FUSHI COPPERWELD INC 10-K 2011
Documents found in this filing:
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2009
¨ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _____________
Commission file number: 001-33669
FUSHI COPPERWELD, INC.
(Exact name of registrant as specified in its charter)
TYG Center Tower B, Suite 2601, Dong San Huan Bei Lu Bing 2, Beijing, PRC 100027>
(Address of Principal Executive Offices, Including Zip Code)
Registrant’s telephone number: (011)-86-10-8447-8280
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $0.006 Par Value NASDAQ Global Select Market
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required 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 report(s)), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Do not check if a smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes ¨ No x
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based upon the closing sale price of the registrant’s common stock as reported on the NASDAQ Global Select Market on March 11, 2010 was approximately $265,705,304. Shares of common stock held by each officer and director and by each person who owns 10% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates.
The number of outstanding shares of the registrant’s common stock on March 11, 2010 was 37,248,672.
I. DOCUMENTS INCORPORATED BY REFERENCE>
The definitive proxy statement for the registrant’s 2010 Annual Meeting of Stockholders to be held in the second quarter of fiscal year 2010 is incorporated by reference in Part III to the extent described therein.
This annual report on Form 10-K is being filed as Amendment No. 1 to our Annual Report on Form 10-K (“Amendment No. 1”) which was originally filed on March 16, 2010 with the Securities and Exchange Commission (the “Original 10-K”). This amendment is filed solely with respect to the following items:
- Part I, Item 1- Description of Business
- Part I, Item 1A- Risk Factors
- Part II, Item 6- Selected Financial Data
- Part II, Item 7- Management’s Discussion and Analysis of Financial Condition and Results of Operations
- Part II, Item 9A- Controls and Procedures; and
- Part IV, Item 15- Exhibit, Financial Statement Schedules.
This Amendment No. 1 is being filed in order to restate:
• Our consolidated balance sheets as of December 31, 2009 and 2008 by increasing deferred tax assets and accumulated comprehensive income and decreasing retained earnings. As a result, our consolidated total assets increased by $2,561,059 and $1,488,206 at December 31, 2009 and 2008, respectively; and
• Our consolidated statements of income for the years ended December 31, 2009, 2008 and 2007 by reclassifying the change in fair value of derivative from other comprehensive income to net income and adjusting the tax effect accordingly. As a result, our consolidated net income for the years ended December 31, 2009, 2008 and 2007 decreased by $2,082,598, increased by $2,731,291 and decreased by $5,620,161, respectively; and
• Our consolidated statements of shareholders’ equity for the years ended December 31, 2009, 2008 and 2007 by decreasing retained earnings increasing accumulated comprehensive income. As a result, our consolidated total shareholder’s equity increased by $2,561,059, $1,488,206 and $2,895,235 for the years ended December 31, 2009, 2008 and 2007, respectively.
The restatement relates to our accounting treatment for our cross-currency interest swap. We concluded that we had unintentionally misinterpreted GAAP previously and the cross-currency interest swap should not have qualified as a cash flow hedge and the change in fair value of $3,155,451, $(4,138,320) and $8,515,396 should be recorded as other income or loss in our consolidated statements of income instead of recorded as other comprehensive income or loss for the years ended December 31, 2009, 2008 and 2007, respectively.
A summary of the effects of this restatement to our financial statements included within this Amendment No. 1 is presented at Note 2, “Summary of Significant Acounting Policies – Restatement of Financial Statements.”
This Amendment No. 1 also corrects the audited condensed parent-only financial statements and footnotes found on pages F-41 through F-45 of the Original 10-K which were erroneously labeled as “unaudited.” Such parent-only financial statements and footnotes will be moved to new footnote number 24 to the audited financial statements and labeled “restated.” Furthermore, this Amendment No. 1 includes a re-issued dual dated audit report of Frazer Frost, LLP, and new officer certifications are being filed as exhibits to this Amendment No. 1.
Except as specifically referenced herein, this Amendment No. 1 to the Annual Report on Form 10-K does not reflect any event occurring subsequent to March 16, 2010, the filing date of the original report.
ITEM 1. DESCRIPTION OF BUSINESS
We believe we are one of the world’s largest producers, based on manufacturing capacity, and a leading innovator of bimetallic wire products, principally copper-clad aluminum, or CCA, and copper-clad steel, or CCS, products. CCA and CCS conductors are generally used as a substitute for solid copper conductors in applications for which either cost savings or specific electrical or physical attributes are necessary. Relative to solid copper wire, our customized, engineered bimetallic wire products significantly reduce the amount of copper metal required to manufacture a conductor, and because copper is expensive relative to aluminum and steel, our products significantly reduce conductor cost per unit length. Our bimetallic conductors combine the conductivity of copper with the light weight of aluminum or the ruggedness of steel to offer favorable end-use and cost characteristics, such as weight savings, increased flexibility of end-products, extended life, increased tensile strength, lower corrosion and oxidation and decreased theft risk, while delivering superior signal transmission capabilities in many applications. These benefits provide for greater ease of handling and installation, which reduce shipping and labor costs and limit waste, ultimately saving our customers money beyond our price advantage over solid copper products. We provide additional value through our innovative design and engineering and proprietary manufacturing processes, ultimately resulting in our superior product quality.
We sell bimetallic wire products to a diverse base of customers worldwide that operate primarily in the telecommunications, electrical utility, and transportation industries. Our products are sold to 536 customers in 37 countries and are marketed under the established “Copperweld®” and “Fushi TM ” brand names. We believe our customers view the Copperweld brand as the premium choice for bimetallic products offered internationally. Our products become components in a wide variety of end-use products and are sold directly to cable manufacturers or through either distributors or sales agents, and to end-users, by our direct sales organization. The PRC represented the largest market for our products, accounting for approximately 80% of our revenues in the fiscal ended December 31, 2009, with North America, Europe and the Middle East and North Africa representing 16%, 3%, and 1% of our revenues in this period, respectively. We continue our efforts to diversify our business, further reducing customer concentration over the past twelve months.
We operate three manufacturing facilities located in Dalian, Liaoning, in the PRC, Fayetteville, Tennessee, in the U.S., and Telford, England, in the U.K. As of December 31, 2009, in aggregate, we have 52,400 MT of annualized CCA capacity and 17,100 MT of annualized CCS capacity globally. We recently completed an expansion of our downstream processing capabilities in our U.S. facility and have also transferred certain manufacturing lines from our U.S. facility to our PRC facility. Furthermore, on February 5, 2010 we acquired Dalian Jinchuan Power Cable Co. (“Jinchuan”), a leading low and medium voltage power cable manufacturer in Northeastern China, for approximately $10.2 million in cash, which allows us to further downstream process our products and provides a strategic expansion into the utility market sub-segment. These capacity and acquisitions changes have allowed us to geographically optimize our capabilities, share technology and manufacturing best-practices between our facilities, expand our product base to include higher value-added and higher margin products, and improve profitability and delivery by eliminating third party processors.
As a result of continued strength in the Chinese market and in our global end-markets, we have remained profitable while many value-added processors of commodity metals have experienced losses resulting from challenging economic conditions. We believe that our continued profitability results from our ability to mitigate the effect of raw materials cost fluctuations through “metals pass through” pricing, our access to growing end-markets due to our global reach, the recognized quality of our products, our leadership position in the industry and associated benefits of scale, our low-cost manufacturing capabilities in the PRC and the proprietary manufacturing technology we employ. While the volatility of our raw materials costs, especially copper, is a primary cause of price variations in our products, and is thus reflected in our revenues, changes in raw materials costs do not typically meaningfully affect our dollar profitability on a per MT basis. Rather, when the costs of our raw materials decrease, our prices to our customers decrease and the amount of our total revenues decreases while the dollar amount of our gross profit on a per MT basis remains relatively stable. As a result, we are able to maintain profitability despite volatility in our raw material costs.
We were incorporated as a Nevada company on October 6, 1982 under the name M, Inc. We changed our corporate name to Parallel Technologies, Inc. in June 1991. We were formed as a “blank check” entity for the purpose of seeking a merger, acquisition or other business combination transaction with a privately-owned entity seeking to become a publicly-owned entity. In a series of restructuring transactions which began in 2005 and were completed in 2006 (the “Restructuring”), we acquired Fushi Holdings, Inc., incorporated in the state of Delaware, which is a holding company for Fushi International (Dalian) Bimetallic Cable Co., Ltd (“Fushi International (Dalian)”), organized under the laws of the People’s Republic of China (PRC). As a result of the restructuring transactions, Fushi International (Dalian) acquired substantially all of the manufacturing assets and business and controls the remaining assets and financial affairs of Dalian Fushi Bimetallic Manufacturing Co., Ltd (“Dalian Fushi”). Dalian Fushi is a limited liability company organized under the laws of the PRC, which is engaged in the manufacture and sale of bimetallic wire products. Following the restructuring, Dalian Fushi became a non-operating entity.
On October 29, 2007 we acquired Copperweld, Bimetallics (“Copperweld”) for $22.5 million in cash. Effective January 15, 2008, we changed our name from Fushi International, Inc. to Fushi Copperweld, Inc. to recognize the worldwide importance of the Copperweld brand while continuing to leverage the Fushi brand, especially in the PRC. We, and our customers, view the Copperweld brand as the premium brand of bimetallic products and will promote the Copperweld brand as a premier product, worldwide.
Our Corporate Structure
The following diagram shows the structure of our company from an operating perspective. The top management functions reside at the Fushi Copperweld level with executive management, operations management, sales management and financial management functioning at this level. The PRC manufacturing, while managed at the corporate level, functions through Fushi Holdings, Fushi International (Dalian), Dalian Jinchuan Power Cable and Dalian Fushi. The US and United Kingdom manufacturing occurs through Copperweld and report to an executive at the Fushi Copperweld level.
Our Business Operations
We operate our business principally through two wholly-owned subsidiaries: Fushi International (Dalian) Bimetallic Cable Co. Ltd. and Copperweld Bimetallics, LLC. Fushi International (Dalian) is a subsidiary of Fushi Holdings, which is wholly-owned by Fushi Copperweld, Inc.
Fushi International (Dalian)
We believe Fushi International (Dalian) is one of the largest and leading providers of bimetallic wire in the PRC. Fushi International (Dalian) operates from a production facility and corporate headquarters located in Dalian, Liaoning, in the PRC. Through Fushi International (Dalian), we develop, design, manufacture, market and distribute copper-clad bimetallic engineered conductor products, principally CCA conductors. As of December 31, 2009, we have approximately 40,000 MT of annualized CCA capacity at our PRC facility, which primarily serves the Asia-Pacific region. In 2009, we expanded our product offerings and production capabilities in the PRC through the transfer of higher capacity CCA machinery that utilizes the same cladding technology we employ at our U.S. facility. This redistribution of CCA capacity allowed us to optimize the geographic location of our manufacturing capabilities and maximize the efficient distribution of these products. We are also in the process of further expanding our production capabilities in our PRC facility through the introduction of CCS production capacity, which was transferred from our U.S. facility, to expand the end-markets and customer bases we serve in the PRC. We anticipate the addition of 8,200 MT of annualized CCS capacity in this facility by the first quarter of 2010, and believe our operation will be the first facility in the PRC to have large-scale CCS production capabilities.
We believe Copperweld is one of the largest and leading providers of bimetallic wire in the North American, European, Middle Eastern and North African markets. Copperweld operates two production facilities in Fayetteville, Tennessee, in the U.S., and in Telford, England, in the U.K. Through these facilities, we develop, design, manufacture, market and distribute copper-clad bimetallic engineered conductor products, principally CCA and CCS conductors. As of December 31, 2009, we have approximately 12,400 MT of annualized CCA capacity and approximately 16,300 MT of annualized CCS capacity at Copperweld’s U.S. facility. We have purchased and installed additional downstream processing equipment for our U.S. facility, which will enable us to further expand our product base to include higher value-added and higher margin products, and improve profitability and delivery by eliminating third party processors. The capital expenditures associated with these projects are now complete and the majority of this equipment came online during the quarter ended June 30, 2009. Our U.K. facility provides processing, sales and service to our European, Middle Eastern, and North African customers, and our processing capabilities at this facility consist primarily of finishing capacity for products shipped from our U.S. facility. Through Copperweld, we have a well-established global sales distribution network and access to proprietary manufacturing technologies.
Financial Information About Geographic Areas
The below table provides a breakdown of our sales by segment for the fiscal years ended December 31, 2009, 2008 and 2007.
The below table provides a breakdown of our long-lived assets by segment for the fiscal years ended December 31, 2009, 2008 and 2007.
We manufacture, market and distribute bimetallic conductors (conductors consisting of two metals), primarily CCA and CCS. Both CCA and CCS are composed of center cores of either aluminum or steel, surrounded by an outer layer, also referred to as a sheath or clad, of pure copper, resulting in an engineered composite bimetallic conductor. Our proprietary manufacturing process results in a metallurgical bond between the copper sheath and the core metal. While the amount of copper used in cladding the core-metal varies widely based on the market and customer needs, we estimate that bimetallic conductors can reduce the amount of copper used by as much as 90% by volume, or 73% by weight, compared to solid copper conductors, which offers our customers considerable cost savings.
In addition, for many applications, bimetallic conductors offer significant advantages over copper wire. Our engineered bimetallic conductor products offer end-users greater performance than solid copper conductors. Our bimetallic conductors combine the efficiency of copper with the lightweight qualities of aluminum in CCA, or with the ruggedness and strength of steel in CCS. Bimetallic conductors offer significant weight savings (CCA), increased flexibility and end-product ease-of-handling (CCA), increased tensile strength (CCS), improved corrosion characteristics (CCA and CCS) and decreased theft risk (CCA and CCS). Conductivity can be customized to fit many applications by changing the percentage of copper. Ultimately, the physical and electrical attributes of our bimetallic products provide our customers with cost savings beyond their intrinsic pricing advantages.
End-user manufacturers in the industry have increasingly pursued alternative technologies to solid copper conductors, such as bimetallic options, due to both performance and economic considerations. Relative to traditional copper conductors, bimetallic conductors offer greater value to a variety of customers. As a result of the benefits of bimetallic conductors, we believe there are substantial opportunities to capture increased market share in applications that have historically been dominated by solid copper wire.
We believe the proprietary manufacturing technology we employ allows us to produce superior products compared to other manufacturers and creates significant barriers to entry in certain end-markets. Manufacturing copper-clad products involves bonding copper tape to an aluminum or steel core rod, drawing the cladded product to a finished diameter and heat treating as necessary depending on customer specifications. We believe the proprietary cladding process we employ differentiates us from our competitors by allowing us to offer superior product quality. Since 1991, Copperweld has had a worldwide exclusive license from kabelmetal electro GmbH (now Nexans Deutschland Industries GmbH & Co. KG) to certain of Nexans’ patents and proprietary manufacturing technology related to the production of bimetallic rods and wire, on which we rely to produce our products. The license was initially for a 15 year term, but in 2000 was extended for an additional 10 years through 2015 and, thereafter, automatically renews for successive one year periods unless either party fails to fulfill its obligations under the license. In addition, our research and development capabilities support the ongoing evolution of our products and the applications we can support. We are continuously working toward new technologies and products that we expect will improve the performance and capabilities of our bimetallic products, thereby allowing us to enter new markets. As an example, we recently installed wire stranding capacity in our U.S. facility, which has allowed us to use our CCS conductors as raw material components to manufacture value-added stranded products that are sold within both the electrical utility and transportation markets.
The Bimetallic Industry
The bimetallic conductor industry is a subset of the broader wire and cable industry, which is a $140 billion global market according to the Freedonia Group, a leading publisher of industry market research. Bimetallic conductors are generally used as substitutes for solid copper conductors. The wire and cable market broadly consists of two large categories: electrical, involving products that are used for electrical current carrying capabilities, and telecommunications, involving products that are used for signal carrying communications purposes. According to CRU International Limited, a leading independent metals research firm, the electrical market accounts for approximately 74% of the worldwide wire and cable market, with telecommunications accounting for the remaining 26%. The global bimetallic wire industry is fast-growing and increasingly competitive. This is especially true in the PRC where there is considerable fragmentation of manufacturers.
The telecommunications market accounted for 47.9% of our revenues in the fiscal year ended December 31, 2009. CCA is an industry-standard center-conductor material in coaxial cable applications due to the signal carrying capabilities of copper on the surface of the center-conductor, the light weight and flexibility of aluminum and the cost savings compared to solid copper wire. A key driver of investment into the telecommunication infrastructure is growth in broadband and mobile subscribers. According to Gartner, Inc., a leading information technology research company, the estimated 2009 broadband penetration rate in emerging markets in Asia was 11% and the mobile penetration rate in Asia was 51%, as compared to 66% and 88% in North America and 62% and 128% in Western Europe, respectively. As a result of the current low levels, Asian mobile penetration rates are expected to increase from 51% in 2009 to 73% in 2013, driven largely by growth in the PRC. Consequently, telecommunication carriers in the PRC are expected to continue investing in infrastructure projects in line with demand. Three major telecommunications carriers in the PRC have announced plans to spend RMB 400 billion, or approximately $59 billion, between 2009 and 2011 to build out the PRC’s third generation, or 3G, mobile networks, which we expect to be a driver for increased bimetallic wire sales going forward.
The utility market accounted for approximately 45.9% of our revenues in the fiscal year ended December 31, 2009. Bimetallic wire, typically CCS, is widely used in U.S. power systems in grounding applications, power cables, electrified railroad tracks and tracer wire (laid to help detect plastic piping or fiber optic cable). CCS manufacturing capacity has yet to be introduced in the PRC market in large and readily available quantities, and we anticipate that opening the first large-scale CCS production capability in the PRC will allow us to be the innovator in developing the PRC market for this product. We believe that the electrical utility market for bimetallics in the PRC is underdeveloped relative to other markets worldwide and could serve as an area of significant growth for our PRC facility. In response to widespread power outages that occurred between 2002 and 2005, two of the largest power grid operators in the PRC have announced transmission and distribution capital expenditure plans of RMB 1,220 billion, or approximately $179 billion, by 2010.
The transportation end-market accounted for approximately 1.1% of our revenues in the fiscal year ended December 31, 2009 and we expect this market to be an important driver of our future growth. Our CCS and CCA wires are used in original equipment and aftermarket applications for electrified rail applications as well as in automobiles, trucks, motorcycles, commercial off road equipment and trailers. In October 2008, the Chinese State Council approved a RMB 2 trillion, or approximately $293 billion, investment plan to construct 25,000 kilometers (16,000 miles) high-speed rail network through 2012. This investment plan extends the previously announced railway building program in the PRC, which allocated RMB 1,250 billion, or $183 billion, in the 11 th five-year plan to be invested between 2006 and 2010. As a result of this increased investment, the railway network in the PRC is expected to grow from 110,000 kilometers at the end of 2011 to over 200,000 kilometers by 2020, according to the Chinese Ministry of Railways.
In addition to the above, we believe that we will see significant growth in our end-markets as the RMB 4 trillion, or $586 billion, stimulus package implemented by the Chinese government in November 2008 continues to gain traction. The stimulus package focuses on transport infrastructure and power grid development (approximately RMB 1.5 trillion, or $220 billion), post-earthquake reconstruction (approximately RMB 1 trillion, or $146 billion) and rural infrastructure development (approximately RMB 370 billion, or $54 billion). According to the PRC’s National Bureau of Statistics, total fixed asset investment during the year to date period ended December 2009 grew by 30.1% over the same period in 2008, partially as a result of the implementation of the stimulus package.
Our Manufacturing Process
Manufacturing copper-clad products involves bonding copper tape to an aluminum or steel core, drawing the clad product to a finished diameter and heat treating as necessary depending upon the customer’s specifications. We use proprietary technologies developed in Dalian and Fayetteville, and also own the worldwide rights to other cladding technologies. These proprietary technologies allow us to produce superior copper-clad products compared to other producers. The Copperweld acquisition has allowed us to share technology between our manufacturing locations. We are continuing to integrate our technologies and equipment so as to better serve our customers from the location that offers the most cost effective and efficient solutions. Our technology base allows us to produce superior products, our combined research and development department supports continuing development and the geographical spread of our manufacturing locations improves our ability to provide superior service to our international customer base.
Research and Development
We are dedicated to continuously improving our current products and to developing new products that will improve the performance and capabilities of bimetallic materials and allow us to enter new markets. We are recognized by the Dalian Municipal Government as a “new and high-technology” enterprise and receive governmental funding and subsidies for our operations and research and development activities. We have also partnered with the University of Alabama and the Shanghai Electric Cable Research Institute to advance the development of new products and production methods. We expect new bimetallic products to evolve as substitutes for, improvements on, or lower-cost alternatives to solid copper wire in new end-markets and applications. We are currently working with several customers that supply original equipment manufacturers in various industries, such as electrified railway equipment, to gain product approval. We continue to focus on expanding within and into new, higher-margin products, applications and markets through ongoing research and development activity.
In November 2007, we were appointed to the Copper-Clad Aluminum Executive Standards committee by the National Standardization Administration of China. As part of the Copper-Clad Aluminum Executive Committee, we assisted in drafting China’s first-ever nationwide standards for copper-clad aluminum wire and are now waiting for the standard issuing. Furthermore, in November 2009, we were appointed to form and organize China’s first composite conductor working group by the National Standardization Administration of China to formulate a nationwide standard for composite conductor wires within the telecommunication, electrical, automotive, railway, industrial and utility industries, as well as in other high frequency signal and power transmission areas.
Quality control begins with our ordering process. Raw material vendors are qualified as suppliers, and are provided specifications that apply to each category of raw material used. When the raw materials arrive, our quality inspectors inspect each shipment for critical quality factors. During the manufacturing process, every employee has the responsibility and authority to identify non-conforming material or any material that shows manufacturing imperfections. Inspectors test our products during and after all aspects of the manufacturing processes.
In our final inspection process, we complete additional testing to insure customers receive compliant products. Additional testing in our laboratories includes tensile strength, breaking load, elongation, conductivity and uniformity of the copper surface depending on the product and the individual customer’s requirements. Our operational processes follow ISO guidelines from vendor selection, manufacturing and customer deliveries.
We typically warrant our products for a period of one year from the date of shipment. This may include replacement or credit to dissatisfied customers. When we receive an indication that a product did not perform as expected, our quality control specialist and laboratory personnel test the product to determine if our process was correct for the specifications submitted by the customer and if the manufacturing process was completed as planned. If we failed to deliver the product according to the customer’s specifications or if the manufacturing process was flawed, we provide immediate credit to the customer. If we produced the product to the customer’s specifications and if the manufacturing process was not flawed, we send a team to the customer’s facilities to determine if we can assist the customer in correcting its internal process. Typically a team consists of at least one engineer, at least one experienced production person and the customer’s sales representative. If the product was manufactured to the proper specifications, our team works with the customer in developing corrective action to solve their problem.
We do not establish reserve funds for potential customer claims because, historically, we have not experienced significant customer complaints or returns. We believe that our customer support teams and our quality and manufacturing procedures will continue to keep claims at a level that does not support the need for a reserve. We review customer returns on a monthly basis and should the need ever arise, may establish a reserve fund as we expand our business by volume and products. If we were to experience a significant increase in warranty claims, our financial results could be adversely affected. See “Risk Factors — Risks Related to Our Business — We do not maintain a reserve fund for warranty or defective products claims. Our costs could substantially increase if we experience a significant number of warranty claims.”
Raw Materials and Suppliers
Our principal raw materials consist of aluminum and steel rods and copper strips, which collectively accounted for approximately 85.0% of our costs of goods sold in during the fiscal year ended December 31, 2009. Changes in the price of copper, which has an established history of volatility, directly affect the prices of our products and may influence the demand for our products. The daily selling price of copper on the COMEX averaged $2.37 per pound for 2009, a decrease of 24.3% from the average of $3.13 per pound for 2008. Copper, steel and aluminum are available in the market and we have not experienced shortages despite the current economic climate. We are constantly reviewing sources for raw materials to prevent shortages as we expand our business. During 2009, copper, aluminum and steel represented 53.3%, 41.3% and 5.4% of our raw material purchases, respectively.
For the fiscal year 2009, our top five suppliers accounted for 60% of our raw material supply compared to 65% in 2008. Our acquisition of Copperweld made additional suppliers in different parts of the world available to us so we believe that we will continue to reduce our dependence on only a few suppliers in future periods. We are in the process of integrating and restructuring our operations in an effort to streamline corporate resources and improve internal efficiency, with a particular focus on manufacturing and sales.
We purchase most of our raw materials at prevailing market prices. We do not have formal long-term purchase contracts with our suppliers and, therefore, we are exposed to the risk of fluctuating raw material prices. Our raw material price risk is mitigated because we generally attempt to pass changes in raw material costs to our customers. See “Risk Factors — Risks Related to Our Business — We depend on a few suppliers for a significant portion of our principal raw materials and we do not have any long-term supply contracts with our raw materials suppliers. Interruptions of production at our key suppliers may affect our results of operations and financial performance.”
In addition to these short-term purchase contracts, we also purchase from our primary suppliers or other suppliers to satisfy additional raw materials needs from additional orders we did not previously project. Due to fluctuating worldwide supply and demand for our principal raw materials, we cannot guarantee that necessary materials will continue to be procured at the prices currently available or that are acceptable to our customers. However, prices adversely affecting the supply and prices of our raw materials have an equal or greater adverse effect on producers of alternatives to our bimetallic products. We maintain multiple suppliers for each type of raw material that we use and monitor the availability of additional suppliers so that we have access to sufficient raw material sources necessary to meet customer demand. Notwithstanding our supply availability practices, we do not have a guarantee that raw material availability will meet our demands. To the extent that our suppliers are not able to provide raw materials in sufficient quantity and quality on a timely and cost-efficient basis, our results of operations could be adversely impacted until we find other qualified suppliers.
Our increasing economies of scale as we streamline the procurement process at the corporate level will enable us to purchase materials in larger volumes, offering us leverage to secure better pricing, and to a lesser degree, increasing the extent to which our suppliers rely on our purchase orders. We believe this relationship of mutual reliance will enable us to reduce our exposure to possible price fluctuations.
Payment terms vary with each supplier. Some suppliers require payment prior to shipment, others offer varying terms from 3 to 30 days following shipment. Demand for raw material in the PRC often requires that we prepay for our raw materials. Price is often affected by our payment terms; therefore, we typically agree to shorter terms in exchange for reduced pricing for our raw materials.
Our products’ target markets are manufacturers of finished wire, cable products and installers of equipment and systems which require conductive materials. We also utilize distributors for targeted markets and products. In most cases, our customers incorporate our products into end-products that they subsequently supply to their customers. The products we manufacture are used by these end-product makers as standard components, materials or parts that are built to their specifications. Therefore, our business is driven, in part, by the strength, growth prospects and activity in the end-markets in which our products are used. Our technical and sales staff frequently provides technical and sales support to our customers.
We do not have long-term purchase commitments from our customers and the term of our sales contracts with our customers varies from 15 days to one year. Furthermore, these contracts normally leave certain major terms such as price and quantity of products open to be determined in each purchase order. These contracts also allow customers to re-adjust the contract price to reflect substantial changes in market conditions such as significant raw material price movements.
We have a large customer base, with approximately 536 customers in 37 countries around the world. The geographic dispersion and large number of customers provide a diverse base of revenue sources that we believe provide additional insulation to slowing economic conditions in selected regions. As a result of our large and diverse customer base our largest customers account for an increasingly smaller, but healthy, percentage of net sales compared to past fiscal years. Our top five customers represented 15.2%, 18.2%, and 24.6% of our net sales during the fiscal years ended December 31, 2009, 2008, and 2007, respectively. Further, we anticipate that our overall customer composition and the concentration of our top customers will change as we expand our business and shift our product portfolio to higher-margin products; however, we can give no assurance that this will be the case.
Marketing, Sales and Distribution
Our sales and marketing is a global operation. We market and sell our products through our direct sales force. In some countries we use sales agents or distributors to provide assistance with or lead our sales and distribution in selected countries.
Since the acquisition of Copperweld, we have begun integrating our sales and marketing functions on a global basis. Our sales team is under the direction of a global sales manager. Our extensive sales and service network covers over 60 countries. We offer various pricing incentives to encourage larger-volume orders and long-term relationships with our customers. As a result of increasing demand for our products and as new marketing opportunities develop, we expect to increase our outside sales force by reassigning current employees and adding additional qualified personnel. During 2009 we expanded our footprint throughout the globe the addition of agents in Europe, the Middle East, and South America. Our sales staff works closely with our customers to understand their needs and provide feedback to us so that we can better address their needs and improve the quality and features of our products. Throughout 2009 and continuing into the 2010 year, we provided professional sales training to our sales force.
In the first quarter of 2010, we hired a global marketing manager to direct our marketing and branding activities within all markets we serve. As an important component of our marketing activities, we attended industry-specific conferences and exhibitions to promote our products and brand name. For example, we attended the “Interwire Convention” in Cleveland, Ohio and the “CRU Conference” in Rome, Italy in 2009. We also plan on attending “WIRE Dusseldorf”, the world’s largest international wire and cable trade fair, in April 2010. We also advertised in industry journals and magazines and marketed our products on the Internet.
Product Delivery and Risk of Loss
We usually deliver our products to our customers’ place of business, while in some cases customers make their own delivery arrangements. Our Shipping Departments arrange for all deliveries regardless of the delivery method. In Dalian we have our own heavy trucks and contracted drivers that allow us to ship our products and also utilize common carriers. In Fayetteville and Telford, we use common carriers. International shipments are arranged through several ocean freight forwarding companies.
We include shipping expenses in the purchase price of our products or as separately stated charges. In either instance, delivery costs are ultimately borne by our customers. In addition, some orders require us to purchase freight insurance on behalf of a customer in which case the cost of such freight insurance is included in the purchase price of the products.
Product Liability Insurance
We currently do not carry product liability or other similar insurance to cover products made and shipped. While historically product liability lawsuits against the Company have been rare and we have never experienced significant failures of our products, we cannot give any assurance that we will not have exposure for liability in the event of the failure of any of our products in the future. See “Risk Factors — Risks Related to our Business — We do not presently maintain product liability insurance in the PRC, and our property and equipment insurance does not cover the full value of our property and equipment, which leaves us with exposure in the event of loss or damage to our properties or claims filed against us.”
Property Insurance and Other Insurance
We maintain property and casualty insurance coverage consistent with local rules and best practices in the PRC, Fayetteville, TN and Telford, England. We use different insurers in each location and solicit competitive bids on a regular basis. We believe that we are adequately protected with an appropriate level of insurance coverage from normally anticipated events.
Historically, our revenues have not been materially impacted by seasonal variations. In the first several years of our operations in the PRC, due to limited manufacturing capacity and demand that outstripped capacity, seasonality was minimal. After the increase of our manufacturing capacities and acquisition of Copperweld, we experienced certain quarterly fluctuations in revenues due to changing and expanding customer demands from different markets. Sales volumes out of Fayetteville, which primarily serves the North American and European markets, are generally lower in our fourth and first quarters, due primarily to cold weather related reduction in demand for construction related products and shutdown of our facility during the year-end holidays. Additionally, the PRC historically experiences a slowdown in demand during our first quarter due to the Chinese New Year holiday. We expect these variations to continue in the future and thus, we believe it is more meaningful to focus on annual rather than interim results.
Competition in the bimetallic industry, particularly in the PRC, can be characterized by rapid growth and a concentration of manufacturers, primarily due to an accelerated replacement of copper by bimetallic products applications. The most significant factors that affect our competitive position are:
We believe that we can differentiate ourselves by offering superior product quality, timely delivery, and better value. See “Risk Factors — Risks Related to Our Business — We may encounter substantial competition in our business and our failure to compete effectively may adversely affect our ability to generate revenue.”
Our Growth Strategies
Our goal is to strengthen our position as the global leader in the bimetallic conductors industry through the following strategies:
Capitalize on Industry Leadership and Low Cost Position to Continue Capturing Market Share. We believe we have been and will continue to be able to benefit from our industry leadership as well as our low cost position as we continue to grow the business. Our diverse global manufacturing capabilities allow us to provide a uniquely comprehensive suite of offerings to customers throughout Asia, North America and Europe. We believe our customers view the Copperweld brand as a premium choice for bimetallic products offered internationally, and that we will be able to capitalize on this as we continue developing new markets and applications for our products. Our low cost facility in the PRC provides us a competitive advantage in product pricing, allowing us to maintain strong margins while continuing to grow and capture market share. In addition, as a result of the cost reduction initiatives that we have implemented, our U.S. facility has effectively lowered its breakeven by approximately 300 MT per month. Our initiatives in our U.S. operating segment continue to enhance our low cost position in comparison to other manufacturers of bimetallic wire. We believe that we will be able to capitalize on our low cost position to continue capturing share in our existing markets as well as to successfully enter new markets.
Accelerate New Product and End Market Development. We are dedicated to continuously improving our current products and developing new products that will improve the performance and capabilities of bimetallic materials and allow us to enter new markets. We are recognized by the Dalian Municipal Government as a “new and high-technology” enterprise and receive governmental funding and subsidies for our operations and research and development activities. We have also partnered with the University of Alabama and the Shanghai Electric Cable Research Institute to advance the development of new products and production methods. We expect new bimetallic products to evolve as substitutes for, improvements on, or lower-cost alternatives to solid copper wire in new end-markets and applications. We are currently working with several customers that supply original equipment manufacturers in various industries, such as electrified railway equipment, to gain product approval. We continue to focus on expanding within and into new, higher-margin products, applications and markets through ongoing research and development activity.
Focus on Margin Enhancement. We believe that there are significant opportunities to increase profitability within our U.S. operating segment, which operated at a loss in the first, second and fourth quarter of 2009, by sharing best practices with our PRC facility. Additional processing equipment was brought online at our U.S. facility to bring more value-added downstream operations in-house, enabling us to sell directly to end-users rather than through third party processors. We expect that these higher value-added products, along with ongoing cost reduction initiatives and greater production rates, will generate improved margins in our U.S. operations.
Optimize Utilization Rates. As we continue to gain market share, we will be focused on optimizing manufacturing capacity and utilization through our manufacturing footprint. We have moved one CCA and two CCS production lines that were under-utilized from our U.S. facility to our PRC facility. We have also purchased one new CCA line utilizing proprietary technology licensed to Copperweld for our PRC facility. In total, the lines we transferred from our U.S. facility are expected to increase capacity at our PRC facility by 72% relative to installed capacity at December 31, 2007. The CCA lines are currently fully operational and we currently expect that the CCS cladding line will be operational during the first quarter of 2010. These lines have added approximately 12,400 MT of annualized CCA capacity and will add approximately 8,200 MT of annualized CCS capacity into the PRC market where we anticipate higher utilization rates due to stronger CCA and CCS demand growth in the region.
Continue Pursuing Strategic Acquisitions That Complement Our Strong Platform. We believe that we are uniquely positioned to act as a global consolidator in our industry as a result of our leadership position in the competitive landscape, our international footprint and the strength of our brand names. We have a history of having consummated highly strategic, well priced, accretive acquisitions, and anticipate that we will continue to actively evaluate possible opportunities that would serve to expand our strategic capabilities, our access to customers and our product lines as well as downstream in our value chain. Partly as a result of the fragmented nature of the industry, we believe attractive potential acquisition candidates may present themselves, and we plan to continue our disciplined pursuit of strategic acquisitions to accelerate our growth, enhance our industry leadership and create value.
Our principal intellectual property rights consist of patents, patent application and the trademarks “Fushi”, which we use in our business, and “Copperweld”, which is a registered trademark that we use. Additionally we have acquired the rights to superior processes that can be renewed when they expire in 2015. We continue to improve the products for which we hold the rights and through our research department, we anticipate continuing our development of proprietary intellectual properties. We employ the services of a law firm to maintain our trademark registrations throughout the world and to identify any potential infringements on our trademarks or our patents.
We believe the proprietary manufacturing technology we employ allows us to produce superior products compared to other manufacturers and creates significant barriers to entry in certain end-markets. Manufacturing copper-clad products involves bonding copper tape to an aluminum or steel core rod, drawing the cladded product to a finished diameter and heat treating as necessary depending on customer specifications. We believe the proprietary cladding process we employ differentiates us from our competitors by allowing us to offer superior product quality. Since 1991, Copperweld has had a worldwide exclusive license from Kabelmetal Electro GmbH (now Nexans Deutschland Industries GmbH & Co. KG) to certain of Nexans’ patents and proprietary manufacturing technology related to the production of bimetallic rods and wire, on which we rely to produce our products. The license was initially for a 15 year term, but in 2000 was extended for an additional 10 years through 2015 and, thereafter, automatically renews for successive one year periods unless either party fails to fulfill its obligations under the license. We pay a royalty to Nexans of 1.7% on the sales of CCA products for which the Nexan’s patents and technology are used. In addition, our research and development capabilities support the ongoing evolution of our products and the applications we can support.
Domain Names We own and operate websites, under the internet domain names www.fushiinternational.com, www.fushiinternational.cn, www.copperweld.com, www.copperweldbimetallic.com, and www.fushicopperweld.com. We pay an annual fee to maintain our registrations and for a service that identifies of any potential infringement on our domain names. The information contained on our website does not form part of this report.
As a global company we are subject to rules and regulations imposed by a wide range of countries and are diligent in maintaining an awareness of those rules. Our common stock is registered with the SEC and, therefore, we are subject to U.S. rules and regulations regarding our securities and disclosure requirements. Our headquarters and a major manufacturing facility are located in the PRC and as such, we are subject to various tax and business governance rules and regulations imposed by the PRC and its political subdivisions. We also have operations in Fayetteville, TN and are subject to various commercial and taxing regulations imposed by the US and Tennessee as well as local governments. Our UK operation is subject to rules and regulations applicable to businesses operating in Great Britain. Failure to comply with the various government regulations can have a negative impact on our company; therefore we are diligent in our compliance with these rules and regulations.
In addition, our common stock is traded on the NASDAQ stock exchange. NASDAQ, while not having the force of governmental regulations, imposes significant corporate governance and reporting rules where failure to follow its rules can have an adverse impact on the public’s perception of investing in our stock. If we fail to comply with NASDAQ corporate governance and listing requirements, we could be subject to delisting from the NASDAQ Global Market.
Backlog of Orders
Our business is characterized generally by short-term order and shipment schedules. Accordingly, we do not consider backlog at any given date to be indicative of future sales. Our backlog consists of product orders for which we have received a customer purchase order or purchase commitment and which have not yet been shipped. At March 12, 2010, our backlog of orders believed to be firm was $6.9 million compared with $3.4 million at March 13, 2009.
We are subject to environmental regulations that are generally applicable to manufacturing companies in the PRC, UK and in the US and we are subject to periodic inspection by environment regulators and must follow specific procedures in some of our processes. We do not have a record of violating environmental regulations or approved practices either in the PRC, UK or in the US.
As of December 31, 2009, we had approximately 526 employees worldwide. A majority of our employees are located outside of the United States in the People’s Republic of China and the United Kingdom. Of our employees, approximately 55.5% work in manufacturing. The remainder of employees includes engineers, sales and administrative personnel.
As a matter of Company policy, we seek to maintain good relations with our employees at all locations. We believe our relationship with our employees is good.
Our website ( www.fushicopperweld.com) contains frequent updated information about us and our operations. Our filings with the Securities and Exchange Commission (SEC) on Form 10-K, Form 10-Q, Form 8-K and Proxy Statements and all amendments to those reports can be viewed free of charge as soon as reasonably practicable after the reports and amendments are electronically filed with or furnished to the SEC by accessing www.fushicopperweld.com and clicking on Investor Relations and then clicking on Financial Reports and Filings. The SEC also maintains a website that contains reports, proxy statements and other information about issuers, such as us, who file electronically with the SEC. The address of that website is http://www.sec.gov. The information on that website is not a part of this report, except as otherwise stated herein. The registration statements, reports and other information so filed can be inspected and copied at the public reference facilities maintained by the SEC at 100 F Street, NE, Washington, D.C. 20549. You can request copies of these documents upon payment of a duplicating fee, by writing to the SEC. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference rooms.
Executive Officers of the Registrant
The following are our Executive Officers as of March 16, 2010.
The following is a description of the business experience for the last five years for each of the above named executive officers of our company:
Mr. Li Fu was appointed our Chairman and CEO on December 13, 2005. Since November 2009 Mr. Fu has served as our Co-Chief Executive Officer alongside Mr. Joseph Longever. Mr. Fu is a founder of Dalian Fushi and has been the Chief Executive Officer since the Company commenced operations in 2001. Mr. Fu graduated from the PLA University of Science and Technology with a degree in Engineering.
Mr. Joseph J. Longever> was appointed our Co-Chief Executive Officer on November 23, 2009. He served as Chief Commercial Officer of Fushi Copperweld from July 2009 to November 2009. Prior to Fushi Copperweld, ran an independent consulting service which he founded in 2007. From 1999 to 2007 he held various Senior Management, Sales, Marketing and operations within Copperweld, including Vice President and Chief Operations Officer. He has also served as Executive Vice President and General Manager at Crest Manufacturing Company; and held sales roles at Texas Instruments.
Mr. Wenbing Christopher Wang> has served as our President since January 21, 2008. He also served as our Chief Financial Officer from December 2005 to August 2009 and has served as our interim Chief Financial Officer since February 28, 2010. Prior to Fushi, Mr. Wang worked for Redwood Capital, Inc., China Century Investment Corporation, Credit Suisse First Boston and VCChina in various capacities. Fluent in both English and Chinese, Mr. Wang holds an MBA in Finance and Corporate Accounting from Simon Business School of University of Rochester. Mr. Wang also currently serves as a director of General Steel Holdings (NYSE: GSI), China Integrated Energy, Inc. (Nasdaq: CBEH) and Orient Paper, Inc. (NYSE Amex: ONP).
Mr. J. Dwight Berry >has served as our Executive Vice President and Chief Operating officer since February 11, 2009. Mr. Berry had served as our Vice President of Commercial Development since June 2008. Prior to Fushi, Mr. Berry served as Chief Operations Officer at Sure Electric, LLC from July 2007 to June 2008 and General Manager at Union Corrugating Company from March 2002 to May 2007.
ITEM 1A. RISK FACTORS
Risks Related to Our Business
Adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs, access to capital and cost of capital.
The capital and credit markets have been experiencing extreme volatility and disruption in recent months, including, among other things, extreme volatility in securities prices, severely diminished liquidity and credit availability, ratings downgrades of certain investments and declining valuations of others. Governments have taken unprecedented actions intended to address extreme market conditions that have included severely restricted credit and declines in real estate values. In some cases, the markets have exerted downward pressure on availability of liquidity and credit capacity for certain issuers. While currently these conditions have not impaired our ability to utilize our current credit facilities and finance our operations, there can be no assurance that there will not be a further deterioration in financial markets and confidence in major economies such that our ability to access credit markets and finance our operations might be impaired. Adverse market conditions may limit our ability to replace, in a timely manner, maturing liabilities and access the capital necessary to operate and grow our business. As such, we may be forced to delay raising capital or bear an unattractive cost of capital which could decrease our profitability and significantly reduce our financial flexibility. Demand for our products is vulnerable to economic downturns. The worsening of economic condition could result in a decrease in or cancellation of orders for our products. We are unable to predict the duration and severity of the current disruption in financial markets and the global adverse economic conditions and the effect such events might have on our business. Our results of operations, financial condition, cash flows and capital position could be materially adversely affected by disruptions in the financial markets. Further, any decreased collectability of accounts receivable or early termination of sales contracts due to the current deterioration in economic conditions could negatively impact our results of operations.
Quarterly operating results may fluctuate due to factors beyond our control, including customer demand and raw materials pricing.
Our quarterly results of operations may fluctuate as a result of a number of factors, including fluctuation in the demand for our products and changes in the price of copper, which directly affects the prices of our products and may influence demand. Quarter-to-quarter comparisons of results of operations have been and will be impacted by the volume of such orders and shipments. In addition, our operating results each quarter could be adversely affected by the following factors, among others, such as variations in the mix of product sales, price changes in response to competitive factors, increases in raw material costs and other significant costs, increases in utility costs (particularly electricity), various types of insurance coverage and interruptions in plant operations. Some uses of our products are subject to seasonality factors which can affect our quarter to quarter results as well.
Fluctuating copper prices impact our business and operating results.
The copper industry is highly volatile and cyclical in nature. Copper prices, which have increased over the past several years followed by more recent sharp declines, have varied significantly and may vary significantly in the future. This affects our business both positively and negatively. Since our products are a substitute for pure copper wire, higher copper prices increase demand for our products, while lower copper prices can decrease demand. Numerous factors influence copper price. These factors include general economic conditions, industry capacity utilization, import duties and other trade restrictions. We cannot predict copper prices in the future or the effect of fluctuations in the costs of copper on our future operating results. We mitigate the impact of changing raw material prices by attempting to pass changes in prices to our customers by adjusting prices at least monthly to reflect changes in raw material prices, as is customary in the industry. We may not be able to adjust our product prices rapidly enough in the short-term to recover the costs of increases in raw materials. Our future profitability may be adversely affected to the extent we are unable to pass on higher raw material costs to our customers.
We may encounter substantial competition in our business and our failure to compete effectively may adversely affect our ability to generate revenue.
The bimetallic industry is becoming increasingly competitive in China. The principal elements of competition in the bimetallic industry are, in our opinion, pricing, payment terms, product availability and quality. While we believe that we have attained a leadership position with respect to all of these factors, our major competitors with substantially greater resources than us may be better able to successfully endure downturns in our industrial sector. In periods of reduced demand for our products, we can either choose to maintain market share by reducing our selling prices to meet the competition or maintain selling prices, which may sacrifice market share. Sales and overall profitability would be reduced under either scenario. In addition, we cannot assure you that additional competitors will not enter our markets, or that we will be able to compete successfully against existing or new competition.
We may not be able to effectively control and manage our growth.
If our business and markets continue to grow and develop as we expect, it will be necessary for us to finance and manage expansion in an orderly fashion. We may face challenges in managing expanding product offerings and in integrating acquired businesses with our own. Such eventualities will increase demands on our existing management and facilities. Failure to manage this growth and expansion could interrupt or adversely affect our operations, cause production backlogs, longer product development time frames and administrative inefficiencies.
A significant portion of our sales are derived from a limited number of customers, and results from operations could be adversely affected and stockholder value harmed if we lose these customers.
Our revenue is dependent, in large part, on significant orders from a limited number of customers. Our top five customers represented 15.2%, 18.2%, and 24.6% of our net sales during the fiscal years ended December 31, 2009, 2008, and 2007, respectively. We believe that revenue derived from current and future large customers will continue to decline as we continue our efforts to diversify our business and reduce customer concentration, but will continue to represent a significant portion of our total revenue. Our inability to continue to secure and maintain a sufficient number of large customers could have a material adverse effect on our business, operating results and financial condition. Moreover, our success will depend in part upon our ability to obtain orders from new customers, as well as the financial condition and success of our customers and general economic conditions.
Shortages or disruptions in the availability of raw materials could have a material adverse effect on our business.
Aluminum and steel rods and copper strips, our principal raw materials, collectively accounted for approximately 85.0% of our costs of goods sold during the fiscal year ended December 31, 2009. We expect that raw materials will continue to account for a significant portion of our cost of goods sold in the future. The prices of raw materials fluctuate because of general economic conditions, global supply and demand and other factors causing monthly variations in the costs of our raw materials purchases. The macro-economic factors, together with labor and other business interruptions experienced by certain suppliers, have contributed to periodic shortages in the supply of raw materials, and such shortages may increase in the future. If we are unable to procure adequate supplies of raw material to meet our future production needs and customer demand, shortages could result in a material loss of customers and revenues and adversely impact our results of operations. In addition, supply shortages or disruptions or the loss of suppliers may cause us to procure our raw materials from less cost effective sources and may have a material adverse affect on our business, revenues and results of operations.
We depend on a few suppliers for a significant portion of our principal raw materials and we do not have any long-term supply contracts with our raw materials suppliers. Interruptions of production at our key suppliers may affect our results of operations and financial performance.
We rely on a limited number of suppliers for most of the raw materials we use. During the fiscal year ended December 31, 2009, purchase from our five largest suppliers of metal raw materials represented approximately 60% of our total raw material purchases. Purchases from our five largest suppliers of raw materials represented 65% and 38.6% in 2008 and 2007, respectively. Interruptions or shortages of supplies from our key suppliers of raw materials could disrupt production or impact our ability to increase production and sales. We do not have long-term or volume purchase agreements with most of our suppliers and we may have limited options in the short-term for alternative supply if these suppliers fail for any reason, including their business failure or financial difficulties, to continue the supply of materials or components. Moreover, identifying and accessing alternative sources may increase our costs. Interruptions at our key suppliers could negatively impact our results of operations, financial performance and the price of our common stock.
Due to increased volatility of raw material prices, the timing lag between the raw material purchase and product pricing can negatively impact our profitability.
Volatility in the prices of raw materials, among other factors, may adversely impact our ability to accurately forecast demand and may have a material adverse impact on our results of operations. For example, our manufacturing activities are determined, and raw materials purchases scheduled, upon forecasted demand while sales prices are determined at the time of order placement, subject to adjustment at fulfillment. The lag between the point when raw materials are acquired in advance and the point when products are actually priced may impact us both positively and negatively, resulting in increased or reduced profitability. In addition, we routinely maintain a certain level of finished goods inventories to meet near term expected demand. Pricing for the sale of these inventories is generally based on current raw material prices. Rapid declines in the price of raw materials may result in our inventories being carried at costs in excess of net realizable value and may have an adverse effect on our results of operations and the price of our common stock.
We rely on short-term financing from banks for our daily operation.
We rely on short-term borrowings to fund our financing needs. If we fail to achieve timely rollover, extension or refinancing of our short-term debt, we may be unable to meet our obligations in connection with debt service, accounts payable and/or other liabilities when they become due and payable. In China, short-term bank loans generally mature in one year or less and contain no specific renewal terms. However, it is customary practice for banks and borrowers to negotiate roll-overs or renewals of short-term borrowings on an on-going basis shortly before they mature. Although we have renewed our short-term borrowings in the past, we cannot assure you that we will be able to renew these loans in the future as they mature. If we are unable to obtain renewals of these loans or sufficient alternative funding on reasonable terms from banks or other parties, we will have to repay these borrowings with the cash on our balance sheet or cash generated by our future operations, if any. We cannot assure you that our business will generate sufficient cash flow from operations to repay these borrowings. In addition, we may be exposed to changes in interest rates. If interest rates increase substantially, our results of operations could be adversely affected.
Substantial defaults by our customers on accounts receivable could have a material adverse affect on our liquidity and results of operations.
A substantial portion of our working capital consists of accounts receivable from customers. If customers responsible for a significant amount of accounts receivable were to become insolvent or otherwise unable to pay for our products, or unable to make payments in a timely manner, our liquidity and results of operations could be materially adversely affected. An economic or industry downturn could materially adversely affect the servicing of these accounts receivable, which could result in longer payment cycles, increased collections costs and defaults in excess of management’s expectations. A significant deterioration in our ability to collect on accounts receivable could affect our cash flow and working capital position and could also impact the cost or availability of financing available to us.
We face manufacturing challenges due to difficulties in forecasting customer demand.
The volume and timing of sales to our customers may vary due to: variation in demand for our customers’ products; our customers’ attempts to manage their inventory; design changes; changes in our customers’ manufacturing strategy; and acquisitions of or consolidations among customers. Due in part to these factors, many of our customers do not commit to long-term production schedules. Our inability to forecast the level of customer orders with certainty makes it difficult to schedule production and maximize utilization of manufacturing capacity. Customers may cancel their orders, change production quantities or delay production for a number of reasons and such actions could negatively impact our operating results. In addition, we make significant operating decisions based on our estimate of customer requirements. The short-term nature of our customers’ commitments and the possibility of rapid changes in demand for their products reduce our ability to accurately estimate the future requirements of those customers.
If we fail to accurately project market demand for our products, our business expansion plan could be jeopardized and our financial condition and results of operations will suffer.
We plan to increase our annual manufacturing capacity and relocate unused capacity from Fayetteville, Tennessee to Dalian, China, to meet an expected increase in demand for our products in the Asia Pacific region. Our decision to increase our manufacturing capacity was based primarily on our projected increases in our sales volume and growth in the size of the bimetallic market in China. If actual customer orders are less than our projected market demand, we may suffer overcapacity problems and may have to leave capacity idle, which can reduce our overall profitability and hurt our financial condition and results of operations.
We may encounter problems associated with our global operations.
A significant portion of our operations consists of manufacturing and sales activities outside of PRC, primarily in the US. Our ability to sell our products and conduct our operations globally is subject to a number of risks. Local economic and political conditions in each country, as well as labor conditions in the US and the UK where we have facilities, could adversely affect demand for our products and services or disrupt our operations in these markets. We may also experience reduced intellectual property protection or longer and more challenging collection cycles as a result of different customary business practices in certain countries where we do business. Additionally, we face the following risks:
Copperweld’s ability to sustain profitability is uncertain.
Prior to acquiring Copperweld, it incurred losses for the entire time it operated as a stand-alone business. Copperweld’s ability to generate sufficient revenues and make profits is dependent in large part on its ability to move more value-added production in house, control manufacturing related costs, manage its growth related expenses, make additional capital expenditures, expand its customer base, increase sales of its current products to existing customers, enter into additional supply arrangements and manage its working capital and other financial resources. Although we have implemented cost reduction initiatives at Copperweld, which resulted in profit of $0.4 million at the operating income level and $0.2 million of net income in the third quarter 2009, we cannot provide any assurance that improved profitability can continue and be sustained at Copperweld in the amounts or during the periods expected.
We face risks associated with future investments or acquisitions.
An important element of our growth strategy is to invest in or acquire businesses that will enable us, among other things, to expand our manufacturing capacity and the products we offer. However, we may be unable to identify suitable investment or acquisition candidates or may be unable to make these investments or acquisitions on commercially reasonable terms, if at all.
If we complete an investment or acquisition, we may not realize the anticipated benefits from the transaction. Integrating an acquired business is distracting and time consuming, as well as a potentially expensive process. The successful integration of any acquired businesses requires us to:
Geographic distance between business operations, the compatibility of the technologies and operations being integrated and the disparate corporate cultures being combined also present significant challenges. Acquired businesses are likely to have different standards, controls, contracts, procedures and policies, making it more difficult to implement and harmonize company-wide financial, accounting, billing, information and other systems. Our focus on integrating operations may also distract attention from our day-to-day business and may disrupt key research and development, marketing or sales efforts. If we cannot overcome these challenges, we may not realize actual benefits from future acquisitions, which will impair our overall business results.
Our inability or failure to protect our intellectual property rights may significantly and materially impact our business, financial condition and results of operations.
Protection of our proprietary processes, methods and other technology is important to our business. We generally rely on a combination of the patent, trade secret, trademark and copyright laws of the PRC, U.S. and certain other countries in which our products are produced or sold, as well as licenses and nondisclosure and confidentiality agreements, to protect our intellectual property rights. The patent, trademark, copyright and trade secret laws of some countries, though, including the PRC, may not protect our intellectual property rights to the same extent as the laws of the U.S.
Failure to protect our intellectual property rights may result in the loss of valuable proprietary technologies. Additionally, some of our technologies are not covered by any patent or patent application and, even if a patent application has been filed, it may not result in an issued patent. If patents are issued to us, those patents may not provide meaningful protection against competitors or against competitive technologies. In addition, upon the expiration of patents issued to us, we will be unable to prevent our competitors from using or introducing products using the formerly-patented technology. As a result, we may be faced with increased competition and our results of operations may be adversely affected. We cannot assure you that our intellectual property rights will not be challenged, invalidated, circumvented or rendered unenforceable.
We also rely upon unpatented proprietary manufacturing expertise, continuing technological innovation and other trade secrets to develop and maintain our competitive position. While we generally enter into confidentiality/non-disclosure agreements with our employees and third parties to protect our intellectual property, we cannot assure you that our confidentiality/non-disclosure agreements will not be breached, that they will provide meaningful protection for our trade secrets and proprietary manufacturing expertise or that adequate remedies will be available in the event of an unauthorized use or disclosure of our trade secrets or manufacturing expertise.
Our intellectual property rights may be challenged or infringed upon by third parties or we may be unable to maintain, renew or enter into new license agreements that are important to our business with third-party owners of intellectual property on reasonable terms. We could also face patent infringement claims from our competitors or others alleging that our processes or products infringe on their proprietary technologies. If we are found to be infringing on the proprietary technology of others, we may be liable for damages, and we may be required to change our processes, to redesign our products partially or completely, to pay to use the technology of others or to stop using certain technologies or producing the infringing product(s) entirely. Even if we ultimately prevail in an infringement suit, the existence of the suit could prompt customers to switch to products that are not the subject of infringement suits. We may not prevail in any intellectual property litigation and such litigation may result in significant legal costs or otherwise impede our ability to produce and distribute key products.
We rely on an exclusive third-party license agreement for patents and technology related to our products, and the termination or material impairment of our rights under that agreement could impede or prevent us from being able to produce or commercialize our products, significantly impacting our competitive position, sales, revenue and growth strategy.
A substantial portion of our business is dependent on a worldwide exclusive license of certain patents and technology related to the production of bimetallic rods and wire from kabelmetal electro GmbH (now Nexans Deutschland Industries GmbH & Co. KG) (“Nexans”), dated June 6, 1991 and subsequently amended. This license imposes certain obligations upon us, including an obligation to make royalty payments to Nexans on certain sales of licensed products. If we fail to fulfill one or more of our obligations under this agreement, and do not adequately cure the breach in a timely manner, or we and Nexans otherwise become involved in a dispute, the breach or dispute could result in the termination of, or could otherwise have a material adverse impact on, our rights under the Nexans license agreement. While we would expect to exercise all rights and remedies available to us, including seeking to timely cure any breach, resolve any dispute, and otherwise seek to preserve our rights under the Nexans patents and technology, we may not be able to do so in a timely manner, at an acceptable cost or at all. If our rights under the Nexans license agreement are terminated or materially impaired, we may not be able to develop similar alternative technology or to negotiate a new license agreement for similar technology with another licensor on reasonable terms or at all. Upon the expiration of any of the Nexans patents exclusively licensed to us, we will be unable to prevent our competitors from using or introducing products using the formerly-patented technology. As a result, we may be faced with increased competition. If we fail to develop and successfully launch new products or more advanced replacement products prior to the expiration of the Nexans patents exclusively licensed to us, our results of operations may be adversely affected. In such event, the quality of our products may suffer, our competitive advantage in the market may be significantly diminished, our revenue may significantly decrease and we may not be able to develop or maintain our customer and strategic relationships.
Potential environmental liability could have a material adverse effect on our operations and financial condition.
As a manufacturer, we are subject to various Chinese environmental laws and regulations on air emission, waste water discharge, solid wastes and noise. Although we believe that our operations are in substantial compliance with current environmental laws and regulations, we may not be able to comply with these regulations at all times as the Chinese environmental legal regime is evolving and becoming more stringent. Therefore, if the Chinese government imposes more stringent regulations in the future, we will have to incur additional and potentially substantial costs and expenses in order to comply with new regulations, which may negatively affect our results of operations. If we fail to comply with any of the present or future environmental regulations in any material aspects, we may suffer from negative publicity and may be required to pay substantial fines, suspend or even cease operations.
Regulations promulgated by the US government, the State of Tennessee and local authorities impose environmental rules and regulations on our Fayetteville operation. Our Fayetteville plant is subject to regular reporting to and inspections by local, state and federal authorities. To date, inspections have not found our Fayetteville plant in violation of any rules or regulations. We believe that we comply in all material respects with the environmental rules imposed on our Fayetteville plant. Our internal procedures require regular monitoring of our processes to assure that we do not violate environmental standards. Failure to comply with Chinese or US environmental laws and regulations may materially and adversely affect our business, financial condition and results of operations.
We do not presently maintain product liability insurance in the PRC, and our property and equipment insurance does not cover the full value of our property and equipment, which leaves us with exposure in the event of loss or damage to our properties or claims filed against us.
We currently do not carry any product liability or other similar insurance in China. We cannot assure you that we would not face liability in the event of the failure of any of our products. This is particularly true given our plan to significantly expand our sales into international markets, like the United States, where product liability claims are more prevalent. We carry product liability insurance for our Fayetteville operations but we have no assurance that the coverage would be sufficient in the event of a claim.
We have purchased automobile insurance with third party liability coverage for our vehicles. In addition, we have purchased property insurance from China United Property Insurance Company to cover real property and plant. Except for property and automobile insurance, we do not have other insurance such as business liability or disruption insurance coverage for our operations in the PRC. In the event of a significant product liability claim or other uninsured event, our financial results and the price of our common stock may be adversely affected. Likewise, we maintain casualty insurance for our plant and equipment in Fayetteville and Telford; however, we cannot assure you that the coverage would be sufficient to replace our equipment in the event of a catastrophe.
We do not maintain a reserve fund for warranty or defective products claims. Our costs could substantially increase if we experience a significant number of warranty claims.
Our product warranties against technical defects of our copper-clad products wires vary, depending on our purchase orders with customers. The warranties require us to replace defective components and pay for the losses customers incur from defective products or a certain percentage of the purchase price as liquidated damages for our failure to meet the specified product specifications and packaging requirements in the purchase orders. We have not established any reserve funds for potential warranty claims since historically we have experienced few warranty claims for our products so that the costs associated with our warranty claims have been low. If we experience an increase in warranty claims or if our repair and replacement costs associated with warranty claims increase significantly, it would have a material adverse effect on our financial condition and results of operations.
We could suffer significant business interruptions.
Our operations and those of our suppliers may be vulnerable to interruption by natural disasters such as the earthquake experienced in Sichuan province of China in May 2008, or other disasters such as fires, explosions, acts of terrorism or war, or government imposed restriction or reduction on industrial manufacturing activities such as the one during the Olympics from August to September 2008. If a business interruption occurs, our business could be materially and adversely affected.
Previously, we were not in compliance with certain financial covenants in our Financing Agreement with Wells Fargo.
For both quarters ended on June 30, 2009 and March 31, 2009, Copperweld reported a negative fixed charge ratio due to the loss incurred on a rolling 12 months basis, and as a result was in violation of maintaining a fixed charge ratio of at least 1.0 to 1.0 under the financing agreement with Wells Fargo. This was the sole violation of the covenants under the terms of the revolving line of credit agreement with Wells Fargo. As of December 31, 2009, we had approximately $4.0 million in borrowings outstanding under the line of credit. The default did not result in any cross defaults under our other existing debt, however, on May 6, 2009, Wells Fargo exercised its right to implement a 2% additional default rate of interest effective April 1, 2009 for the March 31 covenant violation. Although Wells Fargo had the right to accelerate the amounts outstanding they did not exercise such right and on August 11, 2009 we entered into a Forbearance Agreement with them which expired on October 31, 2009. Prior to the expiration on October 27, 2009, we entered into an amendment to the Forbearance Agreement which extends the forbearance period to January 31, 2010. As of February 2, 2010 we paid off all amounts outstanding under the revolving line of credit and closed such line.
Risks Related to Doing Business in the PRC
Changes in the policies of the PRC government could have a significant impact upon the business we may be able to conduct in the PRC and the profitability of that business.
The PRC’s economy is in a transition from a planned economy to a market oriented economy subject to five-year and annual plans adopted by the government that set national economic development goals. Policies of the PRC government can have significant effects on the economic conditions of the PRC. The PRC government has confirmed that economic development will follow the model of a market economy, such as the United States. Under this direction, we believe that the PRC will continue to strengthen its economic and trading relationships with foreign countries and business development in the PRC will follow market forces. While we believe that this trend will continue, we cannot assure you that this will be the case. Our interests may be adversely affected by changes in policies by the PRC government, including:
Although the PRC government has been pursuing economic reform policies for more than two decades, we cannot assure you that the government will continue to pursue such policies or that such policies may not be significantly altered, especially in the event of a change in leadership, social or political disruption, or other circumstances affecting the PRC’s political, economic and social life.
The PRC laws and regulations governing our current business operations are sometimes vague and uncertain. Any changes in such PRC laws and regulations may have a material and adverse effect on our business.
There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including but not limited to the laws and regulations governing our business, or the enforcement and performance of our arrangements with customers in the event of the imposition of statutory liens, death, bankruptcy and criminal proceedings. We and any future subsidiaries are considered foreign persons or foreign funded enterprises under PRC laws, and as a result, we are required to comply with PRC laws and regulations. These laws and regulations are sometimes vague and may be subject to future changes, and their official interpretation and enforcement may involve substantial uncertainty. The effectiveness of newly enacted laws, regulations or amendments may be delayed, resulting in detrimental reliance by foreign investors. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively. We cannot predict what effect the interpretation of existing or new PRC laws or regulations may have on our businesses.
A slowdown or other adverse developments in the PRC economy may materially and adversely affect our customers, demand for our products and our business.
A majority of our operations are conducted in the PRC and more than 80% of our net sales for 2009 were generated from sales in the PRC. Although the PRC economy has grown significantly in recent years, we cannot assure you that such growth will continue. The bimetallic wire industry in the PRC is growing, but we do not know how sensitive we are to a slowdown in economic growth or other adverse changes in the PRC economy which may affect demand for our products. With the addition of Copperweld we are now exposed to global economic conditions. In the future, a slowdown in overall economic growth, an economic downturn or recession or other adverse economic developments globally or in a large segment of the world could have adverse economic developments and may materially and adversely affect our business.
Recently announced tightened controls on the convertibility of RMB into foreign currency have made it more difficult to make payments in U.S. dollars and fund business and operating activities of our subsidiaries located outside of China.
Substantially all of the cash on our balance sheet is in RMB. Tightened restrictions on currency exchanges has considerably limited our ability to convert our cash in RMB to make payments in U.S. dollars or fund business and operating activities of our subsidiaries located outside of China, which has had the most significant impact on our ability to support Copperweld’s operations in Fayetteville, TN. Although as of December 31, 2009, our PRC subsidiaries could legally pay approximately $127.0 million in dividends, our PRC subsidiaries have never paid dividends to our non-PRC subsidiaries and parent company and do not intend to do so for the foreseeable future. Historically, our Dalian subsidiary has provided financial support to our non-PRC subsidiaries and our parent company to meet their cash requirements by transferring its operation fund to those entities. The transfer of operation funds from Dalian to our non- PRC subsidiaries and parent company during 2009 was $21.3 million. Although the PRC government introduced regulations in 1996 to allow greater convertibility of RMB for current account transactions, significant restrictions still remain, including primarily the restriction that foreign-invested enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business after providing valid commercial documents. In addition, remittance of foreign currencies abroad and conversion of RMB for capital account items, including direct investment and loans, is subject to the approval of the PRC State Administration for Foreign Exchange, or SAFE, and other relevant authorities, and companies are required to open and maintain separate foreign exchange accounts for capital account items. As an example, in the first quarter of 2009 the new SAFE restrictions caused a delay in our ability to convert and provide intercompany loans to our US subsidiary to pay interest on our HY Notes and Convertible Notes that were outstanding at the time. As a result, we raised capital from outside sources to allow for such payments to be made through Copperweld. We cannot assure you that the Chinese regulatory authorities will not impose new or more stringent restrictions on the convertibility of RMB, especially with respect to foreign exchange transactions. Any adverse actions by SAFE could affect our ability to get cash, by means of loans or capital contributions, to our parent company and our non-PRC subsidiaries in order to fund operations.
The fluctuation of the Renminbi may materially and adversely affect your investment.
The value of the Renminbi against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in the PRC’s political and economic conditions. Since a significant portion of our revenues are earned in the PRC, any significant revaluation of the Renminbi may materially and adversely affect our cash flows, revenues and financial condition. For example, to the extent that we need to convert U.S. dollars we receive from an offering of our securities into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar could have a material adverse effect on our business, financial condition and results of operations. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our common stock or for other business purposes and the U.S. dollar appreciates against the Renminbi the U.S. dollar equivalent of the we convert would be reduced. In addition, the depreciation of significant U.S. dollar denominated assets could result in a charge to our income statement and a reduction in the value of these assets.
On July 21, 2005, the PRC government changed its policy of tying the value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in a continuous appreciation of the Renminbi against the U.S. dollar. While the international reaction to the Renminbi revaluation generally has been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the Renminbi against the U.S. dollar.
The following table sets forth information concerning exchange rates between the RMB and the U.S. dollar for the periods indicated. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this presentation or will use in the preparation of our periodic reports or any other information to be provided to you. The source of these rates is the Federal Reserve Bank of New York.
If preferential tax concessions granted by the PRC government are changed or expire, our financial results and results of operations would be materially and adversely affected.
Our results of operation may be adversely affected by changes to, or expiration of, preferential tax concessions that our subsidiaries in the PRC currently enjoy. The statutory tax rate generally applicable to domestic PRC companies is 25% per the newly adopted PRC corporate income tax law which came into effect since January 1, 2008. Our subsidiaries, Fushi International (Dalian) as a Wholly Foreign Owned Enterprise, or WFOE, and Dalian Fushi as a “new or high-technology enterprise” located in Economic Development Zone of the Dalian City, have been subject to tax exemptions or relatively low tax rates and continue to enjoy their former preferential tax treatments until such treatments expire in accordance with their current terms. The estimated tax savings for the year ended December 31, 2009 without preferential tax treatment amounted to approximately $5.3 million.
Tax laws in China are subject to interpretation by local tax authorities. Our preferential tax treatment may not remain in effect, or may change, in which case we may be required to pay the higher income tax rate generally applicable to Chinese companies, or such other rate as is required by the laws of China.
Recent PRC regulations relating to acquisitions of PRC companies by foreign entities may create regulatory uncertainties that could restrict or limit our ability to operate. Our failure to obtain the prior approval of the China Securities Regulatory Commission, or the CSRC, for the listing and trading of our common stock could have a material adverse effect on our business, operating results, reputation and trading price of our common stock, and may also create uncertainties in the future.
The PRC State Administration of Foreign Exchange, or “SAFE,” issued a public notice in November 2005, known as Circular 75, concerning the use of offshore holding companies in mergers and acquisitions in China. The public notice provides that if an offshore company controlled by PRC residents intends to acquire a PRC company, such acquisition will be subject to registration with the relevant foreign exchange authorities. The public notice also suggests that registration with the relevant foreign exchange authorities is required for any sale or transfer by the PRC residents of shares in an offshore holding company that owns an onshore company. The PRC residents must each submit a registration form to the local SAFE branch with respect to their ownership interests in the offshore company, and must also file an amendment to such registration if the offshore company experiences material events, such as changes in the share capital, share transfer, mergers and acquisitions, spin-off transactions or use of assets in China to guarantee offshore obligations.
On August 8, 2006, the PRC Ministry of Commerce (“MOFCOM”), joined by the State-owned Assets Supervision and Administration Commission of the State Council, the State Administration of Taxation, the State Administration for Industry and Commerce, the China Securities Regulatory Commission and SAFE, released a substantially amended version of the Provisions for Foreign Investors to Merge with or Acquire Domestic Enterprises (the “Revised M&A Regulations”), which took effect September 8, 2006. These new rules significantly revised China’s regulatory framework governing onshore-to-offshore restructurings and foreign acquisitions of domestic enterprises. These new rules signify greater PRC government attention to cross-border merger, acquisition and other investment activities, by confirming MOFCOM as a key regulator for issues related to mergers and acquisitions in China and requiring MOFCOM approval of a broad range of merger, acquisition and investment transactions. Further, the new rules establish reporting requirements for acquisition of control by foreigners of companies in key industries, and reinforce the ability of the Chinese government to monitor and prohibit foreign control transactions in key industries.
Among other things, the revised M&A Regulations include new provisions that purport to require that an offshore special purpose vehicle, or SPV, formed for listing purposes and controlled directly or indirectly by PRC companies or individuals must obtain the approval of the CSRC prior to the listing and trading of such SPV’s securities on an overseas stock exchange. On September 21, 2006, the CSRC published on its official website procedures specifying documents and materials required to be submitted to it by SPVs seeking CSRC approval of their overseas listings. However, the application of this PRC regulation remains unclear with no consensus currently existing among the leading PRC law firms regarding the scope and applicability of the CSRC approval requirement. Our PRC counsel, Dacheng Law Firm, has advised us that because we completed our onshore-to-offshore restructuring before September 8, 2006, the effective date of the new regulation, it is not necessary for us to submit the application to the CSRC for its approval, and the listing and trading of our common stock does not require CSRC approval.
If the CSRC or another PRC regulatory agency subsequently determines that CSRC approval was required for our restructuring, we may face regulatory actions or other sanctions from the CSRC or other PRC regulatory agencies. These regulatory agencies may impose fines and penalties on our operations in the PRC, limit our operating privileges in the PRC, or take other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our Common Stock.
Also, if later the CSRC requires that we obtain its approval, we may be unable to obtain a waiver of the CSRC approval requirements, if and when procedures are established to obtain such a waiver. Any uncertainties and/or negative publicity regarding this CSRC approval requirement could have a material adverse effect on the trading price of our common stock. Furthermore, published news reports in China recently indicated that the CSRC may have curtailed or suspended overseas listings for Chinese private companies.
It is uncertain how our business operations or future strategy will be affected by the interpretations and implementation of Circular 75 and the Revised M&A Regulations. It is anticipated that application of the new rules will be subject to significant administrative interpretation, and we will need to closely monitor how MOFCOM and other ministries apply the rules to ensure that our domestic and offshore activities continue to comply with PRC law. Given the uncertainties regarding interpretation and application of the new rules, we may need to expend significant time and resources to maintain compliance.
If we make equity compensation grants to persons who are PRC citizens, they may be required to register with SAFE. We may also face regulatory uncertainties that could restrict our ability to adopt additional equity compensation plans for our directors and employees and other parties under PRC law.
On April 6, 2007, SAFE issued the “Operating Procedures for Administration of Domestic Individuals Participating in the Employee Stock Ownership Plan or Stock Option Plan of An Overseas Listed Company, also known as “Circular 78.” It is not clear whether Circular 78 covers all forms of equity compensation plans or only those which provide for the granting of stock options. For any plans which are so covered and are adopted by a non-PRC listed company, such as our company, after April 6, 2007, Circular 78 requires all participants who are PRC citizens to register with and obtain approvals from SAFE prior to their participation in the plan. In addition, Circular 78 also requires PRC citizens to register with SAFE and make the necessary applications and filings if they participated in an overseas listed company’s covered equity compensation plan prior to April 6, 2007. We believe that the registration and approval requirements contemplated in Circular 78 will be burdensome and time consuming.
We intend to make numerous stock option grants under our equity incentive plan to our officers and directors, some of whom are PRC citizens and may be required to register with SAFE. In addition to our officers and directors that received option grants, future participants of our equity incentive plan or any other equity compensation plan we may adopt who are PRC citizens may be required to register with SAFE. If it is determined that any of our equity compensation plans are subject to Circular 78, failure to comply with such provisions may subject us and participants of our equity incentive plan who are PRC citizens to fines and legal sanctions and prevent us from being able to grant equity compensation to our PRC employees. In that case, our business operations may be adversely affected.
Provisions of the Nevada Revised Statutes may discourage a change of control.
We are incorporated in Nevada. Certain provisions of the Nevada Revised Statutes, or NRS, could delay or make more difficult a change of control transaction or other business combination that may be beneficial to stockholders. We are subject to Nevada’s “Combinations With Interested Stockholders” statutes (NRS Sections 78.411 through 78.444), which provide that specified persons who, together with affiliates and associates, own, or within three years did own, 10% or more of the outstanding voting stock of a Nevada corporation with at least 200 stockholders cannot engage in specified business combinations with the corporation for a period of three years after the date on which the person became an interested stockholder, unless the combination or the transaction by which the person first became an interested stockholder is approved by the corporation’s Board of Directors before the person first became an interested stockholder.
Nevada’s “Acquisition of Controlling Interest” statutes (NRS Sections 78.378 – 78.3793) apply only to Nevada corporations with at least 200 stockholders, including at least 100 stockholders of record who are Nevada residents, and which conduct business directly or indirectly in Nevada. As of the date of this prospectus, we do not believe we have 100 stockholders of record who are residents of Nevada, although there can be no assurance that in the future the “Acquisition of Controlling Interest” statutes will not apply to us. The “Acquisition of Controlling Interest” statutes provide that persons who acquire a “controlling interest”, as defined in NRS Section 78.3785, in a company may only be given full voting rights in their shares if such rights are conferred by the disinterested stockholders of the company at an annual or special meeting. However, any disinterested stockholder that does not vote in favor of granting such voting rights is entitled to demand that the company pay fair value for their shares, if the acquiring person has acquired at least a majority of all of the voting power of the company. As such, persons acquiring a controlling interest may not be able to vote their shares.
Our ability to realize our deferred tax assets may be reduced if our estimates of future taxable income and tax planning strategies do not support the carrying amount, and the value of net operating loss carryforwards may be reduced if sales of our securities result in an “ownership change” as defined for U.S. federal income tax purposes.
As of December 31, 2009, we had deferred tax assets of $14.3 million. These and future deferred tax assets may be reduced if our estimates of future taxable income from our operations and tax planning strategies do not support the amount of the deferred tax assets.
It is possible that the value of our net operating loss (“NOL”) carryforwards realizable for income tax purposes be reduced. Section 382 of the Internal Revenue Code imposes restrictions on the use of a corporation’s NOLs, as well as certain recognized built-in losses and other carryforwards, after an “ownership change” occurs. A Section 382 “ownership change” occurs if one or more stockholders or groups of stockholders who own at least 5% of our stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. Although such “ownership change” does not currently exist, other future issuances or sales of our stock (including certain transactions involving our stock that are outside of our control) could also result in an ownership change under Section 382. If an “ownership change” occurs, Section 382 would impose an annual limit on the amount of pre-change NOLs and other losses we can use to reduce our taxable income generally equal to the product of the total value of our outstanding equity immediately prior to the “ownership change” (subject to certain adjustments) and the applicable federal long-term tax-exempt interest rate for the month of the “ownership change.”
Because U.S. federal net operating losses generally may be carried forward for up to 20 years, the annual limitation may effectively provide a cap on the cumulative amount of pre-ownership change losses, including certain recognized built-in losses that may be utilized. Such pre-ownership change losses in excess of the cap may be lost. In addition, if an ownership change were to occur, it is possible that the limitations imposed on our ability to use pre-ownership change losses and certain recognized built-in losses could cause a net increase in our U.S. federal income tax liability and U.S. federal income taxes to be paid earlier than otherwise would be paid if such limitations were not in effect. Further, if the amount or value of these deferred tax assets is reduced, such reduction would have a negative impact on the book value of our common stock.
The PRC State Administration of Foreign Exchange, or SAFE, requires PRC residents to register with, or obtain approval from, SAFE regarding their direct or indirect offshore investment activities.
PRC State Administration of Foreign Exchange Regulations regarding offshore financing activities by PRC residents have undertaken continuous changes which may increase the administrative burden we face and create regulatory uncertainties that could adversely affect the implementation of our acquisition strategy, and a failure by our shareholders who are PRC residents to make any required applications and filings pursuant to such regulations may prevent us from being able to distribute profits and could expose us and our PRC resident shareholders to liability under PRC law.
We will not be able to complete an acquisition of prospective acquisition targets in the PRC unless their financial statements are able to be reconciled to U.S. generally accepted accounting principles in a timely manner.
Companies based in the PRC may not have properly kept financial books and records that may be reconciled with U.S. generally accepted accounting principles. If we attempt to acquire a significant PRC target company and/or its assets, we would be required to obtain or prepare financial statements of the target that are prepared in accordance with and reconciled to U.S. generally accepted accounting principles. Federal securities laws require that a business combination meeting certain financial significance tests require the public acquirer to prepare and file historical and/or pro forma financial statement disclosure with the SEC. These financial statements must be prepared in accordance with, or be reconciled to U.S. generally accepted accounting principles and the historical financial statements must be audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), or PCAOB. If a proposed acquisition target does not have financial statements that have been prepared in accordance with, or that can be reconciled to, U.S. generally accepted accounting principles and audited in accordance with the standards of the PCAOB, we will not be able to acquire that proposed acquisition target. These financial statement requirements may limit the pool of potential acquisition targets with which we may acquire and hinder our ability to expand our operations. Furthermore, if we consummate an acquisition and are unable to timely file audited financial statements and/or pro forma financial information required by the Federal securities laws, we will be ineligible to use the SEC’s short-form registration statement on Form S-3 to raise capital, if we are otherwise eligible at the time. If we are ineligible to use a Form S-3, the process of raising capital may be more expensive and time consuming and the terms of any offering transaction may not be as favorable as they would have been if we were eligible to use Form S-3.
Any recurrence of severe acute respiratory syndrome, or SARS, or another widespread public health problem, could adversely affect our operations.
A renewed outbreak of SARS or another widespread public health problem in the PRC, where a substantial portion of our revenue is derived, could have an adverse effect on our operations. Our operations may be impacted by a number of health-related factors, including quarantines or closures of some of our offices that could leave us without many employees to conduct our business which would materially and adversely affect our operations and financial condition.
We may have difficulty establishing adequate management, legal and financial controls in the PRC.
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. In addition, we may have difficulty in hiring and retaining a sufficient number of qualified employees to work in the PRC. As a result of these factors, we may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet Western standards. Therefore, we may, in turn, experience difficulties in implementing and maintaining adequate internal controls as required under Section 404 of the Sarbanes-Oxley Act of 2002. This may result in significant deficiencies or material weaknesses in our internal controls which could impact the reliability of our financial statements and prevent us from complying with SEC rules and regulations and the requirements of the Sarbanes-Oxley Act of 2002. For example, for the year ended December 31, 2008, management concluded that our internal controls over financial reporting were ineffective due to a material weakness, which related primarily to management not adhering to controls as designed and a significant deficiency, which related to untimely booking of assets. Although we remedied these issues during the second quarter of 2009, any such deficiencies, weaknesses or lack of compliance in the future could have a materially adverse effect on our business.
Risks Related to an Investment in Our Common Stock
Our existing shareholders have substantial influence over our company and their interests may not be aligned with the interests of our other shareholders.
Mr. Li Fu, our founder, chief executive officer and chairman of our board of directors, beneficially owns approximately 29.5% of our outstanding share capital as of March 11, 2010. As such, Mr. Fu has substantial influence over our business, including decisions regarding mergers, consolidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. This concentration of ownership may discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our stock. These actions may be taken even if they are opposed by our other shareholders.
The payment of dividends to Fushi Copperweld from our subsidiaries is subject to legal and other contractual limitations. As a result we may not be able to pay dividends to our stockholders.
We conduct all of our business through our consolidated subsidiaries and affiliated companies, which are located in the PRC, the US and in the UK. Under PRC law, the payment of dividends by entities established in the PRC is subject to limitations. Regulations in the PRC currently permit payment of dividends only out of accumulated profits as determined in accordance with accounting standards and regulations in the PRC, subject to certain statutory procedural requirements. Each of our PRC subsidiaries, including each wholly foreign owned enterprise, is also required to set aside at least 10.0% of their after-tax profit based on PRC accounting standards each year to their general reserves or statutory reserve fund until the aggregate amount of such reserves reaches 50.0% of their respective registered capital. Our statutory reserves are not distributable as loans, advances or cash dividends. In addition, if any of our PRC subsidiaries incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us. In addition, Copperweld’s Limited Liability Company Agreement provides for certain restrictions on distributions, in accordance with applicable law and agreements to which Copperweld may be a party. Any limitations on the ability of our subsidiaries to transfer funds to us could materially adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.
We are unlikely to pay cash dividends in the foreseeable future.
We currently intend to retain any future earnings for use in the operation and expansion of our business. We do not expect to pay cash dividends in the foreseeable future but will review this policy as circumstances dictate. Should we decide in the future to do so, as a holding company, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries.
Future issuances of our common stock in the public market or the issuance of securities senior to our common stock could adversely affect the trading price of our common stock.
Sales by us or our stockholders of a substantial number of shares of our common stock in the public markets, or the perception that these sales might occur, could cause the market price of our common stock to decline or could impair our ability to raise capital through a future sale of, or pay for acquisitions using, our equity securities.
We may issue common stock or equity securities senior to our common stock in the future for a number of reasons, including to finance our operations and growth plans, to adjust our ratio of debt-to-equity, to satisfy our obligations upon the exercise of options, or for other reasons, and to satisfy our funding obligations to our pension plans. We cannot predict the effect, if any, that future sales or issuance of shares of our common stock or other equity securities, or the availability of shares of common stock or such other equity securities for future sale or issuance, will have on the trading price of our common stock.
The price of our common stock may fluctuate significantly, which could negatively affect us and holders of our common stock.
The trading price of our common stock may fluctuate significantly in response to a number of factors, many of which are beyond our control. For instance, if our financial results are below the expectations of securities analysts and investors, the market price of our common stock could decrease, perhaps significantly. Other factors that may affect the market price of our common stock include announcements relating to significant corporate transactions; fluctuations in our quarterly and annual financial results; operating and stock price performance of companies that investors deem comparable to us; and changes in government regulation or proposals relating to us. In addition, the U.S. securities markets have experienced significant price and volume fluctuations. These fluctuations often have been unrelated to the operating performance of companies in these markets. Market fluctuations and broad market, economic and industry factors may negatively affect the price of our common stock, regardless of our operating performance. Any volatility or a significant decrease in the market price of our common stock could also negatively affect our ability to make acquisitions using common stock. Further, if we were to be the object of securities class action litigation as a result of volatility in our common stock price or for other reasons, it could result in substantial costs and diversion of our management’s attention and resources, which could negatively affect our financial results.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth our selected consolidated financial data for the years ended December 31, 2009, 2008, 2007, 2006 and 2005. You should read the following table in conjunction with the consolidated financial statements and related notes contained elsewhere in the report on Form 10-K. Operating results for any year are not necessarily indicative of results for any future periods.
Factors that impact the comparability of revenues for the years presented include:
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements and the notes to those financial statements appearing elsewhere in this Form 10-K. This discussion contains forward-looking statements that involve significant risks and uncertainties. As a result of many factors, such as those set forth under “Forward Looking Statements” and “Item 1A. Risk Factors” and elsewhere in this Form 10-K, our actual results may differ materially from those anticipated in these forward-looking statements.
We believe we are one of the world’s largest producers, based on manufacturing capacity, and a leading innovator of bimetallic wire products, principally copper-clad aluminum, or CCA, and copper-clad steel, or CCS, products. CCA and CCS conductors are generally used as a substitute for solid copper conductors in applications for which either cost savings or specific electrical or physical attributes are necessary. Relative to solid copper wire, our customized, engineered bimetallic wire products significantly reduce the amount of copper metal required to manufacture a conductor, and because copper is expensive relative to aluminum and steel, our products significantly reduce conductor cost per unit length. In fiscal year 2009, our products were sold to over 536 customers in 37 countries. We market our products under the trademarked names of “Copperweld®” and “Fushi TM ”, and sell either directly to cable manufacturers or through distributors or sales agents to end-users.
Although we are engaged in one line of business, as a result of the differing markets primarily served by each of our manufacturing facilities and significant differences in the operating results among each of our facilities, starting with the second fiscal quarter of 2009, we began to analyze our worldwide operations based on two geographic reportable segments: 1) “PRC” which consists of our facilities located in Dalian, Liaoning, the People’s Republic of China (PRC) and 2) “US” which consists of our Fayetteville, Tennessee, (USA), and Telford, England, (UK) facilities. We have combined our U.S. and U.K. operations as one segment since the UK is a subsidiary of the US operating company and is under the direction of our U.S. segment manager. Further, the nature of our products, services and production processes at our U.S. and U.K. facilities, along with the customer base, methods to distribute products and services are nearly identical.
We believe we have a strong market position in all markets in which we compete due to the quality of our products, geographic and customer diversity and our ability to deliver superior products while operating as a low cost provider. As a result, we believe we are now one of the leading producers of bimetallic wire products in the world and are one of the market leaders in North America, Europe, North Africa, the Middle East and the People’s Republic of China. We continue to expand within current and developing markets and create shareholder value by:
To accomplish these goals, we are focused on continuously improving operational efficiency in areas we view to be vital: quality, delivery, cost and innovation. We also take an opportunistic approach to achieving our goals, and thus, we seek acquisitions of businesses which facilitate overall growth and cash flows of the Company.
We manufacture, market and distribute bimetallic conductors (two-metal conductors). These bimetallic conductors are primarily CCA and CCS. These conductors have either aluminum or steel cores, surrounded by an outer layer of pure copper, resulting in a composite bimetallic conductor. The copper sheath, through our processing methods, is metallurgically “bonded” to the core metal. The amount of copper-metal used in cladding the core-metal varies widely, and is based on customers’ needs. However, bimetallic conductors, compared to solid copper conductors, can reduce the amount of copper used by as much as 90% by volume, or 73% by weight which is a considerable cost savings to the company and our customers. For many applications, bimetallic conductors offer significant advantages over copper wire. End-user manufacturers in the industry have increasingly pursued and considered alternative technologies such as bimetallics due to performance and economic considerations. Relative to traditional copper conductors, bimetallic conductors offer greater value to a variety of customers. Because of the benefits of bimetallic conductors, we believe there are substantial opportunities to capture increased market share in applications that have historically been dominated by solid copper wire.
We believe our engineered bimetallic conductor products offer end-users greater value-performance than “solid” copper conductors. Our bimetallic conductors combine the efficiency of copper with the lightweight qualities of aluminum (CCA), or the ruggedness and strength of steel (CCS). Bimetallic conductors offer favorable cost characteristics, weight savings (CCA), increased flexibility and end-product ease-of-handling (CCA), increased tensile strength (CCS), improved corrosion characteristics and decreased theft risk. Conductivity can be customized, by changing the percentage of copper, to fit many applications. The physical and electrical attributes of our bimetallic products provide our customers cost savings beyond their intrinsic pricing advantages.
We believe our proprietary manufacturing technology allows us to produce superior products compared to other manufacturers and creates a significant barrier to entry. Manufacturing copper-clad products involves bonding copper tape to an aluminum or steel core rod, drawing the clad product to a finished diameter and heat treating (annealing) as necessary depending on customer specifications. Our proprietary cladding process differentiates us in terms of manufacturing capabilities, offering superior product quality. Our developmental capabilities support the ongoing evolution of our current products. We are continuously working toward new technologies and products that we expect to improve the performance and capabilities of our bimetallic products thereby allowing us to enter new markets.
While the pricing volatility of our raw materials, especially copper, is a primary cause of cost variations in our products, changes in raw material costs do not materially affect our dollar earnings on a per pound basis. Although an increase in the price of raw materials may serve to reduce our gross margins as a percentage of net sales, likewise, a decline in raw material prices may increase our gross margin as a percentage of net sales. We generally pass the cost of price changes in our raw materials to our customers rather than the percentage changes. We establish prices for our products based on market factors and our cost to produce our products. Typically, we set a base price for our products for our customers with an understanding that as prices of raw materials change, primarily for copper but also for aluminum and steel, we will pass the change through to our customers. Therefore, when prices of raw material increase, our prices to our customers increase and the amount of our total net sales increases while the dollar amount of our gross margin remains relatively stable. As a result, the impact on earnings per share from volatile raw material prices is minimal, although there are timing delays of varying lengths depending upon volatility of metals prices, the type of product, competitive conditions and particular customer arrangements.
Factors driving and affecting operating results include raw material prices, product and price competition, economic conditions in various geographic regions, foreign currency exchange rates, interest rates, changes in technology, fluctuations in customer demand, variations in the mix of products, production capacity and utilization, working capital sufficiency, availability of credit and general market liquidity, patent and intellectual property issues, litigation results and legal and regulatory developments, and our ability to accurately forecast sales demand and calibrate manufacturing to such demand, manage volatile raw material costs, develop, manufacture and successfully market new and enhanced products and product lines, control operating costs, and attract, motivate and retain key personnel to manage our operational, financial and management information systems.
Current Business Environment and 2010 Outlook
With respect to the overall business trends in 2010 and forward, statistics showed that the global economy recovered gradually from recession since the second half of 2009. China, a market from which we have generated most of our revenue and growth, saw its GDP growth in the fourth quarter of 2009 jump to 10.7% as compared to 6.8% in the same period of 2008, and 6.1%, 7.9% and 8.9% in the first, second and third quarter in 2009, respectively.
Furthermore, we think the following macro-level trends will positively impact our business and offer us opportunities to capture new business despite global economic conditions and preserve profitability:
In addition to these macro-level trends, the Company is presented with tremendous opportunities brought by the continued capital expenditures of major telecommunications operators in the PRC in the buildout of a nationwide 3G network. In order to capture the growth opportunities, we will focus on driving profitability by streamlining our organizational structure and business procedures, increasing operational efficiency and optimizing operating processes, while managing production costs and operating expenses.
In addition, we are seeking to continue to develop the high potential utility and transportation markets, to enhance productivity and to expand our sales of higher margin products. We view the market for CCA and CCS wires and cables within the utilities market to be worldwide. We continue to educate the PRC market on the — benefits of CCS for the utilities market in anticipation of our installation of 8,200 MT of CCS capacity at our Dalian facility in the first quarter of fiscal year 2010. Furthermore, we believe the acquisition of Jinchuan will accelerate our expansion into the power cable industry by allowing us to provide our products to the early adopters, both suppliers and customers, more quickly.
Meanwhile, we are also working to strengthen sales management and customer relations. We will seek to consolidate our relationships with our best customers, stop or suspend selling to customers that pose significant credit risk, and develop new customers cautiously. In addition, as part of our ongoing efforts to reduce total operating costs, we continuously improve our ability to efficiently utilize existing and new manufacturing capacity to manage expansion and growth. We believe that effectively utilized manufacturing assets, economy of scale generated, will help offset high raw material prices and dilute overhead over time, thus improving profitability.
We actively seek to identify and promptly respond to key economic and industry trends in order to capitalize on expanding niche markets for our products, and possibly entering into new markets both down and up stream, in order to achieve better returns. We have the resources, technology, working capital and capacity to meet growing market demands. Over the long-term, we believe that we are well positioned to benefit from the growth opportunities in China and throughout the world.
Results of Operations
The following table shows, for the periods indicated, information derived from our consolidated statements of income in thousands of dollars and as a percentage of net sales Percentages may not add due to rounding.
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
Net sales were $182.9 million in 2009, compared to $221.4 million in 2008. The 17.4% decrease in sales is primarily attributable to a 19.7% decline in average selling prices of CCA and a 12.4% decline in average selling price of CCS as a result of a decline in the costs of our raw materials, partially offset by a 11.5% increase in CCA sales volume. We generally pass the cost of price changes in raw materials to customers when we set the base price for our products. As raw material prices change, we pass through that change, whether it results in an increase or decrease in the base price of our products.
The following tables set forth net sales in millions by each of our reporting segments and metric tons (MT) sold on a combined basis:
The PRC segment experienced a decline of 7.7% in net sales for the fiscal year ended December 31, 2009 compared to the fiscal year ended December 31, 2008. The majority of the decrease in PRC net sales is due to a 19.7% decline in average selling prices of CCA as a result of lower acquisition costs of raw materials. This decline was partially offset by a 15.3% increase in metric tons shipped. We expect long-term demand for our telecom based products in the PRC products to be positively affected by the build-out of the homegrown 3G network in the PRC, continued expansion into the utility market due to government spending on infrastructure related buildout and our impending installation of CCS cladding capacity in our Dalian city.
The US segment experienced a significant decline in net sales of 42.8% in all major geographic regions with particular weakness in European and North American markets, for the fiscal year ended December 31, 2009 compared with the fiscal year ended December 31, 2008. This decline in net sales is primarily the result of a 32.5% decline in metric tons shipped and a 13.2% decline in the average selling price. We continue to remain optimistic that the electrical utility industries provide strong growth opportunities for our CCS products within the markets served by our US segment operations. However, delays in disbursement of government stimulus packages and uncertainty in the global economy may continue to depress capital spending by telecommunication and electrical utility providers, and negatively impact markets and consequently our net sales within the markets of the US segment.
Net Sales by Industry
The following table presents the breakdown of combined net sales in millions by industry:
The following table presents the breakdown of metric tons (MT) shipped to customers by industry:
During fiscal year ended December 31, 2009, our sales to the telecommunication markets decreased by 339 metric tons, or 1.8%, compared to the similar period in 2008, primarily due to lower sales within markets served by our US operations as a result of weak economic conditions, partially offset by continued strong demand for our CCA products in the PRC as a result of the 3G buildout. Utility sales increased by 581 metric tons, or 3.6%, in 2009 compared to the similar period in 2008, primarily due to strong demand in the PRC as result of government investment for infrastructure related projects and partially offset by lower sales within markets served by our US operations as a result of weak economic conditions.
Capacity and Output
The following table summarizes installed cladding capacities and output by segment for the fiscal year ended December 31, 2009:
As of December 31, 2009, we had combined CCA annual production capacity of 52,400 metric tons and CCS cladding capacity of 17,100 metric tons on an annualized basis based on our product mix. Installed capacity can increase or decrease based on the size of the rod used in the cladding operation for CCA and on the conductivity engineered into the CCS production. The above capacity figures reflect a further 6,000 metric tons of annualized CCA capacity which was successfully installed and commissioned at our Dalian facility during the second quarter of 2009. We also have plans to install a further 8,200 metric tons of annualized CCS cladding capacity online at our Dalian facility by the end of the first quarter of 2010.
The chart above illustrates the growth of CCA as a percentage of tons sold in fiscal year ended December 31, 2009 compared to the similar period in 2008 for the combined reporting segments. The demand for our CCA products in the PRC strengthened during 2009 compared to 2008 due to increased traction of domestic infrastructure projects related to the stimulus package and 3G network build-out. Furthermore, we experienced a significant tapering of demand of approximately 32.5% for CCA and CCS based products served by facilities in our US reporting segment due to economic conditions in the North American and European markets.
Gross profit was $54.8 million in the fiscal year ended December 31, 2009 compared to $57.3 million in the similar period in 2008, representing a decrease of 4.4%. This decrease is primarily related to lower net sales and partially offset by higher gross margins and a slight increase in metric tons sold. As a percentage of net sales, gross profit increased from 25.9% to 30.0% due primarily to higher margins contributed by our Fayetteville facility, as well as a slight increase in margins at our Dalian facility.
Selling expenses was $4.9 million in the fiscal year ended December 31, 2009 compared to $4.6 million in the similar period in 2008, an increase of $0.3 million or 6.5%. This increase is primarily due to increased efforts in sales to penetrate the electrical utility market. As a percentage of net sales, selling expenses increased from 2.1% in fiscal year 2008 to 2.7% in 2009 primarily due to decreased revenue.
General and Administrative Expenses
General and Administrative expenses was $13.1 million in the fiscal year ended December 31, 2009 compared to $15.6 million in the similar period in 2008, a decrease of $2.5 million or 16.0%. This decrease is primarily a result of cost savings initiatives and lower sales volumes out of our US segment. As a percentage of net sales, general and administrative expenses increased from 7.1% in fiscal year 2008 to 7.2% in 2009 primarily due to lower net sales. During the fiscal year 2009, included in general and administrative expenses were non-factory depreciation and amortization of $1,753,551 and amortization of intangible assets of $476,696, compared to $1,614,476 and $417,681 in the fiscal year 2008.
The following table sets forth operating income by segment, in millions of dollars:
Operating income for the fiscal year ended December 31, 2009, was $36.9 million compared to $37.1 million in the similar period of 2008, a decrease of approximately $0.2 million or 0.5%. The decrease is primarily related lower net sales and as a result of decreased demand for our products within markets served by our US operation due to weak economic conditions. This decrease was partially offset by higher gross margins and a 15.3% increase in tons sold in our PRC segment. Also, the above deceases have been partially offset by lower general and administrative expenses of $2.5 million as result of cost saving initiatives implemented at operations in our US segment and a reduction in cost of professional fees at the corporate level.
The decrease in operating income for the PRC segment of $0.8 million, or 1.9%, compared to the same period in 2008, is largely the result of lower net sales partially offset by higher gross margins and increased tons sold due to continued demand for our CCA products within telecommunication and utility related markets due to the 3G build-out and continued government investment for infrastructure related projects.
Operating income in the US segment decreased by $0.8 million, or 133.3%, primarily due to lower net sales and tons sold compared to the same period in 2008. This decrease is largely the result of lower tons sold due to weak economic conditions. This decrease was partially offset by cost savings initiatives implemented in the first quarter of 2009 which lowered selling, general and administrative expenses by approximately $0.9 million.
Net interest expense decreased to $4.9 million in the fiscal year ended December 31, 2009 from $8.1 million in 2008, while as a percentage of net sales, net interest expense decreased to 2.7% in 2008 from 3.7% in 2008. This decrease is primarily the result of the repayment of Dalian’s short term bank loans and repurchase of the Company’s convertible notes.
U.S. Income Tax
Fushi Copperweld, Inc. (formerly Fushi International, Inc.) is a company incorporated in the State of Nevada, Fushi Holdings is a company incorporated in the State of Delaware, Copperweld Bimetallics, LLC is chartered in the State of Delaware and Copperweld UK, LLC is registered in the United Kingdom. Prior to the acquisition of Copperweld, we conducted substantially all our operations through our PRC operating subsidiaries. With the acquisition of Copperweld, we have a manufacturing facility and administrative offices located in Fayetteville, Tennessee, USA and in Telford, England, UK.
We are subject to United States taxation; however, we do not anticipate incurring significant United States income tax liability during fiscal year 2010 due to the following factors:
Therefore, no provision for U.S. federal income taxes or tax benefits on the undistributed earnings and/or losses of our company has been made.
A valuation allowance is required against deferred tax assets if, based on the weight of available evidence, it is more-likely-than-not that some or all of the deferred tax assets will not be realized. Management believes that the realization of the benefits can be used by their US operating subsidiary in future periods because expectations are that Copperweld U.S. will have taxable income in future periods. US companies must generate a total of $42.1 million of taxable net income by years 2025 to 2029 in order to recover the deferred tax asset balance. Through cost savings initiatives implemented beginning in the fourth quarter of 2008; the Company has lowered total labor overhead by approximately $100,000 per month. The Company is also in the process of refining and improving their manufacturing processes that may further realize cost savings of approximately $300,000 per month. With these cost saving measures in place, the Company believes that it is possible to realize profit at current sales levels at the Fayetteville facility and that Fayetteville will be well positioned to experience increased profitability when the global economic crisis subsides and sales begin to rebound to historical levels. The Company projects the Fayetteville facility to start generating positive annual pre-tax income in fiscal year 2010. Based on its review and taking into consideration the foregoing, the Company believes that, as of December 31, 2009, it was not necessary to provide a valuation allowance for deferred tax assets.
PRC Enterprise Income Tax
In the fiscal year ended December 31, 2009, our business operations were principally conducted by our subsidiaries incorporated in the PRC. PRC enterprise income tax is calculated based on taxable income determined under PRC accounting principles. Effective January 1, 2008, the new ‘Enterprise Income Tax’, or EIT Law in PRC imposes a unified income tax rate of 25.0% on all domestic-invested enterprises and ‘Foreign Invested Enterprises’, or FIEs, such as our PRC operating subsidiaries, the EIT Laws provide certain favorable tax treatment to a company that qualifies as a “New or High-technology Enterprise” or a “Foreign Invested Enterprise” located in the old town of an inshore open city. Additionally, the governments at the provincial, municipal and local levels can provide many tax incentives and abatements based on a number of programs at each level.
The Dalian Municipal Government issued a notice in 2000 providing for a series of tax preferential treatments to companies that qualify as a “New or High-tech Enterprise” or companies that are registered and operate in a specified development zone in Dalian City.
Dalian Fushi, a 100% variable interest, non-operating subsidiary, was incorporated in the PRC and is subject to PRC income tax which is computed according to the relevant laws and regulations in the PRC. Dalian Fushi’s bimetallic composite conductor wire product was approved by Dalian City as a “high-tech” project. As a result, Dalian Fushi is a business entity that is qualified as a “new or high-technology enterprise,” and is entitled to a two-year full exemption from the PRC enterprise income tax starting from its first year of operation, which expired on December 31, 2003, followed by a 50% reduction and other favorable tax treatment for the succeeding three years, which expired on December 31, 2006. The provision for income taxes for the twelve months ended December 31, 2008 was zero as we didn’t have any operation under Dalian Fushi from the beginning of 2007.
Fushi International (Dalian) (“FID”), a wholly owned subsidiary of Fushi Holdings, Inc., was incorporated in the PRC as FIE and is subject to PRC income tax which is computed according to the relevant laws and regulations in the PRC. FID has located its factories in a special economic region in Dalian and is granted certain preferential treatments including a corporate income tax rate of 24%. In September 2005, FID was approved as a wholly foreign owned enterprise. This economic region allows FID a two-year income tax exemption for the years ended December 31, 2006 and 2007, and a 50% income tax reduction for the following three years ended December 31, 2008, 2009, and 2010.
The new effectively EIT Law permits companies to continue to enjoy their existing preferential tax treatments until such treatments expire in accordance with their current terms. Any increase in our effective tax rate as a result of the above may adversely affect our operating results.
Profit before tax for Dalian was $42.3 million in the fiscal year ended December 31, 2009 with losses from the US segment before tax of $1.8 million. Loss at the Fushi Copperweld parent company level was $17.7 million primarily due to interest expenses on the high yield notes, non-cash stock-based compensation, non-cash charges related to changes in fair value of derivative liabilities related to the convertible notes conversion options, as well as professional fees and outside service expenses and partially offset by a gain from the repurchase of the convertible notes. On a consolidated basis, profit before tax was $22.9 million and we recognized a tax expense of $0.9 million.
Net income for the fiscal year ended December 31, 2009 was $22.0 million compared to $31.2 million for the similar period in 2008, a decrease of approximately $9.2 million or 29.5%. Net income as a percentage of net sales is 12.0% and 14.1% during the period of 2009, compared with that of 2008.
Earnings per Share
Basic and diluted earnings per share (EPS) for the fiscal year ended December 31, 2009 were $0.78 and $0.76, compared to $1.14 and $1.10 for the prior year. The weighted average number of shares outstanding to calculate basic EPS was 28.3 million and 27.3 million for 2009 and 2008, respectively. The weighted average number of shares outstanding to calculate diluted EPS was 28.6 million and 28.3 million for 2009 and 2008, respectively.
In the year ended December 31, 2009, the RMB was relatively stable for the whole period. As a result of the slight appreciation of the RMB, we recognized a foreign currency translation gain of $132,816, compared with that of $12.5 million in 2008. Given the uncertainty of exchange rate fluctuations, we cannot estimate the effect of these fluctuations on our future business, product pricing, and results of operations or financial condition. See “Risk Factors — Risks Related to Doing Business in the PRC”. The fluctuation of the Renminbi may materially and adversely affect your investment.
For our operations in the PRC and United Kingdom, the balance sheet amounts, with the exception of equity at December 31, 2009, were translated at 6.826 RMB and £0.619 to $1.00 USD. The average translation rates applied to income and cash flow statement amounts for year ended December 31, 2009 were 6.831 RMB and £0.639 to $1.00 respectively.
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
The following tables set forth net sales in millions by each of our reporting segments and metric tons (MT) sold on a combined basis:
Net sales were $221.4 million in 2008, compared to $128.2 million in 2007. The 73% increase in sales in the fiscal year ended December 2008 was primarily attributable to the full year inclusion of the Copperweld acquisition and an increase in sales from our Dalian facility. Substantially all organic growth was due to increases in sales volumes.
The PRC segment experienced an increase of 35.8% in net sales for the fiscal year ended December 31, 2008 relative to the comparable 2007 period. The majority of the increase in PRC net sales is primarily due to a % increase in metric tons sold.
Prior to the acquisition of Copperweld in October of 2007 we did not engage in operations within our US segment. We began to realize contributions from our operations within the US segment beginning October 29, 2007. As a result, our US segment experienced a significant increase in net sales of 504% for the fiscal year ended December 31, 2008 as compared to the fiscal year ended December 31, 2007. This was primarily due to the full-year inclusion of Copperweld into our operations.
Net Sales by Industry
The following table presents the breakdown of combined net sales in millions by industry:
The following table presents the breakdown of metric tons (MT) shipped to customers by industry:
Gross profit was $57.3 million in 2008, increased 34.9% from approximately $42.4 million in 2007. As a percentage of net sales, gross profit decreased from 33.1% to 25.9%. This was primarily due to the lower margins contributed by the Fayetteville and Telford facilities acquired in October 2007, as well as a slight decline in gross margins in Dalian.
Selling, General and Administrative Expenses
Selling expenses, which principally includes sales related staff salary and benefits, travel expenses, and sales commissions, were $4.6 million in 2008, compared to $1.8 in 2007, a 161.4% increase. This increase is primarily due to the inclusion of a full year of Fayetteville and Telford salaries, as well as a ramp up in sales efforts to penetrate new markets and industries. As a percentage of net sales, selling expenses increased by 0.7% in 2008 compared to 2007. General and administrative expenses, as a percentage of net sales, decreased to 7% of net sales in 2008, compared to 7.8% in 2007. The decrease is primarily due to benefits realized from integrating our global sales team following the acquisition of Copperweld in October 2007 and economies of scale resulting from increased revenues. On a dollar for dollar basis, general and administrative expenses increased to $15.6 million in 2008 compared to $10.0 million in 2007. As with selling expenses, the increase in gross amount of general and administrative expenses primarily is attributed to a full year of expenses associated with the acquisition of Copperweld in October 2007.
The following table sets forth operating income by segment, in millions of dollars: