10-K 1 v144435_10k.htm Unassociated Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

FORM 10-K

x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
 
For the fiscal year ended: December 31, 2008
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
 
For the transition period from __________ to ____________
 
Commission File Number: 001-33758
Fuqi International, Inc.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)
20-1579407
(I.R.S. Employer
Identification No.)

5/F., Block 1, Shi Hua Industrial Zone
Cui Zhu Road North
Shenzhen, 518019
People’s Republic of China
 
N/A
(Address of principal executive offices)
 
(Zip Code)

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE:  +86(755)2580-1888

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
  
Title of Each Class
Name of Each Exchange on Which Registered
Common Stock, $0.001 par value
NASDAQ Global 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 Act. Yes ¨ No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 
Large accelerated filer ¨
Accelerated filer x
 
 
Non-accelerated filer ¨
Smaller reporting company ¨
 
 
(Do not check if a smaller reporting company)
   
    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant on June 30, 2008 (the last business day of the registrant’s most recently completed second fiscal quarter), was approximately $85.4 million based on the closing price of the registrant’s common stock on The Nasdaq Global Market of $8.76 per share.
 
There were 22,005,509 shares of common stock outstanding as of March 31, 2009.

DOCUMENTS INCORPORATED BY REFERENCE: The information required by Part III of Form 10-K is incorporated by reference from the Registrant's definitive proxy statement on Schedule 14A that will be filed no later than the end of the 120-day period following the Registrant's fiscal year end, or, if the Registrant's definitive proxy statement is not filed within that time, the information will be filed as part of an amendment to this Annual Report on Form 10-K/A, not later than the end of the 120-day period.

 
 

 

FUQI INTERNATIONAL, INC.
 
TABLE OF CONTENTS TO ANNUAL REPORT ON FORM 10-K
 
For the Fiscal Year Ended December 31, 2008

ITEM
     
  Page
PART I
       
Item 1.
 
Business
 
1
Item 1A.
 
Risk Factors
 
9
Item 1B.
 
Unresolved Staff Comments
 
21
Item 2.
 
Properties
 
21
Item 3.
 
Legal Proceedings
 
21
Item 4.
 
Submission of Matters to a Vote of Security Holders
 
21
         
PART II
       
Item 5.
 
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
23
Item 6.
 
Selected Consolidated Financial Data
 
25
Item 7.
 
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
26
Item 7A.
 
Quantitative and Qualitative Disclosures about Market Risk
 
40
Item 8.
 
Financial Statements and Supplementary Data
 
41
Item 9.
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
41
Item 9A.
 
Controls and Procedures
 
41
Item 9B.
 
Other Information
 
44
         
PART III
       
Item 10.
 
Directors, Executive Officers and Corporate Governance
 
45
Item 11.
 
Executive Compensation
 
45
Item 12.
 
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
45
Item 13.
 
Certain Relationships and Related Transactions, and Director Independence
 
45
Item 14.
 
Principal Accounting Fees and Services
 
45
PART IV
     
 
Item 15.
 
Exhibits and Financial Statement Schedules
 
45
         
   
Signatures
 
46


 
 

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
 
The information contained in this Form 10-K, including in the documents incorporated by reference into this Form 10-K, includes some statements that are not purely historical and that are “forward-looking statements.” Such forward-looking statements include, but are not limited to, statements regarding the Company and their management’s expectations, hopes, beliefs, intentions or strategies regarding the future, including its financial condition, and results of operations. In addition, any statements that refer to projections, forecasts or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. The words “anticipates,” “believes,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “might,” “plans,” “possible,” “potential,” “predicts,” “projects,” “seeks,” “should,” “will,” “would” and similar expressions, or the negatives of such terms, may identify forward-looking statements, but the absence of these words does not mean that a statement is not forward-looking.
 
 The forward-looking statements contained in this Form 10-K are based on current expectations and beliefs concerning future developments and the potential effects on the parties and the transaction. There can be no assurance that future developments actually affecting the Company will be those anticipated. These forward-looking statements involve a number of risks, uncertainties (some of which are beyond the parties’ control) or other assumptions that may cause actual results or performance to be materially different from those expressed or implied by these forward-looking statements, including the following:

 
·
Vulnerability of discretionary jewelry purchases to general economic downturn in China;
 
 
·
Fluctuation and unpredictability of costs related the gold, platinum and other precious metals and commodities used to manufacture the Company’s product;
 
 
·
Fluctuations in economic conditions in the northeast region of China, where the Company’s sales are geographically concentrated;
 
 
·
Changes in the laws of the PRC that affect the Company’s operations;
 
 
·
Potential strain on the Company’s resources caused from its retail expansion strategy;
 
 
·
Competition in the jewelry industry in China;
 
 
·
Any recurrence of severe acute respiratory syndrome (SARS) or Avian Flu;
 
 
·
The Company’s ability to obtain and maintain all necessary government certifications and/or licenses to conduct the Company’s business;
 
 
·
Development of a public trading market for the Company’s securities;
 
 
·
The cost of complying with current and future governmental regulations and the impact of any changes in the regulations on the Company’s operations;
 
 
·
The Company’s reliance on one source for precious metals;
 
 
·
The Company’s reliance on its distribution network for a significant portion of our revenues;
 
 
·
The Company’s requirement to maintain a large inventory of raw materials and jewelry products, and related risks of theft and fire;
 
 
·
The Company’s reliance on, and ability to renew, outstanding short-term borrowings;
 
 
·
Changes in the political and economic policies of the government in China, where all of the Company’s assets are located and all from where its revenues are derived;
 
 
·
Acquisition of the operations of the Temix Companies in August 2008, which may not result in the expected benefits;
 
 
·
Adverse capital and credit market conditions, and the Company’s ability to meet liquidity needs;
 
 
·
Fluctuation of the foreign currency exchange rate between U.S. Dollars and Renminbi; and
 
 
·
The other factors referenced in this Form 10-K, including, without limitation, under the sections entitled “Risk Factors,” “Financial Information,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Description of Business.”
 
These risks and uncertainties, along with others, are also described above under the heading “Risk Factors.” Should one or more of these risks or uncertainties materialize, or should any of the parties’ assumptions prove incorrect, actual results may vary in material respects from those projected in these forward-looking statements. The Company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required under applicable securities laws.
 
 
 

 
 
PART I
 
ITEM 1.  BUSINESS
 
Our company, Fuqi International, Inc., operates through our wholly-owned subsidiary, Fuqi International Holdings Co., Ltd., a British Virgin Islands corporation (“Fuqi BVI”) and its wholly-owned subsidiary, Shenzhen Fuqi Jewelry Co., Ltd., a company established under the laws of China (“Fuqi China”). Fuqi International, Inc. effected a reverse merger transaction in November 2006 that resulted in our current corporate structure and subsequently reincorporated in Delaware on December 8, 2006. For further information concerning our reverse merger transaction, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Corporate History.”
 
Overview 
 
We are a leading designer of high quality precious metal jewelry in China, developing, promoting, and selling a broad range of products to the luxury goods market in China. Our products consist of a range of unique styles and designs made from gold and other precious metals such as platinum and Karat gold (K-gold).  We also produce jewelry items that contain diamonds and other precious stones on a custom-order basis. Our design database presently contains over 30,000 unique products. We continuously innovate and change our designs based upon consumer trends in China. By continuously creating new designs and rapidly bringing them to market, we believe we are able to differentiate ourselves from our competitors and strengthen our brand identity.
 
Our nationwide distribution network, significant relationships with retailers and self-operated multi-brand retail outlets allow us to test-market, promote and sell our products in almost every province in China. We believe our vertically integrated direct sales operations, which include product development, sales and marketing, and order fulfillment and delivery, allow us to effectively reach consumers and maximize sales throughout China.
 
We have historically sold our products directly to distributors, retailers and wholesalers, who then sell our products to consumers through both retail counters located in department stores and in traditional stand-alone jewelry stores. We sell our products to our customers at price points that reflect the market price of the base material, plus a mark-up reflecting our design fees and processing fees. Typically this markup ranges from 8% to 14%. Our customers then further mark up our products to the consumers up to an additional 30%.  Our target price points for our traditional line of gold jewelry that we wholesale are primarily designed to appeal to China’s growing middle class, with an emphasis on young women consumers.

In order to capture the margin appreciation from direct sales to the consumer, we recently initiated a retail strategy in 2007 in product categories that we believe we will not compete with our existing sales channels. Our retail strategy focuses on finished diamond and other gemstone jewelry, which we have previously provided only on a custom-order basis and which has historically represented only a nominal percentage of our overall sales.  Our finished gemstone jewelry products are primarily designed to appeal to China’s younger, urban customers, who are generally better educated and influenced more by Western culture than older consumers.
 
We intend to open new retail locations by leasing unoccupied space, acquiring existing leases from third parties and/or acquiring the existing jewelry operations of third parties that occupy retail space.  During 2008, we opened and/or acquired 56 retail counters and acquired seven retail stores in municipalities and provincial capitals throughout China.   A majority of these retail locations were acquired in August 2008, when we started to operate the Temix branded jewelry store chain that we acquired from two jewelry companies, Shanghai Tian Mei Jewelry Co. Ltd. and Beijing Yinzhong Tian Mei Jewelry Co. Ltd. (collectively known as the “Temix Companies”).  The Temix Companies are a branded jewelry store chain that offer high quality diamond products with 50 outlets located primarily in Beijing and Shanghai.  Of the 50 outlets, 7 are standalone stores and 43 are store counters within department stores.  We acquired all of the Temix Companies’ stores, counters, leases, registered trade name, exchange membership, and inventories for an aggregate purchase price of approximately $11.7 million.

Also in August 2008, and as a part of the acquisition of Temix, we acquired all of the intellectual property rights related to the business of the Temix Companies pursuant to the Intellectual Property Transfer Agreement (“IP Transfer Agreement”), which was entered into on April 18, 2008 by our wholly-owned subsidiary and Mr. Huang. Pursuant to the IP Transfer Agreement, Mr. Huang received 540,333 shares of our common stock at closing and another 540,333 shares is being placed into an escrow account for the two-year period following the closing and will only be transferred to Mr. Huang if the business of the Temix Companies meets certain performance targets as set forth in the IP Transfer Agreement.

 
1

 

As of December 31, 2008, we had 69 jewelry retail counters and stores in China.  During 2009, we intend to open and/or acquire additional retail counters and retail stores throughout the PRC. However, we intend to continually monitor the results of operations of our current outlets and we may, from time to time, close outlets that we believe are under performing and we replace such outlets with more desirable locations in order to maintain our profitability and cash liquidity.

For the year ended December 31, 2008, wholesale jewelry sales accounted for approximately 97% of our revenue and the remainder was attributable to retail sales. We believe our expansion into the retail market will provide us with:

 
·
direct access to the consumer market, allowing us to respond more rapidly to changing consumer tastes;
 
 
·
an opportunity to grow our revenue base as we roll out our retail strategy;
 
 
·
improved net margins from higher markups in the retail market; and
 
 
·
increased brand awareness. 
 
Our company is headquartered in the city of Shenzhen, in southern China, where we have a large-scale production base that includes a modern factory of more than 53,000 square feet, a dedicated senior design, sales and marketing team, and we have approximately 949 employees, including approximately 805 company-trained production workers.
 
China Jewelry Industry
 
China’s market for jewelry and other luxury goods is expanding, due in part to the country’s rapid economic growth. According to the National Bureau of Statistics of China, China’s real gross domestic product, or GDP, grew by 9.0%, 11.4% and 11.1% in 2008, 2007 and 2006, respectively. Economic growth in China has led to greater levels of personal disposable income and increased spending among China’s expanding middle-class consumer base.  According to Economist Intelligence Unit (EIU), private consumption has grown at approximately 9% compound annual growth rate, or CAGR, over the last decade.
 
China—with its 1.3 billion consumers, higher minimum wages, expanded welfare payments, and reduced income taxes—is the world's third-largest consumer of luxury goods.  China's younger generations, in particular, have bought into consumerism more than their predecessors and been lured by flashy products and high-end merchandise marketed to the wealthy, upper-middle and middle-market consumers.  The jewelry industry in China has grown at an annual rate of approximately 10 percent since the 1980’s and is expected to be the largest market in the world by 2010.  In 2005, domestic sales of jewelry in China amounted to RMB 140 billion, which is approximately US$19.8 billion, and the industry earned $5.49 billion worth of foreign exchange for China through exports.  In 2008, the growth in China’s jewelry industry was higher than its general economic growth. As a result, China became the second largest gold consumer and the largest platinum jewelry market in the world.
 
Our Strategies
 
Our goal is to be the leading vertically integrated designer, manufacturer, and retailer of jewelry in China. We intend to achieve our goal by implementing the following strategies:
 
Aggressively pursue new wholesale distribution channels
 
We intend to broaden the scope of our distribution arrangements to increase sales penetration in targeted markets. We intend to select additional distributors based on their access to markets and retail outlets that are candidates for our jewelry products. Also, we believe that once we have established broad brand awareness, more distributors from remote areas will seek access to our products through our wholesale channel.
 
Expand our retail market footprint
 
We have developed and are executing a retail sales plan aimed at gaining market share in the growing consumer market in China. We intend to acquire leases and open new stores in markets that we believe have a sufficient concentration of our target customers. Our retail expansion program is designed to reach new and existing customers through the opening of new retail locations and through the introduction of new jewelry designs, including our gemstone jewelry line. Retail locations have been determined on the basis of various factors, including geographic location, demographic studies and other jewelry stores or counters in the vicinity of a retail location.

 
2

 

Our retail expansion strategy is designed not to conflict with our existing distributors. For example, generally we sell our traditional gold jewelry products to distributors who then sell them to department stores. The department stores display these products in a retail counter typically owned by the department stores. In most cases there are other counters in the department stores that are owned by third-party companies that sell non-competing products to our gold jewelry products, such as finished gemstone jewelry items. These third-party counters are our targets for the acquisition of leases, which means we will not compete with our distributors or with the department stores. Also, we initially plan to open stores at retail outlets not currently offering our products. In this way we hope to increase market penetration and maintain positive relationships with our distributors.
 
We intend to open new retail locations by leasing unoccupied space, acquiring existing leases from third parties and/or acquiring the existing jewelry operations of third parties that occupy retail space.  During 2008, we opened and/or acquired 56 retail counters and acquired 7 retail stores in municipalities and provincial capitals throughout China.  As of December 31, 2008, we had 69 jewelry retail counters and stores in China.  During 2009, we intend to open and/or acquire additional retail counters and retail stores throughout the PRC.  However, we intend to continually monitor the results of operations of our current outlets and we may, from time to time, close outlets that we believe are under performing and we replace such outlets with more desirable locations in order to maintain our profitability and cash liquidity.
 
We believe that China represents an excellent retail sales opportunity for our own expansion into the retail market for various reasons that include:
 
·
large pool of potential consumers— China has a large population including a rapidly expanding middle-class and younger, urban consumer bases.
 
·
changing consumer preferences— we believe that Chinese consumers are embracing a more Western view of jewelry as a fashion accessory while also valuing the more traditional view of jewelry as an investment.
 
·
growing jewelry market— China’s jewelry market has experienced significant growth.
 
·
large retail market— China’s retail sales market is one of largest in the world.
 
·
favorable regulatory changes— as a member of the World Trade Organization (WTO), China has eliminated a number of restrictions on foreign ownership and operations of retail stores. Tariffs on colored gemstones, gold, silver and pearls have been reduced in the past and economic and trade relationships between China and other major economic powers have generally been liberalized.
 
·
increased profit potential— we believe that the retail market is a viable method to increase our sales profitability and market exposure.

Expand existing and new product offerings
 
Since the commencement of our jewelry operations in 2001, we have expanded our line of products from basic gold jewelry to a range of products that include rings, bracelets, necklaces, earrings and pendants made from precious metals such as platinum, gold, palladium and Karat gold (K-gold). We also manufacture jewelry with diamond and other precious stone inlays, in addition to gold coins and gold bars.

Our jewelry product series include the following:

·
Gold Series. This series includes K-gold, 24K gold ornaments, gold bars, gold coins, gifts, other gold charms and customized products.
 
·
Platinum Series (pt). This series includes pt990, pt950 and pt900 products. The quality markings for platinum are based on parts per thousand. For example, the marking pt900 means that 900 parts out of 1000 are pure platinum, or in other words, the item is 90% platinum and 10% other metals.
 
·
K-Gold Series. This series is primarily derived from Italian-influenced arts and designs.
 
·
Studded Jewelry Series. This series is made from pt950, pt900, 18K gold, 14K gold and other customer-designated rare metals studded with diamonds, emerald, jade and semi-precious stones.  We originally produced studded jewelry products on a custom-order basis only, but we have recently expanded our production to include new lines of studded jewelry products for sale in our retail outlets.
 
 
3

 

Our in-house designers originate many of our designs. They are educated at art schools or colleges in China and have gained an average of three to five years of experience from other jewelry companies. In generating new design ideas, our designers research and study designs that are popular in China and worldwide. Our designers conduct design and market research through various forms, including trade expositions, industrial magazines and the Internet. They also receive feedback from, and respond to, our customers. We continuously design and produce new styles of jewelry and currently carry more than 30,000 product styles, which are growing at a rate of approximately 3,500 styles per annum. We assign serial numbers to each of our products styles, and we maintain an information management system utilizing a product database.
 
Since 2004, we have typically provided over three hundred new designs every month to our wholesale customers.
 
In the coastal cities of China, we believe the demand for platinum and gemstone products has been increasing. In order to capitalize on the growth of demand, we intend to develop platinum as the primary metal from which our jewelry is manufactured. In 2006, we began to shift our product line to produce more platinum jewelry and we intend to invest in the development of a new production line to produce studded platinum jewelry. The production cycle of platinum products is five to seven days while the cycle for gold products is about two days. As such, more working capital will be needed to support this shift of product mix.
 
We recently began offering diamond products and intend to expand product offerings to include jade, and other gemstone products. These products usually have a longer turnover period of at least four to six months but offer higher margins. We believe that it is critical for us to expand our product lines to include these products to be sold in our own retail outlets and to our wholesale customers. We will analyze sales data at all our retail outlets and determine the best product mix a particular outlet will carry to achieve the highest sales revenue. Our new diamond jewelry production line will be sold primarily through our retail outlets.
 
Enhance marketing and promotion efforts to increase brand awareness
 
We continue to devote our efforts towards brand development and utilize marketing concepts in an attempt to enhance the marketability of our products. During the past several years, we have carried out a brand development strategy based on product quality and design excellence. We have launched advertising campaigns with television commercials and we have placed ads in major magazines throughout China to promote our jewelry products. We have also participated and intend to continue to participate in various exhibitions and similar promotional events to promote our products and brand. We are working with professional advertising agents to develop and implement media strategies to further strengthen brand awareness of “Fuqi” and “Temix”.
 
Product Pricing
 
The wholesale pricing of our products is based on three primary components: price of raw materials used, processing fee, and design fee. The price of the raw materials for our jewelry highly depends on the spot price of the raw materials (e.g., gold and platinum) at the time the jewelry is sold. The amount charged as a design fee is determined by management based on various criteria, including market conditions, and production complexity, popularity and uniqueness of the design. Management meets on a monthly basis to determine the design fees charge rate, which generally ranges from 6% to 10% of price of raw materials. The processing fee ranges from 2% to 3% of the price for the raw materials. We pay business tax on our design fee. We also pay a value added tax on the raw materials and processing fee, which we bill to our customers and remit to the local tax authority on a monthly basis. The sales amounts reported in the statements of income are net of the value added tax. The invoices that we provide to our wholesale customers itemize these raw material costs and design and processing fees that make up the total cost charged to them. The retail mark up from the wholesale price is approximately 30%, depending on the complexity of design and other factors.
 
Credit Terms
 
We offer certain of our customers credit terms for payment. We have traditionally granted credit to a customer if the customer has been in existence for at least five years and/or has been doing business with us for at least three years. More recently, we have increased credit decisions to new customers on credit checks from various sources, including department store operators and industry participants. We attempt to minimize credit risk by reviewing a customer’s credit history before extending credit and by continually monitoring the customer’s credit exposure. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Allowance for doubtful accounts is based on our assessment of the collectability of specific customer accounts, the aging of accounts receivable, our history of bad debts, and the general condition of the industry. If a major customer’s credit worthiness deteriorates, or our customers’ actual defaults exceed historical experience, our estimates could change and impact our reported results. For the years ended December 31, 2008 and 2007, we had a provision for bad debt expense of approximately $1.1 million and $0.3 million, respectively, which represented approximately 1.5% and 1.2% of our gross accounts receivables as of December 31, 2008 and 2007, respectively.

 
4

 

Manufacturing
 
We have a large-scale production base that includes a modern factory of more than 53,000 square feet, a dedicated senior design team, and approximately 805 company-trained production workers. In the first quarter of 2008, we analyzed and refined our production procedures to increase efficiency and reduced the number of trained workers by approximately 15%. We periodically review and analyze our production procedures and new technologies to maintain or enhance our production efficiencies. We are in the process of negotiating a program to commence research for new production technology with reputable university in China. Since 2003, we have held an ISO 9001 accreditation, which is an international standard of quality. The International Organization for Standardization (ISO) (http://www.iso.org/iso/en/iso9000-14000/understand/inbrief.html) defines the ISO 9000 quality management system as one of international references for quality management requirements in business-to-business dealings. An organization being accredited by an independent assessment organization has to fulfill:
 
·
     the customer’s quality requirements,
 
·
     applicable regulatory requirements, while aiming to enhance customer satisfaction, and
 
·
     achieving continual improvement of its performance in pursuit of these objectives.
 
The ISO 9000 quality management system is well recognized by People’s Republic of China (“PRC”)’s governmental bodies and businesses. This accreditation can serve as a basis for our customers to determine the minimum standard of quality assurance that we achieve. We believe that this accreditation also indicates to our customers that we are running an effective system to track quality issues and possible rework progress of our products. In January 2007, we also achieved the ISO 14000 accreditation. ISO 14000 is an environmental management system in which the organization being accredited has to (i) minimize harmful effects on the environment caused by its activities, and (ii) achieve continual improvement of its environmental performance.
 
Sales and Marketing
 
We rely on our sales and marketing division, which is located at our executive offices in Shenzhen, China for the distribution of our products in China. With respect to our wholesale distribution of our products, we sell our products primarily to our national and provincial distributors that resell our products to end customers through their own distribution networks, which are typically composed of local distributors and retail outlets. Our wholesale distribution network currently includes approximately 31 provincial distributors and more than 840 direct-sales distributors. These distributors sell our products to local distributors, over 900 retail outlets and directly to end users in China.
 
Our wholesale marketing and distribution strategy is to screen and identify the strongest customers in each distribution channel and to focus on our design and sales efforts towards the largest and fastest growing retailers and distributors. We maintain a broad base of customers and concentrate our efforts on department stores, wholesalers, national jewelry chains, fine jewelers, and stores that sell fashionable jewelry. We also work closely with our major customers and attempt to adjust our product strategies and structure based on customer feedback in order to decrease the likelihood of overstocked, undesired products.
 
Our traditional gold jewelry products that we wholesale are mainly designed for the middle income class in China, with an emphasis on young women. Approximately 50% of these designs are geared towards women between the ages of 20 to 40 years, 5% of these designs are designed for new-born children, 20% of these designs are for middle-aged men and 25% of these designs are for middle to older-aged women. Our products are sold in China at average retail prices equivalent to $200 to $300, including tax. At present, approximately 5 to 6% of our products are marketed on a private label basis, but we anticipate that this percentage will decrease as we continue to develop the “Fuqi” brand.
 
We continue to invest in our brand and our marketing ability in order to increase demand for our products. During the past several years, we have carried out a brand development strategy based on product quality and design excellence. We have participated in various marketing activities and exhibitions to promote our products and brand. For example, in 2004, we were the laurel sponsor for multiple beauty pageants, including the “Miss Intercontinental Final” and the “Miss China Universe.” As a laurel sponsor, we designed and crafted the laurels and/or batons that were presented to a contest winner, in addition to the contest’s second and third place runner-ups. We have also sponsored numerous beauty contests such as:
 
·
     the Final of Miss Global of WTO;
 
·
     the 17th World Miss Universe Contest;
 
 
5

 

·
     the 1st China Miss University Contest; and
 
·
     China Final of Miss World.
 
We believe that the laurels and batons created in connection with our sponsorship of beauty contests provided us an opportunity to showcase our design and craftsmanship ability, in addition to strengthening our brand recognition.

We have received various governmental awards with respect to our brand, including recognition by the China Light Product Quality Assurance Center as a “Chinese Famous Brand,” which is reserved for the top ten most recognized brands of the jewelry industry in China. We have also received other recognitions, including, from the Gems & Jewelry Trade Association of China as a “Famous Brand in the China Jewelry Industry”, from Committee of Shenzhen Famous Brand Accreditation as a “Shenzhen Well-known Brand”, from the Shenzhen City Enterprises Evaluation Association as one of the “Shenzhen 300 enterprises with Ultimate Growth” and from Moody United Certification Ltd as “China Quality Promise Credit Management Enterprise (Brand)”. In October 2007, “Fuqi” was recognized as a “China Top Brand” by General Administration of Quality Supervision, Inspection and Quarantine of the People's Republic of China. We believe that governmental awards and other forms of recognition raise brand recognition for our products.
 
The “Fuqi” trademark has been registered in the United States, Italy, Japan, Hong Kong and China.

We also engage in marketing activities for our retail sales brand.  We acquired the “Temix” brand with our acquisition of substantially all of the assets of the Temix Companies in August 2008. We are working with professional advertising agents to further strengthen our branding and media strategies.
 
Supply of Raw Materials
 
We are a full member of the Shanghai Gold Exchange and a standing council member of the Shenzhen Gold Association of China. The Shanghai Gold Exchange is China’s, and our, sole supply source for precious metals.  We maintain our supply of raw materials at our warehouse in Shenzhen, China. We traditionally purchase large volumes of precious metals approximately five times per month from the Shanghai Gold Exchange in advance and in anticipation of orders resulting from our marketing programs. When we make purchases on the Shanghai Gold Exchange, the Exchange issues a receipt to us that we can redeem for precious metals at various commercial banks in Shenzhen.
 
In an attempt to minimize the risk of storage and devaluation, we only purchase pre-cut gemstones, including ruby and jade, upon customers’ requests.  We do not have a designated supplier for these pre-cut stones. When a customer places an order that requires pre-cut stones, we have traditionally purchased the pre-cut stones, on an as need basis from local supplies in Shenzhen. As we have expanded our retail distribution of our jewelry products and production of diamond jewelry products, we have also began to purchase pre-cut diamonds from reputable internal suppliers through the Shanghai Diamond Exchange.

Competition
 
The jewelry production industry is highly competitive, and our competitors include domestic and foreign jewelry manufacturers, wholesalers, and importers who may operate on a national, regional and local scale. Many of our competitors have substantially greater financial, technical and marketing resources and personnel than us. Our strategy is to provide competitively priced, high-quality products to the high-volume retail jewelry market. We believe competition is largely based on quality, service, pricing, and established customer relationships.
 
In 2007, we entered into the retail jewelry industry, which is also highly competitive. Many of our potential competitors in the retail industry have larger customer bases, longer operating histories and significantly greater financial, technical, marketing and other resources. Most of these retailers, including Chow Sang Sang Group, Luk Fook Jewelry, TSL Jewelry and 3-D Gold Jewelry, have numerous branches set up across China and may have secured the most desirable locations for retail stores. It may be difficult for a newcomer to enter into and expand in the retail industry, but based on our extensive analysis, market review, and planning, we believe that our established production and wholesale distribution business will facilitate our entrance into and expansion in the retail market.
 
Major Customers
 
During the years ended December 31, 2008, 2007 and 2006, there were no single customers that generated more than 10% of the total sales.

 
6

 
 
Seasonality
 
Our business is seasonal in nature. Our sales and net income are generally higher in the fourth calendar quarter than the rest of the year. The primary factors that affect the seasonal changes in our business operations are holidays and traditional Chinese festivals. In the fourth quarter, retailers often experience increased sales due to the weeklong public holiday for Chinese National Day, as well as Christmas and New Year’s Day. In addition, jewelry retailers commonly stock up from wholesalers in the fourth quarter to prepare for potentially higher sales in the following quarter for Chinese New Year. This quarter is also a peak season for marriages and the birth of newborns in China, which have historically resulted in higher sales. This seasonal trend in our business would slightly shift in line with the gap between calendar quarter and lunar quarter and occurred during 2004 and 2005. However, there was a slight variation during 2006. Because of rising precious metal prices in the fourth quarter of 2006, many customers delayed their orders until the first quarter of 2007, resulting in lower-than-expected sales volume in the fourth quarter of 2006, and higher than expected sales in the first quarter of 2007. We experienced increased sales in the fourth quarter of 2007.  For the year ended December 31, 2008, our results of operations appeared to return to the trend of higher sales in the fourth quarter. 

Government Regulations
 
We are subject to various laws and regulations in the PRC, affecting all aspects of our business. In April 2001, the Shenzhen Business Bureau granted our wholly-owned subsidiary, Fuqi China, the right to operate for a period of ten years from the date of inception. On May 17, 2006, we converted Fuqi China into a wholly-foreign-owned enterprise, or WFOE, and formally transferred the ownership of Fuqi China from the founder, Mr. Yu Kwai Chong, to Fuqi BVI. Neither this transfer nor the reverse merger that we conducted in November 2006 changed our business plan. The right to operate as a WFOE expires 30 years from the date of establishment but, based on current PRC legislation, this right is renewable by application. A WFOE can only conduct business within its approved business scope, which appears on its business license. Our license permits us to design, manufacture, sell and market jewelry products to department stores throughout the PRC, and allows us to engage in the retail distribution of our products. Any further amendment to the scope of our business will require additional applications and government approval. We cannot assure you that we will be able to obtain the necessary government approval for any change or expansion of our business.
 
Under applicable PRC laws, supplies of precious metals such as platinum, gold and silver are highly regulated by certain government agencies, such as the People’s Bank of China. Shanghai Gold Exchange is the only PBOC authorized supplier of precious metal materials and, therefore, the primary source of supply for our raw materials, which substantially consist of precious metals. We are required to obtain several membership and approval certificates from these government agencies in order to continue to conduct our business. We may be required to renew such memberships and to obtain approval certificates periodically. If we are unable to renew these periodic membership or approval certificates, it would materially affect our business operations. We are currently in good standing with these agencies.
 
We have also been granted independent import and export rights. These rights permit us to import and export jewelry in and out of China. Based on, in part, the recent decline in the global economy, we do not currently have plans to import jewelry into China.
 
Our production facilities in Shenzhen are subject to environmental regulation by the Environmental Protection Bureau of Shenzhen. We hold all requisite operating permits from the Environmental Protection Bureau. Our permits confirm that we are in compliance with local regulations governing waste production and disposal and that our production facilities meet the public safety regulations regarding refuse, emissions, lights, noise and radiation. To date, we have never been cited for any environmental violations.
 
Employees
 
We have approximately 949 employees, including approximately 805 trained production workers.  In 2008, we began recruiting skilled laborers to fill vacancies for our new diamond line products. As a result, the number of our trained production workers includes approximately 108 trained diamond production workers. Our employees are part of a labor association that represents employees with respect to labor disputes and other employee matters. We have never experienced a work stoppage or a labor dispute that has interfered with our operations. We believe our relationship with our employees is good.
 
We are required to contribute a portion of our employees’ total salaries to the Chinese government’s social insurance funds, including medical insurance, unemployment insurance and job injuries insurance, and a housing assistance fund, in accordance with relevant regulations. Total contributions to the funds are approximately $125,000, $46,000 and $34,000 for the years ended December 31, 2008, 2007 and 2006, respectively. We expect that the amount of our contribution to the government’s social insurance funds will increase in the future as we expand our workforce and operations. We also provide housing facilities for our employees. At present, approximately 63% of our employees live in company-provided housing facilities.

 
7

 
 
Effective January 1, 2008, PRC introduced a new labor contract law that enhances rights for the nation's workers, including open-ended work contracts and severance pay. The legislation requires employers to provide written contracts to their workers, restricts the use of temporary laborers and makes it harder to lay off employees. It also requires that employees with short-term contracts become full-time employees with lifetime benefits after a short-term contract is renewed twice.  Although the new labor contract law will increase our labor costs going forward, we do not anticipate there will be any significantly effects on our overall profitability in the near future since such amount was historically not material to our operating cost. The increase in our operation costs due to the new labor law was not material, and our management anticipates the law may be assist in improving candidate retention for skilled workers.

Available Information
 
Our principal executive offices are located at 5/F., Block 1, Shi Hua Industrial Zone, Cui Zhu Road North, Shenzhen, 518019, People’s Republic of China. Our telephone number is +86 (755) 2580-1888. Our Internet address is www.fuqi.com.cn. We make available free of charge on or through our Internet Website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.
 
 
8

 


 
ITEM 1A: RISK FACTORS
 
Any investment in our common stock involves a high degree of risk. Potential investors should carefully consider the material risks described below and all of the information contained in this Form 10-K before deciding whether to purchase any of our securities. Our business, financial condition or results of operations could be materially adversely affected by these risks if any of them actually occur. Some of these factors have affected our financial condition and operating results in the past or are currently affecting our company. This filing also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks faced described below and elsewhere in this Form 10-K.  Unless the context otherwise requires, the terms “we,” the “Company,” “us,” or “Fuqi” refers to Fuqi International, Inc. and our wholly-owned subsidiaries.
 
RISKS RELATED TO OUR OPERATIONS
 
Jewelry purchases are discretionary, may be particularly affected by adverse trends in the general economy, and an economic decline will make it more difficult to generate revenue.
 
The success of our operations depends to a significant extent upon a number of factors relating to discretionary consumer spending in China. These factors include economic conditions and perceptions of such conditions by consumers, employment rates, the level of consumers’ disposable income, business conditions, interest rates, consumer debt levels, availability of credit and levels of taxation in regional and local markets in China where we manufacture and sell our products. There can be no assurance that consumer spending on jewelry will not be adversely affected by changes in general economic conditions in China and globally.

Most of our sales are of products that include gold, platinum, precious metals and other commodities, and fluctuations in the availability and pricing of commodities would adversely impact our ability to obtain and produce products at favorable prices.
 
The jewelry industry generally is affected by fluctuations in the price and supply of diamonds, gold, platinum and, to a lesser extent, other precious and semi-precious metals and stones. Historically, we have not hedged our requirements for gold, platinum or other raw materials through the use of options, forward contracts or outright commodity purchasing.  In the fourth quarter of 2007, we began to engage in such hedging activities for gold by entering into gold futures contracts, but there is no guarantee that we will benefit in our attempts to hedge against fluctuations in the price or availability of gold.

A significant disruption in our supply of gold, platinum, or other commodities could decrease our production and shipping levels, materially increase our operating costs and materially adversely affect our profit margins. Shortages of gold, platinum, or other commodities, or interruptions in transportation systems, labor strikes, work stoppages, war, acts of terrorism, or other interruptions to or difficulties in the employment of labor or transportation in the markets in which we purchase our raw materials, may adversely affect our ability to maintain production of our products and sustain profitability. Although we generally attempt to pass increased commodity prices to our customers, there may be circumstances in which we are not able to do so. In addition, if we were to experience a significant or prolonged shortage of gold, platinum, or other commodities, we would be unable to meet our production schedules and to ship products to our customers in timely fashion, which would adversely affect our sales, margins and customer relations.

Furthermore, the value of our inventory may be affected by commodity prices. We record the value of our inventory at the lower of cost (using the first-in, first-out method) or market. As a result, decreases in the market value of precious metals such as gold and platinum would result in a lower stated value of our inventory, which may require us to take a charge for the decrease in the value of our inventory.
 
Due to the geographic concentration of our sales in the northeast region of China, our results of operations and financial condition are subject to fluctuations in regional economic conditions.
 
A significant percentage of our total sales are made in the northeast region of China, particularly in the provinces of Liaoning, Jilin and Heilongjiang, and the city of Beijing. For the years ended December 31, 2008 and 2007, approximately 37.7% and 51.1% of revenues, respectively, was generated from this area. Our concentration of sales in this area heightens our exposure to adverse developments related to competition, as well as economic and demographic changes in this region. Our geographic concentration might result in a material adverse effect on our business, financial condition or results of operations in the future.

 
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Our retail expansion strategy depends on our ability to open and operate a certain number of new counters and stores each year, which could strain our resources and cause the performance of our existing operations to suffer.
 
We have historically been engaged only in the manufacture and wholesale distribution of jewelry products and have only recently begun retail operations. Our retail expansion strategy will largely depend on our ability to find sites for, open and operate new retail locations successfully. Our ability to open and operate new retail locations successfully depends on several factors, including, among others, our ability to:
 
·
identify suitable counter and store locations, the availability of which is outside our control;
·
purchase and negotiate acceptable lease terms;
·
prepare counters and stores for opening within budget;
·
source sufficient levels of inventory at acceptable costs to meet the needs of new counters and stores;
·
hire, train and retain personnel;
 
·
secure required governmental permits and approvals;
 
·
successfully integrate new counters and stores into our existing operations;
 
·
contain payroll costs; and
 
·
generate sufficient operating cash flows or secure adequate capital on commercially reasonable terms to fund our expansion plans.
 
Any failure to successfully open and operate new retail counters and stores could have a material adverse effect on our results of operations. In addition, our retail expansion program will place increased demands on our operational, managerial and administrative resources. These increased demands could cause us to operate our business less effectively, which, in turn, could cause deterioration in the financial performance of our overall business.
 
It is not our intention to open new retail counters and stores that materially cannibalize the sales of our existing distributors. However, as with most growing retail operations, there can be no assurance that sales cannibalization will not inadvertently occur or become more significant in the future as we gradually increase our presence in existing markets over time to maximize our competitive position and financial performance in each market.
 
Our acquisition of substantially all of the assets of the Temix Companies in August 2008 may not result in the benefits and revenue growth we expect.

In August 2008, we completed our acquisition of substantially all of the assets of the Temix Companies.  The Temix Companies was our first major acquisition of a jewelry retail operation. We may continue to acquire additional businesses in the future. This acquisition and future acquisitions involve substantial risks, including:

·
integration and management of the operations;
·
Retention of key personnel;
·
integration of information systems, internal procedures, accounts receivable and management, financial and operational controls;
·
retention of customer base of acquired businesses;
·
diversion of management’s attention from other ongoing business concerns; and exposure to unanticipated liabilities of acquired companies.

These and other factors could harm our ability to achieve anticipated levels of profitability or realize other anticipated benefits of an acquisition and could adversely affect our business and operating results.

 
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Competition in the jewelry industry could cause us to lose market share, thereby materially adversely affecting our business, results of operations and financial condition.

The jewelry industry in China is highly fragmented and very competitive. We believe that the market may become even more competitive as the industry grows and/or consolidates. We compete with local jewelry manufacturers and large foreign multinational companies that offer products that are similar to ours. Some of these competitors have larger local or regional customer bases, more locations, more brand equity, and substantially greater financial, marketing and other resources than we have. As a result of this increasing competition, we could lose market share, thereby materially adversely affecting our business, results of operations and financial condition.
 
We may need to raise additional funds in the future. These funds may not be available on acceptable terms or at all, and, without additional funds, we may not be able to maintain or expand our business.

We expect to expend significant resources to expand our retail distribution of jewelry in China. We will require substantial funds in order to finance our retail distribution, fund operating expenses, to develop manufacturing, marketing and sales capabilities and to cover public company costs. In addition to the funds required to open retail locations, additional working capital will be needed to operate retail locations due to longer sales and collection cycles and higher inventory levels required to support retail stores. We also expect to require substantial funds to change our product mix to include more platinum products. Without these funds, we may not be able to meet these goals.  Also, we expect our general and administrative costs to substantially increase due to higher salaries to be paid to our executive officers after the completion of our initial listing in the United States in October 2007.  See “Executive Compensation — Compensation Discussion and Analysis.”  We may seek additional funding through public or private financing or through collaborative arrangements with strategic partners.
 
You should also be aware that in the future:
 
 
·
We cannot be certain that additional capital will be available on favorable terms, if at all;
 
·
Any available additional financing may not be adequate to meet our goals; and
 
·
Any equity financing would result in dilution to stockholders.

If we cannot raise additional funds when needed, or on acceptable terms, we may not be able to effectively execute our growth strategy (including expanding our business to the retail market), take advantage of future opportunities, or respond to competitive pressures or unanticipated requirements. In addition, we may be required to scale back or discontinue our production and development program, or obtain funds through strategic alliances that may require us to relinquish certain rights.
 
Our ability to maintain or increase our revenue could be harmed if we are unable to strengthen and maintain our brand image.
 
We believe that primary factors in determining customer buying decisions in China’s jewelry sector include price, confidence in the merchandise sold, and the level and quality of customer service. The ability to differentiate our products from competitors by our brand-based marketing strategies is a key factor in attracting consumers, and if our strategies and efforts to promote our brand, such as television and magazine advertising and beauty contest sponsorships, fail to garner brand recognition, our ability to generate revenue may suffer. If we are unable to differentiate our products, our ability to sell our products wholesale and our sale of products retail will be adversely affected. If we fail to anticipate, identify or react appropriately or in a timely manner to customer buying decisions, we could experience reduced consumer acceptance of our products, a diminished brand image, higher markdowns, and costs to recast overstocked jewelry. These factors could result in lower selling prices and sales volumes for our products, which could adversely affect our financial condition and results of operations. This risk is particularly acute because we rely on a limited demographic customer base for a large percentage of our sales.
 
There is only one source in China for us to obtain the precious metals used in our jewelry products; accordingly, any interruptions of our arrangement with this source would disrupt our ability to fill customer orders and substantially affect our ability to continue our business operations.
 
Under PRC law, supply of precious metals such as platinum, gold, and silver are highly regulated by certain government agencies. Shanghai Gold Exchange is the only authorized source of supply in China for precious metals used in our jewelry products. We are required to obtain several membership and approval certificates from government agencies in order to do business involving precious metals. We may be required to renew such memberships and to obtain approval certificates periodically. The loss of or inability to renew our membership relationship with the Shanghai Gold Exchange, or its inability to furnish precious metals to us as anticipated in terms of cost, quality, and timeliness, would adversely affect our ability to fill customer orders in accordance with our required delivery, quality, and performance requirements. If this were to occur, we would not have any alternative suppliers in China to obtain our raw materials from, which would result in a decline in revenue and revenue potential and risk the continuation of our business operations.

 
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If we are not able to adapt to changing jewelry trends in China, our inventory may be overstocked and we may be forced to reduce the price of our overstocked jewelry or incur the cost to recast it into new jewelry.
 
We depend on consumer fashions, preferences for jewelry and the demand for particular products in China. Jewelry design trends in China can change rapidly, as evidenced by the recent increase in the consumption of platinum jewelry in the Chinese market. The ability to predict accurately future changes in taste, respond to changes in consumer preferences, carry the inventory demanded by customers, deliver the appropriate quality, price products correctly and implement effective purchasing procedures, all have an important influence on determining sales performance and achieved gross margin. If we fail to anticipate, identify or react appropriately to changes in styles and trends, we could experience excess inventories, higher than normal markdowns or an inability to sell our products. If such a situation exists, we may need to incur additional costs to recast our products to fit the demand, recovering only the value of raw material and all labor invested in the product would be lost.
 
Our failure to manage growth effectively could have an adverse effect on our employee efficiency, product quality, working capital levels, and results of operations.
 
We have been implementing a growth strategy into retail distribution of our products that we believe will result in rapid growth, which will place significant demands on our managerial, operational and financial resources. Any significant growth in the market for our current wholesale business and our planned retail distribution would require us to expand our employee base for managerial, operational, financial, and other purposes. During any growth, we may face problems related to our operational and financial systems and controls, including quality control and delivery and service capabilities. We would also need to continue to expand, train and manage our employee base. We currently have approximately 949 employees, which include approximately 805 company-trained workers, and, at that size, a rapid increase in the number of our employees would be difficult to manage. Continued future growth will impose significant added responsibilities upon the members of management to identify, recruit, maintain, integrate, and motivate new employees. If we are able to expand our retail business, we would need to train or hire additional employees with retail experience.
 
Aside from increased difficulties in the management of human resources, we may also encounter working capital issues, as we will need increased liquidity to finance the purchases of raw materials and supplies, development of new products, establishment of new retail stores, and the hiring of additional employees. Our failure to manage growth effectively may lead to operational and financial inefficiencies that will have a negative effect on our profitability. We cannot assure you that we will be able to timely and effectively meet that demand and maintain the quality standards required by our existing and potential customers.
 
We rely on our distribution network for a significant portion of our revenues. Failure to maintain good distributor relations could materially disrupt our distribution business and harm our net revenues.
 
Our business has become increasingly dependent on the performance of our distributors. During the years ended December 31, 2008, 2007, and 2006, 19%, 16% and 13%, respectively, of our net revenues were generated through our distributors. We currently have 192 distributors. Our largest distributor accounted for approximately 6% and 7% of our gross revenues in fiscal 2008 and 2007, respectively. We do not maintain long-term contracts with our distributors. Maintaining relationships with existing distributors and replacing any distributor may be difficult or time consuming. Our failure to maintain good relationships with our distributors could materially disrupt our distribution business and harm our net revenues.
 
We must maintain a relatively large inventory of our raw materials and jewelry products to support customer delivery requirements, and if this inventory is lost due to theft, our results of operations would be negatively impacted.
 
We purchase large volumes of precious metals approximately five times per month and store significant quantities of raw materials and jewelry products at our warehouse and show room in Shenzhen, China. Although we have an inventory security system in place, in the past we have experienced minor inventory theft at, or in transit to or from, certain of these facilities. We may be subject to future significant inventory losses due to third-party or employee theft from our warehouses or other forms of theft. The implementation of security measures beyond those that we already utilize, which include metal detectors for employees, security cameras, and alarm systems in our warehouse, would increase our operating costs. Also, any such losses of inventory could exceed the limits of, or be subject to an exclusion from, coverage under our insurance policies. Claims filed by us under our insurance policies could lead to increases in the insurance premiums payable by us or the termination of coverage under the relevant policy.

 
12

 

Substantial defaults by our customers on accounts receivable could have a material adverse affect on our liquidity and results of operations.
 
A substantial portion of our working capital consists of accounts receivable from customers.  As of December 31, 2008 and 2007, approximately 57% and 25% of our working capital, respectively, was attributable to accounts receivable. In addition, we have seen a significant increase in our provisions for bad debt.  For the years ended December 31, 2008 and 2007, we had a provision for bad debt expense of approximately $1.1 million and $0.3 million, respectively, which represented approximately 1.5% and 1.2% of our gross accounts receivables as of December 31, 2008 and 2007, respectively.  If customers responsible for a significant amount of accounts receivable were to become insolvent or otherwise unable to pay for our products, or unable to make payments in a timely manner, our liquidity and results of operations could be materially adversely affected. An economic or industry downturn could materially adversely affect the servicing of these accounts receivable, which could result in longer payment cycles, increased collections costs and defaults in excess of management’s expectations. In addition, as we increase our presence in the retail market, we expect the aging of our accounts receivable generated from sales through retail counters to increase as department stores typically defer payments to us of cash receipts collected by them on our behalf. A significant deterioration in our ability to collect on accounts receivable could affect our cash flow and working capital position and could also impact the cost or availability of financing available to us.
 
We are dependent on certain key personnel and loss of these key personnel could have a material adverse effect on our business, financial condition and results of operations.
 
Our success is, to a certain extent, attributable to the management, sales and marketing, and operational and technical expertise of certain key personnel. Each of our named executive officers, including our Chief Executive Officer, Mr. Yu Kwai Chong, performs key functions in the operation of our business. There can be no assurance that we will be able to retain these officers or that such personnel may not receive and/or accept competing offers of employment. The loss of a significant number of these employees could have a material adverse effect upon our business, financial condition, and results of operations. We do not maintain key-man life insurance for any of our senior management.
 
We have significant outstanding short-term borrowings that have been increasing, and we may not be able to obtain extensions when they mature.
 
Our notes payable to banks for short-term borrowings as of December 31, 2008 and 2007, were $21.9 million and $17.1 million, respectively, and bore weighted average interest rates of 6.64% and 6.68%, respectively. Generally, these short-term bank loans mature in one year or less and contain no specific renewal terms. However, in China it is customary practice for banks and borrowers to negotiate roll-overs or renewals of short-term borrowings on an on-going basis shortly before they mature. Although we have renewed our short-term borrowings in the past, we cannot assure you that we will be able to renew these loans in the future as they mature. In particular, a substantial portion of our short-term borrowings are arranged or guaranteed by Mr. Yu Kwai Chong, our controlling stockholder and CEO, or one of his affiliated companies. Since Mr. Chong ceased to be our sole stockholder in November 2006, he may be less inclined to guarantee our bank borrowings. If we are unable to obtain renewals of these loans or sufficient alternative funding on reasonable terms from banks or other parties, we will have to repay these borrowings with the cash on our balance sheet or cash generated by our future operations, if any. We cannot assure you that our business will generate sufficient cash flow from operations to repay these borrowings.

Adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs, access to capital and cost of capital.

The capital and credit markets have been experiencing extreme volatility and disruption in recent months, including, among other things, extreme volatility in securities prices, severely diminished liquidity and credit availability, ratings downgrades of certain investments and declining valuations of others. Governments have taken unprecedented actions intended to address extreme market conditions that have included severely restricted credit and declines in real estate values. In some cases, the markets have exerted downward pressure on availability of liquidity and credit capacity for certain issuers. While currently these conditions have not impaired our ability to utilize our current credit facilities and finance our operations, there can be no assurance that there will not be a further deterioration in financial markets and confidence in major economies such that our ability to access credit markets and finance our operations might be impaired. As of December 31, 2008, we had approximately $21.9 million in short-term notes payable that are due and payable between January 2009 and June 2009. If we are unable to obtain additional financing at or prior to the maturity date of our notes payable, our liquidity will be adversely affected, and without sufficient liquidity, we may be forced to curtail our operations. Adverse market conditions may limit our ability to replace, in a timely manner, maturing liabilities and access the capital necessary to operate and grow our business. As such, we may be forced to delay raising capital or bear an unattractive cost of capital which could decrease our profitability and significantly reduce our financial flexibility. Demand for our services is cyclical and vulnerable to economic downturns. Although our total revenues continue to improve in the year ended December 31, 2008, the current tightening of credit in financial markets could adversely affect the ability of our customers to obtain financing for purchases of our services and could result in a decrease in or cancellation of orders for our services. We are unable to predict the duration and severity of the current disruption in financial markets and the global adverse economic conditions and the effect such events might have on our business. Our results of operations, financial condition, cash flows and capital position could be materially adversely affected by disruptions in the financial markets.

 
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Our quarterly results may fluctuate because of many factors and, as a result, investors should not rely on quarterly operating results as indicative of future results.
 
Fluctuations in operating results or the failure of operating results to meet the expectations of public market analysts and investors may negatively impact the value of our securities. Quarterly operating results may fluctuate in the future due to a variety of factors that could affect revenues or expenses in any particular quarter. Fluctuations in quarterly operating results could cause the value of our securities to decline. Investors should not rely on quarter-to-quarter comparisons of results of operations as an indication of future performance. As a result of the factors listed below, it is possible that in future periods results of operations may be below the expectations of public market analysts and investors. This could cause the market price of our securities to decline.

Factors that may affect our quarterly results include:
 
·
vulnerability of our business to a general economic downturn in China and globally;
 
·
fluctuation and unpredictability of costs related to the gold, platinum and precious metals and other commodities used to manufacture our products;
 
·
seasonality of our business;
 
·
changes in the laws of the PRC that affect our operations;
 
·
our recent entry into the retail jewelry market;
 
·
competition;
 
·
our ability to obtain and maintain all necessary government certifications and/or licenses to conduct our business; and
 
·
development of a public trading market for our securities.
 
RISKS RELATED TO DOING BUSINESS IN CHINA
 
All of our assets are located in China and all of our revenues are derived from our operations in China, and changes in the political and economic policies of the PRC government could have a significant impact upon what business we may be able to conduct in the PRC and accordingly on the results of our operations and financial condition.
 
Our business operations may be adversely affected by the current and future political environment in the PRC. The Chinese government exerts substantial influence and control over the manner in which we must conduct our business activities. Our ability to operate in China may be adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, raw materials, environmental regulations, land use rights, property and other matters. Under the current government leadership, the government of the PRC has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the government of the PRC will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice.
 
Our operations are subject to PRC laws and regulations that are sometimes vague and uncertain. Any changes in such PRC laws and regulations, or the interpretations thereof, may have a material and adverse effect on our business.
 
The PRC’s legal system is a civil law system based on written statutes. Unlike the common law system prevalent in the United States, decided legal cases have little value as precedent in China. There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including but not limited to the laws and regulations governing our business, or the enforcement and performance of our arrangements with customers in the event of the imposition of statutory liens, death, bankruptcy or criminal proceedings. The Chinese government has been developing a comprehensive system of commercial laws, and considerable progress has been made in introducing laws and regulations dealing with economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade. However, because these laws and regulations are relatively new, and because of the limited volume of published cases and judicial interpretation and their lack of force as precedents, interpretation and enforcement of these laws and regulations involve significant uncertainties. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively.

 
14

 

Our principal operating subsidiary, Fuqi China, is considered a foreign invested enterprise under PRC laws, and as a result is required to comply with PRC laws and regulations, including laws and regulations specifically governing the activities and conduct of foreign invested enterprises. We cannot predict what effect the interpretation of existing or new PRC laws or regulations may have on our businesses. If the relevant authorities find us in violation of PRC laws or regulations, they would have broad discretion in dealing with such a violation, including, without limitation:
 
·
levying fines;
 
·
revoking our business license, other licenses or authorities;
 
·
requiring that we restructure our ownership or operations; and
 
·
requiring that we discontinue some or all of our business.
 
A recent increase in the rate of inflation in the PRC could negatively affect our profitability and growth.

While the PRC economy has experienced rapid growth, such growth has been uneven among various sectors of the economy and in different geographical areas of the country. Rapid economic growth can lead to growth in the money supply and rising inflation. According to the National Bureau of Statistics of China, the inflation rate in China reached a high point of 5.9% in 2008 as compared to the past several years. The inflation rate in China was 1.5% in 2006 and 4.8% in 2007.  Many of our operating expenses were increased and are also expected to increase with 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. In order to control inflation in the past, the PRC government has imposed controls on bank credits, limits on loans for fixed assets and restrictions on state bank lending. The implementation of such policies may impede economic growth.

The scope of our business license in China is limited, and we may not expand or continue our business without government approval and renewal, respectively.
 
Our principal operating subsidiary, Fuqi China, is a wholly foreign-owned enterprise organized under PRC law, commonly known as a WFOE. A WFOE can only conduct business within its approved business scope, which ultimately appears on its business license. Our license permits us to design, manufacture, sell and market jewelry products to department stores throughout the PRC and to engage in the retail distribution of our products. Any amendment to the scope of our business requires further application and government approval. In order for us to expand our business beyond the scope of our license, we will be required to enter into a negotiation with the authorities for the approval to expand the scope of our business. We cannot assure you that Fuqi China will be able to obtain the necessary government approval for any change or expansion of our business scope.
 
We will not be able to complete an acquisition of prospective acquisition targets in the PRC unless their financial statements can be reconciled to U.S. generally accepted accounting principles in a timely manner.
 
Companies based in the PRC may not have properly kept financial books and records that may be reconciled with U.S. generally accepted accounting principles. If we attempt to acquire a significant PRC target company and/or its assets, we would be required to obtain or prepare financial statements of the target that are prepared in accordance with and reconciled to U.S. generally accepted accounting principles. Federal securities laws require that a business combination meeting certain financial significance tests require the public acquirer to prepare and file historical and/or pro forma financial statement disclosure with the SEC. These financial statements must be prepared in accordance with, or be reconciled to U.S. generally accepted accounting principles and the historical financial statements must be audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), or PCAOB. If a proposed acquisition target does not have financial statements that have been prepared in accordance with, or that can be reconciled to, U.S. generally accepted accounting principles and audited in accordance with the standards of the PCAOB, we will not be able to acquire that proposed acquisition target. These financial statement requirements may limit the pool of potential acquisition targets with which we may acquire and hinder our ability to expand our retail operations. Furthermore, if we consummate an acquisition and are unable to timely file audited financial statements and/or pro forma financial information required by the Exchange Act, such as Item 9.01 of Form 8-K, we will be ineligible to use the SEC’s short-form registration statement on Form S-3 to raise capital, if we are otherwise eligible to use a Form S-3. If we are ineligible to use a Form S-3, the process of raising capital may be more expensive and time consuming and the terms of any offering transaction may not be as favorable as they would have been if we were eligible to use Form S-3.

 
15

 
 
Recent PRC regulations relating to acquisitions of PRC companies by foreign entities may create regulatory uncertainties that could restrict or limit our ability to operate. Our failure to obtain the prior approval of the China Securities Regulatory Commission, or the CSRC, for the listing and trading of our common stock could have a material adverse effect on our business, operating results, reputation and trading price of our common stock, and may also create uncertainties in the future.
 
The PRC State Administration of Foreign Exchange, or “SAFE,” issued a public notice in November 2005, known as Circular 75, concerning the use of offshore holding companies in mergers and acquisitions in China. The public notice provides that if an offshore company controlled by PRC residents intends to acquire a PRC company, such acquisition will be subject to registration with the relevant foreign exchange authorities. The public notice also suggests that registration with the relevant foreign exchange authorities is required for any sale or transfer by the PRC residents of shares in an offshore holding company that owns an onshore company. The PRC residents must each submit a registration form to the local SAFE branch with respect to their ownership interests in the offshore company, and must also file an amendment to such registration if the offshore company experiences material events, such as changes in the share capital, share transfer, mergers and acquisitions, spin-off transactions or use of assets in China to guarantee offshore obligations.
 
On August 8, 2006, the PRC Ministry of Commerce (“MOFCOM”), joined by the State-owned Assets Supervision and Administration Commission of the State Council, the State Administration of Taxation, the State Administration for Industry and Commerce, the China Securities Regulatory Commission and SAFE, released a substantially amended version of the Provisions for Foreign Investors to Merge with or Acquire Domestic Enterprises (the “Revised M&A Regulations”), which took effect September 8, 2006. These new rules significantly revised China’s regulatory framework governing onshore-to-offshore restructurings and foreign acquisitions of domestic enterprises. These new rules signify greater PRC government attention to cross-border merger, acquisition and other investment activities, by confirming MOFCOM as a key regulator for issues related to mergers and acquisitions in China and requiring MOFCOM approval of a broad range of merger, acquisition and investment transactions. Further, the new rules establish reporting requirements for acquisition of control by foreigners of companies in key industries, and reinforce the ability of the Chinese government to monitor and prohibit foreign control transactions in key industries.
 
Among other things, the revised M&A Regulations include new provisions that purport to require that an offshore special purpose vehicle, or SPV, formed for listing purposes and controlled directly or indirectly by PRC companies or individuals must obtain the approval of the CSRC prior to the listing and trading of such SPV’s securities on an overseas stock exchange. On September 21, 2006, the CSRC published on its official website procedures specifying documents and materials required to be submitted to it by SPVs seeking CSRC approval of their overseas listings. However, the application of this PRC regulation remains unclear with no consensus currently existing among the leading PRC law firms regarding the scope and applicability of the CSRC approval requirement. Our PRC counsel, Shujin Law Firm, has advised us that because we completed our onshore-to-offshore restructuring before September 8, 2006, the effective date of the new regulation, it is not necessary for us to submit the application to the CSRC for its approval, and the listing and trading of our common stock does not require CSRC approval.
 
If the CSRC or another PRC regulatory agency subsequently determines that CSRC approval was required for our restructuring, we may face regulatory actions or other sanctions from the CSRC or other PRC regulatory agencies. These regulatory agencies may impose fines and penalties on our operations in the PRC, limit our operating privileges in the PRC, or take other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our Common Stock.
 
Also, if later the CSRC requires that we obtain its approval, we may be unable to obtain a waiver of the CSRC approval requirements, if and when procedures are established to obtain such a waiver. Any uncertainties and/or negative publicity regarding this CSRC approval requirement could have a material adverse effect on the trading price of our common stock. Furthermore, published news reports in China recently indicated that the CSRC may have curtailed or suspended overseas listings for Chinese private companies.
 
It is uncertain how our business operations or future strategy will be affected by the interpretations and implementation of Circular 75 and the Revised M&A Regulations. It is anticipated that application of the new rules will be subject to significant administrative interpretation, and we will need to closely monitor how MOFCOM and other ministries apply the rules to ensure that our domestic and offshore activities continue to comply with PRC law. Given the uncertainties regarding interpretation and application of the new rules, we may need to expend significant time and resources to maintain compliance.

 
16

 

Failure to comply with the United States Foreign Corrupt Practices Act could subject us to penalties and other adverse consequences.
 
As our ultimate holding company is a Delaware corporation, we are subject to the United States Foreign Corrupt Practices Act, which generally prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Foreign companies, including some that may compete with our company, are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices may occur from time-to-time in the PRC. We can make no assurance, however, 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 and other consequences that may have a material adverse effect on our business, financial condition and results of operations.

Because our funds are held in banks in the PRC that do not provide insurance, the failure of any bank in which we deposit our funds could affect our ability to continue in business.

Banks and other financial institutions in the PRC do not provide insurance for funds held on deposit. A significant portion of our assets are in the form of cash deposited with banks in the PRC, and in the event of a bank failure, we may not have access to our funds on deposit. Depending upon the amount of money we maintain in a bank that fails, our inability to have access to our cash could impair our operations, and, if we are not able to access funds to pay our suppliers, employees and other creditors, we may be unable to continue in business.
 
We had enjoyed certain preferential tax concessions and the loss of these preferential tax concessions may cause our tax liabilities to increase and our profitability to decline.
 
In 2004 and 2005, Fuqi China enjoyed a preferential income tax rate of 7.5% due to its status as a new business. That status expired effective January 1, 2006. The expiration of the preferential tax treatment has increased our tax liabilities and reduced our profitability.  On March 16, 2007, the National People’s Congress of China enacted a new PRC Enterprise Income Tax Law, under which foreign invested enterprises and domestic companies will be subject to enterprise income tax at a uniform rate of 25%. The new law became effective on January 1, 2008. During the transition period for enterprises established before March 16, 2007, the tax rate started gradually being increased in 2008 and will be equal to the new tax rate of 25% in 2012. We believe that our profitability will be negatively affected as a result of the new EIT Law. Any future increase in the enterprise income tax rate applicable to us or other adverse tax treatments could increase our tax liabilities and reduce our net income.
 
If we make equity compensation grants to persons who are PRC citizens, they may be required to register with the State Administration of Foreign Exchange of the PRC, or SAFE. We may also face regulatory uncertainties that could restrict our ability to adopt additional equity compensation plans for our directors and employees and other parties under PRC law.
 
On April 6, 2007, SAFE issued the “Operating Procedures for Administration of Domestic Individuals Participating in the Employee Stock Ownership Plan or Stock Option Plan of An Overseas Listed Company, also know as “Circular 78.” It is not clear whether Circular 78 covers all forms of equity compensation plans or only those which provide for the granting of stock options. For any plans which are so covered and are adopted by a non-PRC listed company, such as our company, after April 6, 2007, Circular 78 requires all participants who are PRC citizens to register with and obtain approvals from SAFE prior to their participation in the plan. In addition, Circular 78 also requires PRC citizens to register with SAFE and make the necessary applications and filings if they participated in an overseas listed company’s covered equity compensation plan prior to April 6, 2007. We believe that the registration and approval requirements contemplated in Circular 78 will be burdensome and time consuming.
 
We intend to make numerous stock option grants under our equity incentive plan to our officers and directors, some of whom are PRC citizens and may be required to register with SAFE. In addition to our officers and directors that received option grants, future participants of our equity incentive plan or any other equity compensation plan we may adopt who are PRC citizens may be required to register with SAFE. If it is determined that any of our equity compensation plans are subject to Circular 78, failure to comply with such provisions may subject us and participants of our equity incentive plan who are PRC citizens to fines and legal sanctions and prevent us from being able to grant equity compensation to our PRC employees. In that case, our business operations may be adversely affected.

 
17

 
 
Any recurrence of severe acute respiratory syndrome, or SARS, the Avian Flu, or another widespread public health problem in the PRC could adversely affect our operations.
 
A renewed outbreak of SARS, the Avian Flu or another widespread public health problem in China, where all of our manufacturing facilities are located and where all of our sales occur, could have a negative effect on our operations. Our business is dependent upon our ability to continue to manufacture our products. Such an outbreak could have an impact on our operations as a result of:
 
·
quarantines or closures of our manufacturing facilities or the retail outlets, which would severely disrupt our operations,
 
·
the sickness or death of our key officers and employees, and
 
·
a general slowdown in the Chinese economy.
 
Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect our operations.
 
Because our business is located in the PRC, we may have difficulty establishing adequate management, legal and financial controls, which we are required to do in order to comply with U.S. securities laws.
 
PRC companies have historically not adopted a Western style of management and financial reporting concepts and practices, which includes strong corporate governance, internal controls and, computer, financial and other control systems. Most of our middle and top management staff are not educated and trained in the Western system, and we may have difficulty hiring new employees in the PRC with such training. In addition, we may need to rely on a new and developing communication infrastructure to efficiently transfer our information from retail nodes to our headquarters. 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. 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. This may result in significant deficiencies or material weaknesses in our internal controls.  In recent years, we have identified both significant deficiencies and material weaknesses in our internal controls.  If we are not able to remediate these deficiencies and material weaknesses, and prevent future deficiencies, it 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.
 
You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based upon U.S. laws, including the federal securities laws, or other foreign laws against us or our management.
 
All of our current operations, including the manufacturing and distribution of jewelry, are conducted in China. Moreover, most of our directors and officers are nationals and residents of China. All or substantially all of the assets of these persons are located outside the United States and in the PRC. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China upon these persons. In addition, uncertainty exists as to whether the courts of China would recognize or enforce judgments of U.S. courts obtained against us or such officers and/or directors predicated upon the civil liability provisions of the securities laws of the United States or any state thereof, or be competent to hear original actions brought in China against us or such persons predicated upon the securities laws of the United States or any state thereof.

RISKS RELATED TO OUR CAPITAL STRUCTURE

We are controlled by one stockholder, whose interests may differ from those of other stockholders. As a result, we could be prevented from entering into potentially beneficial transactions if they conflict with our major stockholder’s interests.
 
As of December 31, 2008, Mr. Yu Kwai Chong, our Chief Executive Officer and our largest stockholder, beneficially owns more than 50% of our outstanding shares. Mr. Chong possesses significant influence over us, giving him the ability, among other things, to elect all or a majority of the Board of Directors and to approve significant corporate transactions. Such stock ownership and control may also have the effect of delaying or preventing a future change in control, impeding a merger, consolidation, takeover or other business combination, or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of our company. Without the consent of Mr. Chong, we could be prevented from entering into potentially beneficial transactions if they conflict with our major stockholder’s interests. The interests of this stockholder may differ from the interests of our other stockholders.

 
18

 

Our stock price is volatile and you might not be able to resell your securities at or above the price you have paid.
 
Since our initial public offering and listing of our common stock on the Nasdaq Global Market on October 23, 2007, the price at which our common stock had traded has been volatile, with a high and low sales price of $11.95 and $3.31, respectively, as through March 23, 2009. You might not be able to sell the shares of our common stock at or above the price you have paid. The stock market has experienced extreme volatility that often has been unrelated to the performance of its listed companies. Moreover, only a limited number of our shares are traded each day, which could increase the volatility of the price of our stock. These market fluctuations might cause our stock price to fall regardless of our performance. The market price of our common stock might fluctuate significantly in response to many factors, some of which are beyond our control, including the following:
 
·
actual or anticipated fluctuations in our annual and quarterly results of operations;
 
·
changes in securities analysts’ expectations;
 
·
variations in our operating results, which could cause us to fail to meet analysts’ or investors’ expectations;
 
·
announcements by our competitors or us of significant new products, contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;
 
·
conditions and trends in our industry;
 
·
general market, economic, industry and political conditions;
 
·
changes in market values of comparable companies;
 
·
additions or departures of key personnel;
 
·
stock market price and volume fluctuations attributable to inconsistent trading volume levels; and
 
·
future sales of equity or debt securities, including sales which dilute existing investors.
 
The sale or availability for sale of substantial amounts of our common stock could adversely affect its market price.
 
The market price of our Common Stock could decline as a result of sales of a large number of shares of our common stock in the market or the perception that these sales could occur. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.
 
As of March 25, 2009, we had 22,005,509 shares of Common Stock outstanding, and approximately 9,750,000 were freely tradable without further restriction under the Securities Act of 1933, as amended, by persons other than our affiliates (within the meaning of Rule 144 under the Securities Act). In addition, our certificate of incorporation permits the issuance of up to approximately 78 million additional shares of common stock. Thus, we have the ability to issue substantial amounts of common stock in the future, which would dilute the percentage ownership held by the existing investors.
 
Effective February 15, 2008, the SEC revised Rule 144, which provides a safe harbor for the resale of restricted securities, shortening applicable holding periods and easing other restrictions and requirements for resales by our non-affiliates, thereby enabling an increased number of our outstanding restricted securities to be resold sooner in the public market. Sales of substantial amounts of our stock at any one time or from time to time by the investors to whom we have issued them, or even the availability of these shares for sale, could cause the market price of our common stock to decline.

 
19

 

If we fail to maintain effective internal controls over financial reporting, the price of our common stock may be adversely affected.
 
We are required to establish and maintain appropriate internal controls over financial reporting. Failure to establish those controls, or any failure of those controls once established, could adversely impact our public disclosures regarding our business, financial condition or results of operations. Any failure of these controls could also prevent us from maintaining accurate accounting records and discovering accounting errors and financial frauds. Rules adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require annual assessment of our internal control over financial reporting, and attestation of this assessment by our company’s independent registered public accountants. The annual assessment of our internal controls requirement first applied to our annual report for the 2007 fiscal year and the attestation requirement of management’s assessment by our independent registered public accountants is included in this annual report for the 2008 fiscal year. The standards that must be met for management to assess the internal control over financial reporting as effective are new and complex, and require significant documentation, testing and possible remediation to meet the detailed standards. We may encounter problems or delays in completing activities necessary to make an assessment of our internal control over financial reporting. In addition, the attestation process by our independent registered public accountants is new to us and we may encounter problems or delays in completing the implementation of any requested improvements and receiving an attestation of our assessment by our independent registered public accountants. If we cannot assess our internal control over financial reporting as effective, or our independent registered public accountants are unable to provide an unqualified attestation report on such assessment, investor confidence and share value may be negatively impacted.
 
As disclosed in Item 9A of this Form 10-K, management’s assessment of our internal control over financial reporting identified certain material weaknesses and significant deficiencies in areas discussed in Item 9A and management determined that our internal control over financial reporting was not effective as of December 31, 2008.  A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.  A significant deficiency is a control deficiency, or a combination of control deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company’s financial reporting.
 
With respect to the effectiveness of our controls and procedures as of December 31, 2007, Stonefield Josephson, Inc., our Independent Registered Public Accounting Firm, indicated to us that our accounting for certain significant transactions were incorrectly calculated or incorrectly recorded, which resulted in adjustments that constituted significant deficiencies in our internal controls over accounting and financial reporting.  Furthermore, in connection with our assessment as of December 31, 2008, our management concluded that our internal controls over financial reporting was not effective due to our failure to maintain effective controls over the period-end closing process, which was caused by an insufficient number of qualified resources.  Our management determined that this deficiency was a material weakness.  Our assessment also concluded that we did not maintain effective control over revenue cycle with revenue recognition in improper periods. While we have implemented steps to remediate the identified material weaknesses, there can be no guarantee that we will be successful in our attempts to correct our significant deficiencies. Our identified material weaknesses and significant deficiencies may raise concerns for investors and may have an adverse impact on the price of our common stock.  See “ITEM 9A. CONTROLS AND PROCEDURES,” below, for additional information.
 
Restrictions on the convertibility of RMB into foreign currency may limit our ability to make dividends or other payments in U.S. dollars or fund possible business activities outside China.
 
All of our net revenues are currently generated in RMB. Any future restrictions on currency exchanges may limit our ability to use net revenues generated in RMB to make dividends or other payments in U.S. dollars or fund possible business activities outside China. Although the PRC government introduced regulations in 1996 to allow greater convertibility of RMB for current account transactions, significant restrictions still remain, including primarily the restriction that foreign-invested enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business after providing valid commercial documents. In addition, remittance of foreign currencies abroad and conversion of RMB for capital account items, including direct investment and loans, is subject to government approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. We cannot assure you the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of RMB, especially with respect to foreign exchange transactions.
 
Because our revenues are generated in RMB and our results are reported in U.S. dollars, devaluation of the RMB could negatively impact our results of operations.
 
The value of RMB is subject to changes in China’s governmental policies and to international economic and political developments. In January, 1994, the PRC government implemented a unitary managed floating rate system. Under this system, the People’s Bank of China, or PBOC, began publishing a daily base exchange rate with reference primarily to the supply and demand of RMB against the U.S. dollar and other foreign currencies in the market during the previous day. Authorized banks and financial institutions are allowed to quote buy and sell rates for RMB within a specified band around the central bank’s daily exchange rate. On July 21, 2005, PBOC announced an adjustment of the exchange rate of the U.S. dollar to RMB from 1:8.27 to 1:8.11 and modified the system by which the exchange rates are determined. This modification has resulted in an approximate 15.72% appreciation of the RMB against the U.S. dollar from July 21, 2005 to December 31, 2008. While the international reaction to the RMB revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in further fluctuations of the exchange rate of RMB against the U.S. dollar, including possible devaluations. As all of our net revenues are recorded in RMB, any future devaluation of RMB against the U.S. dollar could negatively impact our results of operations.

 
20

 

We do not foresee paying cash dividends in the foreseeable future and, as a result, our investors sole source of gain, if any, will depend on capital appreciation, if any.
 
We do not plan to declare or pay any further cash dividends on our shares of common stock in the foreseeable future and we currently intend to retain any future earnings for funding growth. Prior to the reverse merger we effected with VT Marketing Services, the predecessor of Fuqi International, Inc. (the “Reverse Merger”) in November 2006, we were wholly-owned by our founder and Chief Executive Officer, Mr. Yu Kwai Chong. During the years ended December 31, 2008, 2007, and 2006, we paid cash dividends of $0, $0, and $2.7 million, respectively, to Mr. Chong as our sole stockholder prior to the Reverse Merger. We currently have no intention to declare further dividends in the foreseeable future. Payment of dividends is further restricted under the provisions of our existing loan agreements, which prohibit Fuqi China from paying any dividends or making any other distributions to Fuqi BVI without the consent of the lenders. As a result, you should not rely on an investment in our securities if you require the investment to produce dividend income. Capital appreciation, if any, of our shares may be your sole source of gain for the foreseeable future. Moreover, you may not be able to resell your shares in our company at or above the price you paid for them.
 
ITEM 1B. UNRESOLVED STAFF COMMENTS
 
Not applicable, as we have not received written comments from the Securities and Exchange Commission Staff regarding our periodic or current reports under the Securities Act of 1933, as amended, more than 180 days before the end of fiscal year 2008 and no such comments remain unresolved.
 
ITEM 2. PROPERTIES  
 
Our principal executive offices are located at 5/F., Block 1, Shi Hua Industrial Zone, Cui Zhu Road North, Shenzhen 518019, China. We own approximately 15,000 square feet of office and showroom space at this location.
 
Our jewelry production facility is located in Shenzhen, China and, including office spaces, consists of approximately 66,000 square feet of building space. We own approximately 33,000 square feet of this space indirectly through our Chairman, Yu Kwai Chong, and his wife, both of whom hold the property in trust for our benefit. The remaining 33,000 square feet has been leased by us from Shenzhen Jin Tong Hai Enterprises Ltd, since July 2005. We use the space for production facilities, offices and showrooms. Pursuant to the terms of the lease, we lease the space for approximately $130,000 per annum. The lease agreement will terminate in June 2010. We have the right to renew the lease prior to its termination. At the time of renewal, the lease amount will be renegotiated, and based on the current industrial leasing market, we expect that the lease amount will be increased by approximately 30% in the year 2010.
 
In October 2007, we entered into a lease agreement for a 400-square-feet corporate office in San Jose, California. This office lease has a term of two years, expiring in October 2009. Monthly rent for this lease is $720. We intend to terminate the lease in 2009, prior to October 2009.

In March 2008, we entered into a lease agreement for an 817-square-feet corporate office in Hong Kong. This office lease has a term of two years, expiring in February 2010. Monthly rent for this lease is about $1,470.
 
ITEM 3. LEGAL PROCEEDINGS  
 
We are not involved in any material legal proceedings, nor are we aware of any potential or threatened material litigation, or any asserted claims that may result in material litigation or other legal proceedings.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On October 10, 2008, we held our annual meeting of stockholders. Of the 22,005,509 shares eligible to vote, 20,047,631, or 91.1%, votes were returned, formulating a quorum. At the annual stockholders meeting, the following matters were submitted to stockholders for vote: Proposal I—Election of directors and Proposal II—Ratification of the appointment of Stonefield Josephson, Inc. as our independent auditors for the year ending December 31, 2008.

 
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Proposal I—Election of Directors
 
All directors were elected at our annual meeting of stockholders.  The results of voting on these proposals are as follows:
 
Director
 
For
 
Against
 
Withheld 
 
Elected
Yu Kwai Chong
 
19,920,066
 
0
 
0
 
Yes
Ching Wan Wong
 
19,919,016
 
0
 
0
 
Yes
Lie Xi Zhuang
 
19,917,276
 
0
 
0
 
Yes
Lily Lee Chen
 
19,920,895
 
0
 
0
 
Yes
Eileen B. Brody
 
19,914,000
 
0
 
0
 
Yes
Victor A. Hollander
 
19,913,082
 
0
 
0
 
Yes
Jeff Haiyong Liu
 
19,913,750
 
0
 
0
 
Yes
 
Proposal II—Ratification of the appointment of Stonefield Josephson, Inc. as our independent auditors for the year ending December 31, 2008.
 
Proposal II was approved with 19,866,006 shares voted for, 109,347 voted against and 72,277 abstained from voting, thereby, ratifying the appointment of Stonefield Josephson, Inc. as our independent auditors for the year ending December 31, 2008.
 
 
22

 

PART II
 
ITEM 5. MARKET FOR REGISTRANT’S COMMON STOCK, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Market Information
 
Prior to October 23, 2007, our shares of common stock were not listed or quoted for trading on any national securities exchange or national quotation system. On October 23, 2007, we completed the initial public offering and our common stock began trading on the NASDAQ Global Market under the symbol “FUQI.”
 
From our date of listing on October 23, 2007 through December 31, 2008 as set forth below.  The closing price of our common stock on March 26, 2009 on the NASDAQ was $4.32.  As of March 26, 2009, we had approximately 120 common stockholders of record.
 
   
2008
 
   
High
   
Low
 
Fourth Quarter
  $ 8.77     $ 5.12  
Third Quarter
  $ 11.65     $ 7.02  
Second Quarter
  $ 11.95     $ 6.02  
First Quarter
  $ 10.65     $ 6.07  

   
2007
 
   
High
   
Low
 
Fourth Quarter (from listing on October 23, 2007)
  $ 11.75     $ 6.02  

The stock market in general has experienced extreme stock price fluctuations in the past few years.  In some cases, these fluctuations have been unrelated to the operating performance of the affected companies. Many companies have experienced dramatic volatility in the market prices of their common stock. We believe that a number of factors, both within and outside its control, could cause the price of our common stock to fluctuate, perhaps substantially. Factors such as the following could have a significant adverse impact on the market price of its common stock:
 
·
Our ability to obtain additional financing and, if available, the terms and conditions of the financing;
·
Our financial position and results of operations;
·
Concern as to, or other evidence of, the reliability and efficiency of our proposed products and services or our competitors’ products and services;
·
Announcements of innovations or new products or services by we or our competitors;
·
Federal and state governmental regulatory actions and the impact of such requirements on our business;
·
The development of litigation against us;
·
Period-to-period fluctuations in our operating results;
·
Changes in estimates of our performance by any securities analysts;
·
The issuance of new equity securities pursuant to a future offering or acquisition;
·
Changes in interest rates;
·
Competitive developments, including announcements by competitors of new products or services or significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;
·
Investor perceptions of our company; and
·
General economic and other national conditions.
 
Recent Sales of Unregistered Securities
 
None.

 
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Dividends
 
The Company has not paid or does not expect to declare or pay any cash dividends on its common stock in the foreseeable future, and it currently intends to retain future earnings, if any, to finance the expansion of its business. The decision whether to pay cash dividends on the Company’s common stock will be made by the Company’s board of directors, in their discretion, and will depend on its financial condition, operating results, capital requirements and other factors that the board of directors considers significant. Payment of dividends by Fuqi China is further restricted under the provisions of our existing loan agreements, which prohibit Fuqi China from paying any dividends or making any other distributions to Fuqi BVI without the consent of the lenders.
 
The Company’s wholly-owned subsidiary, Fuqi China, prior to merger with the Company, paid cash dividends of $0, $0, and $2.7 million, during the years ended December 31, 2008, 2007 and 2006, respectively. Each of these dividends was paid by the Company’s subsidiary to Mr. Chong, as its sole stockholder, which offset partially the amounts due to the Company’s subsidiary by Mr. Chong.
 
Transfer Agent and Registrar
 
The transfer agent and registrar for our common stock is Computershare Trust Company, Inc.
 
Equity Compensation Plan Information
 
Our equity compensation plan information is provided as set forth in Part III, Item 11 herein.
 
 
24

 
 
ITEM 6.   SELECTED CONSOLIDATED FINANCIAL DATA
 
The following consolidated statements of income data for each of the five years ended December 31, 2008 and the consolidated balance sheet data as of the end of each of the foregoing years are derived from our audited consolidated financial statements.  Historical results are not necessarily indicative of the results of operations for future years. The following data is qualified in its entirety by and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this Form 10-K.
 
Consolidated Statement of Income Data:

   
Years Ended December 31,
 
   
2008
   
2007
   
2006
   
2005
   
2004
 
   
(In Thousands, Except Share Amounts and Earnings per Share)
 
Net sales
                             
Wholesale and distribution
  $ 356,471     $ 144,314     $ 92,409     $ 72,580     $ 56,765  
Retail
    11,134       1,245                    
      367,605       145,559       92,409       72,580       56,765  
Cost of sales
                                       
Wholesale and distribution
    313,645       128,110       83,619       64,964       50,862  
Retail
    8,976       935                    
      322,621       129,045       83,619       64,964       50,862  
Gross profit
    44,984       16,514       8,790       7,616       5,903  
Operating expenses:
                                       
Selling and marketing
    4,910       1,105       490       624       549  
General and administrative
    6,715       2,919       794       671       1,006  
Total operating expenses
    11,625       4,024       1,284       1,295       1,555  
Income from operations
    33,359       12,490       7,506       6,321       4,348  
Other income (expenses):
                                       
Interest expense
    (1,437 )     (1,239 )     (799 )     (498 )     (100 )
Interest income
    123       166       70              
Change of fair value on inventory loan payable
          (46 )                  
Loss on disposal of fixed assets
                            (45 )
Exemption of tax liabilities and estimated penalty payable
          4,162                    
Gain from derivative instrument
    2,362       80                    
Miscellaneous
    333             13       (1 )     4  
Total other income (expenses)
    1,381       3,123       (716 )     (499 )     (141 )
Income before provision for income taxes
    34,740       15,613       6,790       5,822       4,207  
Provision for income taxes
    6,861       2,097       995       452       359  
Net income
    27,879       13,516       5,795       5,370       3,848  
Other comprehensive income - foreign currency translation adjustments
    6,635       2,553       288       143        
Comprehensive income
  $ 34,514     $ 16,069     $ 6,083     $ 5,513     $ 3,848  
Earnings per share - basic
  $ 1.32     $ 0.96     $ 0.51     $ 0.48     $ 0.34  
Earnings per share – diluted
  $ 1.32     $ 0.86     $ 0.50     $ 0.48     $ 0.34  
                                         
Weighted average number of common shares - basic
    21,142,457       14,105,791       11,260,544       11,175,543       11,175,543  
Weighted average number of common shares - diluted
    21,142,457       15,627,494       11,631,459       11,175,543       11,175,543  
 
Consolidated Balance Sheet Data: 
   
As of December 31,
 
   
2008
   
2007
   
2006
   
2005
   
2004
 
   
(In Thousands)
 
Cash
  $ 56,570     $ 63,294     $ 13,355     $ 71     $ 256  
Total assets
    194,849       122,715       31,125       28,115       11,230  
Total liabilities
    58,020       25,455       20,180       20,508       8,535  
Total stockholders’ equity
    136,829       97,260       10,945       7,607       2,695  
 
 
25

 
 
ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion contains forward-looking statements that involve risks and uncertainties. Forward-looking statements include, but are not limited to, statements regarding future events, our plans and expectations and financial projections. Our actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed elsewhere in this Form 10-K. See “Risk Factors.”  Unless the context otherwise requires, the terms “we,” the “Company,” “us,” or “Fuqi” refers to Fuqi International, Inc. and our wholly-owned subsidiaries.
 
Overview
 
We are a leading designer of high quality precious metal jewelry in China, developing, promoting, and selling a broad range of products in the large and rapidly expanding Chinese luxury goods market. Our products consist of a range of unique styles and designs made from precious metals such as platinum, gold, and Karat gold (K-gold).  We also produce jewelry items that contain diamonds and other precious stones on a custom-order basis. We continuously innovate and change our designs based upon consumer trends in China. By continuously creating new designs and rapidly bringing them to market, we are able to differentiate ourselves from our competitors and strengthen our brand identity. Our design database presently contains over 30,000 unique products.
 
We have historically sold our products directly to distributors, retailers and other wholesalers, who then sell our products to consumers through both retail counters located in department stores and in other traditional stand-alone jewelry stores. In the coastal cities of China, we believe the demand for platinum and gemstone products has been increasing. In order to capitalize on the growth in demand, we intend to develop platinum as one of the primary metals from which our jewelry is manufactured. In 2006, we began to shift our product line to produce more platinum jewelry and we intend to invest in the development of a new production line to produce finished gemstone platinum jewelry. The production lead time of platinum products, starting from purchase of raw materials and ending with finished products, is about six to eight days, while the lead time for gold products is about two to four days. Lead-time also varies on the complexity of production and design of our products. As such, we anticipate that more working capital will be needed to support this shift of product mix.
 
Our wholesale prices are based on the spot prices of the raw material that make up our products, with the spot price measured at the time our products are sold. Similarly, the value of our inventory on hand is based on spot prices of the raw materials that make up the inventory. We record the value of our inventory at the lower of cost (using the first-in, first-out method) or market. Our gross margin is therefore affected by changes in the price of raw materials. The increase in our net sales for the year ended December 31, 2008 and the value of inventory as of December 31, 2008 was due in part to the general increase in the market value of precious metals and, to a lesser extent, our expansion of our retail business by our acquisition of substantially all of the assets of the Temix Companies. Any fluctuation in the spot price of precious metal would result in a change in our wholesale revenue and our gross margin, as our sales price is based, in part, on the spot price of the precious metal contained in the product sold. We cannot predict and foresee the volatility of the market value of precious metals in the future. We closely monitor the market price of precious metals and, commencing in the fourth quarter of 2007, have entered into certain gold futures contracts with our supplier, Shanghai Gold Exchange, to manage our consolidated exposure to changes in inventory values due to fluctuations in market prices.  Gold futures offered by Shanghai Gold Exchange are designed for full members to hedge or to acquire inventory at a preset price.  Our futures contracts are not considered as hedges for accounting purposes.  We do not conduct any trading or speculating of these precious metals.

In order to capture the margin appreciation from direct sales to the consumer, we, in 2007, initiated a retail strategy.  During 2008, we opened and/or acquired 56 retail counters and acquired seven retail stores in municipalities and provincial capitals throughout China.  A majority of these retail locations were acquired in August 2008, when we acquired substantially all of the assets of the Temix Companies.

As of December 31, 2008, we held a total of 6 retail counters in two department stores located in Shenyang, 5 retail counters in Beijing, 2 retail counters in Dalian and 6 retail counters in other regions in China under the “Fuqi” brand.   As of the same date, we held a total of twenty-three retail counters in Beijing and twenty retail counters and seven retail stores in Shanghai under the “Temix” brand. Total retail sales generated by our counters and retail stores for the year ended December 31, 2008 was approximately $11.1 million, which was approximately 3% of our sales for the fiscal year. As of December 31, 2008, we had 69 jewelry retail counters and stores in China.  During 2009, we intend to open and/or acquire additional retail counters and retail stores throughout the PRC.  Our retail operations are discussed more fully below under the caption “Retail Operations.”

 
26

 

By initiating our retail strategy, we intend to enhance our profitability in 2009 and further develop our brand reputation.

We originally produced studded jewelry products on a custom-order basis only, but we have recently expanded our production to include new lines of studded jewelry products for sale in our retail outlets.  We believe our new retail strategy creates a significant opportunity for us to both improve our return on capital and increase shareholder value. There are, however, risks related to our planned expansion. Our retail expansion strategy will largely depend on our ability to find sites for, open and operate new retail locations successfully. Our ability to open and operate new retail locations successfully depends on several factors, including, among others, our ability to identify suitable counter and store locations, the availability of which is outside our control; purchase and negotiate acceptable lease terms; prepare counters and stores for opening within budget; source sufficient levels of inventory at acceptable costs to meet the needs of new counters and stores; secure required governmental permits and approvals; successfully integrate new counters and stores into our existing operations; and generate sufficient operating cash flows or secure adequate capital on commercially reasonable terms to fund our expansion plans. Any failure to successfully open and operate new retail counters and stores could have a material adverse effect on our results of operations in the future. In addition, our retail expansion program will place increased demands on our operational, managerial and administrative resources. These increased demands could cause us to operate our business less effectively, which, in turn, could cause deterioration in the financial performance of our overall business.
 
Recent Events
 
Acquisition of Temix
 
On August 7, 2008, we acquired substantially all of the assets of Shanghai Tian Mei Jewelry Co., Ltd. and Beijing Yinzhong Tian Mei Jewelry Co., Ltd., collectively referred to as the “Temix Companies.” The Temix Companies are a 50-outlet branded jewelry store chain with locations primarily in Beijing, Shanghai and Ningbo. Of the 50 outlets, 7 are stand alone stores and 43 are store counters within department stores.

We acquired the substantially all the assets of Temix Companies through our wholly-owned subsidiary, Fuqi International Holdings Co., Ltd., a British Virgin Islands company (“Fuqi Subsidiary”), which entered into an asset purchase agreement dated April 18, 2008, and as amended on August 7, 2008 (the “Asset Purchase Agreement”) with the Temix Companies and Mr. Chujian Huang, the principal of the Temix Companies. According to the terms of the Asset Purchase Agreement, Fuqi Subsidiary acquired substantially all of the assets of the Temix Companies for an aggregate purchase price of 80 million Yuan RMB, which is equal to approximately USD $11.7 million. Per the terms of the agreement, we agreed to pay 80% of the purchase price to the Temix Companies at closing and we will pay the remaining 20% of the purchase price to the Temix Companies on the six-month anniversary of the closing, with such payment being subject to set-off for undiscovered inventory defects.  As of December 31, 2008, the Company paid a total of $7.3 million (approximately 62.4% of the purchase price).  The Temix Companies agreed that we will have additional time to complete our examination of the acquired inventories.  Upon the completion of our examination, we will remit the remaining purchase price to Mr. Chujian Huang.

In addition, we acquired all of the intellectual property used in the operations of the Temix Companies pursuant to an Intellectual Property Transfer Agreement dated April 18, 2008 (“IP Transfer Agreement”) entered into with Fuqi Subsidiary and Mr. Huang. In accordance with the IP Transfer Agreement, Mr. Huang received a total of 1,080,666 shares, which was fixed upon signing of definitive agreement on April 18, 2008. One-half of the shares were issued to Mr. Huang at closing and the other one-half will be subject to an escrow account for a two-year period. The shares held in escrow will be subject to indemnification claims and conditions of the Temix Companies meeting certain performance targets as set forth in the IP Transfer Agreement.

Also, in connection with and as a condition to the closing of the Asset Purchase Agreement and IP Transfer Agreement, the Company entered into an employment agreement with Mr. Huang, pursuant to which he will serve as our Associate Retail Director. The employment agreement has a term of three years unless terminated earlier in accordance with the terms of the agreement.
 
Corporate History
 
We operate through our wholly-owned subsidiary Fuqi International Holdings Co., Ltd., a British Virgin Islands corporation (“Fuqi BVI”) and its wholly-owned subsidiary, Shenzhen Fuqi Jewelry Co., Ltd., (“Fuqi China”) a company established under the laws of the People’s Republic of China. Our company’s principal office is in the city of Shenzhen, in southern China, where we have a large-scale production base that includes a modern factory of more than 53,000 square feet, a dedicated senior design, sales and marketing team, and approximately 949 employees, including approximately 805 company-trained production workers. We believe our current facilities provide adequate space for our planned expansion of our production lines, which will include diamond and other finished gemstone jewelry.

 
27

 

On November 20, 2006, Fuqi BVI entered into a share exchange agreement with VT Marketing Services, Inc. (“VT”) and Mr. Yu Kwai Chong, who is our current Chief Executive Officer and Chairman of the Board of the Directors, to effect a reverse merger transaction (the “Reverse Merger”). Pursuant to the Reverse Merger, Mr. Chong, as the sole shareholder of Fuqi BVI, agreed to exchange all of his shares of Fuqi BVI for shares of VT and VT agreed to acquire all of the issued and outstanding capital stock of Fuqi BVI. VT was formed as part of the implementation of the Chapter 11 reorganization plan (the “Visitalk Plan”) of visitalk.com, Inc., which became effective on September 17, 2004. The Reverse Merger closed on November 22, 2006 and VT issued an aggregate of 11,175,543 shares of common stock in exchange for all of the issued and outstanding securities of Fuqi BVI. Upon the close of the Reverse Merger, VT became the 100% parent of Fuqi BVI and assumed the operations of Fuqi BVI and its subsidiary as its sole business. On November 8, 2006, VT reincorporated from Arizona to Nevada and on December 8, 2006, after the Reverse Merger, VT reincorporated from the Nevada to Delaware and changed its corporate name from “VT Marketing Services, Inc.” to “Fuqi International, Inc.” The transactions contemplated by the Reverse Merger were intended to be a “tax-free” transaction pursuant to the provisions of Section 351 of the Internal Revenue Code of 1986, as amended.
 
For financial accounting purposes, the Reverse Merger was treated as a reverse acquisition by Fuqi BVI, under the purchase method of accounting, and was treated as a recapitalization with Fuqi BVI as the accounting acquirer. Accordingly, our historical financial statements have been prepared to give retroactive effect to the reverse acquisition completed on November 22, 2006, and represent the operations of Fuqi BVI and its wholly-owned subsidiary, Fuqi China.
 
Critical Accounting Policies, Estimates and Assumptions
 
Management’s discussion and analysis of results of operations and financial condition are based upon our consolidated financial statements. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America. These principles require management to make certain estimates and assumptions that affect amounts reported and disclosed in the financial statements and related notes. The most significant estimates and assumptions include valuation of inventories, provisions for income taxes, allowance for doubtful accounts, and purchase price allocation relating to the business acquired. Actual results could differ from these estimates. Periodically, we review all significant estimates and assumptions affecting the financial statements and record the effect of any necessary adjustments.
 
The following critical accounting policies rely upon assumptions and estimates and were used in the preparation of our consolidated financial statements:
 
Revenue Recognition 
 
Wholesale revenue is recognized upon delivery and acceptance of jewelry products by our customers while the retail revenue is recognized upon receipt and acceptance of jewelry products by our customers, provided in each case that the other conditions of sales are satisfied: (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred, upon shipment when title passes, or services have been rendered; (iii) our price to the buyer is fixed or determinable; and (iv) collectibility is reasonably assured.
 
Currency Reporting 
 
Amounts reported are stated in U.S. Dollars, unless stated otherwise. Our functional currency is the RMB. Foreign currency transactions (outside the PRC) are translated into RMB according to the prevailing exchange rate at the transaction dates. Assets and liabilities denominated in foreign currencies at the balance sheet dates are translated into RMB at period-end exchange rates. For the purpose of preparing the consolidated financial statements, the consolidated balance sheets of our company have been translated into U.S. dollars at the current rates as of the end of the respective periods and the consolidated statements of income have been translated into U.S. dollars at the weighted average rates during the periods the transactions were recognized. The resulting translation gain adjustments are recorded as other comprehensive income in the statements of income and comprehensive income and as a separate component of statements of stockholders’ equity.
 
Allowance for Doubtful Accounts
 
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts, the aging of accounts receivable, our history of bad debts, and the general condition of the industry. If a major customer’s credit worthiness deteriorates, or our customers’ actual defaults exceed historical experience, our estimates could change and impact our reported results. We have not experienced any significant amount of bad debt in the past.

 
28

 

Inventory
 
Inventories are stated at the lower of cost or market. The first-in-first-out method is used to account for gold and platinum jewelries and the specific identification method for diamond jewelries. An inventory reserve is maintained where the cost exceeds the net realizable vale. 

Taxation
 
We are incorporated in the State of Delaware, and our wholly owned subsidiary, Fuqi BVI, is a British Virgin Islands company. We are subject to franchise taxes in Delaware and U.S. federal income taxes, but we are not currently generating any taxable operating income. We are not subject to taxation in the British Virgin Islands. Fuqi BVI’s wholly-owned subsidiary, Fuqi China, is a PRC company. 
 
Prior to 2006, we were under the preferential income tax rate of 7.5% in 2005, due to our status of being a new business. That status expired effective January 1, 2006.  On March 16, 2007, the National People’s Congress of China enacted a new PRC Enterprise Income Tax Law, under which foreign invested enterprises and domestic companies will be subject to enterprise income tax at a uniform rate of 25%.  The new law became effective on January 1, 2008.

Prior to the enactment of China’s Enterprise Income Tax Law, which became effective from January 1, 2008, foreign-invested enterprises, or FIEs, were generally subject to a 30% state enterprise income tax plus a 3% local income tax. As result of the new EIT law, our income tax provision increased, which could adversely affect our financial condition and results of operations. Prior to effectiveness of the EIT law, we had enjoyed certain preferential tax concessions and the loss of these preferential tax concessions may cause our tax liabilities to increase and our profitability to decline.

Pursuant to the implementation rules to the new tax law issued in December 2007, and the several subsequent transition rules, Fuqi China has become subject to a normal 25% rate, but are still eligible for lower rates, which are 18%, 20% 22% and 24% in 2008, 2009, 2010 and 2011, under the transition rules. Our effective income tax rates for the years ended December 31, 2008, 2007 and 2006 were 19.8%, 13.4%, and 14.7%, respectively.
 
We are also subject to a 5% business tax on our design fees and a 17% value added tax on the processing fee. The 5% business tax is borne by us while the 17% value added tax is a component of the prices that we charge our customers. The sum of the design fee, processing fee, and the market price of raw materials used to manufacture our products is the wholesale price at which we sell our products. We treat the business tax as a sales-related expense and thus report it under selling and marketing in our statements of income.
 
From the inception of Fuqi China in 2001 to December 31, 2006, we failed to report a cumulative amount of approximately $26 million in cash revenues related to design fees. As of December 31, 2006, we had an accrual of approximately $3.8 million in tax liabilities representing business tax and fees of 5.2% and income tax on the unreported design revenues since inception and an accrual of approximately $1.1 million in estimated penalties. In April 2006, the Shenzhen local tax department levied a $1.8 million assessment against us for unpaid business taxes, fees, and income taxes related to these unreported cash revenues up to the period from inception to December 31, 2005. The assessment was originally due at the end of April 2006 and subject to 0.05% per day of interest and penalties thereafter. On April 28, 2006, we filed for an extension of the deadline to remit these outstanding taxes payable to December 20, 2006, and the extension request was approved by the tax department in July 2006. On December 28, 2006, Shenzhen City Tax Bureau granted a further extension to us from December 20, 2006 to April 25, 2007.
 
On April 25, 2007, we appointed a registered tax agent to apply on behalf of our company for a special reduction or exemption for the unpaid tax liabilities for the period from inception to December 31, 2006. On May 14, 2007, we received a notice from the Shenzhen tax department accepting our application for a tax reduction or exemption and were granted an additional period to remit our outstanding tax liabilities until August 9, 2007. The tax department agreed not to assess any interest and penalties during this review process until August 9, 2007. On August 10, 2007, we received a notice from the tax department conditionally agreeing to fully exempt our tax liabilities in the amount of approximately $3 million on unreported design fee income for the period from inception of our operations in 2001 to December 31, 2006, provided that our common stock is successfully listed on a major overseas stock exchange within 180 days from the date of the tax notice. We fulfilled such condition in October 2007 and obtained acknowledgement from the Shenzhen tax department in November 2007. As a result, the accrued business and income tax liabilities, and the accrued estimated and penalties totaling $4.2 million, was reversed and recorded as non-operating income in our consolidated statement of income for the year ended December 31, 2007.
 
All of the design fee income starting 2007 was properly reported and accounted for and has been fully paid by the tax filing deadline.
 
 
29

 
 
Derivative Instruments

Commencing in the fourth quarter of 2007, we have entered into certain gold future contracts with our supplier, Shanghai Gold Exchange. Gold futures offered by Shanghai Gold Exchange are designed for full members to hedge or to acquire inventory at a preset price. We utilized these future contracts to manage our consolidated exposure to changes in inventory values due to fluctuations in market prices and are not considered as hedges for accounting purpose. Our gold futures positions are marked to market at each reporting date and all unrealized gains and losses are recognized in earnings currently. These contract positions have not had a material effect on our consolidated financial position, results of operations, or cash flows.
 
Stock-based Compensation  

In accordance with SFAS No. 123R, “Share-based Payment: An amendment of FASB Statement No. 123” (“SFAS 123R”), effective January 1, 2006, we are required to recognize compensation expense related to stock options granted to employees based on: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of December 31, 2005, based on the grant date fair value estimated in accordance with SFAS No 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), and (b) compensation cost for all share-based payments granted subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS123R. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates. We did not issue any stock options in 2005 and 2006 and had no outstanding options as of December 31, 2006. On October 26, 2007, we granted options to purchase a total of 1,320,000 shares of our common stock to two executives and four directors. We expect these options to be fully vested and therefore did not account for any forfeiture as the vesting periods of these options are relatively short. We use the Black-Scholes option-pricing model to value stock option awards and expensed the stock-based compensation based on the vesting periods.
 
In August 2007, we entered into employment agreements with three of our executive officers pursuant to which we agreed to grant stock options to acquire shares of the Company’s common stock with a value equal to certain percentage of our annual income before income taxes not to exceed an aggregate market value of $440,000. Options to purchase totaling 121,776 shares were granted to these three executive officers.  The number of options granted was computed based on the aggregate market value of $440,000 dividing by the fair value of each option measured on December 31, 2008 using the Black-Scholes option pricing model.

Fair Value Measurement

On January 1, 2008, the Company adopted the provisions of SFAS No. 157, Fair Value Measurements (“SFAS No. 157”) for financial assets and liabilities. SFAS No. 157 establishes a framework for using fair value to measure assets and liabilities, and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, except for non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis, for which application has been deferred for one year.
 
SFAS No. 157 established the following fair value hierarchy that prioritizes the inputs used to measure fair value:
 
Level 1: 
Quoted prices are available in active markets for identical assets or liabilities as of the reporting date.  
 
Level 2:
Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date.  
 
Level 3:
Pricing inputs include significant inputs that are generally less observable from objective sources.  These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value.  
 
 
30

 
 
SFAS No. 157 requires us to maximize the use of observable inputs and minimize the use of unobservable inputs. If a financial instrument uses inputs that fall in different levels of the hierarchy, the instrument will be categorized based upon the lowest level of input that is significant to the fair value calculation.
 
Our derivative financial instruments are gold futures contracts based on gold price rates, which are observable at commonly quoted intervals for the full term of the derivatives and therefore considered a Level 2 input.
 
Purchase Price Allocations

We accounted for our Temix’s acquisition using the purchase method of accounting. This method requires that the acquisition cost be allocated to the assets we acquired based on their fair values. We make estimates and judgments in determining the fair value of the acquired assets. We base our estimate on the purchase price allocation analysis reports prepared by an independent valuation service group, which have been finalized, as well as our internal judgments based on the existing facts and circumstances. If we were to use different judgments or assumptions, the amounts assigned to the individual assets could be materially different.

Results of Operations
 
The following table sets forth certain financial information from our audited consolidated statements of income expressed as a percentage of revenues and should be read in conjunction with our consolidated financial statements and notes thereto included elsewhere in this Form 10-K. 

     
Years Ended December 31,
 
     
2008
 
2007
   
2006
 
Net sales
                 
Wholesale and distribution
   
96.97
%
99.14
%
 
100.00
%
Retail
   
3.03
%
0.86
%
 
0.00
%
     
100.00
%
100.00
%
 
100.00
%
                   
Cost of sales
                 
Wholesale and distribution
   
85.32
%
88.01
%
 
90.49
%
Retail
   
2.44
%
0.64
%
 
0.00
%
     
87.76
%
88.65
%
 
90.49
%
                   
Gross profit
   
12.24
%
11.35
%
 
9.51
%
                   
Operating expenses:
                 
Selling and marketing
   
1.34
%
0.76
%
 
0.53
%
General and administrative
   
1.83
%
2.01
%
 
0.86
%
                   
Total operating expenses
   
3.17
%
2.77
%
 
1.39
%
                   
Income from operations
   
9.07
%
8.58
%
 
8.12
%
                   
Other income (expense), net
   
0.38
%
2.15
%
 
(0.77
)%
                   
Income before provision for income taxes
   
9.45
%
10.73
%
 
7.35
%
                   
Provision for income taxes
   
1.87
%
1.44
%
 
1.08
%
                   
Net income
   
7.58
%
9.29
%
 
6.27
%
 
 
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Year Ended December 31, 2008 and 2007
 
Net sales
 
Net sales derived from our wholesale and distribution segment, which consist of gross sales net of returns, for the year ended December 31, 2008 increased to $356.5 million, an increase of $212.2 million, or 147%, from net sales of $144.3 million for the year ended December 31, 2007. The increase was primarily attributable to a combination of an increase in both selling price and sales volume. The selling price of our jewelry products is based on the market price of the precious metals (e.g., gold and platinum) in the periods when the products are sold. During 2008, the average price of gold and platinum increased by 18.5% and 20.0%, respectively, as compared with 2007. In addition, there was an increase of 103% in sales volume from approximately 5.9 tons for 2007 to 12.0 tons for 2008 as result of an increase in jewelry products demand by our existing consumers and orders placed by our new customers. Sales volume of gold and platinum for the year ended December 31, 2008 increased by 120% and decreased by 32% to 11 tons and 500kg for 2008 from 5 tons and 736kg for 2007, respectively.

Net sales from wholesale and distribution for the years ended December 31, 2008 and 2007 were comprised of the following:

   
Years Ended December 31,
 
   
2008
 
2007
 
   
Amount in
Millions
 
Percentage
 
Amount in
Millions
 
Percentage
 
Platinum
 
$
31.2
 
8.7
%
$
30.3
   
21.0
%
Gold
   
241.6
 
67.8
   
80.9
   
56.1
 
K-gold and Studded Jewelry
   
71.7
 
20.1
   
33.1
   
22.9
 
Diamond
   
12.0
 
3.4
   
0.0
   
0.0
 
Total
 
$
356.5
 
100.0
%
$
144.3
   
100.0
%
 
Net sales derived from our retail segment for the year ended December 31, 2008 increased by $9.9 million to $11.1 million from $1.2 million in 2007. The increase in retail revenue for the year ended December 31, 2008 is primarily due to the Temix acquisition which accounted for $6.2 million of this increase.

Cost of sales
 
Cost of sales is mainly comprised of costs of raw materials, primarily gold and platinum, in addition to direct manufacturing costs and factory overhead. Cost of sales for the year ended December 31, 2008 increased to $322.6 million, an increase of $193.6 million, or 150%, from $129.0 million for the same period in 2007.

Wholesale and distribution cost of sales increased by $185.5 million, or 145%, in 2008 to $313.6 million from $128.1 million in 2007.  The increase in cost of sales, which was consistent with the increase in net sales, was primarily due to an increase in the cost of raw materials, which resulted from the increase in both sales volume and the general increase in the cost of precious metals. In addition, our direct labor costs increased at a higher rate during 2008 as compared to the same period in 2007 due to the inflationary pressure and enforcement of the New Labor Law effective January 1, 2008.  
 
Cost of retail sales for the year ended December 31, 2008 increased by $8.0 million to $9.0 million from approximately $935,000 for the same period in 2007. The increase in cost of retail sales for the year ended December 31, 2008 included $4.4 million since the Temix acquisition.
 
Gross profit

Gross profit for the year ended December 31, 2008 increased to $45.0 million, an increase of $28.5 million, or 173%, from $16.5 million for 2007. Gross profit margin increased to 12.2% for year ended December 31, 2008, compared to 11.4% for the same period in 2007. The increase in profit margin was primarily derived from an increase in subcontracting fee income, a slight increase in processing fees of our products, which resulted primarily from an increase in sales price of precious metal jewelry, an increase in design styles, an increase in brand awareness, and an expansion in retail presence by our opening up more jewelry counters in new locations and acquisition of Temix’s 50 retail stores during the year ended December 31, 2008.
 
Selling and marketing expenses
 
Selling and marketing expenses are primarily comprised of business taxes, advertising expenses, traveling expenses, production costs of marketing materials, fees to the malls for retail counters, insurance, and delivery expenses. Selling and marketing expenses for the year ended December 31, 2008 were approximately $4.9 million, an increase of $3.8 million, or 345%, from $1.1 million for 2007. Selling and marketing expenses were 1.34% of net sales for the year ended December 31, 2008 compared to 0.76% for the prior year. The increase in selling and marketing expenses as a percentage of net sales was primarily due to an increase of business tax expenses that resulted from an overall increase in our net revenue and salaries for our sales and marketing executives.

 
32

 
 
General and administrative expenses
 
General and administrative expenses consist primarily of payroll expenses, benefits and travel expenses for our staff, professional fees including audit, accounting, legal and financial advisory, depreciation expenses, and general office expenses. General and administrative expenses for the year ended December 31, 2008 were $6.7 million, an increase of $3.7 million, or 123%, from $3.0 million for 2007. General and administrative expenses were 1.83% of net sales for the year ended December 31, 2008 compared to 2.01% for the prior year. The dollar amount increase was primarily due to an increase of legal and professional fees incurred as a result of being a publicly reporting company in the United States and an unsuccessful acquisition attempt of a third-party competitor, expenses related to options granted, and increased salaries to certain executives under the employment agreements executed in October 2007. We anticipate general and administrative expense to remain constant in 2009 due to the non-recurring legal expenses for the unsuccessful attempted acquisition of a third-party competitor in 2008, assuming to no similar expense occurs in 2009, and partly offset by an increase number of staff to support of our retail strategy.
 
Other income (expense), net
 
Other income, net was $1.4 million of income in 2008 compared to $3.1 million of income in 2007. The decrease was a result of the one-time exemption of tax liabilities and estimated penalty payable of $4.2 million in 2007, partly offset by the realized gain approximately $2.4 million from our gold future contracts in 2008. We have entered into the gold future contracts with our supplier, the Shanghai Gold Exchange in 2008 in order to reduce our exposure to volatility in the price of gold. 

Provision for income tax
 
Provision for income tax expense was approximately $6.9 million for the year ended December 31, 2008, an increase of $4.8 million, or 229%, from approximately $2.1 million for 2007. The increase was primarily due to an increase in the taxable income for the year ended December 31, 2008.
 
Net income
 
As a result of the foregoing, net income increased to $27.9 million in 2008, an increase of 107% from $13.5 million in 2007.
 
Year Ended December 31, 2007 and 2006

Net sales
 
Net sales for the year ended December 31, 2007 increased to $145.6 million, an increase of $53.2 million, or 57.6%, from net sales of $92.4 million for the year ended December 31, 2006. The increase was primarily attributable to a combination of an increase in both selling price and sales volume. The selling price of our jewelry products is based on the market price of the precious metals (e.g., gold and platinum) in the periods when the products are sold. During 2007, the average price of gold and platinum increased by 9.94% and 9.33%, respectively, as compared with 2006. In addition, there was an increase of 34% in sales volume from approximately 4.4 tons for 2006 to 5.9 tons for 2007 as result of increase in jewelry products demand by our existing consumers and engaging of new customers. Sales volume of gold and platinum for the year ended December 31, 2007 increased by 39% and 28% to 5 tons and 736kg for 2007 from 3.6 tons and 573kg for 2006, respectively.
 
Net sales for the years ended December 31, 2007 and 2006 were comprised of the following:

   
Years Ended December 31,
 
   
2007
   
2006
 
   
Amount in
Millions
   
Percentage
   
Amount in
Millions
 
Percentage
 
Platinum
 
$
30.9
   
21.2
%
 
$
21.0
   
22.7
%
Gold
   
81.0
   
55.8
     
43.6
   
47.2
 
K-gold and Studded Jewelry
   
33.7
   
23.0
     
27.8
   
30.1
 
Total
 
$
145.6
   
100.0
%
 
$
92.4
   
100.0
%
 
 
33

 

Cost of sales
 
Cost of sales for the year ended December 31, 2007 increased to $129 million, an increase of $45 million, or 54%, from $84 million for the same period in 2006. The increase in cost of sales, which was consistent with the increase in net sales, was primarily due to an increase in the cost of raw materials, which resulted from the increase in sales volume for the year ended December 31, 2007.
 
Gross profit

Gross profit for the year ended December 31, 2007 increased to $16.5 million, an increase of $7.7 million, or 88%, from $8.8 million for 2006. Gross profit margin increased to 11.3% for year ended December 31, 2007, compared to 9.5% for the same period in 2006. The increase in profit margin was primarily derived from a general increase in the design fees of our products, which resulted primarily from an increase in design styles, an increase in brand awareness, and our receipt of various national awards during the year ended December 31, 2007, partially offset by a slight decrease in profit margin during the fourth quarter of 2007, which was primarily related to a limited-time, promotional discount on our design fees and a fluctuation the price of raw materials.
 
Selling and marketing expenses
 
Selling and marketing expenses for the year ended December 31, 2007 were approximately $1.1 million, an increase of $0.6 million, or 120%, from $0.5 million for 2006. Selling and marketing expenses were 0.76% of net sales for the year ended December 31, 2007 compared to 0.53% for the prior year. The slight increase in selling and marketing expenses as a percentage of net sales was primarily due to our extended advertising campaign during Chinese New Year in 2007, an increase in utility cost, higher insurance premium for product delivery, and an increase in retail related expenses.
 
General and administrative expenses
 
General and administrative expenses for the year ended December 31, 2007 were $2.9 million, an increase of $2.1 million, or 263%, from $0.8 million for 2006. General and administrative expenses were 2.01% of net sales for the year ended December 31, 2007 compared to 0.86% for the prior year. The increase as a percentage of revenue was primarily due to an increase of legal and professional fees incurred as a result of being a publicly reporting company in the United States, expenses related to options granted, and increased salaries to certain executives under the employment agreements executed in October 2007.
 
Other income (expense), net
 
Other income, net was $3.1 million of income in 2007 compared to $0.7 million of expense in 2006. The increase was a result of the exemption of tax liabilities and estimated penalty payable of $4.2 million. See the section entitled “Taxation” above, for additional information.
 
Provision for income tax
 
Provision for income tax expense was approximately $2.1 million for the year ended December 31, 2007, an increase of $1.1 million, or 111%, from approximately $995,000 for 2006. The increase was primarily due to an increase in the taxable income for the year ended December 31, 2007.
 
Net income
 
As a result of the foregoing, net income increased to $13.5 million in 2007, an increase of 133% from $5.8 million in 2006.
 
Quarterly Results of Operations

The following table presents the unaudited consolidated statements of income data for each of eight fiscal quarters through December 31, 2008, in dollars. The first quarter is from January 1 to March 31, the second quarter is from April 1 to June 30, the third quarter is from July 1 to September 30, and the fourth quarter is from October 1 to December 31. In management’s opinion, this unaudited information has been prepared on the same basis as our audited consolidated financial statements and includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the unaudited information for the quarters presented. The results of operations for any quarter are not necessarily indicative of results that we might achieve for any subsequent periods. In addition, our operating results have in the past and may in the future fluctuate significantly as a result of many factors, including the seasonality of our business and the unpredictable fluctuation of prices of precious metals. Consequently, we believe that period-to-period comparisons of our operating results may not necessarily be meaningful, and as a result, you should not rely on them as an indication of future performance.

 
34

 

   
Fiscal Year 2008
   
Fiscal Year 2007
 
      Q4       Q3       Q2       Q1       Q4       Q3       Q2       Q1  
   
(in thousands, except for per share data)
 
Net sales
  $ 129,485     $ 93,678     $ 66,876     $ 77,566     $ 55,070     $ 36,248     $ 26,281     $ 27,960  
                                                                 
Gross profit
    18,078       10,998       7,097       8,811       5,820       4,477       3,053       3,164  
                                                                 
Net profit
    9,712       6,521       5,251       6,395       7,413       2,730       1,489       1,883  
                                                                 
Earnings per share - basic
    0.45       0.31       0.25       0.31       0.39       0.21       0.12       0.15  
                                                                 
Earnings per share - diluted
    0.45       0.31       0.25       0.31       0.39       0.21       0.10       0.12  
 
Liquidity and Capital Resources
 
At December 31, 2008, we had retained earnings of $44.7 million and cash and cash equivalents of $56.6 million.  In October 2007, we completed an initial public offering of a total of 8,088,888 shares of our common stock at $9.00 per share. We have used such capital funding for expanding and financing our retail distribution, enhancing our product lines, and for general working capital for our retail operations. We paid a total of approximately $11.7 million to acquire substantially all of the assets of the Temix Companies in August 2008, with $7.3 million having been paid in cash and the remaining $4.4 million is recorded as other payable, related parties in the consolidated balance sheets as of December 31, 2008. We expect to pay the remaining $4.4 million in the second quarter of 2009.  In 2009, we currently plan to open a total of 10 to 20 retail counters and one to three retail stores. The foregoing is subject to change at any given time as our management continually reviews our retail expansion plans, particularly in light of the recent fluctuations in the economy. Our retail operations are discussed more fully below under the caption of “Retail Operations”.
 
At December 31, 2008, we had working capital of $129.4 million and no long-term liabilities. Except for cash and cash equivalents, a majority of our net working capital consisted of inventories and accounts receivable, both of which increased by 50% and 210%, respectively, as of December 31, 2008 as compared to December 31, 2007. The increase in inventory was a result of significant purchases of raw materials of precious metals incurred towards the end of 2008 and was used to expand our sales capabilities by accepting larger sales orders from our customers during the peak holiday season. We do not conduct any trading of our precious metal raw materials.   The increase in accounts receivable was attributable to a substantial increase in revenue generated in November and December, which is the beginning of our traditional peak season, and extending credit terms to some of our customers with high credit standings. We typically offer certain of our customers 30-days credit terms for payment. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Allowance for doubtful accounts is based on our assessment of the collectability of specific customer accounts, the aging of accounts receivable, our history of bad debts, and the general condition of the industry. If a major customer’s credit worthiness deteriorates, or our customers’ actual defaults exceed historical experience, our estimates could change and impact our reported results. We have not experienced any significant amount of bad debt since the inception of our operation.
 
We had outstanding short-term notes payables with banks in an aggregate amount of $21.9 million that are due and payable on dates between January 2009 and June 2009. Our loans are secured by inventory, real properties owned by our affiliated companies and/or guaranteed by our affiliates and our controlling stockholder.
 
We have a general banking facility line of credit with Agricultural Bank of China pursuant to a Maximum Banking Facility Agreement dated August 24, 2006 which was renewed in September 2007 and December 2008. The terms of the agreement enable us to borrow up to a maximum facility amount of $14.6 million. We executed notes payable with this bank under this facility line with terms less than one year. As of December 31, 2008, we had $14.6 million outstanding under the facility, with interest rates ranging from 6.831% to 8.217%. In addition, we have a one-year term loan with the Shenzhen Development Bank that provides for a maximum borrowing of up to approximately $7.3 million. This facility expires in June 2009 and is secured by certain real properties owned by an affiliate company.  As of December 31 2008, we had a total of $7.3 million outstanding under this term loan agreement with interest rates ranging from 4.86% to 5.04% and is secured by certain real properties owned by an affiliate company   The remaining outstanding loans are secured by our inventory, real properties owned by affiliated companies, and/or guaranteed by our affiliates and our controlling stockholder and have certain restrictions and covenants. We do not guarantee any indebtedness of our affiliates.

 
35

 
 
Prior to the Reverse Merger in November 2006, our then-sole stockholder, Mr. Yu Kwai Chong, who is also our President, Chief Executive Officer and Chairman of the Board, made loans to us on a regular basis to meet short term financing needs of our company. Typically, these advances were in amounts ranging from $30,000 to $5.5 million, with no more than $10.0 million outstanding at any time. We did not pay interest on any of these advances. During the same period, Mr. Chong borrowed from our company primarily to fund personal liquidity needs. Since the closing of the Reverse Merger, at which time Mr. Chong ceased to be our sole stockholder, we have not engaged in any cash advance transactions with Mr. Chong and will not engage in these transactions in the future. Prior to the Reverse Merger, effective in November 2006, we paid dividends to our then sole stockholder, Mr. Chong. During the years ended December 31, 2008, 2007, and 2006, we paid cash dividends of $0, $0, and $2.7 million, respectively, to Mr. Chong. We currently have no intention to declare further dividends in the foreseeable future. Payment of dividends is further restricted under the provisions of our existing loan agreements.
 
On our consolidated statements of cash flows, we recorded advances by Mr. Chong to us and related repayments to him as financing activities, and advances by us to Mr. Chong and related repayments by him as investing activities. Advances and repayments were not subject to written loan agreements; the advances were partially repaid within three months while the remaining portions were repaid over three months. In accordance with SFAS 95, we present the gross amounts of the advances and repayments in our consolidated statements of cash flows.
 
A substantial portion of our working capital consists of accounts receivable from customers. If customers responsible for a significant amount of accounts receivable were to become insolvent or otherwise unable to pay for our products, or to make payments in a timely manner, our liquidity and results of operations could be materially adversely affected. An economic or industry downturn could materially adversely affect the servicing of these accounts receivable, which could result in longer payment cycles, increased collections costs and defaults in excess of management’s expectations. In addition, as we increase our presence in the retail market, we expect the aging of our accounts receivable generated from sales through retail counters to increase as department stores typically defer payments to us of cash receipts collected by them on our behalf. A significant deterioration in our ability to collect on accounts receivable could affect our cash flow and working capital position and could also impact the cost or availability of financing available to us.
 
We expect to expend significant resources to continue to expand our retail distribution of our jewelry in China. We will require substantial funds of approximately $25 million in order to finance our expansion, fund operating expenses, to develop manufacturing, marketing and sales capabilities and to cover public company costs.  In addition to the funds required to open retail locations, we believed that significant working capital of approximately $20 million will be needed to operate retail locations due to longer sales and collection cycles and higher inventory levels required to support retail stores. We also expect to require substantial funds of approximately $8 million to change our product mix to include more platinum products. Without these funds, we may not be able to meet these goals.

We believe that our current cash and cash flow from operations will be sufficient to meet our anticipated cash needs, including our cash needs for working capital, for the next 12 months. We believe that the sources of the funding for our expected expenditures in 2009 include our current cash and cash flow from operations.  At December 31, 2008, we had cash and cash equivalents of approximately $56.6 million and retained earnings of approximately $44.7 million.  However, net cash used for operating activities for the year ended December 31, 2008 was approximately $8.0 million, and there is no guarantee that we be able to generate positive cash flow from operations for the year ending December 31, 2009.  In addition, we may require additional cash resources due to our inability to generate positive cash flow from our operations, changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue. We may seek additional funding through public or private financing or through collaborative arrangements with strategic partners.  We cannot be certain that additional capital will be available on favorable terms, if at all, and any available additional financing may not be adequate to meet our goals.  Moreover, any equity financing would result in dilution to stockholders.  If we cannot raise additional funds when needed, or on acceptable terms, we may not be able to effectively execute our growth strategy (including expanding our business to the retail market), take advantage of future opportunities, or respond to competitive pressures or unanticipated requirements. In addition, we may be required to scale back or discontinue our production and development program, or obtain funds through strategic alliances that may require us to relinquish certain rights.
 
 
36

 

The following table sets forth a summary of our cash flows for the periods indicated: 
 
   
Years Ended December 31,
 
   
    2008
   
2007
   
2006
 
   
(In Thousands)
 
Net cash (used for) provided by operating activities
  $ (7,959 )   $ (21,737 )   $ 4,037  
Net cash (used for) provided by investing activities
    (7,088 )  
 (768)
   
 9,613
 
Net cash provided by (used for) financing activities
    4,563    
 71,082
   
 (595)
 
Effect of exchange rate changes on cash
    3,760    
 1,362
   
 229
 
Net (decrease) increase in cash
  $ (6,724 )   $ 49,939     $ 13,284  
Cash at beginning of year
    63,294    
 13,355
   
 71
 
Cash at end of year
  $ 56,570     $ 63,294     $ 13,355  
 
Net cash (used for) provided by operating activities.

Net cash used for operating activities was $8.0 million for the year ended December 31, 2008, compared to net cash used for operating activities of $21.7 million for the same period in 2007. The $13.7 million decrease was primarily due to a increase in inventory in the amount of $3.4 million during the year ended December 31, 2008 compared to an increase of $22.2 million during the same period in 2007, in additional to an increase of accounts payable in the amount of $10.8 million during the year 2008 compared to an increase of $906,000 in the same period in 2007.
 
Net cash used for operating activities was $21.7 million for the year ended December 31, 2007, compared to net cash provided by operations of $4.0 million for the same period in 2006. The $25.7 million decrease was primarily due to an increase in inventory in the amount of $22.2 million during the year ended December 31, 2007 compared to an increase of $109,000 during the same period in 2006, in addition to an increase of accounts receivable in the amount of $13.6 million during the year 2007 compared to an increase of $1.96 million in the same period in 2006.
 
Net cash (used for) provided by investing activities.

Net cash used for investing activities amounted to $7.1 million for the year ended December 31, 2008, compared to net cash used for investing activities of $768,000 for the year ended December 31, 2007. The change was due to $6.5 million cash paid for business acquisitions and $1.0 million spent on additional plant assets.
 
Net cash used for investing activities amounted to approximately $768,000 for the year ended December 31, 2007, compared to net cash provided by investing activities of $9.6 million for the year ended December 31, 2006. The change was due to an increase in restricted cash of approximately $395,000, in addition to the absence of loans and related repayments between our controlling stockholder and us, as had occurred during the year of 2006. 
 
Net cash provided by (used for) financing activities.

Net cash provided by financing activities amounted to $4.6 million for the year ended December 31, 2008, compared to net cash provided by financing activities of $71 million for the same period of 2007. The decrease of cash provided was primarily a result of increased bank loan of $3.6 million and no further capital raised since the initial public offering.

Net cash provided by financing activities amounted to $71 million for the year ended December 31, 2007, compared to net cash used for financing activities of $595,000 for the same period of 2006. The increase of cash provided was primarily a result of net proceeds of $67 million raised from the initial public offering of 8,088,888 shares of our common stock, in addition to net proceeds of $2.8 million from the exercise of warrants that occurred during the second quarter of 2007.
 
Contractual obligations
 
The following table describes our contractual commitments and obligations as of December 31, 2008:

   
Payments due by Period (in $)
 
Contractual Obligations
 
Total
   
Less Than
1 Year
   
1 - 3
Years
   
3 - 5
Years
   
More
Than
5 Years
 
Short-term borrowings
  $ 21,944,904     $ 21,944,904     $     $     $  
Lease of Plant & Office
  $ 306,516     $ 237,730     $ 68,786     $     $  
Lease of Staff Dormitory
  $ 1,434     $ 1,434     $     $     $  
    $ 22,252,854     $ 22,184,068     $ 68,786     $     $  
 
 
37

 

Employment Agreements of Executive Officers and New Labor Contract Law
 
In October 2007, we entered into three-year employment contracts with our five executive officers each of which includes a fixed amount of annual salary and stock options to purchase the Company’s common stock. See “Stock-based Compensation” and Item 11 of Part III, for additional information.
 
Effective January 1, 2008, the PRC introduced a new labor contract law that enhances rights for the nation’s workers, including open-ended work contracts and severance pay. The legislation requires employers to provide written contracts to their workers, restricts the use of temporary laborers and makes it harder to lay off employees. It also requires that employees with short-term contracts become full-time employees with lifetime benefits after a short-term contract is renewed twice.  The new labor contract law has increased our labor costs, but we do not believe such increases have been material to our results of operations, such labor expenses have not historically been material to our operating cost.
 
Retail Operations
 
In April 2007, we entered into a transfer agreement with an unrelated party (the “Transferor”), which has operation agreements with department stores for five jewelry retail counters. Under the terms of the agreement, the Transferor agreed to assign all of the operation rights to us for a fee of $400,000, which was payable in three separate installments. On October 28, 2007, after the Transferor was not able to complete the transfer of the counters, we entered into a cancellation agreement with the Transferor to terminate the transfer transaction as of November 30, 2007. Prior to the termination of the transfer, we had obtained temporary operation rights from the Transferor to operate these counters, and revenue derived from these five retail counters from the period of May to November 2007 amounted to $937,000. Pursuant to the cancellation agreement, we were not obligated to pay the $400,000 transfer fee of $400,000. All the inventory remained in the five counter stores at the last day of the operation was sold to the Transferor based on the pre-determined price. As of December 31, 2008, there was no outstanding balance due to the Transferor.
 
Subsequent to the cancellation agreement, in November 2007, we entered into one-year operating agreements to operate 6 retail jewelry counters at two department stores located in the Shenyang region. We agreed to pay the department stores a commission fee ranging 4.5% to 8% based on types of jewelry sales generated in these jewelry counters. Fees paid to the two department stores totaled $20,669 in 2007 and $200,089 in 2008 and are included in cost of sales expenses in 2007 and marketing expenses in 2008. We recognize revenues when the titles of the merchandises are transferred to the ultimate consumers. Sales generated from counters in these two department stores totaled $3,307,000 and $308,000 for the years ended December 31, 2008 and 2007, respectively.

For the year ended December 31, 2008, the Company opened a total of sixteen new retail counters, of which thirteen of the counters are under the FUQI brand and three counters are under the Temix brand. Including the retail counters and shops acquired through the Temix acquisition, the Company had a total of 62 jewelry counters and 7 jewelry shops located in Beijing, Shanghai, and other PRC regions as of December 31, 2008.

The retail counters and shops are operating under operating leases with terms ranging from 6 months to 1 year with options of extensions. A majority of the leases require payment of contingent rent based on a percentage of store sales. The leasing agreements for five of the retail shops provide for the payment of fees under a fixed rate rent ranging from $826 to $21,740. Fees paid to the department stores and shopping malls totaling $1,362,277, $269,189 and $0 for the years ended December 31, 2008, 2007 and 2006, respectively, are included in selling and marketing expenses.

Seasonality
 
Our business is seasonal in nature. Our sales and net income are generally higher in the fourth calendar quarter than the rest of the year. The primary factors that affect the seasonal changes in our business operations are holidays and traditional Chinese festivals. In the fourth quarter, retailers often experience increased sales due to the weeklong public holiday for Chinese National Day, as well as Christmas and New Year’s Day. In addition, jewelry retailers commonly stock up from wholesalers in the fourth quarter to prepare for potentially higher sales in the following quarter for Chinese New Year. This quarter is also a peak season for marriages and the birth of newborns in China, which have historically resulted in higher sales. This seasonal trend in our business would slightly shift in line with the gap between calendar quarter and lunar quarter and occurred during 2004 and 2005. However, there was a slight variation during 2006. Because of rising precious metal prices in the fourth quarter of 2006, many customers delayed their orders until the first quarter of 2007, resulting in lower-than-expected sales volume in the fourth quarter of 2006, and higher than expected sales in the first quarter of 2007. We experienced increased sales in the fourth quarter of 2007.  For the year ended December 31, 2008, our results of operations appeared to return to the trend of higher sales in the fourth quarter.

 
38

 
 
Off-Balance Sheet Transactions
 
We have no material off-balance sheet transactions.
 
Impact of Recent Currency Exchange Rate Increase
 
We use the U.S. dollar as the reporting currency for our financial statements. Our operations are conducted through our PRC operating subsidiary, Fuqi China, and our functional currency is the RMB. On July 21, 2005, the PRC government changed its policy of pegging the value of the RMB to the U.S. dollar and, as a result, the RMB has appreciated against the U.S. dollar by approximately 17.35% from 1:8.27 on July 21, 2005 to 1:6.8353 on December 31, 2008. In converting our RMB income statement amounts into U.S. dollars we used the following RMB/$ exchange rates: 7.959 for 2006, 7.587 for 2007, and 6.925 for 2008. Our operating results in 2006, 2007 and 2008 have benefited as a result of appreciation of the RMB against the U.S. dollar. There is no guarantee that we will benefit from the exchange rate in the future and our operations may suffer if a less favorable exchange rate develops. 
 
New Accounting Pronouncements 

In December 2007, the FASB issued SFAS No. 141, Business Combinations: (Revised 2007) (“SFAS 141R”). SFAS 141R is relevant to all transactions or events in which one entity obtains control over one or more other businesses. SFAS 141R requires an acquirer to recognize any assets and noncontrolling interest acquired and liabilities assumed to be measured at fair value as of the acquisition date. Liabilities related to contingent consideration are recognized and measured at fair value on the date of acquisition rather than at a later date when the amount of the consideration may be resolved beyond a reasonable doubt. This revised approach replaces SFAS 141’s cost allocation process in which the cost of an acquisition was allocated to the individual assets acquired and liabilities assumed based on their respective fair value. SFAS 141R requires any acquisition-related costs and restructuring costs to be expensed as incurred as opposed to allocating such costs to the assets acquired and liabilities assumed as previously required by SFAS 141. Under SFAS 141R, an acquirer recognizes liabilities for a restructuring plan in purchase accounting only if the requirements of SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities, are met. SFAS 141R allows for the recognition of pre-acquisition contingencies at fair value only if these contingencies are likely to materialize. If this criterion is not met at the acquisition date, then the acquirer accounts for the non-contractual contingency in accordance with recognition criteria set forth under SFAS 5, Accounting for Contingencies, in which case no amount should be recognized in purchase accounting. SFAS 141R is effective as of the beginning of an entity’s first fiscal year that begins after December 15, 2008. The Company is in the process of assessing the potential impact the adoption of SFAS 141R may have on its consolidated financial position or results of operations.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—An Amendment of ARB No. 51 (“SFAS 160”). This Statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity and should be reported as equity on the financial statements. SFAS 160 requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest. Furthermore, disclosure of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest is required on the face of the financial statements. SFAS 160 is effective as of the beginning of an entity’s first fiscal year that begins after December 15, 2008. The Company is in the process of assessing the potential impact the adoption of SFAS 160 may have on its consolidated financial position or results of operations.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, which requires additional disclosure related to derivatives instruments and hedging activities. These enhanced disclosures will discuss (a) how and why a company uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under FASB Statement No. 133 and its related interpretations and (c) how derivative instruments and related hedged items affect a company’s financial position, results of operations and cash flows. SFAS No. 161 is effective for fiscal years beginning on or after November 15, 2008, with earlier adoption allowed. The Company is currently evaluating the impact of adopting SFAS No. 161.
 
In April 2008, the FASB issued FASB Staff Position FAS142-3: Determination of the Useful Life of Intangible Assets. This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets. This FSP is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The guidance for determining the useful life of a recognized intangible asset in this FSP shall be applied prospectively to intangible assets acquired after the effective date. The Company is in the process of assessing the potential impact the adoption of FSP 142-3 may have on its consolidated financial position or results of operations.
 
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In May 2008, the FASB issued Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles ("SFAS 162"). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of non-governmental entities that are presented in conformity with GAAP. SFAS 162 directs the GAAP hierarchy to the entity, not the independent auditors, as the entity is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP. SFAS 162 is effective 60 days following the Securities and Exchange Commission’s approval of the Public Company Accounting Oversight Board amendments to remove the GAAP hierarchy from the auditing standards. The Company is currently evaluating the impact of adopting SFAS No. 162.
 
In June 2008, the FASB issued FASB Staff Position EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. This FSP gives guidance on the computation of earnings per share and the impact of share-based instruments that contain certain nonforfeitable rights to dividends or dividend equivalents. The FSP is effective for fiscal years beginning after December 31, 2008 and early application is prohibited. The Company is in the process of assessing the potential impact the adoption of FSP 03-6-1 may have on its consolidated financial position or results of operations.

At a November 24, 2008 meeting, the FASB ratified the consensus reached by the Task Force in Issue No. 08-6: Equity Method Investment Accounting Considerations (“EITF 08-6”). Because of the significant changes to the guidance on subsidiary acquisitions and subsidiary equity transactions and the increased use of fair value measurements as a result of Statements 141(R) and 160, questions have arisen regarding the application of that accounting guidance to equity method investments. EITF 08-6 provides guidance for entities that acquire or hold investments accounted for under the equity method. This issue is effective for transactions occurring in fiscal years and interim periods beginning on or after December 15, 2008. Early adoption is not permitted. The Company is in the process of assessing the potential impact the adoption of EITF 08-6 may have on its consolidated financial position or results of operations.
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK  
 
Foreign Exchange Risk
 
We use the U.S. dollar as the reporting and functional currency for our financial statements. As we conduct our operations through our PRC subsidiary, the functional currency of our PRC subsidiary is RMB. Substantially all our revenue and related expenses, including cost of revenues and advertising expenses, are denominated and paid in RMB. Transactions in other currencies are recorded in RMB at the rates of exchange prevailing when the transactions occur. Monetary assets and liabilities denominated in other currencies are remeasured into RMB at rates of exchange in effect at the balance sheet dates. Exchange gains and losses are recorded in our statements of operations as other comprehensive income.
 
The value of RMB is subject to changes in China’s governmental policies and to international economic and political developments. In January, 1994, the PRC government implemented a unitary managed floating rate system. Under this system, the People’s Bank of China, or PBOC, began publishing a daily base exchange rate with reference primarily to the supply and demand of RMB against the U.S. dollar and other foreign currencies in the market during the previous day. Authorized banks and financial institutions are allowed to quote buy and sell rates for RMB within a specified band around the central bank’s daily exchange rate. On July 21, 2005, PBOC announced an adjustment of the exchange rate of the U.S. dollar to RMB from 1:8.27 to 1:8.11 and modified the system by which the exchange rates are determined. This modification has resulted in an approximate 15.72% appreciation of the RMB against the U.S. dollar from July 21, 2005 to December 31, 2008. While the international reaction to the RMB revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in further fluctuation of the exchange rate of RMB against the U.S. dollar. As all of our net revenues are recorded in RMB, any future devaluation of RMB against the dollar could negatively impact our results of operations.
 
Interest Rate Risk
 
As of December 31, 2008, we had $21.9 million outstanding under short term credit facilities from banks, with interest rates ranging from 4.860% to 8.217%. As all of these borrowings are short term borrowings, we believe our exposure to interest rate risk is not material. We do not use any derivative financial instruments to manage interest rate risks.
 
 
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Inflation
 
According to the National Bureau of Statistics of China, the inflation rate in China reached a high point of 5.9% in 2008 as compared to the past several years. The inflation rate in China was 1.5% in 2006 and 4.8% in 2007.  Many of our operating expenses were increased and are also expected to increase with inflation. In management's opinion, changes in revenues, net earnings and inventory valuation that have resulted from inflation and changing prices have not been material during the years presented. Management does not expect that the effect of inflation on our overall operating costs will be greater for us than for our competitors within China.
 
Commodity Price Sensitivity
 
As a leading designer and wholesaler of high quality precious metal jewelry in China, we believe that we have to maintain a sufficient inventory to meet demands for our products based on customer orders, sales projection and finished goods for sales to retailers, who will purchase from our show room in our head office in Shenzhen. We are exposed to market risk in connection with our inventory balances, which are comprised primarily of gold, platinum, and jewelry made from gold and platinum. Our inventories are stated at the lower of cost or market value using the “first in, first out” method for gold and platinum jewelries and the specific identification method for diamond jewelries. If there is a downward change in the market price of gold, we are required to mark-down the value of our inventory and record a loss in our statement of income. We cannot predict the extent to which high raw material price levels will continue in the future. We do not have any long-term raw material purchase contracts.

In attempt to protect us against price increases of precious metals, we, in December 2007, entered into future purchase contracts with our supplier, the Shanghai Gold Exchange, to purchase gold. As of December 31, 2008, the fair value of the future gold contracts outstanding was approximately $1,426,000 which was recorded as Gold Future Contracts under current assets. The gain derived from these contracts of approximately $2,362,000 was classified as gain from derivative instrument in the accompanying consolidated statements of income.
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
The information required by this Item 8 is incorporated by reference to information begins on Page F-1 at the end of this Form 10-K.
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
None.
 
ITEM 9A. CONTROLS AND PROCEDURES.
 
(A) Disclosure Controls and Procedures
 
Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
 
As required by Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act, our management has carried out an evaluation, with the participation and under the supervision of our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2008.  As discussed in more detail below, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are ineffective as of December 31, 2008, due to material weaknesses that we identified in internal control over financial reporting, specifically related to period-end closing process and revenue recognition in improper periods.

(B) Report of Management on Internal Control over Financial Reporting
 
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act.  Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness 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 and procedures may deteriorate.

 
41

 

Our management has assessed the effectiveness of our internal control over financial reporting as of December 31, 2008. In making its assessment, management used the criteria described in Internal Control - Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).  The assessment excluded the internal controls over financial reporting relating to substantially all of the assets and operations of the Temix Companies that we acquired on August 7, 2008, as described in note 2 to the Consolidated Financial Statements, and their combined financial statements constitute 11.2 percent of total assets, 1.7 percent of revenues, and (2.8) percent of net income of the consolidated financial statement amounts as of December 31, 2008 and for the year then ended.  Pursuant to guidance issued by the SEC, a company can exclude a material acquired business’s internal controls from management’s report on internal control over financial reporting in the first year of acquisition if it is not possible to conduct an assessment of an acquired business’s internal control over financial reporting.
 
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. A significant deficiency is a control deficiency, or a combination of control deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company’s financial reporting. The following material weaknesses have been identified and included in our management’s assessment as of December 31, 2008:
 
1. 
We did not maintain effective control over the period-end closing process.  Due to the insufficient number of qualified resources, we were unable to timely and accurately complete our work needed to close our books and prepare financial statements in accordance with accounting principles generally accepted in the United States of America. This control deficiency resulted in significant amounts of audit adjustments to our 2008 financial statements.  In addition, this control deficiency could result in a material misstatement to annual or interim financial statements that would not be prevented or detected.   Accordingly, management determined that this control deficiency constitutes a material weakness.
 
2. 
We did not maintain effective control over the revenue cycle with revenue recognition.  We did not properly perform and follow the control procedures set forth in the revenue cycle.  This control deficiency resulted in  significant amounts of sales not being recorded in the proper periods.  Accordingly, management determined that this control deficiency constitutes a material weakness.
 
Based on our management’s assessment of the effectiveness of our internal control over financial reporting, our management has concluded that, as of December 31, 2008, the Company’s internal control over financial reporting was not effective as a result of the aforementioned material weaknesses.

Management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2008 has been audited by Stonefield Josephson, Inc., an independent registered public accounting firm, as stated in their report which is included under “Report of Independent Registered Public Accounting Firm.”
 
Remediation Measures of Material Weaknesses
 
We have implemented, or plan to implement, the measures described below under the supervision and guidance of our management to remediate the above control deficiencies and to strengthen our internal controls over financial reporting. Key elements of the remediation effort include, but are not limited to, the following initiatives, which have been implemented, or are in the process of implementation, as of the date of filing of this Annual Report:
 
1. 
We have increased efforts to enforce internal control procedures.  We have also reorganized the structure of our China financial department and clarified the responsibilities of each key personnel in order to increase communications and accountability.

2. 
We have recruited and will continue to bring in additional qualified financial personnel for the accounting department to further strengthen our China financial reporting function.
 
3. 
We will provide additional training on accounting principles and internal control procedures for our existing staffs. We have also required all personnel in our China financial department to obtain additional accounting certifications.
 
42

 
4. 
We continually review and improve our standardization of our monthly and quarterly data collection, analysis, and reconciliation procedures. To further improve the timeliness of data collection, we are selecting and will install new point of sale systems and enterprise resource planning systems for our wholesale and retail operations.
 
5. 
We have increased the level of communication and interaction among our China management, audit committee, independent auditors and other external advisors. In addition, our Chief Financial Officer and US GAAP team are becoming increasingly involved in and monitor the financial accounting and reporting process in China operations.
 
6. 
We are in the process of expanding the internal control functions and honing related policies and procedures. We have hired a qualified and experienced Internal Audit Manager, who commenced work in January 2009. We also plan to allocate transfer additional resources to the internal audit department for the purpose of enhancing the internal audit function.
 
We believe that we are taking the steps necessary for remediation of the material weaknesses identified above, and we will continue to monitor the effectiveness of these steps and to make any changes that our management deems appropriate
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
Fuqi International, Inc.
Shenzhen, China

We have audited Fuqi International, Inc. and its subsidiaries (“the Company”)’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). As described in Management’s Report on Internal Control Over Financial Reporting, management excluded from its assessment the internal control over financial reporting on the assets and operations of Shanghai Tian Mei Jewelry Co. Ltd. and Beijing Yinzhong Tian Mei Jewelry Co. Ltd. (collectively referred to as “Temix”) which were acquired on August 7, 2008 and whose financial statements constitute 11.2% of total assets, 1.7% of net revenues, and (2.8)% of net income of the consolidated financial statement amounts as of December 31, 2008 and for the year then ended.  Accordingly, our audit did not include the internal control over financial reporting at Temix. Fuqi International, Inc.’s management is responsible 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 “Report of Management on Internal Control over Financial Reporting.” Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. 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 audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides 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.

 
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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness 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.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis.  The following material weaknesses have been identified and included in management’s assessment:

 
·
The Company did not maintain effective control over the period-end closing process. Specifically, due to the insufficient number of qualified resources, the Company was unable to timely and accurately complete its work needed to close its books and prepare financial statements in accordance with accounting principles generally accepted in the United States of America. This control deficiency resulted in significant amounts of audit adjustments to the Company's 2008 financial statements.  In addition, this control deficiency could result in a material misstatement to annual or interim financial statements that would not be prevented or detected.   Accordingly, management determined that this control deficiency constitutes a material weakness.

 
·
The Company did not maintain effective control over the revenue cycle with revenue recognition.  The Company did not properly perform and follow the control procedures set forth in the revenue cycle.  This control deficiency resulted in significant amounts of revenues not being recorded in the proper periods.

These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2008 of the Company and this report does not affect our report on such financial statements and financial statement schedules.
 
In our opinion, management’s assessment that the Company did not maintain effective internal control over financial reporting as of December 31, 2008, is fairly stated, in all material respects, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Also in our opinion, because of the effect of the material weaknesses described above on the achievement of the control objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of  December 31, 2008, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2008 and 2007 and the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows and the related financial statement schedules for each of the years in the three-year period ended December 31, 2008, of Fuqi International, Inc., and our report dated March 30, 2009 expressed an unqualified opinion.

/s/  Stonefield Josephson, Inc.
Wanchai, Hong Kong
March 30, 2009
 
(C) Changes in Internal Controls over Financial Reporting
 
Due to the implementation of the remedial measures to address the material weaknesses as described above, in addition to the designing, planning, and integration of the internal controls over financial reporting for Temix, there were changes in our internal controls over financial reporting during the fourth quarter of fiscal 2008 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
 
ITEM 9B. OTHER INFORMATION

None

 
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PART III  
 
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
 
The information required by this Item 10 is incorporated by reference from our definitive proxy statement on Schedule 14A which will be filed before the end of the 120-day period immediately following the end of our 2008 fiscal year, or, if our definitive proxy statement is not filed within that time, the information will be filed as part of an amendment to this Annual Report on Form 10-K/A, not later than the end of the 120-day period.
 
ITEM 11. EXECUTIVE COMPENSATION
 
The information required by this Item 11 is incorporated by reference from our definitive proxy statement on Schedule 14A which will be filed before the end of the 120-day period immediately following the end of our 2008 fiscal year, or, if our definitive proxy statement is not filed within that time, the information will be filed as part of an amendment to this Annual Report on Form 10-K/A, not later than the end of the 120-day period.
 
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 
The information required by this Item 12 is incorporated by reference from our definitive proxy statement on Schedule 14A which will be filed before the end of the 120-day period immediately following the end of our 2008 fiscal year, or, if our definitive proxy statement is not filed within that time, the information will be filed as part of an amendment to this Annual Report on Form 10-K/A, not later than the end of the 120-day period.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
The information required by this Item 13 is incorporated by reference from our definitive proxy statement on Schedule 14A which will be filed before the end of the 120-day period immediately following the end of our 2008 fiscal year, or, if our definitive proxy statement is not filed within that time, the information will be filed as part of an amendment to this Annual Report on Form 10-K/A, not later than the end of the 120-day period.
 
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
 
The information required by this Item 14 is incorporated by reference from our definitive proxy statement on Schedule 14A which will be filed before the end of the 120-day period immediately following the end of our 2008 fiscal year, or, if our definitive proxy statement is not filed within that time, the information will be filed as part of an amendment to this Annual Report on Form 10-K/A, not later than the end of the 120-day period.
 
PART IV
 
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

1. Financial Statements: See “Index to Consolidated Financial Statements” in Part II, Item 8 of this annual report on Form 10-K.

2. Financial Statement Schedules: See “Schedule I – Condensed Financial Information of Registrant” and   “Schedule II—Valuation and Qualifying Accounts” from page F-38 to F-43 of the Financial Statements of this annual report on Form 10-K.

3. Exhibits: The exhibits listed in the accompanying “Index to Exhibits” are filed or incorporated by reference as part of this Form 10-K.

 
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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Shenzhen, People’s Republic of China, on March 31, 2009.

 
FUQI INTERNATIONAL, INC.
     
 
By:  
/s/ Yu Kwai Chong
 
Name Yu Kwai Chong
 
Title: Chief Executive Officer and President
 
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 Company in the capacities and on the dates indicated.
 
SIGNATURE
 
TITLE
 
DATE
         
/s/  Yu Kwai Chong
 
Chief Executive Officer and President (Principal
Executive Officer)
 
March 31, 2009
Yu Kwai Chong
       
         
/s/  Ching Wan Wong
 
Chief Financial Officer and Director (Principal
Financial Officer and Accounting Officer)
 
March 31, 2009
Ching Wan Wong
       
         
/s/  Lie Xi Zhuang
 
Chief Operating Officer and Director
 
March 31, 2009
Lie Xi Zhuang
       
         
/s/  Lily Lee Chen
 
Director
 
March 31, 2009
Lily Lee Chen
       
         
/s/  Eileen B. Brody
 
Director
 
March 31, 2009
Eileen B. Brody
       
         
/s/  Victor A. Hollander
 
Director
 
March 31, 2009
Victor A. Hollander
       
         
/s/  Jeff Haiyong Liu
 
Director
 
March 31, 2009
Jeff Haiyong Liu
       
 
 
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EXHIBIT INDEX

Exhibit Number
 
Description of Exhibit
2.1
 
Share Exchange Agreement dated November 20, 2006 by and between Fuqi International, Inc., a Delaware corporation (f/k/a VT Marketing Services, Inc.) (the “Registrant”) and Fuqi International Holdings Ltd., a British Virgin Islands company (incorporated by reference from Exhibit 2.1 to the Registrant’s Form 10 filed with the Securities and Exchange Commission on December 29, 2006).
     
3.1
 
Certificate of Incorporation of the Registrant (incorporated by reference from Exhibit 3.1 to the Registrant’s Form 10 filed with the Securities and Exchange Commission on December 29, 2006).
     
3.1(a)
 
Amendment of the Certificate of Incorporation of the Registrant dated February 21, 2007 to increase authorized shares (incorporated by reference from Exhibit 3.1(a) to the Registrant’s Form S-1/A (file no. 333-144290) filed with the Securities and Exchange Commission on August 28, 2007).
     
3.2
 
Bylaws of the Registrant (incorporated by reference from Exhibit 3.2 to the Registrant’s Form 10 filed with the Securities and Exchange Commission on December 29, 2006).
     
4.1
 
Specimen Common Stock Certificate (incorporated by reference from Exhibit 4.1 to the Registrant’s Form S-1/A (file no. 333-144290) filed with the Securities and Exchange Commission on July 2, 2007).
     
10.1
 
Plan Warrant Agreement (incorporated by reference from Exhibit 10.1 to the Registrant’s Form 10 filed with the Securities and Exchange Commission on December 29, 2006).
     
10.2
 
2006 Equity Incentive Plan (incorporated by reference from Exhibit 10.2 to the Registrant’s Form 10 filed with the Securities and Exchange Commission on December 29, 2006).
     
10.3
 
Real Property Lease dated May 8, 2005 (incorporated by reference from Exhibit 10.3 to the Registrant’s Form 10 filed with the Securities and Exchange Commission on December 29, 2006).
     
10.4
 
Employment Agreement dated August 30, 2007 entered into by and between the Company and Yu Kwai Chong (incorporated by reference from Exhibit 10.1 to the Registrant’s Form 8-K filed with the Securities and Exchange Commission on September 6, 2007).
     
10.5
 
Employment Agreement dated August 30, 2007 entered into by and between the Company and Ching Wan Wong (incorporated by reference from Exhibit 10.2 to the Registrant’s Form 8-K filed with the Securities and Exchange Commission on September 6, 2007).
     
10.6
 
Employment Agreement dated August 30, 2007 entered into by and between the Company and Lie Xi Zhuang (incorporated by reference from Exhibit 10.3 to the Registrant’s Form 8-K filed with the Securities and Exchange Commission on September 6, 2007).
     
10.7
 
Employment Agreement dated August 30, 2007 entered into by and between the Company and Heung Sang Fong (incorporated by reference from Exhibit 10.4 to the Registrant’s Form 8-K filed with the Securities and Exchange Commission on September 6, 2007).
     
10.8
 
Employment Agreement dated August 30, 2007 entered into by and between the Company and Xi Zhou Zhuo (incorporated by reference from Exhibit 10.5 to the Registrant’s Form 8-K filed with the Securities and Exchange Commission on September 6, 2007).
     
10.9
 
Registration Rights Agreement dated September 18, 2007 entered into by and between the Company and Bay Peak, LLC (incorporated by reference from Exhibit 10.9 to the Registrant’s Form S-1/A (file no. 333-144290) filed with the Securities and Exchange Commission on October 2, 2007).
     
10.10
 
Maximum General Facility Agreement dated September 27, 2007 entered into by and between the Company and Agriculture Bank of China (incorporated by reference from Exhibit 10.10 to the Registrant’s Form S-1/A (file no. 333-144290) filed with the Securities and Exchange Commission on October 2, 2007).
 
 
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Exhibit Number
 
Description of Exhibit
10.11
 
2007 Equity Incentive Plan (incorporated by reference from Exhibit 99.1 to the Registrant’s Form S-1/A (file no. 333-144290) filed with the Securities and Exchange Commission on August 28, 2007).
     
10.12
 
Form of Notice of Grant of Stock Option for the 2007 Equity Incentive Plan (incorporated by reference from Exhibit 99.2 to the Registrant’s Form S-1/A (file no. 333-144290) filed with the Securities and Exchange Commission on August 28, 2007).
     
10.13
 
Form of Stock Option Agreement (including Addendum) for the 2007 Equity Incentive Plan (incorporated by reference from Exhibit 99.3 to the Registrant’s Form S-1/A (file no. 333-144290) filed with the Securities and Exchange Commission on August 28, 2007).
     
10.14
 
Form of Stock Issuance Agreement (including Addendum) for the 2007 Equity Incentive Plan (incorporated by reference from Exhibit 99.4 to the Registrant’s Form S-1/A (file no. 333-144290) filed with the Securities and Exchange Commission on August 28, 2007).
     
10.15
 
Form of Stock Purchase Agreement (including Addendum) for the 2007 Equity Incentive Plan (incorporated by reference from Exhibit 99.5 to the Registrant’s Form S-1/A (file no. 333-144290) filed with the Securities and Exchange Commission on August 28, 2007).
     
10.16
 
Lease agreement dated October 10, 2007 for office space in San Jose, California (incorporated by reference from Exhibit 10.16 to the Registrant’s Form 10-K filed with the Securities and Exchange Commission on March 28, 2008).
     
10.17
 
Lease agreement dated February 20, 2008 for office space in Hong Kong (incorporated by reference from Exhibit 10.17 to the Registrant’s Form 10-K filed with the Securities and Exchange Commission on March 28, 2008).
     
10.18(a)
 
Asset Purchase Agreement dated April 18, 2008 entered into between the Fuqi International Holdings Co., LTD., Beijing Yinzhong Tianmei Jewelry Co., LTD., Shanghai Tianmei Jewelry Co., LTD., and Chujian Huang (incorporated by reference from Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 21, 2008).
     
10.18(b)
 
Amendment to Asset Purchase Agreement dated August 7, 2008 entered into between the Fuqi International Holdings Co., LTD., Beijing Yinzhong Tianmei Jewelry Co., LTD., Shanghai Tianmei Jewelry Co., LTD., and Chujian Huang (incorporated by reference from Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 12, 2008).
     
10.19
 
Intellectual Property Transfer Agreement dated April 18, 2008 entered into between the Registrant, the Fuqi International Holdings Co., LTD., and Chujian Huang (incorporated by reference from Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 21, 2008).
     
10.20
 
Employment Agreement dated August 7, 2008 by and between the Registrat and Chujian Huang (incorporated by reference from Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 12, 2008).
     
21.1
 
List of Subsidiaries of the Registrant (incorporated by reference from Exhibit 21.1 to the Registrant’s Form 10 filed with the Securities and Exchange Commission on December 29, 2006).
     
23.1
 
Consent of Stonefield Josephson, Inc.
     
31.1
 
Certification of Chief Executive Officer pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2
 
Certification of Chief Financial Officer pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
48

 

Exhibit Number
 
Description of Exhibit
32.1*
 
Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
_______________
* This exhibit shall not be deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any filings. 
 
 
49

 
 
FUQI INTERNATIONAL, INC.   
 
CONSOLIDATED FINANCIAL STATEMENTS
 
INDEX TO FINANCIAL STATEMENTS

 
Page
Report of Independent Registered Public Accounting Firm
F-2
   
Financial Statements: