercised
Options (#)
   Number of
Securities
Underlying
Unexercised
Options (#)
   Equity
Incentive
Plan
Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Options (#)
   Option
Exercise
Price ($)
   Option
Expiration
Date
   Number
of Shares
or Units
of Stock
That
Have Not
Vested (#)
   Market
Value of
Shares or
Units of
Stock
That
Have Not
Vested ($)
   Equity
Incentive Plan
Awards:
Number of
Unearned
Shares, Units
or Other
Rights That
Have Not
Vested (#)
   Equity
Incentive Plan
Awards:
Market or
Payout Value
of Unearned
Shares, Units
or Other
Rights That
Have Not
Vested ($)
 
Name  Exercisable   Unexercisable                             
Jianhua Zhu   -0-    -0-    -0-    -0-    -0-    -0-    -0-    -0-    -0- 
                                              
Daphne Huang   75,000         -0-   $4.50    10/23/2021    -0-    -0-    -0-    -0- 
    75,000         -0-   $4.50    10/23/2021    -0-    -0-    -0-    -0- 
         75,000    -0-   $4.50    10/23/2021    -0-    -0-    -0-    -0- 
Yaying Wang   -0-    -0-    -0-    -0-    -0-    -0-    -0-    -0-    -0- 

 

Option Exercises and Stock Vested

 

The following table summarizes stock option exercises by our named executive officers in 2013 and shares of restricted stock that vested in 2013.

 

   Option Awards   Stock Awards 
Name  Number of Shares
Acquired on
Exercise (#)
   Value
Realized on
Exercise
($)
   Number of Shares
Acquired on
Vesting (#)
   Value
Realized
on
Vesting
($))
 
Jianhua Zhu   -0-    -0-    -0-    -0- 
Daphne Huang   -0-    -0-    -0-    -0- 
Yaying Wang   -0-    -0-    -0-    -0- 

 

Pension Benefits

 

We do not sponsor any qualified or non-qualified defined benefit plans.

 

Nonqualified Deferred Compensation

 

We do not maintain any non-qualified defined contribution or deferred compensation plans.

 

Director Compensation

 

The following table summarizes compensation that our non-employee directors earned during 2013 for services as members of our board of directors.

 

71
 

 

Name  Fees Earned
or Paid in
Cash
($)
   Stock
Awards
($)
   Option
Awards(1)
($)
   Non-Equity
Incentive Plan
Compensation
($)
   Change in
Pension Value
and
Nonqualified
Deferred
Compensation
Earnings
($)
   All Other
Compensation
($)
   Total
($)
 
Robert C. Bruce(2)   63,000    -    41,467    -    -    -    104,467 
Jonathan P. Serbin(2)   51,000    -    41,467    -    -    -    92,467 
Kelvin Lau (2)(3)   51,000    -    41,467    -    -    -    92,467 

 

(1) Reflects the aggregate grant date fair value to option awards granted to the directors, determined in accordance with ASC Topic 718.
(2)

Pursuant to one-year agreements effective as of April 14, 2013, between the Company and each of Robert Bruce, Kelvin Lau and Jonathan Serbin, each of Messrs. Bruce, Lau and Serbin received an option to purchase up to 20,000 shares of common stock of the Company and an annual cash fee of $60,000 paid quarterly, beginning July 1, 2013 (prior to July 1, 2013, the annual rate has been $48,000 paid quarterly). Additionally, Mr. Bruce received quarterly, cash payments of $12,000 per year for serving as Chair of the Audit Committee.  The Company will also reimburse each of Messrs. Bruce, Lau and Serbin for (i) expenses related to his attending meetings of the Board of Directors, meetings of committees of the Board of Directors, executive sessions, stockholder meetings, and other Company-related travel, and (ii) up to $3,000 in expenses related to attending bona fide director education seminars that each director, in his discretion, may select.  The stock options granted to each of Messrs. Bruce, Lau and Serbin in 2013 have an exercise price of $5.60 per share, such options vesting in equal installments on July 14, 2013, October 14, 2013, January 14, 2014 and April 14, 2014, so long as each director is, respectively, serving as a member of the Board of Directors at each such time.

 

ITEM 12.     SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS

 

The following table sets forth as of March 13, 2014 the number of shares of our common stock beneficially owned by (i) each person who is known by us to be the beneficial owner of more than five percent of the Company’s common stock; (ii) each director; (iii) each of the named executive officers in the Summary Compensation Table; and (iv) all directors and executive officers as a group. As of March 13, 2014, we had 30,032,116 shares of common stock issued and outstanding.

 

Beneficial ownership is determined in accordance with SEC rules and generally includes voting or investment power with respect to securities. Unless otherwise indicated, the stockholders listed in the table have sole voting and investment power with respect to the shares indicated. Unless otherwise noted, the principal address of each of the stockholders, directors and officers listed below is c/o Lihua Holdings Limited, Houxiang Minying Industrial Park, Danyang City, Jiangsu Province, PRC 212312, China.

 

All share ownership figures include shares of our common stock issuable upon securities convertible or exchangeable into shares of our common stock within sixty (60) days of March 13, 2014 which are deemed outstanding and beneficially owned by such person for purposes of computing his or her percentage ownership, but not for purposes of computing the percentage ownership of any other person.

 

72
 

 

Name and Address of Beneficial Owner  Number of Shares of
Common Stock
Beneficially Owned (1)
   Percentage of
Outstanding Shares
of Common
Stock (2) (3)
 
           
Magnify Wealth Enterprises Limited (4)(5)   13,350,000    44.45%
           
Jianhua Zhu (5)   13,350,000    44.45%
           
Yaying Wang (6)   13,350,000    44.45%
           
Robert C. Bruce (7)   101,000    * 
           
Jonathan P. Serbin (8)   100,000    * 
           
Siu Ki “Kelvin” Lau (9)   95,000    * 
           
Daphne Huang (10)   165,000    * 
           
All Directors and Executive Officers, as a group (6 persons)   13,811,000    45.99%

   

* Less than one percent

 

(1) Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. Shares of Common Stock subject to securities anticipated to be exercisable or convertible at or within 60 days of the date hereof, are deemed outstanding for computing the percentage of the person holding such option or warrant but are not deemed outstanding for computing the percentage of any other person. The indication herein that shares are anticipated to be beneficially owned is not an admission on the part of the listed stockholder that he, she or it is or will be a direct or indirect beneficial owner of those shares.
(2) Based upon 30,032,116 shares of Common Stock outstanding as of March 13, 2014
(3) In determining the percent of Common Stock beneficially owned on March 13, 2014, (a) the numerator is the number of shares of Common Stock beneficially owned (including shares that the stockholder has the right to acquire within 60 days of March 13, 2014), and (b) the denominator is the sum of (i) the 30,032,116 shares outstanding on March 13, 2014, and (ii) the number of shares of Common Stock which such stockholder has the right to acquire within 60 days of March 13, 2014.
(4) The address of Magnify Wealth is Quastisky Building, P.O. Box 4389, Road Town, Tortola, British Virgin Islands. As the sole director of Magnify Wealth, Mr. Zhu, our CEO and President has sole voting and investment power over the shares.
(5) Includes 13,350,000 shares owned by Magnify Wealth, of which Mr. Zhu, as the sole director of Magnify Wealth, has sole voting and investment power over the shares. Mr. Zhu is deemed to beneficially own all of the 13,350,000 shares of common stock owned by Magnify Wealth as a result of the vesting in full of Mr. Zhu’s option to purchase all 3,000 shares of Magnify Wealth (the “Option Shares”) at $1.00 per share. While the option to purchase the Option Shares has vested in full, Mr. Zhu has not yet exercised the option.
(6) As Mr. Zhu’s wife, Ms. Wang is deemed to be the beneficial owner of all shares of common stock beneficially owned by Mr. Zhu as a result of the vesting of 100% of Mr. Zhu’s Option Shares. Ms. Wang disclaims beneficial ownership over the remaining 2,569,115 shares owned by Magnify Wealth over which Mr. Zhu has sole voting and investment power.

 

73
 

 

(7) Consists of 2,000 shares of common stock held by Mr. Bruce’s wife, 9,000 shares of common stock held directly by Mr. Bruce and 90,000 shares of common stock underlying options held by Mr. Bruce, which are exercisable in the next 60 days
(8) Consists of 100,000 shares of common stock underlying options, which are exercisable in the next 60 days.
(9) Consists of 95,000 shares of common stock underlying options, which are exercisable in the next 60 days.
(10) Consists of 165,000 shares of stock underlying options, which are exercisable in the next 60 days.

 

ITEM 13.     CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

(1) Sales

 

For the years ended December 31, 2013, 2012 and 2011, sales included nil, nil, and $620,295, respectively that were made from Tianyi Telecom.  The controlling stockholders of Tianyi Telecom are related to Ms. Yaying Wang, our COO and one of our directors.

 

(2) Loans

 

On May 19, 2011, Magnify Wealth, 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”). 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.

 

On January 9 and March 15, 2012, in order to partially fund the 2011 special dividend payment and U.S. dollar operating expenses, upon approval by our board of directors, Magnify Wealth loaned US$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 approval by our board of directors, Magnify Wealth loaned US$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 December 31, 2013, there was no outstanding loan under the Note.

 

74
 

 

(3)    Amount due to a related party

 

In June 2011, Mr. Jianhua Zhu loaned the Company $140,000. The loan was unsecured and non-interest bearing. The loan was repaid in August 2011.

 

It is Company’s policy to not enter any transaction (other than compensation arrangements in the ordinary course) with any director, executive officer, employee, or principal stockholder or party related to them, unless authorized by a majority of the directors having no interest in the transaction, upon a favorable recommendation by the Audit Committee (or a majority of its disinterested members).

 

Director Independence

 

Our board of directors has determined that Robert C. Bruce, Jonathan P. Serbin, and Kelvin Lau, the members of the Company’s audit, compensation and nominating and corporate governance committees, are “independent” under the current independence standards of Rule 5605(a)(2) of the Marketplace Rules of The NASDAQ Stock Market, LLC and meet the criteria for independence set forth in Rule 10A(m)(3) under the U.S. Securities Exchange Act of 1934, as amended (the “Exchange Act”). Our board of directors has also determined that these persons have no material relationships with us — either directly or as a partner, stockholder or officer of any entity — which could be inconsistent with a finding of their independence as members of our board of directors.

 

ITEM 14.     PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

Public Accounting Fees

 

The following chart sets forth public accounting fees paid and payable to Crowe Horwath (HK) CPA Limited (“Crowe”) during the years ended December 31, 2013 and 2012:

 

   2013   2012 
Audit Fees  $453,000   $453,000 
Audit Related Fees  $   $ 
Tax Fees  $   $ 
All Other Fees  $   $ 

 

Audit fees were for professional services rendered by Crowe for the audit of our annual financial statements and the review of the financial statements included in our quarterly reports on Forms 10-Q, and services that are normally provided by Crowe in connection with statutory and regulatory filings or engagements for that fiscal year.

 

Audit related fees consist of services provided by Crowe that are reasonably related to the performance of the audit or review of our financial statements and are not reported above under Audit Fees.

 

Pre-Approval of Services

 

The Audit Committee appoints the independent accountant each year and pre-approves the audit services. The Audit Committee chair is authorized to pre-approve specified non-audit services for fees not exceeding specified amounts, if he promptly advises the other Audit Committee members of such approval. All of the services described under the caption “Audit Fees” were pre-approved. 

 

75
 

 

PART IV

 

ITEM 15.     EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

(a) The following are filed with this report:
  (1) The financial statements listed on the Financial Statements’ Table of Contents
  (2) Not applicable

 

(b)   Exhibits

 

EXHIBIT
NUMBER
  DESCRIPTION
3.1   Certificate of Incorporation, as filed with the Delaware Secretary of State on January 24, 2006 (1)
3.2   By-Laws (1)
3.3   Certificate of Ownership and Merger, dated September 19, 2008 (2)
3.4   Certificate of Designations, Preferences, Rights and Limitations of Series A Preferred Stock (2)
10.1   Share Transfer Agreement, dated October 22, 2008 (3)
10.2   Amendment to the Share Transfer Agreement, dated March 7, 2009 (3)
10.3   Land Expropriation Contract dated November 5, 2010 (4)
10.4   Lihua International, Inc. 2009 Omnibus Securities and Incentive Plan (5)
10.5 + 2013 Independent Director Agreement, Robert Bruce
10.6 + 2013 Independent Director Agreement, Jonathan Serbin
10.7 + 2013 Independent Director Agreement, Kelvin Lau
10.8   Jianhua Zhu Employment Agreement, dated October 23, 2011(6)
10.9   Daphne Huang Employment Agreement, dated October 23, 2011 (6)
10.11   Yaying Wang Employment Agreement, dated October 23, 2011 (6)
14   Code of Business Conduct and Ethics (7)
21   List of Subsidiaries (8)
23.1 + Consent of Crowe Horwath (HK) CPA Limited
31.1 + Certification of Chief 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 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 the Principal Financial Officer Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).

 

+ Filed herewith.

 

(1) Incorporated by reference to the Company’s Form 10-SB, filed with the SEC on May 15, 2007
(2) Incorporated by reference to the Company’s Current Report on Form 8-K, filed with the SEC on November 6, 2008
(3) Incorporated by reference to the Company’s Annual Report on Form 10-K filed with the SEC April 2, 2009
(4) Incorporated by reference to the Company’s Current Report on Form 8-K, filed with the SEC on November 12, 2010.
(5) Incorporated by reference to the Company’s Annual Report on 10-K, filed with the SEC on March 14, 2011.
(6) Incorporated by reference to the Company’s Current Report on Form 8-K, filed with the SEC on October 27, 2011.
(7) Incorporated by reference to our Annual Report on Form 10-KSB, filed with the SEC on February 26, 2008
(8) Incorporated by reference to the Company’s Annual Report on 10-K, filed with the SEC on March 31, 2010.

 

76
 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

  LIHUA INTERNATIONAL, INC.
     
Dated: March 17, 2014 By: /s/ Jianhua Zhu
  Name: Jianhua Zhu
  Title: Chairman and Chief Executive Officer

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Dated: March 17, 2014 By: /s/ Jianhua Zhu
  Name: Jianhua Zhu
  Title: Chairman and Chief Executive Officer (Principal Executive Officer)
     
Dated: March 17, 2014 By: /s/ Daphne Huang
  Name: Daphne Huang
  Title: Chief Financial Officer (Principal Accounting Officer)
     
Dated: March 17, 2014 By: /s/Yaying Wang
  Name: Yaying Wang
  Title: Director
     
Dated: March 17, 2014 By: /s/ Jonathan Serbin
  Name: Jonathan Serbin
  Title: Director
     
Dated: March 17, 2014 By: /s/ Robert Bruce
  Name: Robert Bruce
  Title: Director
     
Dated: March 17, 2014 By: /s/ Kelvin Lau
  Name: Kelvin Lau
  Title: Director

 

77
 

 

EXHIBIT INDEX

 

EXHIBIT
NUMBER
  DESCRIPTION
3.1   Certificate of Incorporation, as filed with the Delaware Secretary of State on January 24, 2006 (1)
3.2   By-Laws (1)
3.3   Certificate of Ownership and Merger, dated September 19, 2008 (2)
3.4   Certificate of Designations, Preferences, Rights and Limitations of Series A Preferred Stock (2)
10.1   Share Transfer Agreement, dated October 22, 2008 (3)
10.2   Amendment to the Share Transfer Agreement, dated March 7, 2009 (3)
10.3   Land Expropriation Contract dated November 5, 2010 (4)
10.4   Lihua International, Inc. 2009 Omnibus Securities and Incentive Plan (5)
10.5 + 2013 Independent Director Agreement, Robert Bruce
10.6 + 2013 Independent Director Agreement, Jonathan Serbin
10.7 + 2013 Independent Director Agreement, Kelvin Lau
10.8   Jianhua Zhu Employment Agreement, dated October 23, 2011(6)
10.9   Daphne Huang Employment Agreement, dated October 23, 2011 (6)
10.11   Yaying Wang Employment Agreement, dated October 23, 2011 (6)
14   Code of Business Conduct and Ethics (7)
21   List of Subsidiaries (8)
23.1 + Consent of Crowe Horwath (HK) CPA Limited
31.1 + Certification of Chief 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 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 the Principal Financial Officer Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).

 

+ Filed herewith.

 

(1) Incorporated by reference to the Company’s Form 10-SB, filed with the SEC on May 15, 2007
(2) Incorporated by reference to the Company’s Current Report on Form 8-K, filed with the SEC on November 6, 2008
(3) Incorporated by reference to the Company’s Annual Report on Form 10-K filed with the SEC April 2, 2009
(4) Incorporated by reference to the Company’s Current Report on Form 8-K, filed with the SEC on November 12, 2010.
(5) Incorporated by reference to the Company’s Annual Report on 10-K, filed with the SEC on March 14, 2011.
(6) Incorporated by reference to the Company’s Current Report on Form 8-K, filed with the SEC on October 27, 2011.
(7) Incorporated by reference to our Annual Report on Form 10-KSB, filed with the SEC on February 26, 2008
(8) Incorporated by reference to the Company’s Annual Report on 10-K, filed with the SEC on March 31, 2010.

 

78
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

    Page
     
Report of Independent Registered Public Accounting Firm – Crowe Horwath (HK) CPA Limited   F – 1
     
Consolidated Balance Sheets   F – 2
     
Consolidated Statements of Income and Comprehensive Income   F – 3
     
Consolidated Statements of Stockholders’ Equity   F – 4
     
Consolidated Statements of Cash Flows   F – 5
     
Notes to Consolidated Financial Statements   F-6 – F-36

 

 
 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders of

Lihua International, Inc.

 

We have audited the accompanying consolidated balance sheets of Lihua International, Inc. and Subsidiaries (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of income and comprehensive income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2013. We also have audited Lihua International, Inc. and Subsidiaries’ internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in 1992. Lihua International, Inc. and Subsidiaries’ management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company's internal control over financial reporting based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinion.

 

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness of the internal control over financial reporting to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Lihua International, Inc. and Subsidiaries as of December 31, 2013 and 2012, and the consolidated results of their operations and cash flows for each of the years in the three-year period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, Lihua International, Inc. and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in 1992.

 

/s/ Crowe Horwath (HK) CPA Limited

Hong Kong, China

March 17, 2014

 

F-1
 

 

 LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(AMOUNTS EXPRESSED IN US DOLLARS)

 

   As of December 31, 
   2013   2012 
ASSETS          
CURRENT ASSETS          
Cash and cash equivalents  $203,406,220   $144,300,290 
Accounts receivable, net   60,497,780    45,284,923 
Prepayments for raw material purchases   17,143,138    19,569,239 
Other receivables, deposits and prepayments   337,189    559,955 
Prepaid land use right – current portion   418,502    406,026 
Deferred income tax assets   146,418    24,948 
Inventories   12,140,696    17,844,405 
Total current assets   294,089,943    227,989,786 
OTHER ASSETS          
Property, plant and equipment, net   47,139,458    47,197,115 
Construction in progress   5,559,901    175,006 
Prepaid land use right – long-term portion   18,701,959    18,546,658 
Intangible assets   42,195    3,332 
Total non-current assets   71,443,513    65,922,111 
Total assets  $365,533,456   $293,911,897 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
CURRENT LIABILITIES          
Accounts payable   7,415,370    3,891,110 
Other payables and accruals   7,143,964    4,937,404 
Income taxes payable   4,941,050    5,797,188 
Warrant liabilities   33,262    354,000 
Total current liabilities   19,533,646    14,979,702 
Total liabilities   19,533,646    14,979,702 
           
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, 30,295,955 shares issued and 30,031,908 shares outstanding as of December 31, 2013 (2012: 30,084,883 shares issued and 29,820,836 shares outstanding), respectively   3,029    3,008 
Additional paid-in capital   80,627,496    79,257,921 
Treasury stock, at cost, 264,047 shares as of December 31, 2013 and 2012, respectively   (2,126,597)   (2,126,597)
Statutory reserves   18,723,836    14,566,846 
Retained earnings   222,165,580    170,163,120 
Accumulated other comprehensive income   26,606,466    17,067,897 
Total stockholders' equity   345,999,810    278,932,195 
Total liabilities and stockholders' equity  $365,533,456   $293,911,897 

 

See accompanying notes to consolidated financial statements

 

F-2
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(AMOUNTS EXPRESSED IN US DOLLARS)

  

   Year Ended December 31, 
   2013   2012   2011 
             
NET REVENUE  $900,726,958   $853,766,541   $637,093,439 
                
Cost of sales   (814,327,740)   (764,218,167)   (561,379,767)
                
GROSS PROFIT   86,399,218    89,548,374    75,713,672 
                
Selling expenses   (3,020,600)   (2,954,460)   (2,485,978)
General and administrative expenses   (8,073,172)   (8,621,494)   (6,650,142)
                
Income from operations   75,305,446    77,972,420    66,577,552 
                
Other income (expenses):               
Interest income   660,326    547,679    522,722 
Interest expenses   -    -    (143,779)
Foreign exchange differences   (1,636)   109,638    234,763 
Gain (Loss) on extinguishment of warrant liabilities   (8,369)   73,291    88,777 
Change in fair value of warrants   (106,536)   (124,000)   3,062,575 
Other income (expenses)   35,136    93,819    114,623 
Total other income (expenses)   578,921    700,427    3,879,681 
                
Income before income taxes   75,884,367    78,672,847    70,457,233 
Provision for income taxes   (19,724,917)   (20,730,844)   (17,323,700)
                
NET INCOME  $56,159,450   $57,942,003   $53,133,533 
                
OTHER COMPREHENSIVE INCOME:               
Foreign currency translation adjustments   9,538,569    659,754    9,152,577 
                
COMPREHENSIVE INCOME  $65,698,019   $58,601,757   $62,286,110 
                
Net income per share               
Basic  $1.88   $1.94   $1.78 
Diluted  $1.87   $1.93   $1.77 
                
Weighted average number of shares outstanding               
Basic   29,858,880    29,815,943    29,816,871 
Diluted   29,996,833    29,965,811    30,076,130 

 

See accompanying notes to consolidated financial statements.

 

F-3
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(AMOUNTS EXPRESSED IN US DOLLARS)

 

                       Accumulated     
   Common Stock   Additional               Other     
   Number of       Paid-in   Statutory   Treasury   Retained   Comprehensive     
   Shares   Amount   Capital   Reserves   Stock   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   -    -    -    -    -    53,133,533    -    53,133,533 
Foreign currency translation adjustment   -    -    -    -    -    -    9,152,577    9,152,577 
Exercise of warrants   651,155    65    6,814,073    -    -    -    -    6,814,138 
Repurchase of common stock   (264,047)   -    -    -    (2,126,597)   -    -    (2,126,597)
Common stock dividend   -    -    -    -    -    (992,846)   -    (992,846)
                                         
Share-based payments to employees and directors   -    -    498,212    -    -    -    -    498,212 
Appropriation of statutory reserves   -    -    -    2,862,289    -    (2,862,289)   -    - 
                                         
At December 31, 2011   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   -    -    -    -    -    57,942,003    -    57,942,003 
Foreign currency translation adjustment   -    -    -    -    -    -    659,754    659,754 
Exercise of warrants   48,402    5    311,704    -    -    -    -    311,709 
Share-based payments to employees and directors   -    -    382,089    -    -    -    -    382,089 
Appropriation of statutory reserves   -    -    -    4,148,370    -    (4,148,370)   -    - 
                                         
At December 31, 2012   29,820,836   $3,008   $79,257,921   $14,566,846   $(2,126,597)  $170,163,120   $17,067,897   $278,932,195 
                                         
Net income   -    -    -    -    -    56,159,450    -    56,159,450 
Foreign currency translation adjustment   -    -    -    -    -    -    9,538,569    9,538,569 
Exercise of share options   110,000    11    494,989    -    -    -    -    495,000 
Exercise of warrants   101,072    10    531,073    -    -    -    -    531,083 
Share-based payments to employees and directors   -    -    343,513    -    -    -    -    343,513 
Appropriation of statutory reserves   -    -    -    4,156,990    -    (4,156,990)   -    - 
                                         
At December 31, 2013   30,031,908    3,029    80,627,496    18,723,836    (2,126,597)   222,165,580    26,606,466    345,999,810 

 

See accompanying notes to consolidated financial statements.

 

F-4
 

 

 LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(AMOUNTS EXPRESSED IN US DOLLARS)

 

   Year Ended December 31, 
   2013   2012   2011 
CASH FLOWS FROM OPERATING ACTIVITIES               
Net income  $56,159,450   $57,942,003   $53,133,533 
Adjustments to reconcile net income to cash provided by operating activities:               
Depreciation and amortization   4,361,117    3,669,077    2,294,159 
Loss on disposal of property, plant and equipment   86,330    -    - 
Share-based compensation   343,513    382,089    498,212 
(Gain) loss on extinguishment of warrant liabilities   8,369    (73,291)   (88,777)
Change in fair value of warrants   106,536    124,000    (3,062,575)
Deferred income tax benefits   (118,821)   175,379    (65,136)
(Increase) decrease in assets:               
Accounts receivable   (13,597,256)   (14,065,887)   3,487,873 
Bills receivable   -    -    541,989 
Prepayments for raw material purchases   2,984,314    2,357,227    (21,347,998)
Other receivables, deposits and prepayments   236,354    1,321,844    (1,814,309)
Inventories   6,158,432    (2,294,323)   1,442,579 
Increase (decrease) in liabilities:               
Accounts payable   3,350,965    (2,180,647)   (246,640)
Other payables and accruals   1,987,001    198,772    (782,013)
Income taxes payable   (1,019,365)   1,173,326    (612,900)
Net cash provided by operating activities   61,046,939    48,729,569    33,377,997 
                
CASH FLOWS FROM INVESTING ACTIVITIES               
Purchase of property, plant and equipment and construction in progress   (7,796,777)   (9,365,100)   (16,965,626)
Deposits for plant and equipment   -    -    (3,344,274)
                
Net cash used in investing activities   (7,796,777)   (9,365,100)   (20,309,900)
                
CASH FLOWS FROM FINANCING ACTIVITIES               
Payment of common stock dividend   -    (992,846)   - 
Repayments of short-term bank loans   -    -    (2,322,413)
Repurchase of common stock   -    -    (2,126,597)
Proceeds from exercise of share options   495,000    -    - 
Proceeds from exercise of warrants   95,441    -    1,898,050 
Net cash (used in) provided by financing activities   590,441    (992,846)   (2,550,960)
Foreign currency translation adjustment   5,265,327    291,040    4,511,150 
INCREASE IN CASH AND CASH EQUIVALENTS   59,105,930    38,662,663    15,028,287 
CASH AND CASH EQUIVALENTS, at the beginning of the year   144,300,290    105,637,627    90,609,340 
CASH AND CASH EQUIVALENTS, at the end of the year  $203,406,220   $144,300,290   $105,637,627 
MAJOR NON-CASH TRANSACTION:               
Share-based compensation to employees and directors  $343,513   $382,089   $498,212 
Issuance of common stock to settle warrant liabilities   435,642    311,709    4,916,088 
SUPPLEMENTAL DISCLOSURE INFORMATION               
Cash paid for interest  $-   $-   $143,779 
Cash paid for income taxes  $20,743,750   $19,569,241   $18,056,035 

 

See accompanying notes to consolidated financial statements.

 

F-5
 

 

LIHUA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

 

NOTE 1 DESCRIPTION OF BUSINESS AND ORGANIZATION

 

(A) 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 December 31, 2013, 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

  

(B) REVERSE ACQUISITION

 

On October 31, 2008, the Company entered into a share exchange agreement (“Share Exchange Agreement”) under which the Company issued 14,025,000 shares of its Common Stock, par value $0.0001, to Magnify Wealth Enterprise Limited, the sole shareholder of Ally Profit (the “Ally Profit Shareholder” or “Magnify Wealth”) in exchange for all the issued and outstanding shares of Ally Profit (the “Share Exchange”). As a result of the Share Exchange, Ally Profit has become the Company’s wholly-owned subsidiary and Ally Profit Shareholder acquired a majority of the Company’s issued and outstanding stock. Concurrent with the Share Exchange, Mr. Jianhua Zhu (the managing director of Ally Profit and all of its operating subsidiaries, “Mr. Zhu”) has been appointed the Chief Executive Officer of the Company.

 

As a result, the Share Exchange has been accounted for as a reverse acquisition using the purchase method of ac