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FUQI INTERNATIONAL INC 10-K 2007 Documents found in this filing:UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
For
the
fiscal year ended: December 31, 2006
For
the
transition period from __________ to ____________
Commission
File Number: 000-52383
FUQI
INTERNATIONAL,
INC. (Exact
name of registrant as specified in its charter)
REGISTRANT’S
TELEPHONE NUMBER, INCLUDING AREA CODE: 86-755-2580
6333
SECURITIES
REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None.
SECURITIES
REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act. Yes o 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 o 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 o
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. x
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
(Check one):
Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes o No x
At
December 31, 2006, the last business day of the registrant’s most recently
completed fiscal year, there were 20,715,384 shares of the registrant’s common
stock outstanding, and there was no aggregate market value of such shares held
by non-affiliates of the registrant because the registrant’s common stock was
not trading on any exchange.
There
were 20,715,384 shares of common stock outstanding as of April 13,
2007.
DOCUMENTS
INCORPORATED BY REFERENCE: None.
TABLE
OF CONTENTS
FUQI
INTERNATIONAL, INC.
TABLE
OF CONTENTS TO ANNUAL REPORT ON FORM 10-K
For
the Fiscal Year Ended December 31, 2006
i
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, results of operations,
and the expected impact of the share exchange on the parties’ individual and
combined financial performance. 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:
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.
ii
PART
I
ITEM
1. BUSINESS
Overview
Fuqi
International, Inc. (“Fuqi” or “the Company”) engages in the design,
manufacture, marketing and wholesale distribution of a full range of precious
metal jewelry in China. The Company currently operates through two divisions:
(i) production and (ii) sales and marketing. The production division is
responsible for manufacturing of the Company’s jewelry products and the sales
and marketing division is responsible for the selling and marketing functions
of
the products, including customer relations and customer service. The Company
intends to enter into the retail distribution of its jewelry products by opening
or acquiring retail stores in China during 2007.
Fuqi
operates through the Company’s 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.
Corporate
History
Fuqi
was
originally incorporated in the State of Arizona on September 3, 2004 as VT
Marketing Services, Inc. The Company was a wholly-owned subsidiary of Visitalk
Capital Corporation (“VCC”),
and
was formed as part of the implementation of the Chapter 11 reorganization
plan (the “Visitalk
Plan”)
of
visitalk.com, Inc. (“Visitalk.com”).
Visitalk.com filed for Chapter 11 Bankruptcy in November 2000. The Visitalk
Plan
became effective on September 17, 2004 (the “Effective
Date”).
On
September 22, 2004, Visitalk.com merged into VCC, which was authorized as the
reorganized debtor under the Visitalk Plan.
The
Company’s original business was to use Visitalk.com’s technology to facilitate
peer-to-peer marketing activities. The Visitalk Plan authorized it to acquire
certain technology rights from VCC on the Effective Date. To acquire these
rights, the Company issued to VCC 324,044 shares of its common stock and common
stock purchase warrants allowing holders to purchase additional shares of its
common stock (the “Plan
Warrants”).
The
Visitalk Plan further authorized VCC to distribute 54,837 of the 324,044 shares
of common stock to 240 creditors of Visitalk.com and all of the Plan Warrants
to
645 claimants of Visitalk.com, in accordance with the Visitalk Plan. After
the
distribution of the shares of its common stock and Plan Warrants, but prior
to
the Bay Peak Sale, discussed below, VCC owned approximately 82.1% of its issued
and outstanding common stock.
On
July
21, 2006, the Company sold 1,368,761 shares of common stock (post Reverse Split
described below) to BayPeak, LLC. As part of this transaction (the “Bay
Peak Sale”),
the
Company abandoned its peer-to-peer marketing business, which was transferred
to
VCC, and began to seek companies in Asia with potential, in particular companies
based in China, to acquire. The shares issued in the Bay Peak Sale represented
74.49% of the Company’s outstanding shares. On July 28, 2006, Visitalk.com was
granted its Final Decree by the Bankruptcy Court. On November 6, 2006, the
Company conducted a reverse stock split of its shares common stock and issued
one share for each 15.43 shares of its common stock then outstanding (the
“Reverse
Split”).
No
shareholder was reversed below 100 shares in the Reverse Split and the then
outstanding Plan Warrants were not affected by the Reverse Split. On November
8,
2006, the Company changed its state of incorporation from Arizona to
Nevada.
On
November 20, 2006, the Company entered into a share exchange agreement with
Yu
Kwai Chong, who is the sole shareholder of Fuqi BVI pursuant to which the
Company agreed to acquire all of the issued and outstanding capital stock of
Fuqi BVI (the “Exchange
Transaction”).
The
Exchange Transaction closed on November 22, 2006 and, per the terms of the
share
exchange agreement (the “Share
Exchange Agreement”),
the
Company issued an aggregate of 18,886,666 shares of its common stock in exchange
for all of the issued and outstanding securities of Fuqi BVI. Pursuant to the
Share Exchange Agreement, BayPeak agreed to cancel 8,761 shares of common stock.
Immediately
after the closing of the Exchange Transaction and Reverse Split, the Company
had
20,715,384 outstanding shares of common stock, no options and warrants to
purchase 16,846,982 shares of its common stock. Immediately after the Exchange
Transaction and Reverse Split, the former Fuqi BVI stockholder held
approximately 91.2% of its voting capital stock.
1
On
December 8, 2006, the Company changed its corporate name from “VT Marketing
Services, Inc.” to “Fuqi International, Inc.” and reincorporated from the State
of Nevada to the State of Delaware.
The
Company’s shares of common stock are not currently listed or quoted for trading
on any national securities exchange or national quotation system. The
transactions contemplated by the Share Exchange Agreement, as amended, were
intended to be a “tax-free” incorporation pursuant to the provisions of Section
368 of the Internal Revenue Code of 1986, as amended.
All
share
information presented in this Form 10-K reflect the Reverse Split. For financial
accounting purposes, the Exchange Transaction 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, the Company’s 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,
Shenzhen Fuqi Jewelry Co., Ltd. (“Fuqi China”), a company established under the
laws of the People's Republic of China. Upon the acquisition of Fuqi BVI, the
Company’s sole business operations became that of Fuqi BVI.
Design
and Product Development
Since
the
commencement of its jewelry operations in 2001, the Company has expanded its
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). The Company also
manufactures jewelry with diamond and other precious stone inlays, in addition
to gold coins and gold bars.
The
Company’s product series include the following:
All
of
Fuqi’s designs are originated by its in-house designers. Fuqi’s designers are
educated by 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, the Company’s designers research and study designs that are
popular in China and worldwide. The Company’s designers conduct design and
market research through various forms, including trade expositions, industrial
magazines and the Internet. The Company’s designers also receive feedback from,
and respond to, the Company’s customers. The
Company continuously designs and produces new styles of jewelry and currently
carry more than 20,000 product styles. The
Company assigns serial numbers to each of its products styles, and maintains
an
information management system that utilizes a product database.
Manufacturing
The
Company has a large-scale production base that includes a modern factory of
more
than 53,000 square feet, a dedicated senior design team, and more than 600
trained technical workers. In the production of its jewelry, the Company
believes it uses the latest jewelry processing equipment and procedures. Since
2003, the Company 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 ISO
9000 quality management system is one of international references for quality
management requirements in business-to-business dealings. This means the
organization being accredited by an independent assessment organization has
to
fulfill:
2
The
ISO
9000 quality management system is well recognized by China governmental bodies
and businesses. This accreditation can serve as a basis for the Company’s
customers to determine the minimum standard of quality assurance that the
Company can achieve. The Company believes that this accreditation also indicates
to the Company’s customers that the Company is running an effective system to
track quality issues and possible rework progress of its products. In January
2007, the Company also passes the assessment of ISO 14000 accreditation. The
ISO
defines ISO 14000 system an environmental management system, which means the
organization being accredited by an independent assessment organization has
to:
Fuqi
produced thousands of product styles on the following product processing
lines:
The
Company’s maximum annual output capacity of the gold jewelry, other rare and
precious metal jewelry, K-gold jewelry and inlaid jewelry is approximately
30.0
tons, 15 tons, 5.0 tons and
60,000 pieces, respectively.
Business
and Growth Strategy
Fuqi’s
current business and growth strategy is to:
Fuqi
intends to establish a retail sales plan aimed at gaining market share in the
growing consumer market in China. Fuqi intends to open retail stores throughout
China, initially, and in Hong Kong and the United States in the future. During
2007, Fuqi intends to open and/or acquire 20 retail counters and open 2 retail
stores in municipalities and provincial capitals throughout China. In
2008,
the Company plans to acquire an additional 6 to 7 retail stores and acquire
40
to 50 counters, while opening 2 to 3 stores and 20 to 30 counters in that year.
The Company has identified various locations for its retail outlets and the
Company is currently negotiating the acquisition of leases of such locations
without acquiring the existing business. The Company’s Chinese legal counsel is
preparing a letter of intent with preliminary acquisition terms to be entered
into with sellers with respect to five of these locations. Assuming that
negotiations continue at their current pace without unanticipated delay, the
Company believes that the letters of intent for these five stores and counters
will be entered into in April 2007 and acquired in May 2007. There can be no
assurances that the negotiations and acquisition will continue in a timely
manner or at all.
3
Through
these retail outlets, the Company intends to offer is entire range of jewelry
products to showcase and sell. Furthermore, Fuqi plans to design and manufacture
a number of fine diamond and gem stone jewelry to be sold exclusively in the
Company’s retails shops.
In
connection with the Company’s retail expansion plan, the Company has conducted
an analysis on historical sales information and market studies and, based on
this analysis, the Company has begun to select locations on which the Company
intends establish its retail network. Fuqi has not yet secured any locations
but
it has identified a number of locations in various cities for the first and
second phase of retail expansion. In terms of management talent, the Company
has
identified and begun to negotiate with an experienced senior executive, who
has
over 26 years of experience in retail industry, to join the team for this
expansion. The Company has started in-house design of management and control
system manuals for use of retail outlets. The Company has investigated human
resources markets in these locations identified that it believes that the
availability of sales forces is not an issue. The Company has also researched
and planned organizational and logistical steps, such as legal requirements
of
local governments, management talent, sales forces and outlet locations for
its
retail expansion. Based on this, the Company believes that there is barrier
that
would prevent it from selling its products in the retail market.
The
Company believes that the demand for precious metal jewelries is still growing
in a rate higher than the general economic growth and that its participation
in
retail distribution will not create competition to its existing clients. The
Company believes that its design teams can create new designs and establish
new
markets through its retail network. The Company hopes that the new designs
may
create mass marketing and advertising opportunities for its products, which
the
Company believes may strengthen consumer demand for its products.
Fuqi
believes that China represents an excellent retail sales opportunity for various
reasons that include:
Sales
and Marketing
Fuqi
relies on its sales and marketing division, which is located at its executive
offices in Shenzhen, China for the distribution of its products. Fuqi trains
its
salespeople in its product lines. Fuqi’s marketing and distribution strategy is
to screen and identify the strongest retail customers in each distribution
channel and to focus on design and sales efforts towards the largest and fastest
growing retailers and distributors. Fuqi’s jewelry is sold to a network of
approximately 1,000 distributors, retailers and wholesale agencies. The Company
maintains a broad base of customers and concentrate its efforts on department
stores, wholesalers, national jewelry chains, fine jewelers, and stores that
sell fashionable jewelry to youth. The Company also works closely with its
major
customers and attempt to adjust its product strategies and structure based
on
customer feedback. The Company believes this helps decrease the likelihood
of
overstocked and undesired products.
4
Fuqi
expects to move into the retail distribution of its products in 2007. As
discussed above in “Business and Growth Strategies,” the Company intends open
retail outlets throughout China, initially, and in Hong Kong and in the future,
other countries.
The
Company’s products are mainly designed for the middle income class in China,
with an emphasis on young ladies. Approximately 5% of the Company’s designs are
for new-born children, 20% of its designs are for middle-aged men, 30% of its
designs are for middle to older-aged women and the rest of its designs are
for
young women. The majority of the Company’s products are sold in China at an
average retail price of US$200 to US$300, including tax, which would be a
similar price range if these products were sold in the United
States.
Fuqi
continues to devote its efforts towards brand development and utilize marketing
concepts in an attempt to enhance the marketability of its products. During
the
past two years, Fuqi has carried out a brand development strategy based on
product quality and design excellence. Fuqi has participated in various
marketing activities and exhibitions to promote its products and brand. For
example, in 2004, the Company was the laurel sponsor for multiple beauty
pageants, including the “Miss Intercontinental Final” and the “Miss China
Universe.” As a laurel sponsor, the Company designed and crafted the laurels
and/or batons that were presented to a contest’s winner, in addition to the
contest’s second and third place runner-ups. Fuqi has also sponsored numerous
beauty contests such as:
Fuqi
believes that the laurels and batons created in connection with its sponsorship
of beauty contests provide the Company an opportunity to showcase the Company’s
design and craftsmanship ability, in addition to strengthening its brand
recognition.
Fuqi
has
received various governmental awards with respect to its brand, including
recognition as a “Chinese Famous Brand,” which is reserved for the top ten most
recognized brands of the jewelry in China. The Company also received other
recognitions, including “Famous
Brand in China Jewelry Industry”, “Shenzhen Well-known Brand”, “Shenzhen 300
enterprises with Ultimate Growth” and “China Quality Promise Credit Management
Enterprise (Brand)”. The Company believes that governmental awards and other
forms of recognition raise brand recognition for its products.
The
“Fuqi” trademark has been registered in the United States, Italy, Japan, Hong
Kong and China.
Supply
of Raw Materials
Fuqi
is a
full member of the Shanghai Gold Exchange, a manufacturer designated by the
Platinum Guild International, and a standing council member of Shenzhen Gold
Association of China. Shanghai Gold Exchange is the Company’s primary source of
supply for its raw materials, which consist of precious metals.
Fuqi
maintains its supply of raw materials at its warehouse in Shenzhen, China.
The
Company purchases large volume of precious metals approximately five times
per
month from Shanghai Gold Exchange in advance and in anticipation of orders
resulting from its marketing programs. In order to minimize the risk of storage
and devaluation, the Company only purchases pre-cut gemstones, including ruby
and jade, upon customers’ requests. The Company does not have a designated
supplier for these pre-cut stones. When a customer places an order that requires
pre-cut stones, the Company purchases the pre-cut stones as required from local
supplies in Shenzhen.
Competition
The
jewelry production industry is highly competitive, and the Company’s competitors
include domestic and foreign jewelry manufacturers, wholesalers, and importers
who may operate on a national, regional and local scale. Many of the Company’s
competitors have substantially greater financial, technical and marketing
resources and personnel than the Company. Fuqi’s competitors in the jewelry
production industry include Nongjia, Cuilu, ADK, Junli, Baohengde and
Anshenghua. The Company’s strategy is to provide competitively priced, moderate-
to high-quality products to the high-volume retail jewelry market. The Company
believes competition is largely based on quality, service, pricing, and
established customer relationships.
5
Fuqi
intends to enter into the jewelry retail industry, which is also highly
competitive. Many of the Company’s potential competitors in the retail industry
will 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
Hang Fung Gold Technology, have numerous branches set up across China and may
have secured the most desirable locations for retail stores. It is difficult
for
a newcomer to enter into the retail industry, but the Company believes that
its
established production and wholesale distribution business will facilitate
its
entrance into the retail market.
Major
Customers
During
the year ended December 31, 2005 approximately 15% of the Company’s sales were
generated from one customer, Beijing
Hua Shang Rui Lin Trading Co., Ltd. During the years ended December 31, 2006
and
2004, there were no single customers that generated more than 10% of the total
sales.
Seasonality
The
Company’s business is seasonal in nature. The Company’s sales and net income are
traditionally higher in the fourth calendar quarter than the rest of the year.
The
primary factors that affect the seasonal changes in the Company’s business
operations are holidays and traditional Chinese festivals. In the fourth
quarter, retailers often experience increased sales due to the golden week
of
Chinese National Day, Christmas and New Year’s Day. In addition, jewelry
retailers commonly stock up from wholesalers to prepare for potentially higher
sales during the period before Chinese New Year, which is a peak season of
marriage and newborns in China. This seasonal trend in our business occurred
during 2005; however, there was a slight deviation in during 2006. During fiscal
2006, a larger portion of the Company’s sales was generated during the first
quarter, with net income was $2.3 million for the first quarter of 2006, as
compared to net income of $0.4 million, $0.9 million and $2.1 million for the
second, third and forth calendar quarters, respectively. During
fiscal 2005, the Company had net income was of $2.1 million for the fourth
quarter, as compared to net income of $1.3 million, $0.6 million and $1.3
million for the first, second and third calendar quarters, respectively, of
2005. The Company believes that deviation in 2006 was related to customers
speculating the direction of precious metal prices and holding their orders
longer until their inventory levels were too low to meet the peak season. The
Company believes that, in 2007, the seasonality of the Company’s business
seasonality will return to normal.
Government
Regulations
In
April
2001, the Shenzhen Business Bureau granted Fuqi the right to operate for a
period of ten years from the date of the inception of wholly-owned subsidiary,
Fuqi China. On May 17, 2006, this right allowed the Company to transform Fuqi
China into a Wholly Owned Foreign Enterprise (a “WOFE”)
and
formally transfer the ownership of Fuqi China from the founder to Fuqi BVI.
Neither this transfer nor the Company’s acquisition by the VTM changed its
business plan. The right to operate as a WOFE expires 30 years from the date
of
this approval but based on current PRC legislation, this right is renewable
by
application. A WOFE can only conduct business within its approved business
scope, which ultimately appears on the business license. This license permits
the Company to design, manufacture, sell and market jewelry products to
department stores throughout the PRC. Any amendment to the scope of the
Company’s business requires further application and government approval. The
Company cannot assure you that it will be able to obtain the necessary
government approval for any change or expansion of its business.
Under
the
PRC laws, supplies of precious metals such as platinum, gold and silver are
highly regulated by certain government agencies. Shanghai Gold Exchange is
the
Company’s primary source of supply for its raw materials, which almost
substantially consist of precious metals. The Company is required to obtain
several membership and approval certificates from these government agencies
in
order to continue to conduct its business. The Company may be required to renew
such memberships and to obtain approval certificates periodically. If the
Company is unable to renew these periodic membership or approval certificates,
it would materially affect its business operations. The Company is currently
in
good standing with these agencies.
6
Fuqi
has
also been granted independent import and export rights. These rights permit
the
Company to import and export jewelry in and out of China. With the relatively
lower cost of production in China, the Company intend to expand into overseas
markets after the launch of its China-based retail plan. However, the Company
does not currently have plans to import jewelry into China.
Employees
Fuqi
has
more than 600 full-time employees. The Company is not subject to any collective
bargaining agreements and believes its relationship with its employees is
good.
Fuqi
is
required to contribute a portion of its 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. Fuqi contributed approximately $140,000,
$138,000 and $152,000 for the years ended December 31, 2006, 2005 and 2004,
respectively. Fuqi expects that the amount of its contribution to the
government’s social insurance funds to increase in the future as it expands its
workforce and operations.
Facilities
Fuqi’s
principal executive offices are located at 5/F., Block 1, Shi Hua Industrial
Zone, Cui Zhu Road North, Shenzhen 518019, China. The Company owns approximately
15,000 square feet of office and showroom space at this location.
Fuqi’s
jewelry production facility is located in Shenzhen, China and, including office
spaces, consists of approximately 66,000 square feet of building space. Fuqi
owns approximately 33,000 square feet of this space and the remainder is leased
from a landlord, Guanghong Jin Tong Hai Enterprises Ltd. The Company has
acquired the space for production facility, office and show room located at
5/F., Block 1, Shi Hua Industrial Zone during 2005.
In
July
2005, the Company entered into a leasing agreement with Shenzhen Jin Tong Hai
Enterprises Ltd. to lease the production plan on 4th floor Block 1, Shi Hua
Industrial Park for a approximately $112,000 per annum. from July 2005 to June
2010. The lease agreement will terminate in June 2010. The Company has 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,
the Company expects that the lease amount will be increased by approximately
35%
in the year of 2010.
7
ITEM
1A: RISK
FACTORS
Any
investment in the Company’s 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 its securities. The Company’s business, financial condition
or results of operations could be materially adversely affected by these risks
if any of them actually occur. None of the Company’s securities are currently
listed or quoted for trading on any national securities exchange or national
quotation system. If and when the Company’s securities are traded, the trading
price could decline due to any of these risks, and an investor may lose all
or
part of his investment. Some of these factors have affected Fuqi’s financial
condition and operating results in the past or are currently affecting the
Company. This filing also contains forward-looking statements that involve
risks
and uncertainties. The Company’s 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.
RISKS
RELATED TO THE COMPANY'S OPERATIONS
Jewelry
purchases are discretionary, may be particularly affected by adverse trends
in
the general economy, and a decline in either will make it more difficult to
generate revenue.
The
success of the Company’s 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, the rate of change in employment, the level of consumers’
disposable income, business conditions, interest rates, consumer debt levels,
availability of credit and levels of taxation for the economy as a whole and
in
regional and local markets in China where the Company manufactures and sells
its
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 Fuqi’s 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 its 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. In the past, Fuqi has not hedged its
requirement for gold, platinum or other raw materials through the use of
options, forward contracts or outright commodity purchasing, but it intends
to
engage in such hedging in the future, depending on its available resources.
A
significant disruption in the Company’s supply of gold, platinum, and other
commodities could decrease its production and shipping levels, materially
increase its operating costs and materially adversely affect its profit margins.
Shortages of gold, platinum, and 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 the Company purchases its raw materials
and may adversely affect its ability to maintain production of its products
and
sustain profitability. If the Company was to experience a significant or
prolonged shortage of gold, platinum, and other commodities, the Company would
be unable to meet its production schedules and to ship products to its customers
in timely fashion, which would adversely affect its sales, margins and customer
relations.
Fuqi
has only been engaged in the manufacture and wholesale distribution of jewelry
products and has no experience or operating history with respect to its intended
entry into the retail jewelry market. Fuqi’s attempt to enter the retail market
may fail, divert management’s attention and adversely affect its operating
results.
Fuqi
has
derived nearly all of its net revenues from the production and wholesale
distribution of its jewelry products. The Company intends to devote management
time and resources to establishing retail stores throughout China. The Company
has no experience or operating history in the retail market, and its attempt
to
enter the market could fail and use substantial resources. Because the retail
industry is new to the Company, it may be unable to effectively assess or
address the evolving risks and difficulties present in this market, which could
threaten its capacity to continue overall operations successfully in the
future.
8
Fuqi
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, Fuqi
may
not be able to maintain or expand its business.
Fuqi
expects to expend significant resources to commence its planned retail
distribution of its manufactured jewelry in China. The Company will require
substantial additional funds in order to finance its planned retail
distribution, fund operating expenses, and to develop manufacturing, marketing
and sales capabilities. Fuqi also expects to require additional funds to shift
the focus of its primary product from gold to platinum. Without raising
additional funds, it may not be able to meet these goals. The Company 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:
If
the
Company cannot raise additional funds when needed, or on acceptable terms,
it
may not be able to effectively execute its growth strategy (including entering
the retail market), take advantage of future opportunities, or respond to
competitive pressures or unanticipated requirements. In addition, the Company
may be required to scale back or discontinue its production and development
program, or obtain funds through strategic alliances that may require it to
relinquish certain rights.
Fuqi’s
ability to maintain or increase its revenue could be harmed if Fuqi is unable
to
strengthen and maintain a brand image.
Fuqi
believes that primary factors in determining customer buying decisions in
China’s jewelry sector include customer price, confidence in the merchandise
sold, and the level and quality of customer service. The ability to
differentiate its products from competitors by Fuqi’s brand based marketing
strategies is a factor in attracting consumers, and if its strategy and efforts
to promote its brand, such as beauty contest sponsorship, fails to garner brand
recognition, its ability to generate revenue may suffer. If Fuqi is unable
to
differentiate its products, its ability to sell its products wholesale and
its
planned sale of products retail will be adversely affected. If
the
Company fails to anticipate, identify or react appropriately or in a timely
manner to customer buying decisions, the Company could experience reduced
consumer acceptance of its 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 the Company’s
products, which could adversely affect its financial condition and results
of
operations. This risk is particularly acute because the Company relies on a
limited demographic customer base for a large percentage of its sales.
If
the Company is not able to adapt to changing jewelry trends in China, its
inventory may be overstocked and the Company may be forced to reduce the price
of its overstocked jewelry or incur the cost to recast it into new jewelry.
The
Company depends 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 the Company fails
to
anticipate, identify or react appropriately to changes in styles and trends,
it
could experience excess inventories, higher than normal markdowns or an
inability to sell its products. If such a situation exists, the Company may
need
to incur additional costs to recast its products to fit the demand recovering
only the raw material with all labor invested in the product lost.
9
The
Company’s failure to manage growth effectively could have an adverse effect on
its employee efficiency, product quality, working capital levels, and results
of
operations.
The
Company intends to conduct a growth strategy into retail distribution of its
products that it hopes will result in rapid growth, which will place significant
demands on its managerial, operational and financial resources. Any
significant growth in the market for the Company’s current wholesale business
and its planned retail distribution would require it to expand its employee
base
for managerial, operational, financial, and other purposes. During any growth,
the Company may face problems related to its
operational and financial systems and controls, including quality control and
delivery and service capabilities. The Company would also need to continue
to
expand, train and manage its employee base. The
Company currently has approximately 600 full-time employees, and, at that size,
a rapid increase in the number of its 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 the Company is able to launch its retail business, some of
these employees would need retail experience, which it currently have none.
Aside
from increased difficulties in the management of human resources, the Company
may also encounter working capital issues, as it 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. The Company’s failure to manage growth effectively may lead to
operational and financial inefficiencies that will have a negative effect on
its
profitability. The
Company cannot assure you that it will be able to timely and effectively meet
that demand and maintain the quality standards required by its existing and
potential customers and licensees.
Fuqi
is dependent on certain key personnel and loss of these key personnel could
have
a material adverse effect on its business, financial condition and results
of
operations.
Fuqi’s
success is, to a certain extent, attributable to its management, sales and
marketing, and operational and technical expertise of certain key personnel.
Each of Fuqi’s named executive officers, including its Chief Executive Officer
Yu Kwai Chong, performs key functions in the operation of its business. The
Company does not have employment agreements with such key personnel, and there
can be no assurance that the Company 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 the Company’s business, financial condition, and
results of operations.
Fuqi
is controlled by one shareholder, whose interests may differ from those of
other
shareholders. As a result, Fuqi could be prevented from entering into
potentially beneficial transactions if they conflict with its major
shareholder’s interests.
As
of the
close of the Share Exchange Transaction, Mr. Chong, Fuqi’s Chief Executive
Officer and its largest shareholder, beneficially owns or controls approximately
91.2% of the Company’s outstanding shares. Mr. Chong was the former sole
stockholders of Fuqi BVI. Mr. Chong possesses significant influence over the
Company, giving him the ability, among other things, to elect 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 discourage a potential acquirer from making a tender
offer or otherwise attempting to obtain control of the Company. Without the
consent of Mr. Chong, the Company could be prevented from entering into
potentially beneficial transactions if they conflict with the Company’s major
shareholder’s interests. The interests of this shareholder may differ from the
interests of the Company’s other shareholders.
RISKS
RELATED TO DOING BUSINESS IN CHINA
All
of Fuqi’s assets are located in China and all of its revenues are derived from
its operations in China, and changes in the political and economic policies
of
the PRC government could have a significant impact upon what business Fuqi
may
be able to conduct in the PRC and accordingly on the results of its operations
and financial condition.
10
Fuqi’s
business operations may be adversely affected by the current and future
political environment in the PRC. The PRC has operated as a socialist state
since the mid-1900s and is controlled by the Communist Party of China. The
Chinese government exerts substantial influence and control over the manner
in
which Fuqi must conduct its business activities. The PRC has only permitted
provincial and local economic autonomy and private economic activities since
1988. The government of the PRC has exercised and continues to exercise
substantial control over virtually every sector of the Chinese economy,
including the jewelry industry, through regulation and state ownership. Fuqi’s
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.
Fuqi’s
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 Fuqi’s
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 precedents 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 the Company’s business, or the
enforcement and performance of the Company’s arrangements with customers in the
event of the imposition of statutory liens, death, bankruptcy and 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. The Company is considered a foreign person or foreign funded
enterprise under PRC laws, and as a result, the Company is required to comply
with PRC laws and regulations. The Company cannot predict what effect the
interpretation of existing or new PRC laws or regulations may have on its
businesses. If the relevant authorities find the Company in violation of PRC
laws or regulations, they would have broad discretion in dealing with such
a
violation, including, without limitation:
The
scope of the Company’s business license in China is limited, and the Company may
not expand or continue its business without government approval and renewal,
respectively.
Fuqi
is a
wholly-owned foreign enterprise, commonly known as a WOFE. A WOFE can only
conduct business within its approved business scope, which ultimately appears
on
the business license. Fuqi’s license permits it to design, manufacture, sell and
market jewelry products to department stores throughout the PRC. Any amendment
to the scope of the Company’s business requires further application and
government approval. In order for Fuqi to expand its business beyond the scope
of its license, Fuqi will be required to enter into a negotiation with the
authorities for the approval to expand the scope of its business. The Company
cannot assure you that it will be able to obtain the necessary government
approval for any change or expansion of its business.
Inflation
in China could negatively affect the Company’s profitability and
growth.
While
the
Chinese 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. During the past decade, the rate of inflation in China has been
as
high as approximately 20% and China has experienced deflation as low as minus
2%. If prices for the Company’s products rise at a rate that is insufficient to
compensate for the rise in the costs of supplies such as raw materials, it
may
have an adverse effect on the Company’s 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. In October 2004,
the
People's Bank of China, the PRC's central bank, raised interest rates for the
first time in nearly a decade and indicated in a statement that the measure
was
prompted by inflationary concerns in the Chinese economy. In April 2006, the
People’s Bank of China raised the interest rate again. Repeated rises in
interest rates by the central bank would likely slow economic activity in China
which could, in turn, materially increase the Company’s costs and also reduce
demand for its products.
11
Recent
PRC regulations relating to acquisitions of PRC companies by foreign entities
may create regulatory uncertainties that could restrict or limit the Company’s
ability to operate, including its ability to pay dividends.
The
PRC
State Administration of Foreign Exchange, or “SAFE,”
issued
a public notice in January 2005 concerning foreign exchange regulations on
mergers and acquisitions in China. The public notice states that if an offshore
company controlled by PRC residents intends to acquire a PRC company, such
acquisition will be subject to strict examination by the relevant foreign
exchange authorities. The public notice also states that the approval of the
relevant foreign exchange authorities is required for any sale or transfer
by
the PRC residents of a PRC company's assets or equity interests to foreign
entities for equity interests or assets of the foreign entities.
In
April
2005, SAFE issued another public notice further explaining the January notice.
In accordance with the April notice, if an acquisition of a PRC company by
an
offshore company controlled by PRC residents has been confirmed by a Foreign
Investment Enterprise Certificate prior to the promulgation of the January
notice, the PRC residents must each submit a registration form to the local
SAFE
branch with respect to their respective 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 transaction or use of assets in
China to guarantee offshore obligations. The April notice also provides that
failure to comply with the registration procedures set forth therein may result
in restrictions on any of the Company’s PRC resident shareholders and Fuqi BVI
and Fuqi China. Pending the promulgation of detailed implementation rules,
the
relevant government authorities are reluctant to commence processing any
registration or application for approval required under the SAFE
notices.
In
addition, on August 8, 2006, the Ministry of Commerce (“MOFCOM”), joined by the
State-owned Assets Supervision and Administration Commission of the State
Council, State Administration of Taxation, State Administration for Industry
and
Commerce, China Securities Regulatory Commission and SAFE, amended and released
the Provisions
for Foreign Investors to Merge and Acquire Domestic Enterprises,
new
foreign-investment rules which took effect September 8, 2006, superseding much,
but not all, of the guidance in the prior SAFE circulars. These new rules
significantly revise China’s regulatory framework governing onshore-offshore
restructurings and how foreign investors can acquire 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.
These
new
rules may significantly affect the means by which offshore-onshore
restructurings are undertaken in China in connection with offshore private
equity and venture capital financings, mergers and acquisitions. It is expected
that such transactional activity in China in the near future will require
significant case-by-case guidance from MOFCOM and other government authorities
as appropriate. It is anticipated that application of the new rules will be
subject to significant administrative interpretation, and the Company will
need
to closely monitor how MOFCOM and other ministries apply the rules to ensure
its
domestic and offshore activities continue to comply with PRC law. Given the
uncertainties regarding interpretation and application of the new rules, the
Company may need to expend significant time and resources to maintain
compliance.
12
The
Company’s business operations or future strategy could be adversely affected by
the interpretations and implementation of the SAFE notices and the new rules.
For example, the Company may be subject to more stringent review and approval
process with respect to its foreign exchange activities.
Failure
to comply with the United States Foreign Corrupt Practices Act could subject
the
Company to penalties and other adverse consequences.
Upon
completion of the Share Exchange Transaction, the Company became 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 Fuqi, 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. The Company can
make no assurance, however, that its employees or other agents will not engage
in such conduct for which the Company might be held responsible. If the
Company’s employees or other agents are found to have engaged in such practices,
the Company could suffer severe penalties and other consequences that may have
a
material adverse effect on its business, financial condition and results of
operations.
We
had enjoy certain preferential tax concessions and loss of these preferential
tax concessions may cause our tax liabilities to increase and our profitability
to decline.
The
Company’s subsidiary, Fuqi China, enjoyed a reduced enterprise income tax rate
of 15%, which is granted to all enterprises operating in Shenzhen Special
Economic Zone, and prior to 2006, the Company was under the preferential income
tax rate of 7.5% in 2005 and 2004 due to its status of being a new business.
That status expired effective January 1, 2006. The expiration of the
preferential tax treatment will increase the Company’s tax liabilities and
reduce its profitability. Additionally,
the PRC Enterprise Income Tax Law (the “EIT Law”) was enacted on March 16, 2007.
Under the EIT Law, effective January 1, 2008, China will adopt a uniform tax
rate of 25.0% for all enterprises (including foreign-invested enterprises)
and
cancel several tax incentives enjoyed by foreign-invested enterprises. Since
the
PRC government has not announced implementation measures for the transitional
policy with regards to such preferential tax rates, the Company cannot
reasonably estimate the financial impact of the new tax law to it at this time.
Further, any future increase in the enterprise income tax rate applicable to
the
Company or other adverse tax treatments, could increase the Company’s tax
liabilities and reduce our net income.
Any
recurrence of severe acute respiratory syndrome, or SARS, the Avian Flu, or
another widespread public health problem, in the PRC could adversely affect
the
Company’s operations.
A
renewed
outbreak of SARS, the Avian Flu or another widespread public health problem
in
China, where all of the Company’s manufacturing facilities are located and where
all of its sales occur, could have a negative effect on its operations. The
Company’s business is dependent upon its ability to continue to manufacture its
products. Such an outbreak could have an impact on the Company’s operations as a
result of:
Any
of
the foregoing events or other unforeseen consequences of public health problems
could adversely affect the Company’s operations.
Because
the Company’s business is located in the PRC, it may have difficulty
establishing adequate management, legal and financial controls, which the
Company is 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 the Company’s middle and top management staff are not educated
and trained in the Western system. In addition, the Company may need to rely
on
a new and developing communication infrastructure to efficiently transfer its
information from retail nodes to the head quarter. In addition, the Company
may
have difficulty in hiring and retaining a sufficient number of qualified
employees to work in the PRC. As a result of these factors, the Company 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, the Company 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 the Company’s internal controls which
could impact the reliability of its financial statements and prevent it 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 the Company’s business.
13
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 the Company
or its management.
All
of
the Company’s current operations, including the manufacturing and distribution
of jewelry, are conducted in China. Moreover, most of the Company’s 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 the Company 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 the Company or such persons predicated upon
the
securities laws of the United States or any state thereof.
RISKS
RELATED
TO
THE
COMPANY’S
CAPITAL
STRUCTURE
There
is no current trading market for the Company’s common stock, and there is no
assurance of an established public trading market, which would adversely affect
the ability of its investors to sell their securities in the public
market.
The
Company’s common stock is not currently listed or quoted for trading on any
national securities exchange or national quotation system. In the future, the
Company intends to apply for the listing of its common stock on the NASDAQ
Global Market, or NASDAQ. There is no guarantee that securities will be granted
approval for listing on the NASDAQ. If the Company fails to obtain a listing
on
the NASDAQ, it may seek quotation on the OTC Bulletin Board. The NASD has
enacted changes that limit quotations on the OTC Bulletin Board to securities
of
issuers that are current in their reports filed with the Securities and Exchange
Commission. The effect on the OTC Bulletin Board of these rule changes and
other
proposed changes cannot be determined at this time. The OTC Bulletin Board
is an
inter-dealer, over-the-counter market that provides significantly less liquidity
than the NASDAQ or American Stock Exchange. Quotes for stocks included on the
OTC Bulletin Board are not listed in the financial sections of newspapers as
are
those for the NASDAQ or American Stock Exchange. Therefore, prices for
securities traded solely on the OTC Bulletin Board may be difficult to obtain
and holders of common stock may be unable to resell their securities at or
near
their original offering price or at any price.
The
Company
may not be able to achieve the benefits expected to result from the Share
Exchange Transaction, and, instead, its management’s diverted attention could
materially and adversely affect its daily operations, its stock price and
operating results.
On
November 20, 2006, the Company entered into the Share Exchange Agreement with
the sole shareholder of Fuqi BVI pursuant to which the Company agreed to acquire
all of the issued and outstanding share capital of Fuqi BVI in exchange for
newly issued shares of the Company’s common stock. On November 22, 2006, the
Share Exchange closed, and Fuqi BVI became the Company’s wholly-owned subsidiary
and the Company’s sole business operation became that of Fuqi BVI and its
wholly-owned subsidiary, Fuqi China. Also, the management and directors of
Fuqi
BVI became the management and directors of the Company upon the closing of
the
Share Exchange. In addition, the Company changed its corporate name from “VT
Marketing Services, Inc.” to “Fuqi International, Inc.” and reincorporated from
the State of Nevada to the State of Delaware.
14
The
Share
Exchange was effected for various reasons, including:
There
can
be no assurance that any of the anticipated benefits of the Share Exchange
will
be realized in respect to the Company’s new business operations. In addition,
the attention and effort devoted to achieving the benefits of the Share Exchange
and attending to the obligations of being a public company, such as reporting
requirements and securities regulations, could significantly divert management’s
attention from other important issues, which could materially and adversely
affect the Company’s operating results or stock price in the
future.
If
the
Company
fails to maintain effective internal controls over financial reporting, the
price of its common stock may be adversely affected.
The
Company’s internal control over financial reporting may have weaknesses and
conditions that need to be addressed, the disclosure of which may have an
adverse impact on the price of the Company’s common stock. The Company is
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 Fuqi’s public disclosures regarding the
Company’s business, financial condition or results of operations. The Company’s
failure of these controls could also prevent it from maintaining accurate
accounting records and discovering accounting errors and financial frauds.
In
addition, management’s assessment of internal controls over financial reporting
may identify weaknesses and conditions that need to be addressed in the
Company’s internal controls over financial reporting or other matters that may
raise concerns for investors. Any actual or perceived weaknesses and conditions
that need to be addressed in Fuqi’s internal control over financial reporting,
disclosure of management’s assessment of the Company’s internal controls over
financial reporting or disclosure of its public accounting firm’s attestation to
or report on management’s assessment of its internal controls over financial
reporting may have an adverse impact on the price of its common
stock.
Standards
for compliance with Section 404 of the Sarbanes-Oxley Act of 2002 are uncertain,
and if the Company fails to comply in a timely manner, its business could be
harmed and its stock price could decline.
Rules
adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002
require annual assessment of the Company’s internal control over financial
reporting, and attestation of this assessment by the Company’s independent
registered public accountants. The SEC extended the compliance dates for
non-accelerated filers, as defined by the SEC. Accordingly, the Company believes
that the annual assessment of its internal controls requirement will first
apply
to its annual report for the 2007 fiscal year and the attestation requirement
of
management’s assessment by the Company’s independent registered public
accountants will first apply to its 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.
The Company may encounter problems or delays in completing activities necessary
to make an assessment of its internal control over financial reporting. In
addition, the attestation process by the Company’s independent registered public
accountants is new and it may encounter problems or delays in completing the
implementation of any requested improvements and receiving an attestation of
the
Company’s assessment by its independent registered public accountants. If the
Company cannot assess its internal control over financial reporting as
effective, or its independent registered public accountants are unable to
provide an unqualified attestation report on such assessment, investor
confidence and share value may be negatively impacted.
15
The
Company’s common stock may be considered a “penny stock,” and thereby be subject
to additional sale and trading regulations that may make it more difficult
to
sell.
The
Company’s common stock, which is not currently listed or quoted for trading, may
be considered to be a “penny stock” if it does not qualify for one of the
exemptions from the definition of “penny stock” under Section 3a51-1 of the
Securities Exchange Act of 1934, as amended (the “Exchange Act”) once, and
if, it starts trading. The Company’s common stock may be a “penny stock” if it
meets one or more of the following conditions (i) the stock trades at a price
less than $5.00 per share; (ii) it is NOT traded on a “recognized” national
exchange; (iii) it is NOT listed on the NASDAQ Capital Market, or even if so,
has a price less than $5.00 per share; or (iv) is issued by a company that
has
been in business less than three years with net tangible assets less than $5
million.
The
principal result or effect of being designated a “penny stock” is that
securities broker-dealers participating in sales of the Company’s common stock
will be subject to the “penny stock” regulations set forth in Rules 15-2 through
15g-9 promulgated under the Exchange Act. For example, Rule 15g-2 requires
broker-dealers dealing in penny stocks to provide potential investors with
a
document disclosing the risks of penny stocks and to obtain a manually signed
and dated written receipt of the document at least two business days before
effecting any transaction in a penny stock for the investor's account. Moreover,
Rule 15g-9 requires broker-dealers in penny stocks to approve the account of any
investor for transactions in such stocks before selling any penny stock to
that
investor. This procedure requires the broker-dealer to (i) obtain from the
investor information concerning his or her financial situation, investment
experience and investment objectives; (ii) reasonably determine, based on that
information, that transactions in penny stocks are suitable for the investor
and
that the investor has sufficient knowledge and experience as to be reasonably
capable of evaluating the risks of penny stock transactions; (iii) provide
the
investor with a written statement setting forth the basis on which the
broker-dealer made the determination in (ii) above; and (iv) receive a signed
and dated copy of such statement from the investor, confirming that it
accurately reflects the investor's financial situation, investment experience
and investment objectives. Compliance with these requirements may make it more
difficult and time consuming for holders of the Company’s common stock to resell
their shares to third parties or to otherwise dispose of them in the market
or
otherwise.
The
ability of the Company’s Chinese operating subsidiary to pay dividends may be
restricted due to foreign exchange control regulations of
China.
The
ability of the Company’s Chinese operating subsidiary to pay dividends may be
restricted due to the foreign exchange control policies and availability of
cash
balance of the Chinese operating subsidiary. Because substantially all of the
Company’s operations are conducted in China and its revenues are generated in
China, all of its revenue being earned and currency received are denominated
in
Renminbi (RMB). RMB is subject to the exchange control regulation in China,
and,
as a result, the Company may be unable to distribute any dividends outside
of
China due to PRC exchange control regulations that restrict its ability to
convert RMB into US Dollars.
Fuqi
does not foresee paying cash dividends in the foreseeable future and, as a
result, its investors sole source of gain, if any, will depend on capital
appreciation, if any.
Fuqi
does
not plan to declare or pay any cash dividends on its shares of common stock
in
the foreseeable future and the Company currently intend to retain any future
earnings for funding growth. The Company’s wholly-owned subsidiary, Fuqi China,
prior to merger with the Company, paid
cash
dividends of $2,739,726, $5,421,687 and $3,975,904 during the years ended
December 31, 2006, 2005 and 2004, 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. Fuqi currently has no intention to declare dividends in the
foreseeable future. As a result, you should not rely on an investment in the
Company’s securities if you require dividend income. Capital appreciation, if
any, of the Company’s shares may be your sole source of gain for the foreseeable
future. Moreover, you may not be able to resell your shares in Fuqi at or above
the price you paid for them.
ITEM
1B. UNSOLVED STAFF COMMENTS
Not
applicable.
16
ITEM
2. PROPERTIES
Fuqi’s
principal executive offices are located at 5/F., Block 1, Shi Hua Industrial
Zone, Cui Zhu Road North, Shenzhen 518019, China. The Company owns approximately
15,000 square feet of office and showroom space at this location.
The
Company’s jewelry production facility is located in Shenzhen, China and,
including office spaces, consists of approximately 66,000 square feet of
building space. The Company owns approximately 33,000 square feet of this space
and the remainder is leased from a landlord, Guanghong Jin Tong Hai Enterprises
Ltd. The Company has acquired the space for production facility, office and
show
room located at 5/F., Block 1, Shi Hua Industrial Zone during 2005.
In
July
2005, Fuqi entered into a leasing agreement with Shenzhen Jin Tong Hai
Enterprises Ltd. to lease the production plan on 4th floor Block 1, Shi Hua
Industrial Park for a approximately $112,000 per annum, from July 2005 to June
2010. The lease agreement will terminate in June 2010. The Company has 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,
the Company expects that the lease amount will be increased by approximately
35%
in the year of 2010.
ITEM
3. LEGAL PROCEEDINGS
Fuqi
is
not involved in any material legal proceedings, nor is it 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
December 8, 2006, prior to the effective registration of the Company’s common
stock under Section 12(g) of the Securities Exchange Act of 1934, as amended,
the Board of Directors of the Company resolved to take action by unanimous
written consent to reincorporate the Company from the State of Nevada to the
State of Delaware and to change its name from “VT Marketing Services, Inc.” to
“Fuqi International, Inc.,” effective December 8, 2006. The reincorporation and
name change was approved by the written consent of the majority stockholder
of
the Company that holds 91.2% of its voting capital stock.
17
PART
II
ITEM
5.
MARKET FOR REGISTRANT’S COMMON STOCK, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES
OF EQUITY SECURITIES
Market
Information
The
shares of common stock of the Company are not currently listed or quoted for
trading on any national securities exchange or national quotation system. The
Company intends to apply for listing of its common stock on the
NASDAQ.
If
and
when the Company’s common stock is listed or quoted for trading, the price of
its common stock will likely fluctuate in the future. 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. The Company believes
that
a number of factors, both within and outside its control, could cause the price
of the Company’s 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:
Recent
Sales of Unregistered Securities
On
September 17, 2004, and in accordance with the Visitalk.com’s implementation of
the Chapter 11 reorganization plan (as previously defined, the “Visitalk
Plan”),
the
Company issued to VCC 324,044 shares of common stock and common stock purchase
warrants allowing holders to purchase additional shares of its common stock
(the
“Plan Warrants”) to acquire certain technology rights from VCC. The Visitalk
Plan further authorized VCC to distribute 54,837 of the 324,044 shares of common
stock to 240 creditors of Visitalk.com and all of the Plan Warrants to 645
claimants of Visitalk.com, in accordance with the Visitalk Plan. Section 1145
of
the Bankruptcy Code exempts the original issuance of securities under a plan
of
reorganization (as well as subsequent distributions by the distribution agent)
from registration under the Securities Act and state securities laws. Under
Section 1145, the issuance of securities pursuant to a plan of reorganization
is
exempt from registration if three principal requirements are satisfied:
18
The
Company believes that the offer and sale of the common stock and the Plan
Warrants, in accordance with the Visitalk Plan, satisfy the requirements of
Section 1145(a) of the Bankruptcy Code and, therefore, are exempt from
registration under the Securities Act and state securities laws.
On
July
21, 2006, pursuant to Stock Purchase Agreements, the Company issued a total
of
1,460,011 shares of common stock (post Reverse Split) to two investors for
an
aggregate amount of $67,500. On July 21, 2006, it issued 36,617 shares of common
stock to VCC in connection with the Stock Purchase Agreements. The securities
were offered and issued to investors under the Stock Purchase Agreements in
reliance upon exemptions from registration pursuant to Section 4(2) under the
Securities Act of 1933, as amended, and Rule 506 promulgated thereunder. The
investors qualified as an accredited investor (as defined by Rule 501 under
the
Securities Act of 1933, as amended). On July 21, 2006, the Company
also
issued 1,317 shares of common stock to 134 unaffiliated shareholders under
an
anti-dilution arrangement in the Visitalk Plan. The
Company believes that the offer and sale of the common stock, in accordance
with
the Visitalk Plan, satisfy the requirements of Section 1145(a) of the Bankruptcy
Code and, therefore, are exempt from registration under the Securities Act
and
state securities laws.
On
November 22, 2006, pursuant to an Exchange Agreement, the Company acquired
all
of the outstanding capital stock of Fuqi BVI in a stock for stock exchange.
The
Company issued a total of 18,886,666 shares of common stock to Yu Kwai Chong,
who was the sole shareholder of Fuqi BVI, in exchange for all of the issued
and outstanding capital of Fuqi BVI. The securities were offered and issued
to
Yu Kwai Chong in reliance upon exemptions from registration pursuant to Section
4(2) under the Securities Act of 1933, as amended, and Rule 506 promulgated
thereunder. Yu Kwai Chong qualified as an accredited investor (as defined by
Rule 501 under the Securities Act of 1933, as amended).
Stockholders
As
of
December 31, 2006, the Company had approximately 208 common stockholders. In
addition, the Company has 330 holders of its Plan Warrants and no option
holders.
Rule
144
The
Company had 20,715,384 shares of common stock currently issued and outstanding
as of the close of the Share Exchange Transaction. In general, under
Rule 144 under the Securities Act of 1933, as amended (the "Securities
Act"), a person who has beneficially owned shares of the Company’s common stock
for at least one year would be entitled to sell within any three-month period
a
number of shares that does not exceed the greater of:
Sales
under Rule 144 are also subject to manner of sale provisions and notice
requirements and to the availability of current public information about the
Company for at least 90 days.
Under
Rule 144(k) under the Securities Act, a person who is not deemed to have
been one of the Company’s affiliates at any time during the 90 days preceding a
sale, and who has beneficially owned the shares proposed to be sold for at
least
two years is entitled to sell the shares without complying with the manner
of
sale, public information, volume limitation or notice provisions of
Rule 144.
Warrants
The
Company also currently has outstanding two series of Plan Warrants with
8,423,491 in each series. Each Plan Warrant provides for the purchase of one
share of common stock. The Series C Plan Warrants are exercisable at $3.00
per
share and the Series E Plan warrants are exercisable at $4.00 per share. Any
common stock issued upon exercise of a Plan Warrant is immediately tradable
without restriction. The Plan Warrants are governed by a Warrant Agreement.
The
Warrant Agreement that governs the Plan Warrants restricts any one stockholder
from acquiring ownership greater than 4.99% of the Company’s common
stock.
19
Dividends
The
Company 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.
The
Company’s wholly-owned subsidiary, Fuqi China, prior to merger with the Company,
paid cash dividends of $2,739,726, $5,421,687 and $3,975,904 during the years
ended December 31, 2006, 2005 and 2004 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
The
transfer agent and registrar for the Company’s common stock is Computershare
Trust Company, Inc.
Penny
Stock Regulation
The
Company’s common stock, which is not currently listed or quoted for trading, may
be considered to be a “penny stock” if it does not qualify for one of the
exemptions from the definition of “penny stock” under Section 3a51-1 of the
Securities Exchange Act of 1934, as amended (the “Exchange Act”) once, and
if, it starts trading. The Company’s common stock may be a “penny stock” if it
meets one or more of the following conditions (i) the stock trades at a price
less than $5.00 per share; (ii) it is NOT traded on a “recognized” national
exchange; (iii) it is NOT quoted on the NASDAQ Capital Market, or even if so,
has a price less than $5.00 per share; or (iv) is issued by a company that
has
been in business less than three years with net tangible assets less than $5
million.
The
principal result or effect of being designated a “penny stock” is that
securities broker-dealers participating in sales of the company’s common stock
will be subject to the “penny stock” regulations set forth in Rules 15-2 through
15g-9 promulgated under the Exchange Act. For example, Rule 15g-2 requires
broker-dealers dealing in penny stocks to provide potential investors with
a
document disclosing the risks of penny stocks and to obtain a manually signed
and dated written receipt of the document at least two business days before
effecting any transaction in a penny stock for the investor’s account. Moreover,
Rule 15g-9 requires broker-dealers in penny stocks to approve the account of
any
investor for transactions in such stocks before selling any penny stock to
that
investor. This procedure requires the broker-dealer to (i) obtain from the
investor information concerning his or her financial situation, investment
experience and investment objectives; (ii) reasonably determine, based on that
information, that transactions in penny stocks are suitable for the investor
and
that the investor has sufficient knowledge and experience as to be reasonably
capable of evaluating the risks of penny stock transactions; (iii) provide
the
investor with a written statement setting forth the basis on which the
broker-dealer made the determination in (ii) above; and (iv) receive a signed
and dated copy of such statement from the investor, confirming that it
accurately reflects the investor’s financial situation, investment experience
and investment objectives. Compliance with these requirements may make it more
difficult and time consuming for holders of the Company’s common stock to resell
their shares to third parties or to otherwise dispose of them in the market
or
otherwise.
Equity
Compensation Plans
Refer
to
ITEM 11 below for information with respect to the Company’s equity compensation
plan.
20
ITEM
6. SELECTED
CONSOLIDATED FINANCIAL DATA
21
Recapitalization
The
acquisition of Fuqi BVI, and its wholly oned subsidiary Fuqi China, by the
Company pursuant to the Share Exchange Transaction was accounted for as a
recapitalization by the Company. The recapitalization was, at the time of the
Share Exchange, the merger of a private operating company (Fuqi BVI) into a
non-operating private shell corporation with nominal net assets and as such
is
treated as a capital transaction, rather than a business combination. As a
result no goodwill is recorded. The transaction is the equivalent to the
issuance of stock by the private company for the net monetary assets of the
shell corporation. The pre-acquisition financial statements of Fuqi BVI are
treated as the historical financial statements of the consolidated companies.
The financial statements presented reflect the change in capitalization for
all
years presented, therefore the capital structure of the consolidated enterprise,
being the capital structure of the legal parent, is different from that
appearing in the financial statements of Fuqi BVI in earlier periods due to
the
recapitalization.
ITEM
7. MANAGEMENT DISCUSSION AND ANALYSIS 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, the Company’s plans and expectations and
financial projections. The Company’s 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
“ITEM
1A.
RISK FACTORS.”
Overview
Fuqi
is
engaged in the design, manufacture, marketing and wholesale distribution of
a
full range of precious metal jewelry in China. The Company currently operates
through two divisions: (i) production and (ii) sales and marketing. The
production division is responsible for manufacturing of the Company’s jewelry
products and the sales and marketing division is responsible for the selling
and
marketing functions of the products, including customer relations and customer
service. The Company intends to enter into the retail distribution of its
jewelry products by opening or acquiring retail stores in China during 2007.
Fuqi generates its revenues primarily from the sale of gold and platinum
jewelry. The Company intends to develop platinum as the primary metal from
which
its jewelry is manufactured to capitalize on the recent increase in consumption
of platinum jewelry in China. The Company also will devote resources to
strengthen its brand name in the China jewelry industry by expanding the
marketing and promotion of its products and maintaining large-scale production
of quality products. The
Company’s operations are subject to all of the risks inherent in establishing a
business enterprise in China, particularly one that is dependent, initially,
on
the ever-changing retail trends in products that are discretionary. If
Fuqi
does not receive the consumer or business acceptance that it anticipate, its
revenues and operating results will likewise not reach the levels it
anticipates. In
addition, the Company’s ability to effectively conduct its operations must be
evaluated in light of the problems, expenses, difficulties, complications and
delays frequently encountered in connection with establishing a growth business,
including uncertainty as to production capabilities, market acceptance,
marketing methods, expenses and competition. The Company may not be successful
in its proposed new business activities, such as entering the retail market
for
its products.
The
Chinese jewelry industry has recently experienced growth due to a series of
governmental reforms, an increase in income levels and growth in the urban
population in China. The industry is also highly competitive, and the Company’s
competitors include domestic and foreign jewelry manufacturers, wholesalers,
and
importers who may operate on a national, regional and local scale. Many of
the
Company’s competitors have substantially greater financial, technical and
marketing resources and personnel than the Company. As the Company believes
competition is largely based on quality, service, and pricing, its strategy
is
to provide competitively priced, moderate- to high-quality products to the
high-volume retail jewelry market. The Company also intends to enter into the
jewelry retail industry, which is also highly competitive. Many of the Company’s
potential competitors in the retail industry will have larger customer bases,
longer operating histories and significantly greater financial, technical,
marketing and other resources. It may be difficult for a newcomer to enter
into
the retail industry, but the Company believes that its established production
and wholesale distribution business will facilitate its entrance into the retail
market.
22
The
Company would need to raise additional capital as required to match its
expansion plan. The Company anticipates that it would need approximately $40.0
million in additional capital to execute its retail plan for the coming two
years. If the Company is able to obtain the additional capital, a substantial
portion of it, approximately $20.0 million, would be used to acquire raw
materials. A smaller portion of the additional capital, approximately $16.0
million, would be used for the opening or acquiring of retail outlets.
Approximately $2.0 million of the additional capital would be used to acquire
components and additional toolings while the remaining portion of the additional
capital would be applied to working capital for labor to manufacture jewelry
and
marketing and promotional activities.
Corporate
History
Fuqi
was
originally incorporated in the State of Arizona on September 3, 2004 as VT
Marketing Services, Inc. The Company was a wholly-owned subsidiary of Visitalk
Capital Corporation (“VCC”),
and
was formed as part of the implementation of the Chapter 11 reorganization plan
(the “Visitalk
Plan”)
of
visitalk.com, Inc. (“Visitalk.com”).
Visitalk.com filed for Chapter 11 Bankruptcy in November 2000. The Visitalk
Plan
became effective on September 17, 2004 (the “Effective
Date”).
On
September 22, 2004, Visitalk.com merged into VCC, which was authorized as the
reorganized debtor under the Visitalk Plan. As part of the Visitalk Plan, the
Company issued shares of its common stock and warrants to purchase shares of
its
common stock that were distributed to creditors and claimants of Visitalk.com.
The Company’s original business was to use Visitalk.com’s technology to
facilitate peer-to-peer marketing activities. On July 21, 2006, the Company
sold
1,368,761 shares of common stock (post Reverse Split) to BayPeak, LLC. As part
of this transaction (the “Bay
Peak Sale”),
the
Company abandoned its peer-to-peer marketing business, and began to seek
companies in Asia with potential, in particular companies based in China, to
acquire. The shares issued in the Bay Peak Sale represented 75% of the Company’s
outstanding shares at the time of issuance. On July 28, 2006, Visitalk.com
was
granted its Final Decree by the Bankruptcy Court. On November 6, 2006, the
Company conducted a reverse stock split of its shares common stock and issued
one share for each 15.43 shares of its common stock then outstanding (the
“Reverse
Split”).
No
shareholder was reversed below 100 shares in the Reverse Split and the then
outstanding Plan Warrants were not affected by the Reverse Split. On November
8,
2006, the Company changed its state of incorporation from Arizona to
Nevada.
On
November 20, 2006, the Company entered into a share exchange agreement with
Yu
Kwai Chong, who is the sole shareholder of Fuqi BVI pursuant to which the
Company agreed to acquire all of the issued and outstanding capital stock of
Fuqi BVI (the “Exchange
Transaction”).
The
Exchange Transaction closed on November 22, 2006 and, per the terms of the
share
exchange agreement (the “Share
Exchange Agreement”),
the
Company issued an aggregate of 18,886,666 shares of its common stock (post
Reverse Split) in exchange for all of the issued and outstanding securities
of
Fuqi BVI. Pursuant to the Share Exchange Agreement, BayPeak agreed to cancel
8,761 shares of common stock.
On
December 8, 2006, the Company changed its corporate name from “VT Marketing
Services, Inc.” to “Fuqi International, Inc.” and reincorporated from the State
of Nevada to the State of Delaware.
For
financial accounting purposes, the Exchange Transaction 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 acquirer. Accordingly, the
Company’s 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, Shenzhen Fuqi
Jewelry Co., Ltd. (“Fuqi China”), a company established under the laws of the
People's Republic of China. Upon the acquisition of Fuqi BVI, the Company’s sole
business operations became that of Fuqi BVI.
Critical
Accounting Policies, Estimates and Assumptions
Management's
discussion and analysis of results of operations and financial condition are
based upon the Company’s 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 and
allowance for doubtful accounts, the recoverability of the long-lived assets.
Actual results could differ from these estimates. Periodically, the review
all
significant estimates and assumptions affecting the financial statements and
records the effect of any necessary adjustments.
23
The
following critical accounting policies rely upon assumptions and estimates
and
were used in the preparation of the Company’s consolidated financial
statements:
Revenue
Recognition. Revenue
is recognized upon delivery and acceptance of jewelry products by the Company’s
customers, provided 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) the Company’s
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. The Company’s functional currency
is
reported in Renminbi ("RMB"). Foreign currency transactions (outside 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. The Company’s
functional currency is RMB. For the purpose of preparing the consolidated
financial statements, the consolidated balance sheets of the Company have been
translated into U.S. dollars at the current rates as of end of the respective
period and the statements of operations 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 shareholders'
equity.
Allowance
for Doubtful Accounts.
The
Company maintains an allowance for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments.
Allowance for doubtful accounts is based on the Company’s assessment of the
collectibility of specific customer accounts, the aging of accounts receivable,
its history of bad debts, and the general condition of the industry. If a major
customer's credit worthiness deteriorates, or the Company’s customers' actual
defaults exceed historical experience, the Company’s estimates could change and
impact its reported results. The Company has not been experiencing any
significant amount of bad debt in the past.
Inventory.
Inventories are stated at lower of cost (using the first-in, first-out method)
or market. The Company continually evaluates the composition of its inventories
assessing slow-moving and ongoing products. The Company’s products contain gold
and platinum material which will not become obsolete and accordingly the Company
did not provide any reserve for slow-moving and obsolete inventory.
24
Results
of Operations
The
following table sets forth the consolidated statements of operations of the
Company for the years ended December 31, 2006, 2005 and 2004 U.S.
dollars:
25
Years
Ended December 31, 2006 and 2005
Net
sales
for the year ended December 31, 2006 increased to $92.4 million, an increase
of
$19.8 million, or 27.3%, compared to net sales of $72.6 million for the year
ended December 31, 2005. The increase in net sales was primarily the result
of
an increase in the Company’s prices, which was the result of an increase in the
price of precious metals, and a change in product mix. In 2006, the Company
sold
572,557 grams platinum jewelry, an increase of 97,519 grams, or 20.5%, compared
to 475,038 grams sold in 2005. The sales price per gram for platinum jewelry
was
higher than that of gold. The Company believes that the change in product mix
was the combined effect of narrowing price gap between platinum and gold and
marketing efforts.
Sales
for
the years ended December 31, 2006 and 2005 were comprised of the following
(expressed in millions of dollars):
Cost
of
sales is mainly comprised of costs of raw materials, primarily gold and
platinum, in addition to direct manufacturing costs and factory overhead, which
accounted for approximately 1% of the cost of sales for the year December 31,
2006. Cost of sales for the year ended December 31, 2006 increased to $83.6
million, an increase of $18.6 million, or 28.6%, compared to cost of sales
of
$65.0 million for the year 2005. The increase was primarily due to the increase
in net sales for year ended December 31, 2006, and the percentage of the
increase in cost of sales was relatively close to the increase in net sales.
The
small difference in change in percentage was mainly generated by more labor
hours for processing platinum.
Gross
profit for the year ended December 31, 2006 increased to $8.8 million, an
increase of $1.2 million, or 15.8%, compared to $7.6 million for the same period
in 2005. The increase in gross profit resulted primarily from the increase
in
net sales, which resulted from an increase in precious metal prices. However,
gross profit margin decreased to 9.5% for year ended December 31, 2006, compared
to 10.5% for the same period in 2005. The decrease in gross profit margin was
mainly attributed to the Company’s intended reduction in its margin to attract
more sales in order to reduce the adverse effects caused by wide fluctuation
of
precious metal prices during the second and the third quarters in 2006. There
was a general decrease in total demand caused by wide fluctuation in precious
metal prices. The Company decreased its margin to encourage retailers to
replenish their inventory through increased buying during the period of
uncertain fluctuations in the prices of precious metal prices. However, the
Company did not experience a significant effect in attracting sales by lowering
its gross margin and the Company reinstated its normal gross margin rates in
the
fourth quarter of 2006.
Selling
and marketing expenses are primarily comprised of business taxes, advertising
expenses, traveling expenses, production costs of marketing materials, insurance
and delivery expenses. Selling and marketing expenses for the year ended
December 31, 2006 were $490,191, a decrease of $133,940, or 21.5%, as compared
to $624,131 for the year ended December 31, 2005. The decrease in selling and
marketing expenses was primarily due to the Company’s more targeted and focused
marketing efforts. The Company expects a higher selling and marketing expenses
due to higher business taxes in line with increase of sales. In addition, the
Company expects to spend more on advertising expenses in an attempt to
strengthen brand awareness and establish and maintain a strong market
position.
General
and administrative expenses consist primarily of payroll compensation, benefits
and travel expenses for the Company’s staff, professional fees such as
accountants and financial advisors, depreciation expenses, as well as
administrative office expenses. General and administrative expenses for the
year
ended December 31, 2006 were $793,453, an increase of $122,262, or 18.2%, as
compared to $671,191 for the same period in 2005. The increase in general and
administrative expenses was mainly due to costs and fees incurred in connection
with a reverse merger with a U.S. corporation. The Company expects its general
and administrative expenses will increase due to the various additional legal,
accounting and other requirements applicable to a public company in the United
States and those incremental costs being incurred in retail establishments
and
operations. The Company expects general and administrative expenses will be
higher because more professional costs will be incurred to improve the Company’s
ability to meet requirements of a public company in the US.
26
Interest
expenses were approximately $799,000 for the year ended December 31, 2006,
an
increase of $301,000, or 60.4%, as compared to $498,000 for year ended December
31, 2005. The increase in interest expense was primarily a result of the
Company’s increase in interest rate of short term bank financing for the year
ended December 31, 2006.
Provision
for income tax expense was approximately $995,000 for the year ended December
31, 2006, an increase of $542,000, or 119.6%, as compared to approximately
$453,000 for the same period in 2005. The increase was primarily due to the
increase in the Company’s operating income for the year ended December 31, 2006.
Companies in China are generally subject to a 30% state enterprise income tax
and a 3% national income tax. The Company’s subsidiary, Fuqi China, enjoyed a
reduced enterprise income tax rate of 15%, which is granted to all enterprises
operating in Shenzhen Special Economic Zone. Prior to 2006, the Company was
under the preferential income tax rate of 7.5% in 2005 and 2004 due to its
status of being a new business. That status expired effective January 1, 2006.
Because of the recent announcement in income tax rate restructure, the Company
will be subject to an income tax rate of 25%. However, the impacts will depend
on the timing for Shenzhen city to apply the new tax rate.
Net
income increased to $5.8 million for year ended December 31, 2006 from $5.4
million for the year ended December 31, 2005, an increase of $0.4 million,
or
7.4%. The Company believes that, taking into account the increase of expenses
should be able to maintain the net income to sales ratio of 2007 as that of
2006.
Other
comprehensive income was $288,000 during 2006, an increase of $144,000 or 100%,
as compared to $144,000 during 2005. The China government maintained a
relatively fixed exchange rate against U.S. dollars until the end of the third
quarter of 2005. The China government exchange rate continued to appreciate
during the year ended December 31, 2006.
Years
Ended December 31, 2005 and 2004
Net
sales
for the year ended December 31, 2005 increased to $72.6 million, an increase
of
$15.8 million, or 27.9%, compared to net sales of $56.8 million for the year
ended December 31, 2004. The increase in net sales was primarily the result
of
an increase in the quantity
of
jewelry that the Company sold, which increased
primarily because it lengthened the accounts receivable period.
Sales
for
the years ended December 31, 2005 and 2004 were comprised of the following
(expressed in million of dollars):
Cost
of
sales for the year ended December 31, 2005 increased to $65.0 million, an
increase of $14.1 million, or 27.7%, compared to cost of sales of $50.9 million
for the year ended December 31, 2004. The increase was primarily due to the
increase in net sales for the year ended December 31, 2005, and the percentage
of the increase in cost of sales was relatively level with the increase in
net
sales. To
the
extent that inflation effected the cost of raw materials, the extra cost caused
by inflation was shifted to customers. The increase in cost of sales is in
proportion to the increase in net sales.
The
Company
obtained short term bank financings to acquire raw materials to meet the
demands.
27
Gross
profit for the year ended December 31, 2005 increased to $7.6 million, an
increase of $1.7 million, or 28.8%, compared to $5.9 million for the year ended
December 31, 2004. The increase in gross profit resulted primarily from the
increase in net sales. Gross profit margin remained relatively stable at 10.5%
for the year ended December 31, 2005, compared to 10.4% for the year ended
December 31, 2004.
Selling
and marketing expenses for the year ended December 31, 2005 were $624,000,
an
increase of $75,000, or 13.7%, as compared to $549,000 for the year ended
December 31, 2004. The increase in selling and marketing expenses was primarily
due to the increase of promotion and advertising activities.
General
and administrative expenses for the year ended December 31, 2005 were $671,000,
a decrease of $335,000, or 33.3%, as compared to $1,006,000 for the year ended
December 31, 2004. The decrease in general and administrative expenses was
mainly due to a decrease in legal and professional fees in the year ended
December 31, 2005 as majority of the audit fees for the historical financial
statement were incurred in 2005. In addition the Company accrued estimated
penalties on unpaid business taxes related to the cash revenues in 2004. The
Company settled the outstanding taxes amount with the tax authority during
2006
and as a result, no penalties were assessed. Accordingly, no penalties were
accrued for the year of 2005.
Interest
expenses were approximately $498,000 for the year ended December 31, 2005,
an
increase of $398,000, or 398%, as compared to $100,000 for year ended December
31, 2004. The increase in interest expense was primarily a result of increased
bank loans borrowed in the year ended December 31, 2005.
Provision
for income tax expense was approximately $452,000 for the year ended December
31, 2005, an increase of $93,000, or 25.9%, as compared to approximately
$359,000 for the year ended December 31, 2004. The increase was primarily due
to
the increase in the Company’s operating income for the year ended December 31,
2005.
Other
comprehensive income increased by $143,000 during 2005 compared to $0 during
2004. The China government maintained a relatively fixed exchange rate against
U.S. dollars until the end of the third quarter of 2005 and therefore there
were
no adjustments related to foreign currency translations during 2004.
Net
income increased to $5.4 million for the year ended December 31, 2005 from
$3.8
million for the year ended December 31, 2004, an increase of $1.6 million,
or
42%.
Liquidity
and Capital Resources
At
December 31, 2006, Fuqi had retained earnings of $3,288,426 and had cash of
$13,354,981. Fuqi has historically financed its operations with cash flows
generated from operations, as well as through the borrowing of long term or
short term bank loans. The Company uses its inventory as a guarantee to
loans.
The
Company currently has current loan payables
in an aggregate amount of $14,086,852, which consists of (i) a note for
$1,280,623 with an interest rate of 5.76% that matured in January 2007, (ii)
two
notes for $2,561,246 with an interest rate of 5.85% that is due in February
2007, (iii) four notes for $3,841,869 with an interest rate of 5.832% that
is
due in January 2007, (iv) a note for $1,280,623 with an interest rate of 6.138%
that is due in March 2007, (v) a note for $960,467 with an interest rate of
6.732% that is due in July 2007, (vi) a note for $960,467 with an interest
rate
of 6.732% that is due in September 2007, (vii) a note for $1,024,498 with an
interest rate of 6.426% that is due in September 2007, (viii) a note for
$896,436 with an interest rate of 6.426% that is due in October 2007 and (ix)
a
note for $1,280,623 with an interest rate of 6.732% that is due in December
2007. The Company’s loans are secured by inventory, real property and/or
guaranteed by the Company’s affiliates.
Net
cash
provided by operating activities was $4.0 million for the year ended December
31, 2006, compared to net cash provided by operations of $3.2 million for the
same period in 2005. Net cash provided increased by $0.8 million primarily
because of (i) the utilization of VAT refundable of $0.4 million, (ii) decrease
in inventory of $0.1 million and (iii) recovery of inventory loan receivable
of
$0.7 million, in addition to a change in prepaid expenses. During 2006, precious
metal prices fluctuated widely from the second quarter to end of third quarter.
As a result, most of the customers did not purchase in the same pattern of
the
previous year, the Company’s jewelry stock moved slowly, and its level of
inventory increased to a high level prior to the extended holidays in China
(such as the Labor Day and the National Day). During this period, the timeliness
of the Company’s receipt of payment was also affected. As a result, the
Company
experienced a use of cash of $2.8 million by accounts receivable and of $1.6
million by decreased sales deposits. Since the Company does not use hedging
tools for precious metals, it continued to acquire some inventory when the
price
had dropped to a lower level. The Company believed, however, that its customers
and the market did not have sufficient inventory to meet the demand in the
fourth quarter of 2006, which is the highest sales season of the year, and
that
most of the Company’s inventory was sold in the fourth quarter.
28
Net
cash
provided by investing activities amounted to $9.6 million for the year ended
December 31, 2006, compared to net cash used for investing activities of $17.9
million for the year ended December 31, 2005. The change is because the major
shareholder repaid his advance to the Company. The grossed up amount of the
advance to the shareholder was approximately $58 million during the year ended
December 31, 2006.
Net
cash
used for financing activities amounted to $595,000 for the year ended December
31, 2006, compared to net cash provided by financing activities of $14.6 million
for the year ended December 31, 2005. The change was primarily a result of
the
Company taking its short-term bank loans in 2005 and while no new loans were
taken out in 2006.
The
Company believes that its current cash and cash flow from operations will be
sufficient to meet its anticipated cash needs, including its cash needs for
working capital, for the next 12 months for its wholesale business. The Company
may, however, require additional cash resources due to changing business
conditions or other future developments, including any investments or
acquisitions the Company may decide to pursue.
Fuqi
intends to establish a retail sales plan aimed at gaining market share in the
growing consumer market in China. Fuqi intends to open retail stores throughout
China, initially, and in Hong Kong and the United States in the future. During
2007, Fuqi intends to open and/or acquire 20 retail counters and open 2 retail
stores in municipalities and provincial capitals throughout China.
In 2008,
the Company plans to acquire an additional 6 to 7 retail stores and acquire
40
to 50 counters, while opening 2 to 3 stores and 20 to 30 counters in that year.
The Company has identified various locations for its retail outlets and the
Company is currently negotiating the acquisition of leases of such locations
without acquiring the existing business. The Company’s Chinese legal counsel is
preparing a letter of intent with preliminary acquisition terms to be entered
into with sellers with respect to five of these locations. Assuming that
negotiations continue at their current pace without unanticipated delay, the
Company believes that the letters of intent for these five stores and counters
will be entered into in April 2007 and acquired in May 2007. There can be no
assurances that the negotiations and acquisition will continue in a timely
manner or at all.
The
Company would need to raise additional capital as required to match its
expansion plan. The Company anticipates that it would need approximately $40.0
million in additional capital to execute its retail plan for the coming two
years. If the Company is able to obtain the additional capital, a substantial
portion of it, approximately $20.0 million, would be used to acquire raw
materials. A smaller portion of the additional capital, approximately $16.0
million, would be used for the opening or acquiring of retail outlets.
Approximately $2.0 million of the additional capital would be used to acquire
components and additional toolings while the remaining portion of the additional
capital would be applied to working capital for labor to manufacture jewelry
and
marketing and promotional activities. Additional
capital for this objective would be required that is in excess of the Company’s
liquidity, requiring the Company to raise additional capital through an equity
offering or secured or unsecured debt financing. The availability of additional
capital resources will depend on prevailing market conditions, interest rates,
and its existing financial position and results of operations.
The
following table describes the Company’s contractual commitments and obligations
as of December 31, 2006 (in thousands):
Seasonality
The
Company’s business is seasonal in nature. The Company’s sales and net income are
traditionally higher in the fourth calendar quarter than the rest of the year.
The
primary factors that affect the seasonal changes in the Company’s business
operations are holidays and traditional Chinese festivals. In the fourth
quarter, retailers often experience increased sales due to the golden week
of
Chinese National Day, Christmas and New Year’s Day. In addition, jewelry
retailers commonly stock up from wholesalers to prepare for potentially higher
sales during the period before Chinese New Year, which is a peak season of
marriage and newborns in China. This seasonal trend in our business occurred
during 2005; however, there was a slight deviation in during 2006. During fiscal
2006, a larger portion of the Company’s sales was generated during the first
quarter, with net income of $2.3 million for the first quarter of 2006, as
compared to net income of $0.4 million, $0.9 million and $2.1 million for the
second, third and forth calendar quarters, respectively. During
fiscal 2005, the Company had net income of $2.1 million for the fourth quarter,
as compared to net income of $1.3 million, $0.6 million and $1.3 million for
the
first, second and third calendar quarters, respectively, of 2005. The Company
believes that deviation in 2006 was related to customers
speculating the direction of precious metal prices and holding their orders
longer until their inventory levels were too low to meet the peak season. The
Company believes that, in 2007, the seasonality of the Company’s business
seasonality will return to normal.
29
Off-Balance
Sheet Transactions
The
Company has no material off-balance sheet transactions.
New
Accounting Pronouncements
In
February 2006, the Financial Accounting Standards Board issued SFAS No. 155,
"Accounting for Certain Hybrid Financial Instruments -- an amendment of FASB
Statements No. 133 and 140." SFAS No. 155 simplifies the accounting for certain
hybrid financial instruments, eliminates the FASB's interim guidance which
provides that beneficial interests in securitized financial assets are not
subject to the provisions of SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," and eliminates the restriction on the
passive derivative instruments that a qualifying special-purpose entity may
hold. SFAS No. 155 is effective for all financial instruments acquired or issued
after the beginning of an entity's first fiscal year that begins after September
15, 2006, however, early adoption is permitted for instruments acquired or
issued after the beginning of an entity's fiscal year in 2006. The Company
is
evaluating the impact of this new pronouncement to its financial position and
results of operations or cash flows.
In
March
2006, the FASB issued SFAS No. 156 (“FAS 156”), “Accounting for Servicing of
Financial Assets—An Amendment of FASB Statement No. 140.” Among other
requirements, FAS 156 requires a company to recognize a servicing asset or
servicing liability when it undertakes an obligation to service a financial
asset by entering into a servicing contract under certain situations. Under
FAS
156 an election can also be made for subsequent fair value measurement of
servicing assets and servicing liabilities by class, thus simplifying the
accounting and provide for income statement recognition of potential offsetting
changes in the fair value of servicing assets, servicing liabilities and related
derivative instruments. The Statement will be effect beginning the first fiscal
year that begins after September 15, 2006. The Company does not expect the
adoption of FAS 156 will have a material impact on the Company’s financial
position or results of operations.
In
June
2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty in
Income Taxes." This interpretation requires companies to determine whether
it is
more likely than not that a tax position will be sustained upon examination
by
the appropriate taxing authorities before any part of the benefit can be
recorded in the financial statements. FIN 48 provides guidance on
de-recognition, classification, accounting in interim periods and disclosure
requirements for tax contingencies. FIN 48 is effective for fiscal years
beginning after December 15, 2006. The differences between the amounts
recognized in the statements of financial position prior to the adoption of
FIN
48 and the amounts reported after adoption will be accounted for as a
cumulative-effect adjustment recorded to the beginning balance of retained
earnings. The Company is evaluating the impact of this new pronouncement to
the
Company’s financial position and results of operations or cash
flows.
In
September 2006, the FASB issued Statement No. 157, "Fair Value Measurements."
SFAS 157 defines fair value, establishes a framework and gives guidance
regarding the methods used for measuring fair value, and expands disclosures
about fair value measurements. SFAS 157 is effective for financial statements
issued for fiscal years beginning after November 15, 2007, and interim periods
within those fiscal years. The Company is evaluating the impact of this new
pronouncement to its financial position and results of operations or cash
flows.
In
September 2006, the FASB issued Statement No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB
Statements No. 87, 88, 106, and 132(R)." SFAS 158 requires companies to
recognize the overfunded or underfunded status of a defined benefit
post-retirement plan as an asset or liability in its balance sheet and to
recognize changes in that funded status in the year in which the changes occur
through comprehensive income, effective for fiscal years ending after December
15, 2006. SFAS 158 also requires companies to measure the funded status of
the
plan as of the date of its fiscal year-end, with limited exceptions, effective
for fiscal years ending after December 15, 2008. The Company does not expect
the
adoption of SFAS 158 will have a material impact on the Company’s financial
position or results of operations, as its does not currently have any defined
benefit pension or other post-retirement plans.
30
In
September 2006, the Securities and Exchange Commission (“SEC”) issued Staff
Accounting Bulletin No. 108 (“SAB 108”),“Financial
Statements - Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial Statements”.
SAB
108 provides guidance on how prior year misstatements should be taken into
consideration when quantifying misstatements in current year financial
statements for purposes of determining whether the current year's financial
statements are materially misstated. SAB 108 provides that once a current year
misstatement has been quantified, the guidance in SAB No. 99, “Financial
Statements - Materiality”,
should
be applied to determine whether the misstatement is material and should result
in an adjustment to the financial statements. Under certain circumstances,
prior
year financial statements will not have to be restated and the effects of
initially applying SAB 108 on prior years will be recorded as a cumulative
effect adjustment to beginning Retained Earnings on January 1, 2006, with
disclosure of the items included in the cumulative effect. The Company does
not
expect the application of the provisions of SAB 108 to have a material impact,
if any, on the consolidated financial statements.
In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities”. The objective of this statement is
to improve financial reporting by providing entities with the opportunity to
mitigate volatility in reported earnings caused by measuring related assets
and
liabilities differently without having to apply complex hedge accounting
provisions. This Statement is expected by the board to expand the use of fair
value measurement, which is consistent with the Board's long-term measurement
objectives for accounting for financial instruments. This statement is effective
for fiscal years beginning after November 15, 2007. The Company is currently
evaluating the impact of adopting this statement; however, the Company does
not
expect the adoption of this provision to have a material effect on its financial
position, results of operations or cash flows.
Change
in Accountants
After
the
close of the Share Exchange, on November 22, 2006, the Company dismissed
Epstein, Weber & Conover, P.L.C. ("EWC") as its independent registered
public accounting firm following the change in control of the Company in
connection with the Share Exchange. The Company engaged EWC to audit its
financial statements for the year ended December 31, 2005 and 2004. The report
of EWC on the financial statements of the Company for the fiscal years ended
December 31, 2005 and 2004 did not contain any adverse opinion or disclaimer
of
opinion and was not qualified or modified as to uncertainty, audit scope, or
accounting principle, except for an explanatory paragraph relative to the
Company’s ability to continue as a going concern. While EWC was engaged by the
Company, there were no disagreements with EWC on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope
or
procedure with respect to the Company, which disagreements if not resolved
to
the satisfaction of EWC would have caused it to make reference to the subject
matter of the disagreements in connection with its report on the Company’s
financial statements for the fiscal years ended December 31, 2005 and 2004.
The
Company engaged Stonefield Josephson, Inc., which served as Fuqi China’s
independent registered certified public accountants for the fiscal years ended
December 31, 2005, 2004 and 2003, as the Company’s independent registered public
accounting firm as of November 22, 2006, the close of the Share
Exchange.
ITEM
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Foreign
Currency Risk. The
functional currencies of the Company are Renminbi (RMB). Substantially all
of
the Company’s operations are conducted in the PRC. The Company’s sales and
purchases are conducted within the PRC in RMB. Conversion of RMB into foreign
currencies is regulated by the People’s Bank of China through a unified floating
exchange rate system. Although the PRC government has stated its intention
to
support the value of the RMB, there can be no assurance that such exchange
rate
will not again become volatile or that the RMB will not devalue significantly
against the U.S. dollar. Exchange rate fluctuations may adversely affect the
value, in U.S. dollar terms, of the Company’s net assets and income derived from
its operations in the PRC. In addition, the RMB is not freely convertible into
foreign currency and all foreign exchange transactions must take place through
authorized institutions.
31
Credit
Risk.
The
Company’s product revenues are concentrated in production and sales of fine
jewelry products, which are highly competitive with frequent changes in styles
and fashion. Significant customer preference changes in the industry or customer
requirements, or the emergence of competitive products with better marketing
strategies and more well-known brand name, could adversely affect the Company’s
operating results. Financial instruments that potentially subject the Company
to
concentration of credit risk consist principally of trade accounts receivable.
The credit risk in the accounts receivable is mitigated by the fact that the
Company performs ongoing credit evaluations of its customers’ financial
condition and that accounts receivable are primarily derived from large
credit-worthy companies throughout the PRC. In addition, the Company has
attempted to diversify its customer base. Historically, the Company has not
experienced significant losses related to trade receivables. Generally, no
collateral is required.
Country
Risk. Substantially
all of the Company’s business, assets and operations are located and conducted
in China. While China’s economy has experienced significant growth in the past
twenty years, growth has been uneven, both geographically and among various
sectors of the economy. The Chinese government has implemented various measures
to encourage economic growth and guide the allocation of resources. Some of
these measures benefit the overall economy of China, but may also have a
negative effect on the Company. For example, the Company’s operating results and
financial condition may be adversely affected by government control over capital
investments or changes in tax regulations applicable to the Company. If there
are any changes in any policies by the Chinese government and the Company’s
business is negatively affected as a result, then its financial results,
including its ability to generate revenues and profits, will also be negatively
affected.
Inflation.
Inflationary
factors such as increases in the Company’s overhead costs may adversely affect
its operating results. Although the Company does not believe that inflation
has
had a material impact on its financial position or results of operations to
date, a high rate of inflation in the future may have an adverse effect on
its
ability to maintain current levels of gross margin and selling, general and
administrative expenses as a percentage of net revenues if the selling prices
of
its products do not increase with these increased costs.
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 of this Form 10-K.
ITEM
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
ITEM
9A. CONTROLS AND PROCEDURES
Disclosure
controls and procedures are designed to ensure that information required to
be
disclosed in the reports filed or submitted under the Securities Exchange Act
of
1934, as amended (“Exchange Act”) is recorded, processed, summarized and
reported, within the time period specified in the Securities and Exchange
Commission’s (“SEC”) rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed in the reports filed under the Exchange
Act
is accumulated and communicated to management, including the Company’s Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure.
The
Company’s Chief Executive Officer and Chief Financial Officer, in consultation
with its other members of management and advisors as appropriate, performed
an
evaluation of the effectiveness of our disclosure controls and procedures as
defined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act. Based upon
that
evaluation, the Company’s Chief Executive Officer and its Chief Financial
Officer concluded that its disclosure controls and procedures are effective
in
alerting them in a timely fashion to all material information required to be
included in its periodic filings with the SEC. However, the Company’s
independent auditors have identified significant deficiencies that the Company
is currently working to correct. The significant deficiencies are described
below in that subsection captioned "Significant Deficiencies In Disclosure
Controls And Procedures Or Internal Controls".
32
Changes
In Internal Control Over Financial Reporting
The
term
“Internal Control Over Financial Reporting” is defined as a process designed by,
or under the supervision of, the Company’s Chief Executive Officer and Principal
Financial Officer, and effected by its board of directors, management and other
personnel, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with accounting principles generally accepted in the
United States.
On
November 20, 2006, the Company entered into a share exchange agreement with
Yu
Kwai Chong, who is the sole shareholder of Fuqi BVI pursuant to which the
Company agreed to acquire all of the issued and outstanding capital stock of
Fuqi BVI (the “Exchange Transaction”). The Exchange Transaction closed on
November 22, 2006 and, per the terms of the share exchange agreement (the “Share
Exchange Agreement”) Fuqi BVI became the Company’s wholly-owned subsidiary and
the Company’s sole business operations became that of Fuqi BVI. Also as a result
of the Share Exchange, the internal control over financial reporting utilized
by
Fuqi BVI prior to the Share Exchange became the internal control over financial
reporting of the Company. This change in internal control over financial
reporting occurred during our last fiscal quarter and has materially affected,
or is reasonably likely to materially affect, the Company’s internal control
over financial reporting. Other than the foregoing and except as noted below
in
that subsection captioned "Significant Deficiencies In Disclosure Controls
And
Procedures Or Internal Controls", there were no changes in its internal control
over financial reporting identified in connection with its evaluation of these
controls during the quarter ended December 31, 2006, there have been no changes
in the Company’s internal control over financial reporting identified in
connection with the evaluation required by paragraph (d) Rule 13a-15 or 15d-15
under the Exchange Act that occurred during the quarter ended December 31,
2006
that has materially affected, or is reasonably likely to affect, the Company’s
internal control over financial reporting.
Significant
Deficiencies In Disclosure Controls And Procedures Or Internal
Controls
The
Company’s independent auditors, Stonefield Josephson, Inc., identified that its
accounting on certain significant transactions were incorrectly calculated
or
incorrectly recorded. During the course of the audit field work, its independent
auditors discovered these errors. The independent auditors discussed these
matters with the Company’s Chief Financial Officer, and it subsequently
reevaluated the transactions and recorded the necessary adjustments. The
auditors believe that these adjustments reflected significant deficiencies
in
the Company’s internal controls over accounting and financial reporting. The
Company is in the process of improving its internal controls in an effort to
improve is control processes and procedures with training programs that will
start in the second quarter of 2007. Management and directors will continue
to
work with its auditors and other outside advisors to ensure that the Company’s
controls and procedures are adequate and effective.
ITEM
9B. OTHER INFORMATION
None.
PART
III
ITEM
10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE
GOVERNANCE
The
following individuals constitute the Company’s board of directors and executive
management:
Yu
Kwai Chong
Mr.
Chong
is the founder of the Company and has been its President, Chief Executive
Officer and Chairman of the Board of Directors since inception in April 2001.
As
CEO, Mr. Chong is responsible for the strategic planning, marketing and overall
growth of the Company. In addition, Mr. Chong currently holds a directorship
position at a number of private companies in China, including Shenzhen Rongxing
(Group) Limited, Guangdong Grand Heaven Information Security Systems Engineering
Co., Ltd., Shenzhen Xinke Investment Co., Ltd., Shenzhen Laiyongchu Alcohol
Distillery Co., Ltd., Shenzhen Professional Rugged Computer Co., Ltd., and
Shenzhen Union Broadband Communication Co., Ltd. These companies engage in
businesses that range from investment management, IT engineering to computer
and
communication equipment management.
33
Ching
Wan Wong
Mr.
Wong
has been the Company’s Chief Financing Officer (CFO) since the inception of Fuqi
BVI in January 2004. From April 2002 to the present, Mr. Wong worked as a tax
consultant at the Guandong Yuexin Registered Tax Agent Co., Ltd. From September
2000 to March 2002, Mr. Wong served as the finance director of MindShare China,
a communications firm. Mr. Wong received his Bachelor of Business Administration
from the Chinese University of Hong Kong and his Bachelor of Commerce from
University of Southern Queensland. He is a registered accountant in Australia,
Hong Kong, and Canada, and has taken the position of CFO in China for a
multinational media company and is experienced in international financial
management.
Lie
Xi Zhuang
Mr.
Zhuang is a co-founder and Chief Operating Officer of Fuqi China with the
responsibility for production management and cost control. Prior to founding
Fuqi China in January 2004, Mr. Zhuang was the Business Manager of Shenzhen
Ping
Shen Gold and Silver Jewelry Co., Ltd. since 1997, and from 1993 to 1997, Mr.
Zhuang was the Business Manager of Shenzhen Gao De Gold and Silver Jewelry
Company. Mr. Zhuang was certified with a Higher Diploma in Management by Hunan
Xiang Tan University.
Family
Relationships
There
are
no family relationships among the individuals comprising the Company’s board of
directors.
Director
Compensation
The
Company does not currently have an established policy to provide compensation
to
members of its Board of Directors for their services in that capacity. The
Company intends to develop such a policy in the near future.
The
Board of Directors and Committees
The
Company’s Board of Directors does not maintain a separate audit, nominating or
compensation committee. Functions customarily performed by such committees
are
performed by our Board of Directors as a whole. The Company is not required
to
maintain such committees under the rules applicable to companies that do not
have securities listed or quoted on a national securities exchange or national
quotation system. The Company is also not currently required to maintain
independent members of its Board of Directors. If the Company is successful
in
listing its common stock on the NASDAQ, the Company would be required to have,
prior to listing, independent directors and an independent audit committee
formed, in compliance with the requirements for listing on the American Stock
Exchange and in compliance with Rule 10A-3 of the Securities Exchange Act of
1934. The Company intends to independent directors and create board committees
in the near future.
Section
16(a) Beneficial Ownership Reporting Compliance.
The
Company’s securities are currently registered under Section 12 of the Securities
Exchange Act of 1934, as amended. As a result, and pursuant to Rule 16a-2,
the
Company’s directors and officers and holders of 10% or more of its common stock
are currently required to file statements of beneficial ownership with regards
to their ownership of equity securities under Sections 13 or 16 of the Exchange
Act. The Company’s current officers, directors and beneficial holders of 10% or
more of its equity securities became subject to such requirement and to date,
based solely upon a review of Forms 3, 4 and 5 and any amendments thereto
furnished to the Company during its most recent fiscal year, none of the
Company’s officers or directors has failed to file on a timely basis, as
disclosed in the above forms, reports required by Section 16(a) of the Exchange
Act during the most recent fiscal year.
Code
of Ethics.
As
of
December 31, 2006, the had not yet to adopt a Code of Business Conduct and
Ethics applicable to its principal executive officer, principal financial
officer, principal accounting officer or controller, or persons performing
similar functions. The Board of Directors of the Company is currently reviewing
drafts of a Code of Business Conduct and Ethics that will be applicable to
all
directors, officers and executive employees, including the Chief Executive
Officer and Chief Financial Officer.
34
ITEM
11. EXECUTIVE COMPENSATION
Compensation
Discussion And Analysis
Prior
to
the Share Exchange on November 22, 2006, the Company was engaged in businesses
unrelated to its current operations. The officers and directors of the Company
prior to the Share Exchange are no longer employed by or affiliated with the
Company. Phillip Cory Roberts, the Company’s president during 2006 prior to
Share Exchange, received no compensation or other perquisites for serving in
such capacity.
The
Company’s Chairman, Chief Executive Officer, and President, Yu Kwai Chong,
determined the compensation for the Company’s current executive officers that
was earned and paid in fiscal 2006. The compensation consisted solely of each
executive officers salary. None of the Company’s current executive officers
received cash bonuses during the fiscal years of 2006, 2005 and
2004.
The
Company believes that the current salaries paid to its Chief Executive Officer,
Chief Financial Officer and Chief Operating Officer during 2006, 2005, and
2004
is indicative of the fair value of the services provided to the Company, as
measured by the local market in China. Once or soon after the Company has become
a company with securities publicly traded in the United States, it intends
to
substantially increase the annual compensation to its Chief Executive Officer,
Chief Financial Officer and Chief Operating Officer. Prior to the compensation
increases that are anticipated for the Company’s executive officers, the Board
will establish a compensation committee of independent directors that will
develop a compensation program for the Company’s executive officers for fiscal
2007 and thereafter to determine the proper levels and nature of executive
compensation to achieve the objectives of the Company as described below. The
reasons for the substantially higher compensation is based on the increased
amount of responsibilities to be assumed by each of these executives after
the
Company becomes a public listed company. In addition, the Company expects to
seek to enter into long term employment contracts with its executive officers,
after its securities are traded on a U.S. exchange, to increase stability of
the
Company. The Company also expects to expand the scope of its compensation,
such
as the possibility of granting options to executive officers and tying
compensation to predetermined performance goals.
The
Company’s board of directors has not yet developed or considered a compensation
program for its executive officers for fiscal 2007 and beyond. It is expected
that the Company’s board will seek to establish a compensation program for
executive officers that will be designed to attract, as needed, individuals
with
the skills necessary for it achieves its business plan, to motivate those
individuals, to reward those individuals fairly over time, and to retain those
individuals who continue to perform at or above the levels that the Company
expects. The Company also expects that its executive compensation program will
be designed to afford its executive officers a sense of ownership in the Company
and overall entrepreneurial spirit, and to link rewards to measurable company
and individual performance.
In
addition, the Company’s board of directors does not currently have a
compensation committee. The Company anticipates that its board of directors
will
establish a compensation committee in fiscal 2007 that will be comprised of
non-employee members of its board of directors. The Company’s current
expectation is that the compensation committee of its board of directors will
perform, at least annually, a strategic review of the compensation program
for
its executive officers to determine whether it provides adequate incentives
and
motivation to its executive officers and whether it adequately compensates
its
executive officers relative to comparable officers in other companies with
which
the Company competes for executives. Those companies may or may not be public
companies or companies located in the PRC or even, in all cases, companies
in
the jewelry business.
Summary
Compensation Table
The
following table sets forth information concerning the compensation for the
three
fiscal years ended December 31, 2006, 2005, and 2004 of the principal executive
officer, principal financial officer, in addition to, as applicable, the
Company’s three most highly compensated officers whose annual compensation
exceeded $100,000, and up to two additional individuals for whom disclosure
would have been required but for the fact that the individual was not serving
as
an executive officer of the Company at the end of the last fiscal year
(collectively, the “Named Executive Officers”).
35
Employment
Agreements
The
Company does not currently have employment agreements with any of its named
executed officers.
Director
Compensation
For
the
year ended December 31, 2006, none of the members of the Company’s Board of
Directors received compensation for his or her service as a director. The
Company does not currently have an established policy to provide compensation
to
members of its Board of Directors for their services in that capacity. The
Company intends to develop such a policy in the near future.
Grants
of Plan-Based Awards in 2006
There
were no option grants in 2006.
Outstanding
Equity Awards at 2006 Fiscal Year-End
There
were no option exercises or options outstanding in 2006.
Option
Exercises and Stock Vested in Fiscal 2006
There
were no option exercises or stock vested in 2006.
36
Equity
Incentive Plans
In
November 2006, the Company’s stockholders approved an equity incentive plan
(“2006 EIP”) for employees, non-employee directors and other service providers
covering 3,000,000 shares of common stock. Prior to this, the Company had an
approved 2004 Equity Incentive Plan, which was replaced by the 2006 EIP. No
options are currently outstanding under either plan. Any options to be granted
under the 2006 EIP may be either “incentive stock options,” as defined in
Section 422A of the Internal Revenue Code, or “nonqualified stock options,”
subject to Section 83 of the Internal Revenue Code, at the discretion of the
Company’s board of directors and as reflected in the terms of the written option
agreement. The option price shall not be less than 100% of the fair market
value
of the optioned common stock on the date the option is granted. The option
price
shall not be less than 110% of the fair market value of the optioned common
stock for an optionee holding at the time of grant, more than 10% of the total
combined voting power of all classes of the Company’s stock. Options become
exercisable based on the discretion of the Company’s board of directors and must
be exercised within ten years of the date of grant.
Securities
Authorized for Issuance Under Equity Compensation Plans
The
following table provides current information regarding compensation plans,
including individual compensation arrangements, under which equity securities
of
the Company are authorized for issuance.
ITEM
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
Beneficial
ownership is determined in accordance with the rules of the SEC. In computing
the number of shares beneficially owned by a person and the percentage of
ownership of that person, shares of common stock subject to options and warrants
held by that person that are currently exercisable or become exercisable within
60 days of the filing date of this Form 10-K are deemed outstanding even if
they
have not actually been exercised. Those shares, however, are not deemed
outstanding for the purpose of computing the percentage ownership of any other
person.
The
following table sets forth certain information with respect to beneficial
ownership of the Company’s common stock based on 20,715,384 issued and
outstanding shares of common stock, by:
37
Unless
otherwise indicated, the persons and entities named in the table have sole
voting and sole investment power with respect to the shares set forth opposite
the stockholder’s name, subject to community property laws, where applicable.
Unless otherwise indicated, the address of each stockholder listed in the table
is c/o Fuqi International, Inc., 5/F., Block 1, Shi Hua Industrial Zone, Cui
Zhu
Road North, Shenzhen 518019, People’s Republic of China.
(1)
Phillip Cory Roberts has voting and investment control over the shares held
by
Bay Peak LLC.
ITEM
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
Fuqi
BVI Share Exchange Agreement
On
November 22, 2006, pursuant to the Share Exchange Agreement, the Company
acquired all of the outstanding capital stock of Fuqi BVI, in a stock for stock
exchange. The Company issued to Yu Kwai Chong, who is the sole Fuqi BVI
stockholder, 18,886,666 shares of common stock in exchange for all of the issued
and outstanding shares of capital stock of Fuqi BVI. The new shares issued
to
the Fuqi BVI stockholder represented 91.2% of the Company’s voting capital stock
immediately after the Exchange Transaction. Mr. Chong is also the Chairman
of
Fuqi BVI and the Company’s Chief Executive Officer and Chairman of the Board.
Prior to the effective date of the Exchange Transaction, the Company was
controlled by Bay Peak. Bay Peak is the Company’s second largest stockholder and
owns approximately 6.6% of the Company’s issued and outstanding shares of common
stock.
Transactions
with Bay Peak
On
July
21, 2006, the Company sold 1,368,761 shares of common stock (post Reverse Split)
to BayPeak, LLC, of which 8,761 shares were subsequently cancelled upon the
close of the Share Exchange. As part of this transaction (the “Bay Peak Sale”),
the Company abandoned its peer-to-peer marketing business, which was transferred
to VCC, and began to seek companies in Asia with potential, in particular
companies based in China, to acquire. The shares issued in the Bay Peak Sale
represented 75% of the Company’s outstanding shares. Certain affiliates of Bay
Peak became executive officers and directors of the Company after the Bay Peak
Sale, all of which resigned upon the closing of the Share Exchange on November
22, 2006.
38
Yu
Kwai Chong
Yu
Kwai
Chong, who is the Company’s largest shareholder, President, Chief Executive
Officer and Chairman of the Board and was the principal executive officer and
sole shareholder of Fuqi BVI prior to the Share Exchange, has conducted various
related party transactions with Fuqi BVI in the past. These transactions
include:
The
Company did not charge any interest on receivable from nor pay any interest
on
amount due to unaffiliated parties. The
Company believes that Mr. Chong and Fuqi
BVI
arrangements are at fair market value and are on terms comparable to those
that
would have been reached in arm's-length negotiations had the parties been
unaffiliated at the time of the negotiations.
Director
Independence
See
Item
10 “Directors, Officers and Corporation Governance” for a discussion of board
member independence.
ITEM
14. PRINCIPAL
ACCOUNTING FEES AND SERVICES.
The
following table presents fees, including reimbursements for expenses, for
professional audit services rendered by Stonefield Josephson, Inc. for the
audits of the Company’s annual financial statements and interim reviews of the
Company’s quarterly financial statements for the years ended December 31, 2006
and December 31, 2005 and fees billed for other services rendered by Stonefield
Josephson, Inc. during those periods. The Company’s predecessor auditors,
Epstein, Weber & Conover, P.L.C., did not provide any services in relations
with the audits of the accompanying audited financial statements for the years
ended December 31, 2006 and 2005 and the reviews of the interim financial
statements included in the notes of the financial statements. Accordingly,
their
fees for other services were not included.
39
(1)
Audit
Fees consist of fees billed for professional services rendered for the audit
of
the Company's consolidated annual financial statements and review of the interim
consolidated financial statements included in quarterly reports and services
that are normally provided by Stonefield Josephson, Inc. in connection with
statutory and regulatory filings or engagements, including the Form 10 that
the
Company has filed with the Securities and Exchange Commission.
(2)
Audit-Related Fees consist of fees billed for assurance and related services
that are reasonably related to the performance of the audit or review of the
Company's consolidated financial statements and are not reported under "Audit
Fees."
40
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 Schedule: See “Schedule II—Valuation and Qualifying
Accounts” below in this Item 15 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.
41
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 April 17, 2007.
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.
42
EXHIBIT
INDEX
43
FUQI
INTERNATIONAL, INC.
CONSOLIDATED
FINANCIAL STATEMENTS
DECEMBER
31, 2006, 2005, AND 2004
F-1
Report
of Independent Registered Public Accounting Firm
Board
of
Directors
Fuqi
International, Inc.
Shenzhen,
China
We
have
audited the accompanying consolidated balance sheets of Fuqi International,
Inc.
and subsidiaries as of December 31, 2006, and 2005 and the related
consolidated statements of income and comprehensive income, stockholders' equity
and cash flows for each of the three years in the period ended December 31,
2006. Our audits also included the financial statement schedule listed in the
Index at Item 15(a). These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express
an
opinion on these financial statements and schedule based on our
audits.
We
conducted our audits in accordance with the
standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audits to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. We were not engaged to perform an audit of the Company’s internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures
that
are appropriate in the circumstances, but not for the purpose of expressing
an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly,
we express no such opinion. An audit also includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our
opinion.
In
our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Fuqi International, Inc.
and
subsidiaries as of December 31, 2006 and 2005, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2006 in conformity with accounting principles generally accepted
in
the United States of America. Also, in
our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
As
discussed in Note 1 to the consolidated financial statements, in 2006 the
Company adopted Statement of Financial Accounting Standards No. 123 (Revised
2004), Share-Based Payment.
/s/
Stonefield Josephson, Inc.
Wanchai,
Hong Kong
April
12,
2007
F-2
The
accompanying notes form an integral part of these consolidated financial
statements
F-3
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