10-Q 1 v084765_10q.htm Unassociated Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934  FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2007.

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 FOR THE TRANSITION PERIOD FROM _________ TO __________

COMMISSION FILE NUMBER: 0-19276
_______________

Fushi International, Inc.
(EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
 
NEVADA
  
13-3140715
INCORPORATION OR ORGANIZATION
  
(I.R.S. EMPLOYER IDENFIFICATION NO.)
 
1 Shuang Qiang Road, Jinzhou, Dalian, People’s Republic of China 116100
________________________________________________________________
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)    (ZIP CODE)

ISSUER 'S TELEPHONE NUMBER, INCLUDING AREA CODE: 011-86-411-8770-3333

_______________

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No o.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x.
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Act).

Large accelerated filer o   Accelerated filer o    Non-accelerated filer x
 
The number of shares of Common Stock of the Registrant, par value $.006 per share, outstanding on July 15, 2007, was 22,178,578.
 
Transitional Small business Disclosure Format (Check one): Yes o ; No x.
 

FUSHI INTERNATIONAL INC.
INDEX TO JUNE 30,2007 FORM 10-Q
 
   
Page
Part I - Financial Information  
3
   
Item 1 - Financial Statements  
3
   
Consolidated Balance Sheets as of June 30, 2007 (unaudited) and December 31, 2006  
3
   
Consolidated Statements of Income and Other Comprehensive Income for the three months and six months ended June 30, 2007 (unaudited) and June 30, 2006 (unaudited)  
4
   
Consolidated Statements of Cash Flows for the six months ended June 30, 2007 (unaudited) and June 30, 2006 (unaudited)  
5
   
Notes to the Consolidated Financial Statements (unaudited)  
6
   
Item 2 – Management's Discussion and Analysis of Results of Operations and Financial Condition  
28
   
Item 3 – Quantitative and Qualitative Disclosure about Market Risk
41
   
Item 4 – Controls and Procedures  
42
   
Part II - Other Information  
43
   
Item 4 – Submission of Matters to a Vote of Security Holders   
 43
   
Item 6 – Exhibits
43
   
Signature Page  
 44
 
2
 
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2007 AND DECEMBER 31, 2006
 
   
June 30,
 
December 31,
  
   
2007
  
2006
  
   
(Unaudited)
     
           
ASSETS 
  
CURRENT ASSETS:
          
Cash
  
$
75,205,436
  
$
20,493,551
  
Accounts receivable, trade
    
9,497,345
   
7,042,408
 
Inventories
    
9,704,840
   
7,403,116
 
Notes receivables
    
176,210
   
-
 
Other receivables and prepaid expenses
    
1,096,741
   
497,380
 
Advances to suppliers
    
5,508,117
   
3,390,917
 
Total current assets 
    
101,188,689
   
38,827,372
 
 
              
PLANT AND EQUIPMENT, net
    
54,065,998
   
47,256,475
 
 
              
OTHER ASSETS:
              
Advances to suppliers, noncurrent
    
10,453,486
   
4,559,357
 
Intangible asset, net
    
5,543,810
   
5,518,931
 
Deferred loan expense
    
3,270,904
   
-
 
Cross Currency hedge receivable
    
802,523
   
-
 
Total other assets 
    
20,070,723
   
10,078,288
 
               
 Total assets
  
$
175,325,410
  
$
96,162,135
  
               
LIABILITIES AND SHAREHOLDERS' EQUITY
  
CURRENT LIABILITIES:
              
Accounts payable, trade
  
$
742,254
  
$
1,055,684
  
Liquidated damage payable
    
-
   
1,466,250
 
Other payables and accrued liabilities
    
2,607,226
   
321,276
 
Customer deposits
    
-
   
531,065
 
Taxes payable
    
181,468
   
982,345
 
Short term bank loans
    
11,703,500
   
12,504,135
 
Current portion of long term debt
    
10,520,000
   
-
 
Loan from shareholder
    
557,520
   
3,911,256
 
               
Total current liabilities 
    
26,311,968
   
20,772,011
 
               
LONG TERM LIABILITIES:
              
Long term bank loans
    
-
   
10,256,000
 
Notes Payable
    
60,000,000
   
-
 
Total long term liabilities 
    
60,000,000
   
10,256,000
 
               
CROSS CURRENCY HEDGE PAYABLE
    
871,519
   
-
 
               
 Total liabilities
    
87,183,487
   
31,028,011
 
               
               
SHAREHOLDERS' EQUITY:
              
Preferred stock, $0.001 par value, 5,000,000 shares authorized, none outstanding as of
June 30, 2007 and December 31, 2006, respectively
    
-
   
-
 
Common stock, $0.006 par value, 100,000,000 shares authorized,
22,178,578 and 20,046,162 shares issued and outstanding as of June 30, 2007 and December 31, 2006, respectively
    
133,072
   
120,277
 
Additional paid in capital
    
40,065,842
   
29,364,955
 
Deferred stock option compensation
    
(1,808,305
)
  
-
 
Statutory reserves
    
6,115,309
   
4,452,467
 
Retained earnings
    
38,791,251
   
28,496,702
 
Accumulated other comprehensive income
    
4,844,754
   
2,699,723
 
Total shareholders' equity 
    
88,141,923
   
65,134,124
 
               
 Total liabilities and shareholders' equity
  
$
175,325,410
  
$
96,162,135
  
 
3
 

FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND
OTHER COMPREHENSIVE INCOME
FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2007 AND 2006
 
   
Three months ended June 30,
  
Six months ended June 30,
  
   
2007
  
2006
  
2007
  
2006
  
   
(Unaudited)
  
(Unaudited)
  
(Unaudited)
  
(Unaudited)
  
REVENUES
  
$
26,085,908
  
$
18,335,021
  
$
47,223,825
  
$
32,925,164
  
 
                          
COST OF GOODS SOLD
    
16,433,794
   
10,199,652
   
29,886,532
   
19,521,213
 
 
                          
GROSS PROFIT
   
9,652,114
   
8,135,369
   
17,337,293
   
13,403,951
 
 
                          
OPERATING EXPENSE
                          
Selling expenses
    
193,916
   
132,629
   
369,110
   
249,249
 
General and administrative expenses
    
2,028,574
   
730,180
   
3,469,576
   
1,486,701
 
Total operating expense
    
2,222,490
   
862,809
   
3,838,686
   
1,735,950
 
 
                          
INCOME FROM OPERATIONS
    
7,429,624
   
7,272,560
   
13,498,607
   
11,668,001
 
 
                          
OTHER INCOME (EXPENSE)
                          
Interest income
   
318,244
   
1,419
   
509,454
   
12,431
 
Interest expense
    
(1,666,043
)
  
(263,458
)
  
(2,948,115
)
  
(513,564
)
Gain on cross currency hedge
    
802,523
   
-
   
802,523
   
-
 
Other income
   
112,506
   
229,175
   
174,616
   
320,722
 
Other expense
    
(14,195
)
  
(113,552
)
  
(79,694
)
  
(138,850
)
Total other expense
    
(446,965
)
  
(146,416
)
  
(1,541,216
)
  
(319,261
)
 
                          
INCOME BEFORE INCOME TAXES
    
6,982,659
   
7,126,144
   
11,957,391
   
11,348,740
 
 
                          
PROVISION FOR INCOME TAXES
    
-
   
(60,064
)
  
-
   
396,616
 
 
                          
NET INCOME
   
6,982,659
   
7,186,208
   
11,957,391
   
10,952,124
 
 
                          
OTHER COMPREHENSIVE INCOME
                         
Foreign currency translation adjustment
    
2,113,689
   
722,695
   
3,016,550
   
1,118,315
 
Cross currency hedge adjustment
    
(872,519
)
  
-
   
(871,519
)
  
-
 
 
                          
COMPREHENSIVE INCOME
  
$
8,223,829
  
$
7,908,903
  
$
14,102,422
  
$
12,070,439
  
 
                          
NET INCOME PER SHARE-BASIC
  
$
0.32
  
$
0.36
  
$
0.57
  
$
0.55
  
BASIC WEIGHTED AVERAGE NUMBER OF SHARES
    
21,487,056
   
19,894,315
   
21,116,447
   
19,894,315
 
NET INCOME PER SHARE-DILUTED
  
$
0.28
  
$
0.34
  
$
0.49
  
$
0.51
  
DILUTED WEIGHTED AVERAGE NUMBER OF SHARES
    
25,192,643
   
21,434,692
   
24,667,346
   
21,434,692
 
 
4

FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2007 AND 2006
 
   
2007
  
2006
  
   
(Unaudited)
  
(Unaudited)
  
CASH FLOWS FROM OPERATING ACTIVITIES:
          
Net income
 
$
11,957,391
  
$
10,952,124
  
Adjustments to reconcile net income to cash
              
provided by (used in) operating activities:
              
Depreciation
    
936,956
   
1,000,658
 
Amortization of intangibles 
    
115,590
   
111,392
 
Amortization of loan commission 
    
329,096
   
-
 
Amortization of stock option compensation 
    
645,158
   
-
 
Gain on cross currency hedge 
    
(802,523
)
  
-
 
Change in operating assets and liabilities:
              
(Increase) decrease in assets:
              
Accounts receivable 
    
(2,242,709
)
  
(4,120,223
)
Inventories 
    
(2,082,422
)
  
(791,091
)
Other receivables and prepayments 
    
(907,670
)
  
(6,857,149
)
Notes receivables 
    
(173,811
)
  
-
 
Advance to suppliers 
    
(2,002,283
)
  
-
 
Increase (decrease) in liabilities:
              
Accounts payable 
    
(335,966
)
  
781,513
 
Other payables and accrued liabilities 
    
2,246,676
   
283,392
 
Customer deposits 
    
(537,320
)
  
-
 
Other taxes payable 
    
(814,918
)
  
(2,544,011
)
Income taxes payable 
    
-
   
(3,629,850
)
 Net cash provided by (used in) operating activities
    
6,331,245
   
(4,813,245
)
               
CASH FLOWS FROM INVESTING ACTIVITIES:
              
Purchase of property and equipment
    
(6,453,915
)
  
(5,057,136
)
Advances for purchase of equipment
    
(5,698,131
)
  
-
 
 Net cash used in investing activities
    
(12,152,046
)
  
(5,057,136
)
               
               
CASH FLOWS FROM FINANCING ACTIVITIES:
              
Loan from shareholder
    
557,520
   
42,720
 
Repayment to shareholders
    
(4,004,253
)
  
-
 
Due to related companies
    
-
   
20,000
 
Due from related companies
    
-
   
3,323,528
 
Proceeds from bank loans
    
11,546,600
   
13,450,000
 
Payments on bank loans
    
(12,628,669
)
  
(7,496,902
)
Net proceeds from convertible notes
    
56,400,000
   
-
 
Additional paid in capital
    
-
   
(82,313
)
Proceeds from warrants exercised
    
6,793,969
   
-
 
 Net cash provided by financing activities
    
58,665,167
   
9,257,033
 
               
EFFECT OF EXCHANGE RATE ON CASH
    
1,867,519
   
(966,386
)
               
INCREASE (DECREASE) IN CASH
    
54,711,885
   
(1,579,734
)
               
CASH, beginning of period
    
20,493,551
   
6,163,670
 
               
CASH, end of period
  
$
75,205,436
  
$
4,583,936
  
               
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
              
               
Cash paid for interest expense
  
$
691,963
  
$
655,951
  
               
Cash paid for income taxes
  
$
-
  
$
4,044,883
  
 
5

FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
Note 1 - Organization

Fushi International, Inc. was incorporated under the name of M, Inc. in the state of Nevada on October 6, 1982. The name was changed to Parallel Technologies, Inc. (“Parallel”) on June 3, 1991 and changed to Fushi International, Inc. (“Fushi International”) on January 30, 2006. On December 13, 2005, Fushi International acquired Diversified Product Inspections, Inc. (“DPI”) and its wholly owned subsidiary, Dalian Diversified Product Inspections Bimetallic Cable Co., Ltd. (“Dalian DPI”).

DPI is engaged in the manufacturing and selling of copper clad aluminum and steel wire, both of which are bimetallic composite wire products that are principally used for network signal transmission cable, cable television wire and other applications. Dalian DPI commenced business on December 28, 2005. Dalian Fushi Bimetallic Manufacturing Company Limited (“Dalian Fushi”) is a 100% variable interest entity of the Company. The business activities of Dalian Fushi are the same with those of Dalian DPI.  


Fushi International, Fushi Holdings, Fushi International (Dalian) and Dalian Fushi are hereinafter referred to as “the Company”.

Note 2 - Summary of significant accounting policies

Principles of consolidation

The accompanying consolidated financial statements include the financial statements of Fushi International and it’s wholly owned subsidiaries, Fushi Holdings, Fushi International (Dalian)  and its 100% variable interest entity Dalian Fushi. All significant inter-company transactions and balances have been eliminated in consolidation.

Basis of presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

In the opinion of management, the unaudited consolidated financial statements contain all adjustments consisting only of normal recurring accruals considered necessary to present fairly the Company's financial position at June 30, 2007, the results of operations for the three and six months ended June 30, 2007 and 2006, and cash flows for the six months ended June 30, 2007 and 2006. The results for the six months ended June 30, 2007 are not necessarily indicative of the results to be expected for the entire fiscal year ending December 31, 2007.
 
6

FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
These financial statements should be read in conjunction with the Company's annual report on Form 10-KSB as filed with the Securities and Exchange Commission.

Consolidation of variable interest entity

In accordance with Interpretation No. 46R, Consolidation of Variable Interest Entities ("FIN 46R"), variable interest entities (VIEs) are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders lack adequate decision making ability. All VIEs with which the Company is involved must be evaluated to determine the primary beneficiary of the risks and rewards of the VIE. The primary beneficiary is required to consolidate the VIE for financial reporting purposes.

The Company has concluded that Dalian Fushi is a VIE and that the Company is the primary beneficiary. Under the requirements of FASB Interpretation No. 46 (R), Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 ("FIN 46"), the Company consolidated the financial statements of Dalian Fushi, a VIE of Fushi International (Dalian). As both companies are under common control, the financial statements have been prepared as if the transaction had occurred retroactively.

Use of estimates
 
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Revenue recognition
 
The Company's revenue recognition policies are in compliance with Staff Accounting Bulletin (“SAB”) 104. Sales revenue is recognized at the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are recorded as customer deposits.

Shipping and handling costs related to costs of goods sold are included in selling, general and administrative costs which totaled $272,019 and $194,556 for the six months ended June 30, 2007 and 2006, respectively, and $128,100 and $112,684 for the three months ended June 30, 2007 and 2006, respectively.

Advertising costs

Advertising costs for the six months ended June 30, 2007 and 2006 were $23,593 and $8,318 respectively, and for the three months ended June 30, 2007 and 2006 were $18,895 and $0, respectively. These costs are expensed as incurred.

Other comprehensive income

The reporting currency of the Company is the US dollar. The functional currency of Fushi International and Fushi Holdings is the US dollar. The functional currency of Fushi International (Dalian) and Dalian Fushi is Renminbi (RMB).
 
7
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)

For the subsidiaries whose functional currencies are RMB, all assets and liabilities accounts were translated at the exchange rate on the balance sheet date; stockholder's equity are translated at the historical rates and items in the statement of operations items are translated at the average rate for the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of shareholders’ equity. The resulting translation gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred. Items in the cash flow statement are translated at the average exchange rate for the period.

Translation adjustments resulting from this process included in accumulated other comprehensive income in the consolidated statement of shareholders’ equity amounted to $4,844,754 and $2,699,723 as of June 30, 2007 and December 31, 2006, respectively. Assets and liabilities at June 30, 2007 and December 31, 2006 were translated at 7.60 and 7.80 RMB to $1.00 USD. The average translation rates applied to income statement accounts and statement of cash flows for the six months ended June 30, 2007 and 2006 were 7.71 and 8.05 RMB to $1.00 USD, and for the three months ended June 30, 2007 and 2006 were 7.69 and 8.02, respectively. As a result, amounts related to assets and liabilities reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet.

Changes in the fair values of derivative financial instruments accounted for as cash flow hedges, to the extent they qualify for hedge accounting, are recorded in accumulated other comprehensive income. As of March 30, 2007, $452,632 was recorded as a loss on the derivative investment in other comprehensive income/loss. As of June 30, 2007, net change in the fair value of the hedge totaled $418,887 and was recorded in other comprehensive income.

Cash and concentration of risk

The Company considers all highly liquid investments with original maturities of three months or less at the time of purchase to be cash equivalents, for cash flow statement purposes. Cash includes cash on hand and demand deposits in accounts maintained with state owned banks within the PRC and the United States.

Certain financial instruments, which subject the Company to concentration of credit risk, consist of cash. The Company maintains balances at financial institutions which, from time to time, may exceed Federal Deposit Insurance Corporation insured limits for the banks located in the Unites States. Balances at financial institutions or state owned banks within the PRC are not covered by insurance. As of June 30, 2007 and December 31, 2006, the Company had deposits in excess of federally insured limits total of $75,005,436 and $20,195,702, respectively. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant risks on its cash in bank accounts.
 
8
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
Accounts receivables and allowance for doubtful accounts

Management regularly reviews aging of receivables and changes in payment trends by its customers, and records a reserve when they believe collection of amounts due are at risk. Accounts considered uncollectible are written off. At June 30, 2007, management concluded no reserves were necessary. The Company had accounts receivable of $9,497,345 and $7,042,408 as of June 30, 2007 and December 31, 2006, respectively.

Inventories
 
Inventories are stated at the lower of cost or market using a weighted average method. Inventories consist of raw materials, work in process, finished goods and supplies. Raw materials consist of copper, aluminum and steel used in production. The cost of finished goods included direct costs of raw materials as well as direct labor used in production. Indirect production costs such as utilities and indirect labor related to production such as assembling, shipping and handling costs are also included in the cost of inventory.

The Company reviews its inventory regularly for possible obsolete goods or to determine if any reserves are necessary for potential obsolescence. As of June 30, 2007, the Company has determined that no reserves are necessary.

Financial instruments

The Company analyzes all financial instruments with features of both liabilities and equity under SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” SFAS No 133, “Accounting for Derivative Instruments and Hedging Activities” and EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” The convertible preferred shares issued in 2005 and the convertible noted issued in 2007 did not require bifurcation or result in liability accounting. Additionally, the Company analyzes registration rights agreements associated with any equity instruments issued to determine if penalties triggered for late filing should be accrued under FSP EITF 00-19-2, “Accounting for Registration Payment Arrangements.”

Statement of Financial Accounting Standards No. 107 (SFAS 107), “Disclosures about Fair Value of Financial Instruments” requires disclosure of the fair value of financial instruments held by the Company. SFAS 107 defines the fair value of financial instruments as the amount at which the instrument could be exchanged in a current transaction between willing parties. The Company considers the carrying amount of cash, accounts receivable, other receivables, accounts payable, accrued liabilities, and long term debts to approximate their fair values because of the short period of time between the origination of such instruments and their expected realization and their current market rate of interest. Hedging instruments are carried at fair value.

Derivative Financial Instruments

The Company uses a cross currency hedge, a derivative financial instrument, to hedge the risk of rising interest rates on their variable interest rate debt. This type of derivative financial instrument is known as a cash flow hedge. The Company accounts for this interest rate swap in accordance with FAS No. 133, “Accounting for Derivatives Instruments and Hedging Activity,” which requires the derivative to be carried on the balance sheet at fair value and to meet certain documentary and analytical requirements to qualify for hedge accounting treatment. The above derivative qualifies for hedge accounting under FAS 133 and, accordingly, changes in the fair value is reported in accumulated other comprehensive income, net of related income tax effects. Amounts included in accumulated other comprehensive income are reclassified into earnings when the hedged transaction effects earnings.
 
9
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
At the inception of the transaction, the Company documents the relationship between hedging instruments and hedged items, as well as its risk management objective and the strategy for undertaking various hedge transactions. This process includes linking all derivatives designated to specific firm commitments of forecast transactions. The Company also documents its assessment, both at inception and on an ongoing basis, of whether the derivative financial instruments that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items.

Stock-Based Compensation

The Company adopted Statement of Financial Accounting Standards No. 123R, “Share-Based Payments”. This Statement requires a public entity to measure the cost of services received in exchange for an award of equity instruments based on the grant-date fair value of the award .That cost will be recognized over the period during which services received. Stock compensation for stock granted to non-employees has been determined in accordance with SFAS 123R and the Emerging Issues Task Force consensus Issue No. 96-18, "Accounting for Equity Instruments that are issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods or Services" ("EITF 96-18"), as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.

Plant and equipment, net
 
Plant and equipment are stated at cost. Expenditures for maintenance and repairs are charged to earnings as incurred; additions, renewals and betterments are capitalized. When property and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations. Depreciation of property and equipment is provided using the straight-line method for substantially all assets with estimated lives as follows:
 
   
Estimated Useful Life
  
Buildings
    
20-30 years
  
Machinery and equipment
    
10-15 years
  
Other equipment
    
5 years
  
Transportation equipment
    
5 years
  
 
Construction in progress represents the costs incurred in connection with the construction of buildings or new additions to the Company’s plant facilities.
 
10
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
No depreciation is provided for construction in progress until such time as the assets are completed and are placed into service. The Company borrowed $10,520,000 to fund additions to the plant. Interest capitalized for the six months ended June 30, 2007 and 2006 were $157,528 and $142,378, respectively.

The Company periodically evaluates the carrying value of long-lived assets in accordance with SFAS 144. When estimated cash flows generated by those assets are less than the carrying amounts of the asset, the Company recognizes an impairment loss. Based on its review, the Company believes that, as of June 30, 2007, there were no impairments of its long-lived assets.

Intangible assets

Intangible assets consist of land use rights and patents. The Company amortizes the land use rights on a straight line basis over 50 years and patents over 7-15 years.

The Company evaluates intangible assets for impairment periodically and whenever events or changes in circumstances indicate that the carrying value may not be recoverable from its estimated future cash flows. Recoverability of intangible assets, other long-lived assets, and goodwill is measured by comparing their net book value to the related projected undiscounted cash flows from these assets, considering a number of factors including past operating results, budgets, economic projections, market trends and product development cycles. If the net book value of the asset exceeds the related undiscounted cash flows, the asset is considered impaired, and a second test is performed to measure the amount of impairment loss. As of June 30, 2007, no impairment of intangible assets has been recorded.

Research and development

Research and development expenses include salaries, consultant fees, supplies and materials, as well as costs related to other overhead such as facilities, utilities and other departmental expenses. The costs we incur with respect to internally developed technology and engineering services are included in research and development expenses as incurred as they do not directly relate to any particular licensee, license agreement or licenses fee.

Research and development costs are recorded in selling and general and administrative expenses. Research and development costs were $57,271 and $84,665 for the six months ended June 30, 2007 and 2006, respectively, and amounted to $ 22,306 and $54,879 for the three months ended June 30, 2007 and 2006, respectively.

Earning per share

The Company reports earnings per share in accordance with the provisions of SFAS No. 128, "Earnings Per Share." SFAS No. 128 requires presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average common shares outstanding during the period.
 
11
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock using the treasury method.
 
Income taxes

The Company adopted Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (SFAS 109). SFAS 109 requires the recognition of deferred income tax liabilities and assets for the expected future tax consequences of temporary differences between income tax basis and financial reporting basis of assets and liabilities. Provision for income taxes consist of taxes currently due plus deferred taxes.

Deferred tax is accounted for using the balance sheet liability method in respect of temporary differences arising from differences between the carrying amount of assets and liabilities in the financial statements and the corresponding tax basis used in the computation of assessable tax profit. In principle, deferred tax liabilities are recognized for all taxable temporary differences, and deferred tax assets are recognized to the extent that it is probably that taxable profit will be available against which deductible temporary differences can be utilized. Deferred tax is calculated at the tax rates that are expected to apply to the period when the asset is realized or the liability is settled.
 
Deferred tax is charged or credited in the income statement, except when it related to items credited or charged directly to equity, in which case the deferred tax is also dealt with in equity. Deferred tax assets and liabilities are offset when they relate to income taxes levied by the same taxation authority and the Company intends to settle its current tax assets and liabilities on a net basis. There are no deferred tax amounts at June 30, 2007.

The Company adopted FASB Interpretation 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), as of January 1, 2007. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The adoption had no affect on the Company’s financial statements.

Value added tax

Sales revenue represents the invoiced value of goods, net of a value-added tax (“VAT”). All of the Company’s products that are sold in the PRC are subject to a Chinese value-added tax at a rate of 17% of the gross sales price. This VAT may be offset by VAT paid by the Company on raw materials and other materials included in the cost of producing their finished product. The Company recorded VAT Payable and VAT receivable net of payments in the financial statements. The VAT tax return is filed offsetting the payables against the receivables.
 
12
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
Recently issued accounting pronouncements

In June 2006, the Emerging Issues Task Force (EITF) reached a consensus on EITF No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (EITF No. 06-3). EITF No. 06-3 permits that such taxes may be presented on either a gross basis or a net basis as long as that presentation is used consistently. The adoption of EITF No. 06-3 on January 1, 2007 did not impact our consolidated financial statements. We present the taxes within the scope of EITF No. 06-3 on a net basis.

In September 2006, FASB issued SFAS 157 ‘Fair Value Measurements’. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. However, for some entities, the application of this Statement will change current practice. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Management is currently evaluating the effect of this pronouncement on financial statements.

In February 2007, the Financial Accounting Standards Board (‘‘FASB’’) issued Statement of Financial Accounting Standards (‘‘SFAS’’) No. 159, The Fair Value Option for Financial Assets and Financials Liabilities — Including an Amendment of FASB Statement No. 115. This standard permits measurement of certain financial assets and financial liabilities at fair value. If the fair value option is elected, the unrealized gains and losses are reported in earnings at each reporting date. Generally, the fair value option may be elected on an instrument-by-instrument basis, as long as it is applied to the instrument in its entirety. The fair value option election is irrevocable, unless a new election date occurs. SFAS No. 159 requires prospective application and also establishes certain additional presentation and disclosure requirements. The standard is effective as of the beginning of the fiscal year that begins after November 15, 2007. The Company is currently evaluating the provisions of SFAS No. 159 to determine the potential impact, if any, the adoption will have on the Company’s financial statements.

In June 2007, the FASB issued FASB Staff Position No. EITF 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services Received for use in Future Research and Development Activities” (“FSP EITF 07-3”), which addresses whether nonrefundable advance payments for goods or services that used or rendered for research and development activities should be expensed when the advance payment is made or when the research and development activity has been performed. Management is currently evaluating the effect of this pronouncement on financial statements.

Note 4 - Additional product sales information
 
The Company’s revenues by geographic area, namely the Chinese domestic market and international market, are as follows:
 
   
June 30, 2007
 
June 30, 2006
 
 
 
(Unaudited)
 
(Unaudited)
  
Domestic China
  
$
45,938,181
  
$
32,031,345
  
Other foreign countries
    
1,285,644
    
893,819
  
Total sales
  
$
47,223,825
  
$
32,925,164
  
 
13
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 

Inventories consisted of the following:

   
June 30, 2007
 
December 31, 2006
 
 
 
(Unaudited)
      
Raw materials
  
$
7,950,433
  
$
5,380,640
  
Work in process
    
1,069,302
    
242,350
  
Finished goods
    
352,272
    
1,736,507
  
Packaging materials
    
11,571
    
14,727
  
Semi finished goods
    
321,262
    
28,892
  
Totals
  
$
9,704,840
  
$
7,403,116
  
 
Note 6 - Plant and equipment

Plant and equipment consisted of the following:
 
   
June 30, 2007
 
December 31, 2006
 
 
 
(Unaudited)
      
Buildings and improvements
  
$
19,326,896
  
$
18,809,588
  
Transportation equipment
    
3,047,419
    
2,559,806
  
Machinery
    
10,055,544
    
8,814,271
  
Equipments
    
433,199
    
415,083
  
Construction in progress
    
28,077,425
    
22,110,429
  
Totals
    
60,940,483
    
52,709,177
  
Less accumulated depreciation
    
(6,874,485
)
  
(5,452,702
)
Totals
  
$
54,065,998
  
$
47,256,475
  
 
Depreciation expense for the six months ended June 30, 2007 and 2006 amounted to $936,956 and $1,000,658, and for the three months ended June 30, 2007 and 2006 amounted to $635,360 and $562,284, respectively.

Interest capitalized as of June 30, 2007 and December 31, 2006 was $157,528 and $282,641, respectively

Note 7 - Advances to suppliers

Advances on inventory purchases are monies deposited or advanced to outside vendors on future inventory and equipment purchases. Most of the Company’s vendors require a certain amount of money to be deposited with them as a guarantee that the Company will receive their purchases on a timely basis. The advances to suppliers were $5,508,117 and $3,390,917 for inventory and $10,453,486 and $4,559,357 for equipment purchases as of June 30, 2007 and December 31, 2006, respectively.
 
14
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
Note 8 - Major customers and suppliers

Five major customers accounted for 31% and 35% of the sales for the six months ended June 30, 2007 and 2006, respectively. Total receivable balance due from these customers at June 30, 2007 and 2006 amounted to $3,159,065 and $4,080,212 respectively.

Five major suppliers provided approximately 93% and 91% of the Company’s purchases of raw materials for the six months ended June 30, 2007 and 2006, respectively. Advances to these vendors amounted to $2,821,935 and $5,771,021, respectively.

Note 9 - Intangible assets

Intangible assets consist of land use rights and patents. All land in the People’s Republic of China is government owned and cannot be sold to any individual or company. However, the government grants the user a “land use right” (the Right) to use the land. The Company amortizes the Right on a straight line basis over 50 years.

Intangible assets consisted of the following:
 
   
June 30, 2007
 
December 31, 2006
 
 
 
(Unaudited)
      
Patents
  
$
1,417,570
  
$
1,381,996
  
Land use rights
    
5,267,758
    
5,135,564
  
     
6,685,328
    
6,517,560
  
Less: accumulated amortization
    
(1,141,518
)
  
(998,629
)
Total
  
$
5,543,810
  
$
5,518,931
  
 
Amortization expense for the six months ended June 30, 2007 and 2006 amounted to $115,590 and $111,392, and for the three months ended June 30, 2007 and 2006 amounted to $58,107 and $55,696, respectively.

Note 10 - Income taxes

Under the existing Income Tax Laws of PRC, the Company is generally subject to an income tax at an effective rate of 33% (30% state income taxes plus 3% local income taxes) on income reported in the statutory financial statements after appropriate tax adjustments. For enterprise that qualifies as a "new or high-technology enterprise" or a “Foreign Invested Enterprise (“FIE”) located in the old town of an inshore open city, it subject to a income tax rate of 24%.

In addition, if the enterprise is located in a specially designated region where it allows foreign enterprises a two-year income tax exemption and a 50% income tax reduction for the following three years.
 
15
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
The Company’s wholly owned subsidiary, Fushi International (Dalian), is a foreign limited liability company and located in the old town of an inshore open city. The Company has income tax exemption for the years ended December 2006 and 2007 and 50% income tax reduction for the years ended December 31, 2008, 2009 and 2010.

Dalian Fushi was incorporated in the PRC and is subject to PRC income tax. Dalian Fushi located its factory in a special economic region in Dalian, PRC and qualified as a "new or high-technology enterprise" who is allowed a two year income tax exemption beginning in 2002, the first year after they became profitable, and a 50% income tax reduction for the following three years, 2004 through 2006. Dalian Fushi has incurred operation loss for the six months ended June 30, 2007. No provision for income taxes were taken for the six months ended June 30, 2007 and 2006

The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the years ended June 30:
 
   
June 30, 2007
 
June 30, 2006
 
 
 
(Unaudited)
 
(Unaudited)
  
U.S. Statutory rates
    
34.0
%
  
34.0
%
Foreign income not recoginized in USA
    
(34.0
)
  
(34.0
)
China income taxes
    
33.0
    
33.0
  
China income tax exemption
    
(33.0
)
  
(18.0
)
Total provision for income taxes
    
-
%
  
15.0
%
 
The estimated tax savings for the six months ended June 30, 2007 amounted to $548,738 The net effect on earnings per share had the income tax been applied would decrease basic earnings per share from $0.59 to $0.57 and diluted earning per share from $0.52 to $0.48.

Beginning January 1, 2008, the new Chinese Enterprise Income Tax (“EIT”) law will replace the existing laws for Domestic Enterprises (“DES”) and Foreign Invested Enterprises (“FIEs”). The new standard EIT rate of 25% will replace the 33% rate currently applicable to both DES and FIEs. The two years tax exemption, three years 50% tax reduction tax holiday for production-oriented FIEs will be eliminated. However, the new EIT Law permits companies to continue to enjoy their existing preferential tax treatments until such treatments expire in accordance with their current terms. The Company is currently evaluating the effect of the new EIT law will have on its future financial positions.

Fushi International, Inc. and Fushi Holdings were incorporated in the United States and have incurred net operating losses for income tax purposes the six months ended June 30, 2007. The net operating loss carry forwards for United States income taxes amounted to $2,725,893 which may be available to reduce future years’ taxable income. These carry forwards will expire, if not utilized, through 2025 and 2027. Management believes that the realization of the benefits from these losses appears uncertain due to the Company’ limited operating history and continuing losses for United States income tax purposes. Accordingly, the Company has provided a 100% valuation allowance on the deferred tax asset benefit to reduce the asset to zero. The valuation allowance at June 30, 2007 was $926,804. Management will review this valuation allowance periodically and make adjustments as warranted.
 
16
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
Value Added Tax

VAT on sales and VAT on purchases amounted to $7,841,691 and $5,297,848 for the six months ended June 30, 2007 and $4,687,393 and $2,829,041 for the six months ended June 30, 2006, respectively. Sales and purchases are recorded net of VAT collected and paid as the Company acts as an agent for the government. VAT taxes are not impacted by the income tax holiday.

Taxes payable consisted of the following:
 
   
June 30, 2007
 
December 31, 2006
 
 
 
(Unaudited)
      
VAT
  
$
181,468
  
$
607,968
  
Others
    
-
    
374,377
  
Total taxes payable
  
$
181,468
  
$
982,345
  
 
Note 11 - Loan from shareholder

In September 2006, one of the Company's shareholders advanced $4,450,000 to the Company for operations. The balance as of June 30, 2007 and December 31, 2006 was $557,520 and $3,911,256, respectively. This loan is non-interest bearing, unsecured and is payable in cash on demand.

Note 12 - Liquidated damage payable 

The Company was obligated to make efforts to file a registration statement with the SEC for the registration of the common stock issued upon the conversion of the series B convertible preferred stock to be declared effective by the SEC within 90 days and not later than 120 days from the date of its initial filling. After the 120th day of the initial filing and for each 30-calendar day period thereafter in which the registration statement fails to be declared effective, the Company shall issue to each investor a number of shares of common stock equal to 3% of such investor's shares covered by such registration statement at that time.

The Company accrued $1,466,250 as liquidated damages payable and expensed that amount in the year ended December 31, 2006. This amount accrued is based on the penalties due between May 14, 2006 through August 2, 2006 and it is valued at $5.75, the highest bid on August 2, 2006, the date of the registration statement was declared effective. In January 2007, the Company issued 255,000 shares of common stock to the investors as payment for the liquidated damages.
 
17
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)

Note 13 - Short term bank loans

Short term bank loans represent amounts due to various banks and are due on demand or normally within one year. These loans generally can be renewed with the banks. Short term bank loans consisted of the following:
 
   
June 30, 2007
 
December 31, 2006
 
 
 
(Unaudited)
      
Dalian Commercial Bank Sahekou Branch due May 15, 2007 annual interest at 6.338%, secured by the Company land use right and building
  
$
-
  
$
974,320
  
               
Bank of China Dalian Xinhaiwen Branch,due March 11, 2007 annual interest at 5.94%, secured by the Company land use right and building
    
-
    
3,846,000
  
               
Bank of China Dalian Xinhaiwen Branch,due February 22, 2007 annual interest at 6.547%, secured by the Company land use right and building
    
-
    
2,564,000
  
               
Bank of China Dalian Xinhaiwen Branch,due March 27, 2007 annual interest at 6.547%, secured by the Company land use right and building
    
-
    
2,179,400
  
               
Bank of China Dalian Xinhaiwen Branch, due April 21, 2007 annual interest at 6.732%, secured by the Company land use right and building
    
-
    
2,820,400
  
               
ShenZhen Development Bank, Dalian Branch various due dates and interest rates, secured by export letter of credits
    
-
    
120,015
  
               
Bank of China Dalian Xinhaiwen Branch,due October 8, 2007 annual interest at 6.732%, secured by the Company land use right and building
    
3,945,000
    
-
  
               
Bank of China Dalian Xinhaiwen Branch due December 19, 2007 annual interest at 7.029%, secured by the Company land use right and building
    
2,288,100
    
-
  
               
Bank of China, Xinghaiwan Branch Due March 28, 2008, annaul interest at 7.227%, secured by the Company land use right and building
    
2,577,400
    
-
  
               
Bank of China, Xinghaiwan Branch Due Febuary 15, 2008, annaul interest at 7.029%, secured by the Company land use right and building
    
2,893,000
        
               
Total
  
$
11,703,500
  
$
12,504,135
  
 
Total interest expense on the short term loans for the six months ended June 30, 2007 and 2006 amounted to $399,589 and $484,265, and for the three months ended June 30, 2007 and 2006 amounted to $203,084 and $164,481, respectively.
 
18
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
Note 14 - Long term bank loans
 
Long term debts are loans borrowed from banks which are mainly used for the purpose of purchasing additions to the plant and equipment and consisted of the following at:
 
   
June 30, 2007
 
December 31, 2006
 
 
 
(Unaudited)
      
ICBC, Dalian JinZhou Branch
          
Due April 10, 2008, annaul interest at 5.58%, secured by the Company land use right and building
  
$
5,260,000
  
$
5,128,000
  
               
ICBC, Dalian JinZhou Branch
              
Due April 10, 2008, annaul interest at 5.58%, secured by the Company land use right and building
    
5,260,000
    
5,128,000
  
               
Minus : current maturities
    
(10,520,000
)
  
-
  
                   
Long term debt - less current maturities
  
$
-
  
$
10,256,000
  
 
Interest incurred on the long term loans for the six months ended June 30, 2007 and 2006 was $293,508 and $171,686, of which capitalized interest amounted to $157,528 and $142,387, respectively. Interest for the three months ended June 30, 2007 was $148,986, of which $82,010 was capitalized. Those two bank loans are due within one year and were reclassified as current liabilities at June 30, 2007.

Note 15 - Long term notes payable

On January 24, 2007, the Company and Citadel Equity Fund Ltd. ("Citadel") entered into a Notes Purchase Agreement. On January 29, 2007, the Company closed a $60 million financing with Citadel.  In this transaction, Citadel purchased (i) floating rate $40 million principal amount (less 3% Notes Discount and 4% commission for proceeds of $37,200,000) of guaranteed senior secured floating rate notes (“HY notes”) due 2012 and (ii) $20 million principal amount (less 4% commission for proceeds of $19,200,000) of the Company’s 3% senior secured convertible notes (“Convertible notes”) due 2012, which are convertible into shares of the Company's common stock at an initial conversion price of $7.00 per share. These notes are secured by the shares of the Company's wholly-owned subsidiary, FHI. Citadel was also granted certain corporate governance rights over the Company and its subsidiaries.  The floating rate notes bear interest at LIBOR (approximately 5.3% at June 30, 2007) + 7% and changes to LIBOR + 5.6% permanently upon successful completion of Qualifying IPO within eighteen months from January 24, 2007. The interest on the variable and fixed rate notes are payable semi-annually in arrears in January and July. See below for discussion of swap agreement changing variable interest to 8.3% fixed.

Management has completed its review of the accounting for the transactions and has concluded that the conversion option does not qualify as an embedded derivative under FAS 133 nor does it qualify for beneficial conversion treatment under EITF 98-5 and 00-27.
 
19
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
Neither the Notes nor the Common Stock issuable upon conversion of the Convertible Notes have been registered under the U.S. Securities Act of 1933, as amended, nor is the Company obligated to so register them.

As security for the Notes, the Company and The Bank of New York, as collateral agent, entered into a share pledge agreement, dated January 25, 2007 (the "Share Pledge Agreement"), to guarantee the Notes with all of the shares of common stock of FHI held by the Company as collateral. The Company owns 100% of the FHI, which is pledged as collateral on the notes.

In connection with the transaction, the Company, FHI, Dalian DPI, Dalian Fushi, Li Fu, our Chairman and Chief Executive Officer, Mathus Yue Yang, our President, Chris Wenbing Wang, our Chief Financial Officer and Citadel entered into an Investor Rights Agreement dated January 25, 2007. Pursuant to the Investor Rights Agreement, Citadel was granted, among other things and subject to certain conditions, the right to designate up to certain number of the Company's board of directors, a right of first refusal with respect to any financing sought by the Company and the right to approve the Company's annual business plan and budget. In addition, pursuant to the Investor Rights Agreement, Messrs. Fu, Yang and Wang agreed to a non-competition covenant relating to their employment and ability to engage in a business that is competitive with the Company's business for five years.

The HY Notes and the Convertible Notes were issued pursuant to indentures, each dated January 25, 2007 (the “HY Indenture” and “CB Indenture”, respectively, and together, the "Indentures") among the Company, the FHI, as guarantor, and The Bank of New York, as trustee for the Notes. Pursuant to the Indentures, FHI has agreed, and all of the Company's other existing and future domestic subsidiaries are obligated, to guarantee, on a senior secured basis, to the holders of the Notes and the trustee the payment and performance of the Company's obligations thereunder.

Additional 3.3% of principal amount of the convertible note, applies to failure to maintain listing on certain Nasdaq markets as of July 24, 2008, payable by July 31, 2008 and additional Interest of 3% will be applied if no Qualifying IPO has occurred on or before July 24, 2008.

The Company is required to comply with certain financial covenants, including maintenance of a fixed charge coverage ratio of at least 2.0 and maintenance of a leverage ratio not exceeding 5.5. Management believes the Company was in compliance with all of these covenants as of June 30, 2007.

As of June 30, 2007, the Company has a total of $60,000,000 long term notes payable outstanding. Deferred commission amounted to $3,270,904 and interest expense for the three and six months ended June 30, 2007 amounted to $179,507and $329,096.

Note 16 - Derivative financial instruments

Cross currency hedge
 
The Company's operations are exposed to a variety of global market risks, including the effect of changing interest rates. This exposure is managed, in part, with the use of financial derivatives. The Company uses financial derivatives only to hedge exposures in the ordinary course of business and dose not invest in derivative instruments for speculative purposes.
 
20
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
To hedge exposures associated with the Guaranteed Senior Secured Floating Rate Notes due 2012 (2012 Note),on April 10, 2007, the Company entered into a cross currency swap transaction (the Swap) with Merrill Lynch Capital Services, Inc. (“MLCS”) . The Swap, with a notional principal value of $40 million,converts the LIBOR + 7% per annum USD variable interest rate to a 8.3% per annum RMB fixed interest rate. The agreement was deemed effective January 24, 2007. The Swap requires semi-annual payment in arrears on July 24 and January 24 and matures earlier of (1) cash settlement defined as early termination; or (2) January 24, 2012, at which point the Swap requires an exchange of RMB and USD based principals. Under the terms of the cross currency swap, the Company receives variable interest rate payments in USD and makes fixed interest rate payments in RMB with settlement netted in USD, thereby creating the equivalent of fixed-rate debt. MLCS requires the Company to deposit $1,000,000 with them to secure the agreement. The deposit may be increased to $3,000,000 if the exchange rate for RMB to USD falls below 6.5, and to $5,000,000 if the exchange rate falls below 5.5. This swap is designated and qualified as a cash flow hedge.

Since its effective date, the fair value of this swap agreement changed to a payable of $452,632 on March 31, 2007, and a payable of $871,519 on June 30, 2007, respectively. For the six months ended June 30, 2007, changes in fair value of the Swap resulted in an increase in the liability and a loss to other comprehensive income of $871,519, net of taxes. As of June 30, 2007, the Company had cross currency hedge receivable amounting to $802,523, which was recorded as a gain from derivative transactions and received in July 2007 from MLCS. For six months ended June 30, 2007, there were no amounts recorded in the consolidated statement of income in relation to this interest rate swap related to ineffectiveness.

Note 17 - Supplemental disclosure of cash flow information

Income taxes paid amounted to $0 and $4,044,883 for the six months ended June 30 2007 and 2006, respectively. Interest paid for the six months ended June 30, 2007 and 2006 amounted to $536,539 and $655,951, respectively

784,575 shares of Series A preferred stock and 216,000 shares of Series B preferred stock were converted into 19,818,718 shares of common stock during 2006.

The Company has issued 255,000 shares of common stock in payment of liquated damage payable as disclosed in note 12.

$2,400,000 in loan commission and $1,200,000 in loan discount were netted against $60 million in loan proceeds.

650,000 options were granted to executives and directors in exchange for two year services.
 
21
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
Note 18 - Accumulated other comprehensive income

The components of accumulated other comprehensive income as follows:
 
Accumulated other comprehensive income:
      
Balance at December 31, 2006
  
$
2,699,723
  
Foreign currency translation gain
    
3,016,550
  
Fair value of cross currency hedge at April 10, 2007
    
(452,632
)
Net change during the period related to cross currency hed
    
(418,887
)
Balance at June 30, 2007
  
$
4,844,754
  
 
Note 19 - Earnings per share

The following demonstrates the calculation for earnings per share:
 
   
Three months ended June 30
 
Six months ended June 30,
 
 
 
2007
 
2006
 
2007
 
2006
 
 
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
  
Net income for basic earnings per share
  
$
6,982,659
  
$
7,186,208
  
$
11,957,391
  
$
10,952,124
  
Add: Interest expense for convertible note
    
150,000
    
-
    
250,000
    
-
  
Net income for diluted earnings per share
  
$
7,132,659
  
$
7,186,208
  
$
12,207,391
  
$
10,952,124
  
                           
Weighted average shares used in basic computation
    
21,487,056
    
19,894,315
    
21,116,447
    
19,894,315
  
Diluted effect of warrants and convertible note
    
3,705,587
    
1,540,377
    
3,550,899
    
1,540,377
  
Weighted average shares used in diluted computation
    
25,192,643
    
21,434,692
    
24,667,346
    
21,434,692
  
                           
Earnings per share
                          
Basic
  
$
0.32
  
$
0.36
  
$
0.57
  
$
0.55
  
Diluted
  
$
0.28
  
$
0.34
  
$
0.49
  
$
0.51
  
 
Note 20 - Shareholders' Equity

(A)
Reverse stock split

On January 30, 2006, the Company effected a 245.27:1 reverse stock split.  All share and per share amounts have been retroactively restated throughout these financial statements to reflect the effect of the reverse split.

(B)
Series A and Series B Convertible Preferred Stocks

The Series A and Series B Convertible Preferred Stocks (“Series A and B Stocks”) were automatically converted into common stock upon the effectiveness of the reverse split on January 30, 2006 under the certificates of designation for Series A and B Stocks.
 
22
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
(C)
Following the reverse stock split and as of December 2006, the Company had outstanding:
 
(1)
20,046,162 shares of common stock, par value $.006.
 
(2)
Warrants purchasing 2,056,015 shares of common stock at an exercise price of $3.67 per share, expires December 2010.
 
(3)
Warrants purchasing 424,929 shares of common stock with exercise prices of $3.11 per share, expires December 2011

(D)
During the six months of 2007, the following activities were recorded:

(1)
255,000 shares of common stock at $0.006 par value were issued pursuant to liquidated damage payable that was recorded in 2006.

(2)
1,853,427 shares of warrants were exercised for common stock. The warrants were initially issued on December 13, 2005 and were each exercisable for one share of the Company’s common stock at $3.67 per share. 202,588 shares of warrants were forfeited on May 25, 2007.

(3)
3,739 shares of warrants were exercised for common stock. The warrants were initially issued on December 13, 2005 and were each exercisable for one share of the Company’s common stock at $3.11per share.

The Company has 421,190, warrants exercisable at $3.11 outstanding as of June 30, 2007 and the following is a summary of the warrant activities:
 
   
Number of Warrants Outstanding
  
Number of Warrants Exercisable
  
Weighted- Average Exercise Price
  
Average Remaining Contractual Life
  
Balance at December 31,
                  
2006
    
2,480,944
    
2,480,944
  
$
3.57
    
3.95 years
  
Granted
    
-
    
-
    
-
        
Forfeited
    
(202,588
)
  
(202,588
)
$
3.67
        
Exercised
    
(1,857,166
)
  
(1,857,166
)
$
3.67
        
Balance at June 30, 2007
    
421,190
    
421,190
  
$
3.11
    
3.46 years
  
 
Note 21 - Stock options based compensation

On May 21 and June 7, 2007, the Company issued 500,000 and 150,000 options to four executives and three independent directors, respectively, for requisite service period of two years starting from the grant date. The vesting period is two years.
 
23
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
The fair values of stock options grants to the executives and the independent directors were estimated at the date of grant using the Black-Scholes option-pricing model with the following assumptions:
 
 
  
Expected
  
Expected
  
Dividend
  
Risk Free Interest
  
Grant Date Fair
  
 
  
Life
  
Volatility
  
Yield
  
Rate
  
Value
  
Executive
    
2.0yrs
    
50
%
  
0
%
  
4.57
%
$
3.81
  
Independent Director
    
2.0yrs
    
50
%
  
0
%
  
4.57
%
$
3.64
  

-    Although historical volatility is generally useful in estimating expected volatility, the Company’s share price exhibited abnormal level of volatility (133%) from January 30, 2006, the first day of trade after completing reverse stock split, to June 29, 2007.  After the reverse split, the shares were thinly traded, creating extremely volatile price movements.  By contrast, for the 180days up to June 29, 2007, the Company’s trading volume increased and the share price appears to have stabilized.  Therefore, the Company estimated its expected volatility for the granted stock options on the 180-day historical volatility, which is 44.75%, and added additional minor volatility for planned expansion of activities over the next two years, to result in the expected volatility of 50% used in the calculation.  
 
-    Expected dividend yield of zero: the company has never paid a dividend and does not anticipate paying dividends in the foreseeable future.

-    Risk-free interest rate of 4.57%:  the risk-free interest rate was based on U.S. Treasury yields with a remaining term that corresponds to the expected term of the option.

-    Expected life:  Because the Company has no historical share option exercise experience to estimate future exercise patterns, the expected life was determined using the simplified method as these awards meet the definition of "plain-vanilla" options under the rules prescribed by Staff Accounting Bulletin No. 107.

The fair value of the stock option grant to the executives was $3.81 per share on the date of grant.  The fair value of the stock option grant to the independent directors was $3.64 per share on the date of grant. 

Stock compensation expense is recognized based on awards expected to vest, and there were no estimated forfeitures as the Company has a short history of issuing options. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised in subsequent periods, if necessary, if actual forfeitures differ from those estimates.

The 500,000 executive options and 150,000 director options had fair value of approximately $1,906,957and $546,506 respectively.  Total compensation expense associated with the option grants was $645,158 for the six months ended June 30, 2007.   The expense was recorded entirely as selling and administrative expenses.

 As of June 30, 2007, the total compensation cost related to stock options not yet recognized was $1.81 million and will be recognized over the weighted average life of 2 years.
 
24
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
Following is a summary of the status of options outstanding at June 30, 2007:
 
Outstanding Option
 
Exercisable Options
 
Exercise Price
 
Number
 
Average Remaining Contractual Life
 
Average Exercise Price
 
Number
 
Weighted Average Exercise Price
  
$12.30
    
500,000
    
1.89 years
  
$
12.30
    
133,336
  
$
12.30
  
$11.75
    
150,000
    
1.94 years
  
$
11.75
    
37,500
  
$
11.75
  
 
Note 22 - Statutory reserves

The laws and regulations of the People’s Republic of China require that before a Sino-foreign cooperative joint venture enterprise distributes profits to its partners, it must first satisfy all tax liabilities, provide for losses in previous years, and make allocations, in proportions determined at the discretion of the board of directors, after the statutory reserve. Statutory reserves represent restricted retained earnings.

Surplus reserve fund

The Company is required to transfer 10% of its net income, as determined in accordance with the PRC accounting rules and regulations, to a statutory surplus reserve fund until such reserve balance reaches 50% of the Company’s registered capital.

The transfer to this reserve must be made before distribution of any dividend to shareholders. For the six months ended June 30, 2007, the Company transferred $728,976 representing 10% of the year’s net income determined in accordance with PRC accounting rules and regulations, to this reserve.

The surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholding or by increasing the par value of the shares currently held by them, provided that the remaining reserve balance after such issue is not less than 25% of the registered capital.

Note 23 - Current vulnerability due to certain concentrations

The Company's operations are carried out in the PRC. Accordingly, the Company's business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC, and by the general state of the PRC's economy.

The Company's operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in the North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange. The Company's results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.
 
25
 
FUSHI INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(Unaudited)
 
Note 24 - Commitments and contingencies

On September 19, 2006, the Company has been named a defendant in a pending litigation that was filed at the China International Economic and Trade Arbitration Commission over a disputed investment consulting agreement. The damage claimed amounts to US$420,000 for past due commission. The Company claims that the plaintiff did not render services as stipulated in the agreement and believes any negative outcome of this litigation is highly unlikely.

On December 11, 2006, the Company has been named a defendant of an action filed in a United States District Court related to a disputed contract agreement. The Company believes the claim is without merit and does not anticipate any negative outcome of this case.

As discussed in Note 16, the Company entered into a swap agreement that required a $1,000,000 deposit to secure the transaction. If the exchange rate for RMB to US Dollars drops below certain levels, the Company will be required to deposit up to $5,000,000.
 
26
 
Item 1A. Risk Factors. The following risk factors are in addition to those previously disclosed by us.
 
Our rapid expansion could significantly strain our resources, management and operational infrastructure which could impair our ability to meet increased demand for our products and hurt our business results.
 
To accommodate our anticipated growth, we will need to expend capital resources and dedicate personnel to implement and upgrade our accounting, operational and internal management systems and enhance our record keeping and contract tracking system. Such measures will require us to dedicate additional financial resources and personnel to optimize our operational infrastructure and to recruit more personnel to train and manage our growing employee base. If we cannot successfully implement these measures efficiently and cost-effectively, we will be unable to satisfy the demand for our products, which will impair our revenue growth and hurt our overall financial performance.
 
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 to meet an expected increase in demand for our products. 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 will likely suffer overcapacity problems and may have to leave capacity idle, which may reduce our overall profitability and hurt our financial condition and results of operations.
 
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 to our existing target customer base, broaden our distribution channel, and capitalize on opportunities to expand into new markets. 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 require us to:
 
 
•
  
integrate and retain key management, sales, research and development, production and other personnel;
 
•
  
incorporate the acquired products or capabilities into our offerings from an engineering, sales and marketing perspective;
 
•
  
coordinate research and development efforts;
 
•
  
integrate and support pre-existing supplier, distribution and customer relationships; and
 
•
  
consolidate duplicate facilities and functions and combine back office accounting, order processing and support functions.
 
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.
 
If the bimetallic industry does not grow as we expect or grows at a slower speed than we expect, our sales and profitability may be materially adversely affected.
 
We derive most of our sales revenue from sales of our products in China. The continued development of our business depends, in large part, on continued growth in the bimetallic industry, especially the CCA market in China. Although China’s bimetallic industry has grown rapidly in the past, it may not continue to grow at the same growth rate in the future or at all. However, the developments in our industry are, to a large extent, outside of our control and any reduced demand for our products, any other downturn or other adverse changes in China’s bimetallic or related industries could severely harm our business.
 
27
 

DISCLAIMER REGARDING FORWARD-LOOKING STATEMENTS
 
Certain statements in this report, including statements in the following discussion, which are not statements of historical fact, may be deemed to be “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 which are basically statements about the future. For that reason, these statements involve risk and uncertainty since no one can accurately predict the future. Words such as “plans,” “intends,” “will,” “hopes,” “seeks,” “believes,” “anticipates,” “expects,” and the like, often identify such forward-looking statements, but are not the only indication that a statement is a forward-looking statement. Such forward-looking statements include statements concerning our plans and objectives with respect to the present and future operations of Fushi International, Inc. (the “Company,” “we” or “us”), and statements which express or imply that such present and future operations will or may produce revenues, income or profits. Numerous factors and future events could cause the Company to change such plans and objectives, or fail to successfully implement such plans or achieve such objectives, or cause such present and future operations to fail to produce revenues, income or profits. Therefore, the reader is advised that the following discussion should be considered in light of the discussion of risks and other factors contained in this report on Form 10-Q and in the Company’s other filings with the Securities and Exchange Commission. No statements contained in the following discussion should be construed as a guarantee or assurance of future performance or future results. These forward-looking statements are made as of August 14, 2007; the date of the filing of this Form 10-Q and the Company undertakes no responsibility to update these forward-looking statements. 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the financial statements and accompanying notes and the other financial information appearing in Part I, Item 1 and elsewhere in this report.

OVERVIEW

We are engaged, through our indirectly wholly-owned operating subsidiary Fushi International (Dalian) Bimetallic Cable Co., Ltd. (“Fushi International (Dalian)”), in the manufacture and sale of bimetallic composite wire products, principally copper clad aluminum wires ("CCA"). CCA is an electrical conductor which has an outer sleeve of copper metallurgically bonded to a solid aluminum core. Normally using 70% less copper than conventional copper wire, but offering materially the same utility and functionality, CCA is a cost effective substitute for solid copper wire in a wide variety of applications such as coaxial cable for cable television and various video and data applications, signal transmission lines for telecommunication networks, distribution lines for electricity, electrical transformers, wire components for electronic instruments and devices, utilities, appliances, automotive, building wire and other industrial wires.

We manufacture all of our products at our 500,000 square foot manufacturing facilities in the City of Dalian, PRC. Virtually all of our products are sold to customers located in the PRC, or subsidiaries of multinational corporations in the PRC. Our largest customers include the PRC operations of U.S.-based Andrew Corporation, ACOME Xintai Cable, Ltd. and Leoni (Changzhou) Electronics Co., Ltd.

Our quarterly results of operations may fluctuate as a result of a number of factors, including fluctuation in the demand for and shipments of our products and changes in the prices of raw materials, primarily copper. Copper prices exhibited greater than normal levels of volatility in 2006 and first six months of 2007. We normally purchase copper at the prevailing Shanghai Changjiang Metals Exchange (SCME) spot price. For the three months and six months ended June 30, 2007, copper strip costs accounted for approximately 50.01% and 50.23% of our raw material costs, respectively, or 47.73% and 48.02% of costs of goods sold, respectively. Our product is primarily used as a substitute for copper. When there is a large differential between the price of copper and aluminum, demand for our product increases, as do our margins. When the differential narrows, demand for our product may moderate, as will our margins. We generally attempt to pass along to our customers changes in the prices of copper and other raw materials. Our short-term and long-term profitability depends on our ability to effectively pass along price increases, among other factors. For further information, please see “Risk Factors” in our Annual Report on Form 10-KSB for the year ended December 31, 2006.
 
28

Factors driving and affecting operations results, among others, include the variations in the mix of products, production capacity and utilization, working capital sufficiency, product availability, quality, and particular customer arrangements. From time to time, we consider acquisition opportunities that could materially increase the size of our business operations.

With respect to the overall business outlook for the remainder of 2007 and forward, we believe that high copper prices will keep demand strong. We anticipate sales growth to continue to be aggressive and broadly based, principally due to increased conversion market visibility, expanding market sizes, defensible product profitability, and momentum to gain additional market share. 

Recent Developments

On July 25, 2007, the Company held its Annual General Meeting of Shareholders. At the meeting, the shareholders elected Fu Li, Yue Yang, Feng Bai, Barry Raeburn, Jiping Hua as Directors of the Company.

The shareholders also approved and ratified the appointment of Moore Stephens Wurth Frazer and Torbet, LLC as the Company’s independent auditors for the fiscal year ending December 31, 2007.
 
29
 
Financial Highlights
 
   
Three months ended June 30,
      
Six months ended June 30,
      
   
2007
      
2006
      
2007
      
2006
      
   
(Unaudited)
      
(Unaudited)
      
(Unaudited)
      
(Unaudited)
      
REVENUES
  
$
26,085,908
    
100.0
% 
$
18,335,021
    
100.0
% 
$
47,223,825
    
100.0
% 
$
32,925,164
    
100.0
%
                                                   
COST OF GOODS SOLD
    
16,433,794
   
63.0
%
  
10,199,652
   
55.6
%
  
29,886,532
   
63.3
%
  
19,521,213
   
59.3
%
                                                   
GROSS PROFIT
   
9,652,114
   
37.0
%
  
8,135,369
   
44.4
%
  
17,337,293
   
36.7
%
  
13,403,951
   
40.7
%
                                                   
OPERATING EXPENSE
                                                  
Selling expenses
    
193,916
   
0.7
%
  
132,629
   
0.7
%
  
369,110
   
0.8
%
  
249,249
   
0.8
%
G & A expenses
    
2,028,574
   
7.8
%
  
730,180
   
4.0
%
  
3,469,576
   
7.3
%
  
1,486,701
   
4.5
%
Total operating expense
   
2,222,490
   
8.5
%
  
862,809
   
4.7
%
  
3,838,686
   
8.1
%
  
1,735,950
   
5.3
%
                                                   
INCOME FROM OPERATIONS
    
7,429,624
   
28.5
%
  
7,272,560
   
39.7
%
  
13,498,607
   
28.6
%
  
11,668,001
   
35.4
%
                                                   
OTHER INCOME (EXPENSE)
    
(446,965
)
  
-1.7
%
  
(146,416
)
  
-0.8
%
  
(1,541,216
)
  
-3.3
%
  
(319,261
)
  
-1.0
%
                                                   
INCOME BEFORE INCOME TAXES
    
6,982,659
   
26.8
%
  
7,126,144
   
38.9
%
  
11,957,391
   
25.3
%
  
11,348,740
   
34.5
%
                                                   
PROVISION FOR INCOME TAXES
    
-
   
0.0
%
  
(60,064
)
  
-0.3
%
  
-
   
0.0
%
  
396,616
   
1.2
%
                                                   
NET INCOME
 
$
6,982,659
    
26.8
%
$
7,186,208
    
39.2
%
$
11,957,391
    
25.3
%
$
10,952,124
    
33.3
%
                                                   
 
Strategies we are in the process of implementing include:

 
·
In existing markets, backed by a 100% to 150% planned increase in the number of production lines, we intend to significantly strengthen our leadership position through economies of scale and adopting aggressive pricing strategies, possibly sacrificing individual order profitability on temporary basis, to continue our momentum and gain additional market share.
 
 
·
In newly entered markets, such as flat wire for electrical transformers, our expanded capacity will allow us to achieve a dominant market share as a first mover. Because, to our knowledge, no competition has presently succeeded in entering this market due to quality and technical barriers, we believe we can enjoy a very high level of profits in this market. We believe this will also make up for reduced profits in the other markets and allow us to have improved product mix and overall sales and margin expansion.


RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2007 AND JUNE 30, 2006

Our business for the three months ended June 30, 2007 continued to demonstrate robust revenue growth. Despite comparison to a high net revenue and net profit base in the same period last year, which included benefits from quick and significant copper price increase, we managed to grow revenue by 42.3%. This was primarily driven by higher average selling prices and higher volumes shipped. Numerous factors contributed to our strong growth: volatile copper price, strong market demand, new and expanded applications for our products, government and industry initiatives, and specifically, accelerated substitution for solid copper in telecom cable, magnet wires, and more recently, power cable. In addition, during the quarter, we were able to pass along most of the higher raw material costs to our customers and therefore maintain our normal gross and net margins.
 
30

Selected Financial Data:
 
   
For the three months ended
  
Increase
   
30-Jun-07
  
30-Jun-06
  
/(decrease)
Net Sales
  
$
26,085,908
  
$
18,335,021
    
42.3%
Gross Profit
    
9,652,114
    
8,135,369
    
18.6%
Operating Income
    
7,429,624
    
7,272,560
    
2.2%
Net Income
  
$
6,982,659
  
$
7,186,208
    
-2.8%
                   
Gross Margins
    
37.00
%
  
44.40
%
    
Net Margins
    
26.80
%
  
39.20
%
    
                   
EPS- Basic
  
$
0.32
  
$
0.36
    
-11.1%
EPS- Diluted
  
$
0.28
  
$
0.34
    
-17.6%
 
   
For the three months ended
  
Increase
Price and Production Metrics:
  
30-Jun-07
  
30-Jun-06
  
/(decrease)
Avg. Copper Price (Changjiang, China)- RMB/ton
    
65,830
    
65,172
    
1.0%
Avg. Aluminum Price (Changjiang, China)- RMB/ton
    
20,334
    
20,741
    
-2.0%
CCA Average Selling Price- USD/ton
    
6,378
    
6,132
    
4.0%
                   
Shipment- tons
    
4,090
    
2,990
    
36.8%
Avg. # of Production Lines
    
29
    
20
    
43.3%
Capacity (tons/2- regular shifts)
    
4,300
    
3,000
    
43.3%
Utilization
    
95.1
%
  
99.7
%
  
-4.6%
 
Net Sales

Sales of $26.1 million in the second quarter of 2007 increased $7.8 million from $18.3 million in the same period in 2006. Our sales increase was primarily attributable to a 36.8% volume increase and 4% average selling price increase. The volume growth as measured in total tons shipped was driven by strong customer demand across a broader mix of end markets and supported by expanded manufacturing capacity. The average selling price improvement year-over-year resulted primarily from the increase of raw material prices, particularly copper prices.
 
31
     
The following table breaks down application categories as percentage of total sales:

 
  
2Q 2007
 
  
shipment (tons)  
  
% of total sales
Co-axial Cable
    
2,419
   
59.1%
Magnet and Special Enameled Wire
    
661
   
16.2%
Shielded Wire
    
1,010
   
24.7%
Total
    
4,090
   
100.00%
 
The following table sets forth the revenue contribution by geographic location:

   
2Q 2007
  
2Q 2006
  
Domestic China
    
96.5%
 
  
98.5%
 
International
    
3.5%
 
  
1.5%
 
 
The following table sets forth information concerning our five largest customers for the second quarters of 2007 and 2006, respectively:

FIVE LARGEST CUSTOMERS
% of Net Sales for the
three months ended
June, 2007
  
% of Net Sales for
the three months
ended June 30, 2006
Jiangxi Lianchuang Photoelectricity Science Co.
7.73%
  
9.09%
Taizhou Yihua Specialty Electric Co., Ltd.
6.24%
  
5.44%
Leoni (Changzhou) Electronics Co., Ltd.
6.00%
  
N/A
Shantou Jinqiao Cable Co., Ltd.
5.58%
  
6.91%
Zhuhai Hansheng Industrial Co., Ltd
5.60%
  
7.77%
ACOME Xintai Cable CO., Ltd.
N/A
  
5.57%
       
Five Largest Customers as % of Total:
31.15%
  
34.78%

During the three months ended June 30, 2007, we continued to diversify our customer base. Our five largest customers accounted for 31.2% of total sales, down 3.6% compared to 34.8% of the second quarter ended June 30, 2006.

As of June 30, 2007, the receivable balance due from these five customers represented 34.0% of total accounts receivables, down 24.7% from 57.9% as compared to corresponding period in 2006. We routinely extend unsecured credit to large or regular customers with good credit history. Management reviews its accounts receivable on a regular basis to determine if the allowance for doubtful accounts is adequate at each quarter-end. We only extend 30 to 90 day trade credit to our largest customers, which tend to be well-established and large businesses, and we have not seen any accounts receivable go uncollected beyond 90 days or experienced any write-off of accounts receivable in the past. Thus, we elected not to make any provision for doubtful accounts and consider all accounts receivable collectable.

Cost of Goods Sold

Cost of Goods Sold was $16.4 million for the three months ended June 30, 2007, compared to $10.2 million for the three months ended June 30, 2006, representing an increase of $6.2 million or 61.1%. Cost of Goods Sold measured by percentage of net sales was 63.0%, compared to 55.6% for the prior year. While average SCME copper spot prices increased only marginally by 1%, when comparing the two periods, from RMB65,122 per ton ($8,147) to RMB 65,830 per ton ($8,229), average cost of sales per ton increased to $4,018 in the second quarter of 2007, by $607, or 17.8%, from $3,411 in the second quarter of 2006. The percentage mismatch was primarily due to a sharp increase in copper prices between the first and second quarters of 2006. The sharp increase in copper prices of approximately 51% resulted in substantially lower cost of goods sold as lower cost inventory acquired in the first quarter of 2006 was sold in the second quarter of 2006 with pricing based on the then prevailing raw material costs. In 2007, spot market copper prices increased approximately 28% from the first quarter to the second quarter. As a result, we also benefited from the sell through of lower cost inventory acquired in the prior. However, the inventory gain in the second quarter of 2007 was lower than the gain in the corresponding period in 2006. In addition, increased depreciation costs directly related to manufacturing activities, utility costs, and shipping and handling costs also contributed to the COGS increase as a percentage of net revenue, partially offset by fixed costs spread over a higher revenue base.
 
32

Cost of Goods Sold principally consists of the cost of raw materials, labor, utilities, manufacturing costs, manufacturing related depreciation, machinery maintenance costs, purchasing and receiving costs, inspection costs, shipping and handling costs, and other fixed costs.

The following table sets forth the percentage of raw material purchases from our five largest suppliers:
 
Five Largest Suppliers
% of Purchase for the Three Months
Ended June 30, 2007
Dalian Guojia Enterprise
16.54%
Beijing Golden Eagle Huichuang Copper Co.
31.81%
Baotou Aluminum Co., Ltd
17.68%
Dalian Zhonghe Trading Co.
13.10%
Harbin Electric Cable Co.
14.18%
 
 
 Five largest suppliers as % of total purchase:
93.31%

The five largest raw material suppliers provided 93.31% of our purchases of raw materials for the three-month period ended June 30, 2007.

Gross margin

Gross profit for the three months ended June 30, 2007 was $9.7 million, up 18.6% from gross profit of approximately $8.2 million for the corresponding period in the prior year. The gross margin decreased to 37.0% from 44.4% year-over-year, principally due to a decline in the inventory gains realized from the fluctuations of copper prices.

Our recent operating results have been both positively and negatively affected by the rise in raw material prices, primarily copper. As current inventory purchase costs increased due to higher raw material prices, our RMB mark-up to customers remained relatively constant. This resulted in higher sales revenue amounts and gross profit amounts but lower gross margins.

Due to the lag in working through our inventory layers, existing inventory purchased at previously lower prices and sold as prices increased resulted in higher gross profit margins. A decrease in commodity prices in a short period of time could have the opposite effect, negatively affecting results.

A majority of our sales are pursuant to a pricing formula that is based on the SCME spot prices of copper and aluminum. The demand for our products is highly correlated to, and the attractiveness of our products is considerably affected by, the price ratio between copper and aluminum. Year-over-year, spot prices of copper have escalated rapidly and has been subject to significant volatility. The average quarterly spot prices per ton of copper and aluminum at New York Mercantile Exchange (COMEX), London Metals Exchange (LME), and Shanghai Changjiang Metals Exchange (SCME) of PRC, along with related gross margins of our company, for the periods indicated, are summarized as follows:
 
33
 
   
2Q'06
  
3Q'06
  
4Q'06
  
1Q'07
  
2Q’07
  
Avg. COMEX Cu (USD/ton)
    
6,740
    
7,080
    
6,380
    
5,400
    
6,920
  
Avg. COMEX Al (USD/ton)
    
2,448
    
2,230
    
2,452
    
2,445
    
2,490
  
Comex Cu/Al
    
2.75
    
3.17
    
2.60
    
2.21
    
2.78
  
                                 
Avg. LME Cu (USD/ton)
    
6,540
    
6,960
    
6,420
    
5,380
    
6,940
  
Avg. LME Al (USD/ton)
    
2,432
    
2,292
    
2,473
    
2,503
    
2,482
  
LME Cu/Al
    
2.69
    
3.04
    
2.60
    
2.15
    
2.80
  
                                 
Avg. SCME (RMB/ton)
    
65,172
    
68,814
    
67,318
    
60,757
    
65,886
  
Avg. SCME Al (RMB/ton)
    
20,741
    
19,890
    
21,288
    
19,307
    
20,312
  
China SCME Cu/Al
    
3.14
    
3.46
    
3.16
    
3.15
    
3.24
  
 
                      
Gross Margins
    
44.4
%
  
30.9
%
  
33.1
%
  
36.4
%
  
37.0
%

We believe that the gross margins for future quarters may continue to fluctuate due to several factors, including, continued raw-material price volatility, changes in the relative mix of our products, pricing dynamics especially changes in mark-up, among other things. As exhibited by our historical profitability pattern, although raw material prices fluctuate over time, which caused monthly variation in the costs of raw material purchases, the fluctuations tend to be short term, making forecasting operating results and performance on annual and long term basis much easier to do than on quarterly basis. Consequently, it is more meaningful to focus on annual rather than interim financial and operating results.

Overall, as we continue to focus on enhancing profitability, with positive and negative effects mentioned above offsetting each other, we believe gross margins can stabilize in a range of 33% to 38% on an annual basis.

Selling, General and Administrative Expenses
 
Selling expenses, which principally include sales related staff salary and welfare, travel expenses, and sales commissions, were $193,916 for the three months ended June 30, 2007, compared to $132,629 for the three months ended 2006, representing an increase of 46.2%. As a percentage of net sales, selling expenses remained small and relatively unchanged at 0.7%. General and administrative expenses, as a percentage of net sales, increased to 7.8% for the three months ended June 30 2007, compared with 4.0% for the three months ended June 30 2006. Factors which caused this increase were higher administrative and professional fee costs related to Sarbanes-Oxley compliance and other requirements as a public company. Also included in the general and administrative expenses for the second quarter of 2007 was share-based compensation expense under SFAS 123(R), which was $645,158, equivalent to 2.5% of net revenues. Research and development expenses of $22,306, which were included in general and administrative expenses, decreased by $32,573, as compared to the six months ended June 30, 2006.
 
As we prepare to ramp up production capacity and more aggressively address market opportunities, we anticipate an expansion of our sales force to better respond to the market. Depreciation will rise sharply in future quarters due to a significantly expanded asset base as we are starting to take delivery of the purchased machinery and equipment to increase capacity. Going forward, we anticipate that the G&A costs will initially increase at a faster pace than sales growth in the next two quarters as we gear up for the planned capacity-doubling expansion and then stabilize and decrease in terms of percentage of sales as we enter the next phase of development and benefit greatly from economics of scale and improved efficiency. We believe this will eventually contribute to net margin expansion.
 
34

Interest Expense

Interest expense was $1.7 million for the three months ended June 30, 2007, compared to $0.3 million for the three months ended June 30, 2006, representing a 532.4% increase. The sharp increase is largely due to the accrued interest due on the notes we sold in our $60 million hybrid financing during the quarter ended March 31, 2007 (the Financing”). Interest expenses on our revolving credit facilities for the three months ended June 30, 2007 and 2006 amounted to $203,084 and $164,481, respectively.

Income tax

Fushi International, Inc. (formerly Parallel Technologies, Inc.) is a company incorporated in the State of Nevada and Fushi Holdings, Inc.(formerly DPI) is a company incorporated in the State of Delaware. We conduct substantially all our operations through our PRC operating subsidiaries. Although we are subject to United States taxation, we do not anticipate incurring significant United States income tax liability for the foreseeable future because:
 
 
·
we did not conduct any material business or maintain any branch office in the United States during the three months ended June 30, 2007,
 
·
the earnings generated from our non-U.S. operating companies are generally eligible for a deferral from United States taxation until such earnings are repatriated to the United States, and
 
·
we believe that we will not generate any significant amount of income inclusions under the income imputation rules applicable to a United States company that owns "controlled foreign corporations" for United States federal income tax purposes.
 
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.
 
PRC Enterprise income tax
 
In 2006, our business operations were solely conducted by our subsidiaries incorporated in the PRC. PRC enterprise income tax is calculated based on taxable income determined under PRC accounting principles. In accordance with “Income Tax Law of China for Enterprises with Foreign Investment and Foreign Enterprises,” or the Income Tax Law, “Foreign Invested Enterprises”, or FIEs, established in the PRC are generally subject to an “Enterprise Income Tax”, or EIT, rate of 33%. PRC domestic companies are governed by the Enterprise Income Tax Laws of the PRC and are also generally subject to an EIT rate of 33%. However, the Income Tax 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 "New or High-tech Enterprise” or companies that are registered and operate in a specified development zone in Dalian City.

Dalian Fushi 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 Cit 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. We are considering available options under applicable PRC tax laws that would enable us to qualify for further preferential tax treatment. The provision for income taxes for the three months ended June 30, 2007 was zero as we did not conduct any operations under Dalian Fushi from the beginning of 2007.
 
35
 
Fushi International (Dalian) (formerly Dalian DPI) was incorporated in the PRC as an Foreign Invested Enterprise (“FIE”) and is subject to PRC income tax which is computed according to the relevant laws and regulations in the PRC. Fushi International (Dalian) 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, Dalian DPI was approved as a wholly foreign owned enterprise. This economic region allows Fushi International (Dalian) 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.

On March 16, 2007, the National People’s Congress of China passed the new EIT Law, which will take effect as of January 1, 2008. The new EIT Law imposes a unified income tax rate of 25.0% on all domestic-invested enterprises and FIEs, such as our PRC operating subsidiaries, unless they qualify under certain limited exceptions. However, the EIT Law permits companies to continue to enjoy their existing preferential tax treatments until such treatments expire in accordance with their current terms. We expect details of the transitional arrangement for the five-year period from January 1, 2008 to December 31, 2012 applicable to enterprises approved for establishment prior to March 16, 2007 to be set out in more detailed implementing rules to be adopted in the future. Any increase in our effective tax rate as a result of the above may adversely affect our operating results. However, details regarding implementation of this new law are expected to be provided in the form of one or more implementing regulations to be promulgated by the PRC government, and the timing of the issuance of such implementing regulations is currently unclear.

Net Income

Net income for the second quarter of 2007 was $7.0 million, or 26.8% of net revenue, compared to $7.2 million, or 39.2% of net revenue, in the same period last year. The compressed net margin was due principally to i) a decline in the inventory gain from rising copper prices; ii) higher general and administrative expenses as a result of expansion initiatives and share-based compensation expense; iii) higher interest expense associated with senior notes issued in the Financing. Excluding non-cash charges for share-based compensation expense, the net margin would increase to 29.3%.
 
Basic and diluted earnings per share (EPS) for the second quarter of 2007 were $0.32 and $0.28, respectively, compared to $0.36 and $0.34, in the same period last year, respectively. Excluding share-based compensation expense, the earnings per share on a diluted basis would have been 0.30 for the second quarter of 2007. The weighted average shares outstanding used to calculate basic and diluted EPS were 21.5 million and 25.2 million, respectively.
 
The following table sets forth the computation of basic and diluted earnings per share:
 
   
For the three months ended
  
EARNINGS   
  
30-Jun-07
  
30-Jun-06
  
Net income
  
$
6,982,659
  
$
7,186,208
  
               
BASIC   
              
Income applicable to common shareholders
  
$
6,982,659
  
$
7,186,208
  
Basic weighted-average common stock outstanding
    
21,487,056
    
19,894,315
  
Basic earnings per share
  
$
0.32
  
$
0.36
  
               
DILUTED   
              
Income applicable to common shareholders
  
$
6,982,659
  
$
7,186,208
  
Add: Interest expense for the Convertible Notes
  
$
150,000
        
Adjusted income applicable to common shareholders
  
$
7,132,659
  
$
7,186,208
  
               
Basic weighted-average common stock outstanding
    
21,487,056
   
19,894,315
 
Effect of dilutive securities:*
              
Warrants
    
848,587
   
1,540,377
 
Assumed conversion of 3% Senior Secured
    
2,857,000
       
Convertible Notes due 2012
              
Diluted weighted-average common stocks outstanding
    
25,192,643
    
21,434,692
  
Diluted earnings per share
  
$
0.28
  
$
0.34
 

*Stock option grants are not included due to anti-dilutive effect.
 
36

Foreign Currency Translation Gains

In the three months ended June 30, 2007, the RMB steadily rose against the US dollar. As a result of the appreciation of the RMB, we recognized a foreign currency translation gain of $2.1 million. Given the uncertainty of exchange rate fluctuations, we cannot estimate the effect of these fluctuations on our future business, product pricing, 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.” in our Annual Report on Form 10-KSB for the year ended December 31, 2006.
 
Materially all of our revenues and a majority of our expenses in the first six months of 2007 were denominated in RMB. Our Statements of Operations and Cash Flow were translated for the six months ended June 30, 2007 and 2006 at RMB1.00 to US $0.12970 (or US $1.00 to RMB7.71) and RMB1.00 to US $0.12422 (or US $1.00 to RMB8.05), and for the three months ended June 30, 2007 and 2006 were at RMB1.00 to US $ 0.13003 (US $1.00 to RMB7.69) and RMB1.00 to US $0.12468 (or US $1.00 to RMB8.02), respectively. Balance sheet amounts with the exception of equity at June 30, 2007 were translated at RMB1.00 to US $0.13157, or US $1.00 to RMB7.60. The equity accounts were stated at their historical rate.

SIX MONTHS ENDED JUNE 30, 2007 AND JUNE 30, 2006

Financial Highlights
 
   
For the six months ended
  
Increase
   
30-Jun-07
  
30-Jun-06
  
/(decrease)
Net Sales
  
$
47,223,825
  
$
32,925,164
    
43%
Gross Profit
    
17,337,293
    
13,403,951
    
29%
Operating Income
    
13,498,607
    
11,668,001
    
16%
Net Income
    
11,957,391
    
10,952,124
    
9%
                   
Gross Margins
    
36.70
%
  
40.70
%
    
Net Margins
    
25.30
%
  
33.30
%
    
                   
EPS- Basic
  
$0.57
 
 
$0.55
 
 
3.6%
EPS- Diluted
  
 
$0.49
 
 
$0.51
 
 
-3.9%
 
37

Net Sales

Sales revenue increased $14.3 million, or 43.4%, to $47.2 million for the six months ended June 30, 2007 from $32.9 million for the same period ended on June 30, 2006. This increase was principally attributable to increased product shipment and higher selling prices driven by higher copper prices, increased market demand for our products, and expanded capacity.
     
Gross Profit Margin

We achieved gross profit of $17.3 million for the six months ended June 30, 2007, up 29.3% from gross profit of approximately $13.4 million for the corresponding period in the prior year. The increase was principally due to a 27.6% volume increase as measured by tons shipped. Gross profit margin was 36.7%, down 4% from 40.7% as compared to the corresponding period in 2006. While the gross margin remained relatively unchanged comparing the first quarter of the two corresponding periods, the second quarter last year benefited more from a sharp increase in copper pricesas described above, resulting in better than normal gross margin in the second quarter of 2006 overall. However, the inventory gain in the second quarter of 2007 was lower than the gain in the corresponding period in 2006. The impact of lower copper price gain on the gross margin for the three months ended June 30, 2007 was partially offset by improved product mix towards more fine wire products which carry higher profitability. Fine wire volume shipped in the first half of 2007 represented 14.4% of total volume shipped, as compared to 6.9% in the corresponding period last year.

Operating Expenses

We incurred total operating expenses of $3.84 million, or 8.1% of net sales, for the six months ended June 30, 2007. This represented an increase of $2.1 million, or 121.1%, as compared to $1.7 million, or 5.3% of net sales for the six months ended June 30, 2006. As a percentage of net sales, selling expenses remained relatively unchanged at 0.8% and general and administrative expenses increased significantly from 4.5% to 7.3%. Although we benefited from economies of scale, the increase in operating expenses nevertheless outpaced revenue growth due to increased professional fees related to public company and non-cash share-based compensation expenses.

Net Income

Our net income was $12.0 million, or 25.3% of net sales, for the six months ended June 30, 2007, as compared to $11.0 million, or 33.3% of net sales, for the six months ended June 30, 2006. The increase reflected continued expansion in sales revenue levels, continued strong demand for our products as a result of high copper prices and sustained profitability.

Basic and diluted earnings per share (EPS) for the six months ended June 30, 2007, were $0.57 and $0.49, respectively, compared to $0.55 and $0.51, in the same period last year, respectively. Excluding share-based compensation expense, the earnings per share on a diluted basis would have been 0.54 for the six months ended June 30, 2007. The weighted average shares outstanding used to calculate basic and diluted EPS for the comparative periods were 21.1 million and 24.7 million, respectively.
 
38

LIQUIDITY AND CAPITAL RESOURCES
 
We have historically financed our operations and capital expenditures principally through private sales of equity securities, the Financing in which we placed high yield senior notes and convertible senior notes, bank loans and cash provided by operations. In addition, the warrants remaining outstanding of the 2,125,000 we sold as part of financings in December, 2005 became callable during the quarter ended June 30, 2007 because the trading price of our common stock exceeded $10.00 per share for 10 consecutive trading days. We took the necessary steps to call the remaining warrants And 1,549,038 warrants were subsequently exercised while 202,588 automatically expired by May 25, 2007. The aggregate proceeds received by us were approximately $6.8 million for the six months ended June 30, 2007.
 
As is customary in our industry, we provide payment terms to most of our customers that exceed terms that we receive from our suppliers. Therefore, the Company’s liquidity needs have generally consisted of working capital necessary to finance receivables and raw material inventory. Capital expenditures have historically been necessary to expand the production capacity of the Company’s manufacturing operations.

In summary, our cash flows were:
 
   
For the Six Months Ended
 
   
29-Jun-07
  
30-Jun-06
  
Net cash provided by (used in) operating activities
  
$
6,331,245.31
  
$
(4,813,245.00
)
Net cash used in investing activities
    
(12,152,046
)
  
(5,057,136
)
Net cash provided by (used in) financing activities
    
58,665,167
   
9,257,033
 
Effect of exchange rate change on cash and cash equivalents
    
1,867,519
   
(966,386
)
Net increase (decrease) in cash and cash equivalents
    
54,711,885
   
(1,579,734
)
Cash and cash equivalents at beginning of period
    
20,493,551
   
6,163,670
 
Cash and cash equivalents at end of period
  
$
75,205,436.26
  
$
4,583,936.00
  
 
For the six months ended June 30, 2007, net cash provided by operating activities was $6.3 million. This was primarily attributable to our net income of $12.0 million, adjusted by an add-back of non-cash expenses primarily consisting of depreciation and amortization of $1.4 million and share-based compensation expense of $0.7 million, and a $6.9 million increase in working capital. Specifically, the working capital increase was primarily due to (i) a $2.2 million accounts receivable increase driven by revenue growth; (ii) a $2.1 million inventory increase, principally raw materials, to support planned expansion and sales growth; (iii) a $2.0 million increase in advance to suppliers, consisting primarily of prepayments for copper supplies in advance of shipment; and (iv) a $2.2 million increase in other payables and accrued liabilities.
 
For the six months ended June 30, 2007, net cash used in investing activities was $12.2 million, and was primarily attributable to $6.5 million capital expenditure on new equipment and machinery including $5.7 million advances for purchase of equipment.
 
39

For the six months ended June 30, 2007, net cash provided by financing activities was $58.7 million, and was primarily attributable to $56.4 million net proceeds from the high yield notes and convertible notes and $6.8 million proceeds from warrants exercised. We also rolled over maturing, short term working capital loans in the amount of $12.6 million and drew down $11.5 million from our existing credit line facilities to meet working capital needs. Maturities for the working capital financing range from three to six months. We intend to renew these loans when they become due.

As of June 30, 2007, we had cash and cash equivalents of $75.2 million, up $70.6 million from $4.6 million at June 30, 2006.

On January 24, 2007, in connection with the Financing, we entered into a Notes Purchase Agreements with Citadel Equity Fund Ltd and raised $60 million in gross proceeds through a hybrid financing, which consists of (i) $40 million Guaranteed Senior Floating Rate Notes due 2012 (the “HY Notes”) with an initial interest rate of LIBOR plus 7.0% subject to 140bps step down upon qualifying event and (ii) $20 million 3% Senior Secured Convertible Notes due 2012 (the “Convertible Notes”). We received $56.4 million in net proceeds after deducting placement agent commission and notes discount which are included in “Deferred Loan Expenses” in the accompanying consolidated balance sheets. The applicable fees and expenses are amortized over the respective lives of the HY Notes and the Convertible Notes on a straight-line basis over 5 years, respectively. Amortization was $329,096 for the six months ended June 30, 2007. In terms of use of proceeds, we intend to apply a substantial portion of the net proceeds from the financing to corporate expansion and general corporate purposes, including but not limited to, funding of working capital needs, purchase of new equipment to meet existing orders and to provide additional capacity for further expansion, and other general corporate purposes.
 
The HY Notes and Convertible Notes contain customary affirmative and negative covenants and other provisions, including restrictions on the incurrence of additional debt, creation of liens, making restricted payments, paying dividends, maintenance of a maximum leverage ratio, maintenance of a fixed charge coverage ratio, and minimum net worth. We were in compliance with all of these requirements as of June 30, 2007.
 
For the remainder of 2007, as we accelerate expansion, we expect continued capital expenditures for maintaining and adding manufacturing equipment. We also anticipate that our working capital requirements may increase during the balance of 2007 as a result of continued increases in sales and potential increases in the price of copper. We believe that our existing cash, cash equivalents and cash flows from operations, proceeds from the HY Notes and Convertible Notes and proceeds from warrant exercise, combined with availability under our revolving credit facility, will be sufficient to meet our present anticipated future cash needs. We may, however, require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue.
 
CRITICAL ACCOUNTING POLICIES
 
There have been no changes in our critical accounting policies or significant accounting estimates as disclosed in our 2006 Annual Report on Form 10-KSB (see Note 2 in the Notes to the Consolidated Financial Statements included elsewhere in this Form 10-Q).
 
40
 
Item 3.   Quantitative and Qualitative Disclosures About Market Risk

Commodity Price Risk 
 
Certain raw materials used by us are subject to price volatility caused by supply conditions, political and economic variables and other unpredictable factors. The primary purpose of our commodity price management activities is to manage the volatility associated with purchases of commodities in the normal course of business. We do not speculate on commodity prices.
 
We are exposed to price risk related to our purchase of copper used in the manufacture of our products. Our copper price management strategy involves the use of natural techniques, where possible, such as purchasing copper for future delivery at fixed prices. We did not have any commodity price derivatives or hedging arrangements outstanding at June 30, 2007 and did not employ any commodity price derivatives during the quarter then ended.
 
Foreign Exchange Risk

Our reporting currency is the Renminbi. Substantially all of our operations are conducted in the PRC, with the exception of our export business and limited overseas purchases of raw materials. Most of our sales and purchases are conducted within the PRC in Renminbi, which is the official currency of the PRC. As a result, the effect of the fluctuations of exchange rates is considered minimal to our business operations.
 
The PRC State Administration for Foreign Exchange, under the authority of the People’s Bank of China, controls the conversion of Renminbi into foreign currencies. The principal regulation governing foreign currency exchange in China is the Foreign Currency Administration Rules (1996), as amended, or the “Rules.” Under the Rules, once various procedural requirements are met, Renminbi is convertible for current account transactions, including trade and service-related foreign exchange transactions and dividend payments, but not for capital account transactions, including direct investment, loans or investments in securities outside China, without prior approval of the State Administration of Foreign Exchange of the People’s Republic of China, or its local counterparts.
 
Since July 2005, the Renminbi has no longer been pegged to the U.S. dollar. Although currently the Renminbi exchange rate versus the U.S. dollar is restricted to a rise or fall of no more than 0.3% per day and the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the Renminbi may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future, the PRC authorities may lift restrictions on fluctuations in the Renminbi exchange rate and lessen intervention in the foreign exchange market.
 
Any devaluation of the Renminbi against the U.S. dollar would consequently have an adverse effect on our financial performance and asset values when measured in terms of U.S. dollars. On the other hand, the appreciation of the Renminbi could make our customers’ products more expensive to purchase because many of our customers are involved in the export of goods, which may have an adverse impact on their sales. A decrease in sales by our customers could reduce our sales and revenues. In addition, from time to time we may have U.S. dollar denominated borrowings, and therefore a decoupling of the Renminbi many affect our financial performance in the future.
 
We recognized a foreign currency translation adjustment of approximately $2.1 million and $3.0 million, for the three months and six months ended June 30, 2007, respectively.

Interest Rate Risk

We are primarily exposed to interest rate risk arising from 6 months LIBOR rate on which the interest rate for our HY Notes is based. If there was a hypothetical 1% change in 6-month LIBOR interest rate, the net impact to earnings and cash flows would be approximately $0.4 million on annualized basis.
 
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In order to mitigate our exposure to volatility in interest rates and foreign currency exchange rates associated with the Guaranteed Senior Secured Floating Rate Notes due 2012 (2012 Note), on April 10, 2007, the Company entered into a cross currency swap transaction (the Swap) with Merrill Lynch Capital Services, Inc. (“MLCS”) . The Swap, with a notional principal value of $40 million, converts the LIBOR + 7% per annum USD variable interest rate to a 8.3% per annum RMB fixed interest rate. The agreement was deemed effective January 24, 2007. The Swap requires semi-annual payment in arrears on July 24 and January 24 and matures earlier of (1) cash settlement defined as early termination; or (2) January 24, 2012, at which point the Swap requires an exchange of RMB and USD based principals. Under the terms of the cross currency swap, the Company receives variable interest rate payments in USD and makes fixed interest rate payments in RMB with settlement netted in USD, thereby creating the equivalent of fixed-rate debt. The Company uses this derivative instrument only to hedge exposures in the ordinary course of business and does not invest in derivative instruments for speculative purposes.

The fair value of the Swap is determined with the assistance of third party provided calculations which reflect the present values of the difference between estimated future variable-rate receipts in USD and future fixed-rate payments in RMB. For the six months ended June 30, 2007, changes in fair value of the Swap designated and effective as cash flow hedge resulted in an increase in the liability and a loss to other comprehensive income of $871,519, net of taxes. As of June 30, 2007, the Company had cross currency hedge receivable amounting to $802,523, which was recorded as a gain from derivative transactions and subsequently received in July 2007 from MLCS.
 
Credit Risk

We have not experienced significant credit risk, as most of our customers are long-term customers with excellent payment records. We review our accounts receivable on a regular basis to determine if the allowance for doubtful accounts is adequate at each quarter-end. We only extend 30 to 90 day trade credit to our largest customers, which tend to be well-established and large businesses, and we have not seen any accounts receivable go uncollected beyond 90 days or experienced any write-off of accounts receivable in the past.
 
Inflation

In recent years, China has not experienced significant inflation, and thus inflation has not had a material impact on our results of operations. According to the National Bureau of Statistics of China, the change in Consumer Price Index in China was 3.9%, 1.8% and 1.5% in 2004, 2005 and 2006, respectively.
 
Item 4. Controls and Procedures.
 
(a) Evaluation of disclosure controls and procedures. Our chief executive officer and our chief financial officer, after evaluating the effectiveness of the company’s “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934, as amended (the “Exchange Act”), Rules 13a-15e and 15d-15e) as of the end of the period covered by this report (the “Evaluation Date”), have concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective.
 
(b) Changes in internal controls. During the fiscal quarter covered by this quarterly report, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect our internal control over financial reporting.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control systems are met. Because of the inherent limitations in all control systems no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Such limitations include the fact that human judgment in decision-making can be faulty and that breakdowns in internal control can occur because of human failures, such as simple errors or mistakes or intentional circumvention of the established process.
 
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PART II
 
Item 4.  Submission of Matters to a Vote of Security Holders

On Wednesday, July 25, 2007 at 10:00 a.m., we held an Annual Meeting of Stockholders (“Annual Meeting”) at our executive offices.

The purpose of the Annual Meeting was:

 
1.
To elect five members to our Board of Director to serve until their respective successors are elected and qualified; and

 
2.
To ratify and approve Moore Stephens Wurth Frazer and Torbet, LLP, as our independent public accountants, to audit our financial statements for the fiscal ending December 31, 2007.

The five nominated directors were elected and Moore Stephens Wurth Frazer and Torbet, LLP was ratified and approved as out independent auditor.
 
Below is a breakdown of the votes cast in respect of the proposals:
 
 
Proposals for:
  
 
For
  
 
Against
  
 
Withheld
  
 
Abstentions
Li Fu as our director
  
15,913,609
  
—
  
—
  
—
Mathus Yue Yang as our director
  
15,913,609
  
—
  
—
  
—
Barry Raeburn as our director
  
15,913,609
  
—
  
—
  
—
Jiping Hua as our director
  
15,913,609
  
—
  
—
  
—
Feng Bai as our director
  
15,913,609
  
—
  
—
  
—
                 
Moore Stephens Wurth Frazer and Torbet LLP as our independent public accountant
  
15,913,609
  
—
  
—
  
—
 
Item 6. Exhibits

(a) Exhibits

31.1 – Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 – Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 – Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
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SIGNATURES

Pursuant to the requirements of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned there unto duly authorized.
 
  FUSHI INTERNATIONAL, INC.
     
     
Date: August 14, 2007
BY:
/s/ Wenbing Chris Wang
   
Wenbing Chris Wang
   
Chief Financial Officer
 
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INDEX TO EXHIBITS
 
EXHIBIT
NUMBER
  
DESCRIPTION
     
31.1
  
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2
  
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
32.1
  
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
 
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