Fushi Copperweld, Inc. - FORM 10-Q - XML - IDEA: XBRL DOCUMENT - May 9, 2012

Note–2 - Principles of Consolidation

The consolidated financial statements include the financial statements of Fushi, its wholly-owned subsidiaries and consolidated variable interest entity (“VIE”), in which the Company is the primary beneficiary. All significant intercompany balances and transactions have been eliminated on consolidation.

Fushi has no direct or indirect legal ownership interest in Dalian Fushi. The legal registered capital interests of Dalian Fushi are held by four individuals as nominee shareholders. Through a series of contractual agreements, including the Entrusted Management Agreement, the Voting Proxy Agreement, the Share Pledge Agreement and Exclusive Option Agreement (collectively, the “VIE Agreements”) among Fushi International, Dalian Fushi and its shareholders, Fushi, through Fushi International, has a controlling financial interest in Dalian Fushi. The Company holds an exclusive call option to acquire Dalian Fushi for nil consideration and has provided financing to Dalian Fushi. Dalian Fushi holds the title to an office building and land use rights in Dalian on behalf of the Company; however, Dalian Fushi does not conduct any business operations.

In accordance with ASC Sub-topic 810-10, Dalian Fushi is determined to be a VIE because (i) the registered capital interests of Dalian Fushi that are held by nominee shareholders do not allow the nominee shareholders to participate in any profit or loss of Dalian Fushi and (ii) the nominee shareholders do not have the power to direct the activities of Dalian Fushi that most significantly impact its economic performance and do not have the obligation to absorb the expected losses and right to receive the expected residual returns of Dalian Fushi.

In accordance with ASC Sub-topic 810-10, the Company is determined to be the primary beneficiary of Dalian Fushi and the financial statements of Dalian Fushi are consolidated in the Company’s consolidated financial statements.

The Company is the primary beneficiary of Dalian Fushi because the Company has (i) the power to direct activities of Dalian Fushi that most significantly impact the economic performance of Dalian Fushi; (ii) the obligation to absorb the expected losses and the right to receive expected residual return of Dalian Fushi that could potentially be significant to Dalian Fushi; and (iii) there is no party apart from the Company that holds any variable interest in Dalian Fushi.

Under the terms of the VIE Agreements, the Company (i) was irrevocably appointed by the nominee shareholders of Dalian Fushi with the exclusive right to exercise the shareholder’s voting rights of Dalian Fushi. (ii) has the right to independently manage Dalian Fushi’s business, including appointing all board of directors and management (iii) has the right to receive Dalian Fushi’s profits and bear its losses (iv) has the right to dispose all assets of Dalian Fushi and (v) the option to acquire 100% of the registered capital interests in Dalian Fushi for nil consideration.

The assets and liabilities of Dalian Fushi as of March 31, 2012 and December 31, 2011, and revenues and net loss of Dalian Fushi for the three-month period ended March 31, 2012 and 2011 are as follows:

Risks and uncertainties of the VIE Arrangements

The Company relies on the VIE Agreements to manage Dalian Fushi. However, these contractual arrangements may not be as effective as direct equity ownership in providing the Company with control over Dalian Fushi. Any failure by Dalian Fushi or its registered capital holders to perform their obligations under the VIE Agreements would have a material adverse effect on the financial position of the Company. All the VIE Agreements are governed by PRC law and provide for the resolution of disputes through arbitration in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. The legal system in the PRC is not as developed as some other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit the Company’s ability to enforce these contractual arrangements. In addition, if the legal structure and the VIE Agreements were found to be in violation of any existing or future PRC laws and regulations, the Company may be subject to fines or other legal or administrative sanctions.

In the opinion of management, based on the legal opinion obtained from the Company’s PRC legal counsel, the above contractual arrangements are legally binding and enforceable and do not violate current PRC laws and regulations. However, there are uncertainties regarding the interpretation and application of existing and future PRC laws and regulations. Accordingly, the Company cannot be assured that PRC regulatory authorities will not ultimately take a contrary view to its opinion. If the VIE Arrangements are found to be in violation of any existing or future PRC laws and regulations, the Company may lose its controlling financial interests in Dalian Fushi and would no longer be able to consolidate the financial results of Dalian Fushi in the Company’s consolidated financial statements. In the opinion of management, the likelihood of loss in respect of the Company’s VIE Arrangements is remote based on current facts and circumstances.

All the equity (net assets) and profits (losses) of Dalian Fushi are attributed to the Company. Therefore, no non-controlling interest in Dalian Fushi is presented in the Company’s consolidated financial statements.