10-Q/A 1 c45285_10-qa.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q/A (Amendment No. 2) (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, 2006 or [ ] 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: 333-112111 ------------------------------------------------------- Zhongpin Inc. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 54-2100419 --------------------------------------------------------- ---------------------- (State or other jurisdiction of incorporation (I.R.S. Employer or organization) Identification No.) 21 Changshe Road, Changge City, Henan Province, The People's Republic of China -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) 011 86 374-6216633 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Not Applicable -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) 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 ninety (90) days. YES _X_ NO ___ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check One): Large accelerated filer ___ Accelerated filer ___ Non-accelerated filer _X_ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ___ NO _X_ As of September 13, 2006, 11,752,568 shares of the registrant's common stock, and 6,900,000 shares of the registrant's Series A preferred stock, each such share convertible into one share of the registrant's common stock, were outstanding. EXPLANATORY NOTE In this Amendment No. 2 to the Quarterly Report on Form 10-Q, we will refer to Zhongpin Inc., a Delaware corporation, as "our company," "we," "us," and "our." We are filing this Amendment No. 2 to our Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2006 to correct the following items: o Part I, Item 1. Unaudited Financial Statements and Notes to Consolidated Financial Statements and Part I, Item II. Management's Discussion and Analysis of Financial Condition and Results of Operations to reflect the additional expense recorded in connection with the accrual of a liability that may be payable to the holders of our Series A convertible preferred stock and related purchase warrants because of our failure to register in a timely manner for resale under the Securities Act of 1933, as amended, the shares of our common stock issuable upon the conversion or exercise of such securities. Pursuant to Rule 12b-15 promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), this Amendment No. 2 presents new certifications pursuant to Rule 13a-14(a)/15d-14(a) and Rules 13a-14(b)/15d-14(b) under the Exchange Act. Except as described above, no substantive change has been made to the Quarterly Report as originally filed. This Amendment No. 2 does not reflect events occurring after the filing of the Quarterly Report as originally filed or modify or update those disclosures affected by subsequent events. ZHONGPIN INC. FORM 10-Q INDEX PART I FINANCIAL INFORMATION PAGE ------ --------------------- ---- Item 1. Unaudited Financial Statements: Consolidated Balance Sheets as of June 30, 2006 (unaudited) and December 31, 2005 ...................... 2 Consolidated Statements of Operations and Comprehensive Income (unaudited) for the three and six months ended June 30, 2006 and 2005 ........... 3 Consolidated Statement of Changes in Stockholders' Equity (unaudited) for the six months ended June 30, 2006 ......................................... 4 Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2006 and 2005 ........... 5 Notes to Consolidated Financial Statements (unaudited) ... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ................... 22 PART II OTHER INFORMATION Item 6. Exhibits.................................................. 37 SIGNATURES.................................................................. 38 i ZHONGPIN INC. PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS The accompanying unaudited consolidated balance sheets, statements of operations and comprehensive income, of changes in stockholders' equity, and of cash flows and related notes thereto, have been prepared in accordance with generally accepted accounting principles ("GAAP") for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission ("SEC"). Accordingly, they do not include all of the disclosures required by GAAP for complete financial statements. The financial statements reflect all adjustments consisting only of normal, recurring adjustments, which are, in the opinion of management, necessary for a fair presentation for the interim periods. The accompanying financial statements should be read in conjunction with the notes to the aforementioned financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and notes thereto included in our Annual Report on Form 10-K, as amended, for the transition period from June 30, 2005 to December 31, 2005. The results of operations for the three- and six-month periods ended June 30, 2006 are not necessarily indicative of the results to be expected for the entire fiscal year or any other period. ZHONGPIN INC. CONSOLIDATED BALANCE SHEETS (AMOUNTS IN U.S. DOLLARS) JUNE 30, 2006 DECEMBER 31, 2005 ------------- ----------------- ASSETS (Unaudited) (Restated) Current assets Cash and cash equivalents $ 14,519,039 $ 10,142,394 Accounts receivable and other receivables 14,733,543 10,002,918 Purchase deposits 88,873 220,836 Prepaid expenses and deferred charges 140,985 99,009 Inventories 6,352,818 2,347,312 Tax refund receivables 794,618 644,232 ------------- ----------------- Total current assets 36,629,876 23,456,701 Property, plant and equipment (net) 22,638,938 10,212,848 Related party receivables 270,148 267,658 Other receivables -- 632,063 Construction contracts 8,814,597 16,931,178 Intangible assets 5,476,867 1,753,124 ------------- ----------------- Total assets $ 73,830,426 $ 53,253,572 ============= ================= LIABILITIES AND EQUITY Current liabilities Bank overdraft $ -- $ 619,579 Accounts payable and other payables 10,916,854 10,278,464 Accrued liabilities 968,793 759,420 Short term loans payable 12,944,619 18,995,853 Taxes payable 943,674 2,055,925 Deposits from clients 250,331 769,398 Research and development grants payable 1,339,887 2,436,804 Long term loans payable-current portion 145,671 145,671 ------------- ----------------- Total current liabilities 27,509,829 36,061,114 Long term loans payable 2,107,165 2,264,448 ------------- ----------------- Total liabilities 29,616,994 38,325,562 Minority interest 431,037 411,742 Equity Preferred stock: par value $0.001; 10,000,000 authorized; 6,900,000 shares issued and outstanding 6,900 -- Common stock: par value $0.001; 25,000,000 authorized; 11,752,578 shares issued and outstanding 11,753 11,753 Additional paid in capital 25,209,926 2,102,933 Retained earnings 17,984,977 12,097,834 Accumulated other comprehensive income 568,839 303,748 ------------- ----------------- Total equity 43,782,395 14,516,268 ------------- ----------------- Total liabilities and equity $ 73,830,426 $ 53,253,572 ============= ================= The accompanying notes are an integral part of these consolidated financial statements. 2 ZHONGPIN INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (AMOUNTS IN U.S. DOLLARS) (UNAUDITED)
Three Months Ended Six Months Ended June 30, June 30, -------------------------------- -------------------------------- 2006 2005 2006 2005 -------------- -------------- -------------- -------------- (Restated) (Restated) Revenues Sales revenues 31,777,348 18,591,118 62,270,855 32,996,247 Cost of sales 27,052,820 15,574,225 52,966,975 27,383,004 -------------- -------------- -------------- -------------- Gross profit 4,724,528 3,016,893 9,303,880 5,613,243 Operating expenses General and administrative expenses 1,579,624 276,520 2,478,648 500,169 Operating expenses 716,090 327,304 1,520,236 692,663 -------------- -------------- -------------- -------------- Total operating expenses 2,295,714 603,824 3,998,884 1,192,832 -------------- -------------- -------------- -------------- Income from operations 2,424,814 2,413,069 5,304,996 4,420,411 Other income (expense) Interest income 149,648 40,364 245,338 89,269 Other income (expenses) 23,844 (17,978) 36,236 (3,304) Allowances income 1,113,661 5,435 1,226,845 44,082 Exchange gain 4,319 (31,103) 18,028 (42,276) Interest expense (227,587) (458,908) (607,815) (808,658) -------------- -------------- -------------- -------------- Total other income (expense) 1,063,885 (462,190) 918,632 (720,887) -------------- -------------- -------------- -------------- Net income before taxes 3,492,669 1,950,879 6,223,628 3,699,524 Provision for income taxes 171,945 122,789 317,190 122,789 -------------- -------------- -------------- -------------- Net income after taxes 3,320,754 1,828,090 5,906,438 3,576,735 Minority interest 8,575 6,801 19,295 19,055 -------------- -------------- -------------- -------------- Net income $ 3,312,179 $ 1,821,289 $ 5,887,143 $ 3,557,680 ============== ============== ============== ============== Foreign currency translation adjustment 123,941 -- 265,091 -- -------------- -------------- -------------- -------------- Comprehensive income $ 3,436,120 $ 1,821,289 $ 6,152,234 $ 3,557,680 ============== ============== ============== ============== Basic earnings per common share $ 0.18 $ 0.15 $ 0.34 $ 0.30 Diluted earnings per common share $ 0.14 $ 0.15 $ 0.28 $ 0.30 Basic weighted average shares outstanding 11,752,578 11,752,578 11,752,578 11,752,578 Diluted weighted average shares outstanding 23,137,578 11,752,578 21,248,411 11,752,578
The accompanying notes are an integral part of these consolidated financial statements. 3 ZHONGPIN INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (AMOUNTS IN U.S. DOLLARS) (UNAUDITED) (Restated)
Accumulated Additional Other Preferred Stock Common Stock Paid In Retained Comprehensive Shares Par Value Shares Par Value Capital Earnings Income Total ---------- --------- ------------ ---------- ----------- ----------- ----------- ----------- Balance at January 1, 2003 -- $ -- 1 $1,816,425 $ 182,319 $ 1,935,634 $ -- $ 3,934,378 Net income for the year -- -- -- 1,536,272 1,536,272 Dividends paid -- -- -- -- -- (56,392) -- (56,392) ---------- --------- ------------ ---------- ----------- ----------- ----------- ----------- Balance December 31, 2003 -- -- 1 1,816,425 182,319 3,415,514 -- 5,414,258 Net income for the year -- -- -- -- -- 2,768,473 -- 2,768,473 ---------- --------- ------------ ---------- ----------- ----------- ----------- ----------- Balance December 31, 2004 -- -- 1 1,816,425 182,319 6,183,987 -- 8,182,731 Merger on May 20 -- -- -- 115,942 -- -- -- 115,942 Recapitalization on Sept. 15 -- -- 9,999 (1,922,367) 1,922,367 -- -- -- Net income for the year 5,913,847 -- 5,913,847 Foreign currency translation adjustment -- -- -- -- -- -- 303,748 303,748 ---------- --------- ------------ ---------- ----------- ----------- ----------- ----------- Balance December 31, 2005 -- -- 10,000 10,000 2,104,686 12,097,834 303,748 14,516,268 Items applied retroactively: -- Recapitalization on January 30, 2006 -- -- 415,432,354 405,442 (405,442) -- -- -- Reverse stock split on February 16, 2006 (1:35.349) -- -- (403,689,776) (403,689) 403,689 -- -- -- ---------- --------- ------------ ---------- ----------- ----------- ----------- ----------- Restated December 31, 2005 -- -- 11,752,578 11,753 2,102,933 12,097,834 303,748 14,516,268 Increase in Preferred Stock 6,900,000 6,900 -- -- -- -- -- 6,900 Warrant expense 3,190 3,190 Net income for the period -- -- -- -- -- 5,887,143 -- 5,887,143 Increase in additional paid in capital -- -- -- -- 23,103,803 -- 23,103,803 Foreign currency translation adjustment -- -- -- -- -- -- 265,091 265,091 ---------- --------- ------------ ---------- ----------- ----------- ----------- ----------- Balance June 30, 2006 6,900,000 $ 6,900 11,752,578 $ 11,753 $25,209,926 $17,984,977 $ 568,839 $43,782,395 ========== ========= ============ ========== =========== =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 4 ZHONGPIN INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (AMOUNTS IN U.S. DOLLARS) (UNAUDITED) SIX MONTHS ENDED JUNE 30, --------------------------- 2006 2005 ------------ ------------ (Restated) Cash flows from operating activities: Net income $ 5,887,143 $ 3,557,680 Adjustments to reconcile net income to net cash provided by (used in) operations: Minority interest 19,295 214,854 Depreciation 361,958 290,522 Amortization 51,605 10,923 Exchange gain (18,027) -- Provision for allowance for bad debt (76) -- Warrants issued for services 3,190 -- Changes in operating assets and liabilities: Accounts receivable and other receivables (4,101,052) (4,122,488) Purchase deposits 131,963 1,580 Prepaid expense and deferred charges (41,976) (128,046) Inventories (4,005,506) (1,059,548) Tax refunds receivable (150,386) (1,786) Accounts payable and accrued liabilities (249,154) (291,419) Taxes payable (1,112,251) (46,193) Deposits from clients (519,067) 139,634 ------------ ------------ Net cash used in operating activities (3,742,341) (1,434,287) Cash flows from investing activities: Construction in progress -- (250,349) Additions to fixed assets (4,669,791) (378,489) Additions to intangible assets (3,775,109) -- ------------ ------------ Net cash used in investing activities (8,444,900) (628,838) Cash flows from financing activities: Repayment of Bank overdraft (619,579) -- Proceeds from short-term loans 10,492,500 16,550,797 Repayment of short-term loans (16,543,734) (4,657,450) Repayment of long-term loans (157,283) (1,582,575) Proceeds from preferred stock 23,110,703 -- Payments of dividends -- -- ------------ ------------ Net cash provided by financing activities 16,282,607 10,310,772 Effect of rate changes on cash 281,279 -- ------------ ------------ Increase (decrease) in cash and cash equivalents 4,376,645 8,247,647 Cash and cash equivalents, beginning of period 10,142,394 5,204,637 ------------ ------------ Cash and cash equivalents, end of period $ 14,519,039 $ 13,452,284 ============ ============ Supplemental disclosures of cash flow information: Cash paid for interest $ 636,044 $ 808,658 Cash paid for income taxes $ 312,672 $ -- The accompanying notes are an integral part of these consolidated financial statements. 5 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for annual financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The consolidated operating results for the six months ended June 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. For further information, refer to the financial statements and footnotes thereto included herein for the three years ended December 31, 2005. 1. ORGANIZATION AND NATURE OF OPERATIONS Zhongpin Inc. ("Zhongpin") was incorporated on February 4, 2003 as Strong Technical Inc. in the State of Delaware for the purpose of operating a personnel outsourcing service that provides skilled workers to industry. On March 30, 2005, an 82.4% controlling interest in our company was acquired by Halter Capital Corporation and all previous operations were discontinued. On January 30, 2006, we acquired Falcon Link Investment Limited ("Falcon") in a stock exchange by issuing 397,676,704 (11,250,000 post-split) shares of our common stock in exchange for all of the issued and outstanding capital stock of Falcon. The acquisition transaction was accounted for as a reverse acquisition resulting in the recapitalization of Falcon. Accordingly, the historical financial statements of Falcon have been retroactively restated to give effect to the recapitalization as if it had occurred at the beginning of the first period presented. Zhongpin and its subsidiaries are collectively referred to herein as "our company," "we," "us" and "our." Falcon was incorporated in the Territory of the British Virgin Islands ("BVI") on July 21, 2005 as a holding company for the purpose of owning all of the equity interests of Henan Zhongpin Food Co., Ltd. ("HZFC"), a People's Republic of China ("PRC") company. Falcon acquired 100% ownership of HZFC by paying 20,940,000 Renminibi ("RMB") ($2,528,986) to the holders of HZFC, who where also the holders of Falcon. The transaction was accounted for as a transfer of entities under common control, wherein HZFC was the continuing entity. The historical financial statements of Falcon are essentially those of HZFC and are shown as if the transfer had taken place at the beginning of the first period presented. HZFC was established in the PRC on May 20, 2005 for the sole purpose of holding the capital stock of Henan Zhongpin Food Share Company Limited ("Food Share") and its subsidiaries. The owners of Food Share formed HZFC by investing 16,000,000 RMB ($1,932,367). HZFC acquired Food Share by paying 15,040,000 RMB ($1,816,425) to the holders of Food Share, who were also the holders of HZFC, in exchange for 100% ownership of Food Share. The transaction was accounted for as a transfer of entities under common control, wherein Food Share was the continuing entity with an increase in registered capital of 960,000 RMB ($115,942). The historical financial statements of HZFC are essentially those of Food Share shown with an increase in capital as if the transfer had taken place at the beginning of the first period presented. Food Share was incorporated in the PRC. It is headquartered in Henan Province in the PRC and its corporate office is in Changge City. Through our subsidiaries, we are principally engaged in the production of pork, pork products and vegetables, and the retail sales of pork, processed pork products, vegetables and other grocery items to customers throughout the PRC and other export countries, either directly or through its subsidiaries. On January 30, 2006, we consummated an agreement with the shareholders of Falcon whereby we issued 397,676,704 (11,250,000 post-split) shares of our common stock in exchange for all of the issued and outstanding stock of Falcon. Immediately prior to the transaction there were 17,765,650 (502,578 post-split) shares outstanding as compared to 415,442,354 (11,752,578 post-split) shares outstanding immediately following the transaction. Consequently, Falcon became a wholly-owned subsidiary of our company. The transaction was accounted for as a reverse acquisition resulting in a recapitalization of Falcon, wherein Falcon's historical financial statements became those of our company, retrospectively restated to reflect the adopted capital structure of our company as if the transaction had occurred at the beginning of the first period presented. These financial statements have been adjusted to reflect such restatement. 6 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND NATURE OF OPERATIONS (continued) In conjunction with the acquisition of Falcon, on January 31, 2006, we sold for $8.00 per unit 3.45 million units, each consisting of two shares of Series A convertible preferred stock and a five-year warrant to purchase 35.349 (one post-split) common shares at a purchase price of $0.1414467 ($5.00 post split) per share. Each preferred share is convertible into 35.349 (one post-split) common shares. The outstanding shares of Series A convertible preferred stock are convertible into an aggregate of 243,908,100 (6,900,000 post-split) common shares and the outstanding warrants are exercisable to purchase an aggregate of 121,954,050 (3,450,000 post-split) common shares. On February 16, 2006, we amended our articles of incorporation to change our name from Strong Technical, Inc. to Zhongpin Inc. In the same amendment, we changed our authorized common stock to 25,000,000 shares with a par value of $0.001 per share and our authorized preferred stock to 10,000,000 shares with a par value of $0.001 per share. On February 16, 2006, we effected a 1:35.349 reverse split of our outstanding common stock. Immediately prior to the split, 415,442,354 common shares were outstanding as compared to 11,752,578 common shares outstanding immediately following the split. The aggregate number of shares of common stock issuable upon conversion of our outstanding shares of Series A convertible preferred stock was reduced from 243,908,100 common shares to 6,900,000 common shares, and the aggregate number of shares of our common stock issuable upon the exercise of our outstanding warrants was reduced from 121,954,050 common shares to 3,450,000 common shares. The purchase price of the shares issuable exercise of our outstanding warrants was increased to $5.00 per share. Details of Food Share's subsidiaries are as follows: DOMICILE/DATE REGISTERED PERCENTAGE NAME OF INCORPORATION CAPITAL OF OWNERSHIP Henan Zhongpin Industrial 18,000,000 RMB Company Limited PRC/ Jan. 17, 2002 ($2,173,913) 88.00% Henan Zhongpin Import and 5,060,000 RMB Export Trading Company PRC/Aug. 11, 2004 ($611,111) 88.93% Zhumadian Zhongpin 5,000,000 RMB Food Company Limited PRC/June 7, 2006 ($625,344) 100% 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The consolidated financial statements include the accounts of Zhongpin Inc. (formerly Strong Technical, Inc.), Falcon Link Investment Limited, Henan Zhongpin Food Co., Ltd., Henan Zhongpin Food Share Company Limited, Henan Zhongpin Industrial Company Limited, Henan Zhongpin Import and Export Trading Company and Zhumadian Zhongpin Food Company Limited. All material intercompany accounts and transactions have been eliminated in consolidation. The consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that 7 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities as of 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. U.S. GAAP differs from that used in the statutory financial statements of our PRC subsidiaries, which were prepared in accordance with the relevant accounting principles and financial reporting regulations as established by the Ministry of Finance of the PRC. Certain accounting principles stipulated under U.S. GAAP are not applicable in the PRC. The RMB of the People's Republic of China has been determined to be our functional currency. The balance sheets of our company and our subsidiaries were translated at year end exchange rates. Expenses were translated at moving average exchange rates in effect during the year. The effects of rate changes on assets and liabilities are recorded as accumulated other comprehensive income. FISCAL YEAR Our financial statements have been prepared using December 31 as the fiscal year end. MINORITY INTEREST IN SUBSIDIARIES We record minority interest expense, which reflects the minority shareholders' portion of the earnings of Henan Zhongpin Industrial Company Limited and Henan Zhongpin Import and Export Trading Company. During 2005, Henan Zhongpin Industrial Company Limited increased its registered capital from 5,000,000 RMB to 18,000,000 RMB, which required the minority holders to increase their investment by 1,560,000 RMB, effectively increasing the minority interest shown on our balance sheet by $188,406. In June 2006, Zhumadian Zhongpin Food Company Limited was registered with a registered capital of 5,000,000 RMB, which is 100%-owned by Henan Zhongpin Food Share Company Limited. RESTRICTIONS ON TRANSFER OF ASSETS OUT OF THE PRC Dividend payments by HZFC are limited by certain statutory regulations in the PRC. No dividends may be paid by HZFC without first receiving prior approval from the Foreign Currency Exchange Management Bureau. Dividend payments are restricted to 85% of profits, after tax. CONTROL BY PRINCIPAL STOCKHOLDERS Our directors and executive officers and their affiliates or related parties own, beneficially and in the aggregate, the majority of the voting power of the outstanding shares of our common stock. Accordingly, if our directors and executive officers and their affiliates or related parties vote their shares uniformly, they would have the ability to control the approval of most corporate actions, including increasing our authorized capital stock and the dissolution or merger of our company or the sale of our assets. START-UP COSTS In accordance with the provisions of the American Institute of Certified Public Accountants' Statement of Position (SOP) 98-5, "Reporting on the Costs of Start-up Activities," we expense all start-up and organizational costs as they are incurred. 8 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. SIGNIFICANT ESTIMATES Several areas require significant management estimates relating to uncertainties for which it is reasonably possible there will be a material change in the near term. The more significant areas requiring the use of management estimates relate to the valuation of receivables, equipment and accrued liabilities, and the useful lives for amortization and depreciation. CASH EQUIVALENTS We consider all highly-liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. ACCOUNTS RECEIVABLE Accounts receivable are stated at cost, net of allowance for doubtful accounts. Based on our experience and current practice in the PRC, management provides for an allowance for doubtful accounts equivalent to those accounts that are not collected within one year plus 5% of receivables less than one year old. INVENTORIES Inventories are stated at the lower of cost, determined on a weighted average basis, and net realizable value. Work-in-progress and finished goods are composed of direct material, direct labor and an attributable portion of manufacturing overhead. Net realizable value is the estimated selling price, in the ordinary course of business, less estimated costs to complete and dispose. LAND USE RIGHTS We adopted the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), effective January 1, 2002. Under SFAS 142, goodwill and indefinite lived intangible assets are not amortized, but are reviewed annually for impairment, or more frequently, if indications of possible impairment exist. We have performed the requisite annual transitional impairment tests on intangible assets and determined that no impairment adjustments were necessary. REVENUE RECOGNITION We recognize revenue on the sales of our products as earned when the customer takes delivery of the product according to previously agreed upon pricing and delivery arrangements, and when we believe collectibility is reasonably assured. We sell primarily perishable and frozen food products. As such, any right of return is only for a few days and has been determined to be insignificant by management. Accordingly, no provision has been made for returnable goods. 9 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) EARNINGS PER SHARE Basic earnings per common share ("EPS") are calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Our Series A convertible preferred stock is a participating security. Consequently, the two-class method of income allocation is used in determining net income available to common stockholders. Diluted EPS is calculated by adjusting the weighted average outstanding shares, assuming conversion of all potentially dilutive securities, such as stock options and warrants. The numerators and denominators used in the computations of basic and diluted EPS are presented in the following table:
Three Months Ended June 30, Six Months Ended June 30, 2006 2005 2006 2005 ------------ ------------ ------------ ------------ NUMERATOR FOR BASIC AND DILUTED EPS Net income (numerator for Diluted EPS) $ 3,312,179 $ 1,821,289 $ 5,887,143 $ 3,557,680 Net income allocated to preferred stock (1,225,248) -- (1,934,062) -- ------------ ------------ ------------ ------------ Net income to common stockholders (Basic) $ 2,186,931 $ 1,821,289 $ 3,953,081 $ 3,557,680 ============ ============ ============ ============ DENOMINATORS FOR BASIC AND DILUTED EPS Common stock outstanding after recapitalization and 1:35.349 reverse stock split 11,752,578 11,752,578 11,752,578 11,752,578 ------------ ------------ ------------ ------------ DENOMINATOR FOR BASIC EPS 11,752,578 11,752,578 11,752,578 11,752,578 ============ ============ ============ ============ Add: Weighted average preferred as if converted 6,900,000 -- 5,750,000 -- Add: Weighted average stock warrants outstanding 4,501,667 -- 3,745,833 -- ------------ ------------ ------------ ------------ DENOMINATOR FOR DILUTED EPS 23,154,245 11,752,578 21,248,411 11,752,578 ============ ============ ============ ============ EPS - Basic $ 0.18 $ 0.15 $ 0.34 $ 0.34 ------------ ------------ ------------ ------------ EPS - Diluted $ 0.14 $ 0.15 $ 0.28 $ 0.28 ------------ ------------ ------------ ------------
SHIPPING AND HANDLING COSTS Shipping and handling amounts billed to customers in related sales transactions are included in sales revenues. Direct shipping costs are included in operating expenses, which were approximately $483,500 and $161,900 for the three months ended June 30, 2006 and 2005, respectively, and $711,500 and $350,900 for six months ended June 30, 2006 and 2005, respectively. Handling costs are included in costs of sales, which were approximately $96,800 and $105,000 for the three months ended June 30, 2006 and 2005, respectively, and $276,800 and $265,000 for the six months ended June 30, 2006 and 2005, respectively. 10 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SUMMARY OF ACCOUNTING POLICIES (continued) ADVERTISING COSTS Advertising costs are expensed as incurred. Advertising expenses were approximately $68,700 and $26,600 for the three months ended June 30, 2006 and 2005, respectively, and $94,700 and $42,600 for the six months ended June 30, 2006 and 2005, respectively. RESEARCH AND DEVELOPMENT COSTS The PRC government has made a cash grant to our company specifically to fund research and development. We have recorded this grant as a liability titled "Research & development grants payable" on our balance sheet. Qualifying research and development costs reduce the liability while non-qualifying research and development costs are expensed as incurred. Research and development costs were approximately $47,000 and $27,000 for the three months ended June 30, 2006 and 2005, respectively, and $111,000 and $87,000 for the six months ended June 30, 2006 and 2005, respectively. PROPERTY AND EQUIPMENT Impairment of long-lived assets is recognized when events or changes in circumstances indicate the carrying amount of an asset, or related groups of assets, may not be recoverable. Under the provisions of SFAS No. 144, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," we recognize an "impairment charge" when the expected net undiscounted future cash flows from an asset's use and eventual disposition are less than the asset's carrying value and the asset's carrying value exceeds its fair value. Measurement of fair value for an asset or group of assets may be based on appraisal, market values of similar assets or estimated discounted future cash flows resulting from the use and ultimate disposition of the asset or assets. Expenditures for maintenance, repairs and betterments, which do not materially extend the normal useful life of an asset, are charged to operations as incurred. Upon sale or other disposition of assets, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in income. Depreciation and amortization are provided for financial reporting purposes primarily on the straight-line method over the estimated useful lives, ranging from five to 50 years. OPERATING LEASES Operating leases represent those leases under which substantially all the risks and rewards of ownership of the leased assets remain with the lessors. Rental payments under operating leases are charged to expense on the straight-line basis over the period of the relevant leases. INCOME TAXES Income tax expense is based on reported income before income taxes. Deferred income taxes reflect the effect of temporary differences between assets and liabilities that are recognized for financial reporting purposes and the amounts that are recognized for income tax purposes. In accordance with Statement of Financial Accounting Standard ("SFAS") No. 109, "Accounting for Income Taxes," these deferred taxes are measured by applying currently enacted tax laws. We recorded income tax expenses of 11 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SUMMARY OF ACCOUNTING POLICIES (continued) $171,945 and $122,789 for the three months ended June 30, 2006 and 2005, respectively, and $317,190 and $122,789 for the six months ended June 30, 2006 and 2005, respectively. We withhold and pay income taxes on our employees' wages, which fund the Chinese government's sponsored health and retirement programs for all of our employees. For our employees, we were obligated to make contributions to the social insurance bureau under the laws of the PRC for pension and retirement benefits. 3. BUSINESS ACQUISITIONS Food Share formed Henan Zhongpin Import and Export Trading Company on August 11, 2004 as a joint venture with Li Jun Wei, an individual, to facilitate exporting of our goods. We own 88.93% of Henan Zhongpin Import and Export Trading Company. 4. ACCOUNTS RECEIVABLE AND OTHER RECEIVABLES We accrue an allowance for bad debts related to our receivables. The receivable and allowance balances at June 30, 2006 and December 31, 2005 were as follows: June 30, 2006 December 31, 2005 ------------- ------------ Accounts receivable $ 15,881,901 $ 10,337,838 Other receivables 584,230 2,013,757 Allowance for bad debts (1,732,588) (1,716,614) ------------ ------------ $ 14,733,543 $ 10,634,981 ============ ============ Current $ 14,733,543 $ 10,002,918 Non-current -- 632,063 ------------ ------------ $ 14,733,543 $ 10,634,981 ============ ============ Other receivables consist primarily of cash advances to suppliers to ensure preferential pricing and delivery. The advances bear no interest and are expected to be repaid in cash. Repayment is typically required to be made in less than one year. Advances that are not expected to be paid within one year are classified as non-current. 5. INVENTORIES Inventories at June 30, 2006 and December 31, 2005 consisted of: June 30, 2006 December 31, 2005 ------------- ----------------- Raw materials $ 457,269 $ 210,288 Low value consumables & packaging 320,905 147,000 Work-in-progress 731,998 290,149 Finished goods 4,842,646 1,699,875 ------------- ------------- Net inventories $ 6,352,818 $ 2,347,312 ============= ============= 12 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment at cost at June 30, 2006 and December 31, 2005 consisted of: June 30, 2006 December 31, 2005 ------------- ----------------- Machinery and equipment $ 11,755,169 $ 6,832,887 Furniture and office equipment 350,249 253,187 Motor vehicles 329,043 281,371 Buildings 12,801,546 5,084,728 ------------- ------------- Subtotal 25,236,007 12,452,173 Less: accumulated depreciation (2,597,069) (2,239,325) ------------- ------------- Net property and equipment 22,638,938 10,212,848 ============= ============= Depreciation expense $ 361,958 $ 602,008 7. INTANGIBLE ASSETS Intangible assets consist of prepaid land use rights. According to the laws of the PRC, the government owns all of the land in the PRC. Companies or individuals are authorized to possess and use the land only through land use rights granted by the PRC government. Accordingly, we paid in advance for certain land use rights. Prepaid land use rights are being amortized and recorded as lease expense using the straight-line method over the use terms of 20 to 50 years. Intangible assets at June 30, 2006 and December 31, 2005 consisted of the following: June 30, 2006 December 31, 2005 ------------- ----------------- Land use rights $ 5,617,102 $ 1,840,937 Accumulated amortization (140,235) (87,813) ------------- ------------- $ 5,476,867 $ 1,753,124 ============= ============= Amortization expense $ 51,605 $ 37,431 8. RELATED PARTY RECEIVABLES Related party receivables consist of advances made by our company to the minority interest holders of Henan Zhongpin Industrial Company Limited for their investment in the registered capital of that entity. The advances are non-interest bearing and have no fixed repayment terms. Consequently, they are classified as non-current assets. 13 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. CONSTRUCTION IN PROGRESS Construction in progress at June 30, 2006 and December 31, 2005 consisted of: Completion or Estimated Construction Project Completion Date June 30, 2006 December 31, 2005 -------------------- --------------- ------------- ----------------- Industrial plant February 2006 $4,871,031 $16,931,178 Production line for chilled pork January 2007 3,725,925 -- Land use right of Industrial Park No.4 land December 2007 217,641 -- ---------- ----------- $8,814,597 $16,931,178 ========== =========== 10. LOANS PAYABLE SHORT-TERM LOANS Short-term loans are due within one year. Of the $12.94 million aggregate principal amount of short-term loans at June 30, 2006, loans in the principal amount of $4.00 million were secured by our land and plants located in the PRC and guaranteed by Henan Zhongpin Industry Co., Ltd. Loans in the principal amount of $1.29 million were secured by our land and plants located in the PRC and loans in the aggregate principal amount of $7.63 million were guaranteed by Henan Zhongpin Industry Co., Ltd. These loans bear interest at prevailing lending rates in the PRC ranging from 3.0% to 7.0% per annum. At June 30, 2006, there was approximately $65.71 million in available unused lines of credit. LONG-TERM LOANS Our long-term loan bears interest at the rate of 6.0% per annum. The balances of loans payable at June 30, 2006 and December 31, 2005 were as follows: June 30, December 31, 2006 2005 ------------- ------------- Short Term Loans Payable $ 12,944,619 $ 18,995,853 Long Term Loans Payable 2,107,165 2,264,448 Add: Current Portion 145,671 145,671 ------------- ------------- Net Long Term Loans Payable 2,252,836 2,410,119 ------------- ------------- $ 15,197,455 $ 21,405,972 ============= ============= Long Term Repayment Schedule ---------------------------------------------------------------- Payments due in 2006 - current portion $ 72,835 Payments due in 2007 - 50% current portion 145,671 Payments due in 2008 145,671 Payments due in 2009 145,671 Payments due in 2010 145,671 Payments due thereafter 1,597,317 ---------- $2,252,836 ========== 14 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. COMMITMENTS AND CONTINGENCIES LEGAL PROCEEDINGS From time to time, we have disputes that arise in the ordinary course of our business. At June 30, 2006, there was no material legal proceeding to which we were a party or to which any of our property was subject that will have a material adverse effect on our financial condition. REGISTRATION RIGHTS AGREEMENT In connection with the issuance of our Series A convertible preferred stock and warrants on January 30, 2006, we entered into a registration rights agreement with certain investors. The agreement requires us to effect the registration of our common stock issuable upon the conversion of the Series A convertible preferred stock and the exercise of the warrants. If such registration was not effective by June 20, 2006, we were required to pay the investors liquidated damages in an amount equal to 1-1/2% per month times the amount paid by the investors for the purchase of our Series A convertible preferred stock and warrants until such registration becomes effective. This could cost us approximately $414,000 per month until such registration becomes effective. On June 20, 2006, such registration had not become effective, and we started to accrue a liability in the amount of $414,000 plus $138,000 (10/30 times $414,000) plus related interest payable for this contingency because a loss is reasonably possible and a loss amount can be reasonably estimated. This amount of penalty has not yet been paid to certain investors in accordance with the registration rights agreement. 12. ALLOWANCES INCOME "Allowances income" consists of grants from the government of the PRC for our participation in specific programs, such as import and export, branding, and city maintenance and construction. We received allowances income as follows: Three Months Ended June 30, Six Months Ended June 30, --------------------------- ------------------------- 2006 2005 2006 2005 ---------- ------ ---------- ------- Allowance income $1,113,661 $5,435 $1,226,845 $44,082 In addition to paying our company for our participation in ongoing programs, the PRC government has made a cash grant to our company specifically to fund research and development. We recorded this grant as a liability titled "Research & development grants payable" on our balance sheet rather than as revenue. As qualifying research and development costs are incurred, we reduce the liability rather than recording an expense. 13. FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments" ("SFAS 107") requires entities to disclose the fair values of financial instruments except when it is not practicable to do so. Under SFAS No. 107, it is not practicable to make this disclosure when the costs of formulating the estimated values exceed the benefit when considering how meaningful the information would be to financial statement users. 15 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued) As a result of the difficulties presented in the valuation of the loans payable to related entities/parties because of their related party nature, estimating the fair value of these financial instruments is not considered practical. The fair values of all other assets and liabilities do not differ materially from their carrying amounts. None of the financial instruments held are derivative financial instruments and none were acquired or held for trading purposes in the first six months of 2006 or in our 2005 or 2004 fiscal years. 14. NEW ACCOUNTING PRONOUNCEMENTS In February 2006, the Financial Accounting Standards Board ("FASB") issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140." The statement permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips are not subject to the requirements of Statement 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends Statement 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. The Statement is effective for financial instruments acquired or issued after the beginning of the first fiscal year that begins after September 15, 2006. We expect the Statement will have no material impact on our consolidated financial statements. In February 2006, the FASB issued Staff Position No. FAS 123(R)-4, "Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event." This position addresses the classification of options and similar instruments issued as employee compensation that allow for cash settlement upon the occurrence of a contingent event, amending paragraphs 32 and A229 of SFAS No. 123 (revised 2004), "Share-Based Payment." As we have not traditionally paid compensation through the issuance of equity securities, no impact is expected on our consolidated financial statements. In October 2005, the FASB issued Staff Position No. FAS 13-1, "Accounting for Rental Costs Incurred during a Construction Period." This position addresses the accounting for rental costs associated with operating leases that are incurred during a construction period. Management believes this position has no application to our company. In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections ("SFAS No. 154"), which replaced Accounting Principles Board Opinion No. 20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principles. It requires retrospective application to prior periods' financial statements of changes in accounting principles, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The impact on our operations will depend on future accounting pronouncements or changes in accounting principles. 16 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. NEW ACCOUNTING PRONOUNCEMENTS (Continued) In March 2005, the FASB issued FASB Interpretation ("FIN") No. 47, "Accounting for Conditional Asset Retirement Obligations." FIN 47 clarifies that the term "Conditional Asset Retirement Obligation" as used in FASB Statement No. 143, "Accounting for Asset Retirement Obligations," refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Accordingly, an entity is required to recognize a liability for the fair value of a Conditional Asset Retirement Obligation if the fair value of the liability can be reasonably estimated. FIN 47 is effective no later than the end of the first fiscal year ending after December 15, 2005. Management does not believe the adoption of FIN 47 will have a material effect on our consolidated financial position, results of operations or cash flows. In November 2004, the FASB issued Statement No. 151, "Inventory Costs." SFAS No. 151 requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as current period charges and that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The statement is effective for fiscal periods beginning after June 15, 2005. We believe the application of SFAS No. 151 will have no significant impact on our consolidated financial statements. 15. PREFERRED STOCK The principal terms of our Series A convertible preferred stock are as follows. DIVIDENDS. The holders of our Series A convertible preferred stock are entitled to receive, when and as declared by our board of directors, dividends in such amounts as may be determined by our board of directors from time to time out of funds legally available therefor. No dividends (other than those payable solely in common stock) will be paid to the holders of common stock until there shall have been paid or declared and set apart during that fiscal year for the holders of our Series A convertible preferred stock a dividend in an amount per share that the holders would have received for the shares of common stock issuable upon conversion of their shares of Series A convertible preferred stock. PREFERENCE ON LIQUIDATION. In the event of our merger or consolidation or the sale of all or substantially all of our assets or other liquidation of our company, holders of our Series A convertible preferred stock shall get a priority in payment over all other classes of stock. In such event, the Series A convertible preferred stock would be entitled to receive the greater of (i) the original purchase price of the Series A convertible preferred stock or (ii) the amount the holder would get if such holder converted all of such holder's Series A convertible preferred stock into common stock. VOTING. The holder of each share of Series A convertible preferred stock (i) shall be entitled to the number of votes with respect to such share equal to the number of shares of common stock into which such share of Series A convertible preferred stock could be converted on the record date for the subject vote or written consent (or, if there is no such record date, then on the date that such vote is taken or consent is effective) and (ii) shall be entitled to notice of any stockholders' meeting in accordance with our by-laws. 17 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15. PREFERRED STOCK (Continued) APPOINT AND ELECT A DIRECTOR. So long as the number of shares of common stock issuable upon conversion of the outstanding shares of Series A convertible preferred stock is greater than 10% of the number of outstanding shares of common stock (on a fully diluted basis), the holders of record of the shares of Series A convertible preferred stock, exclusively and as a separate class, shall be entitled to elect one of our directors. CONVERSION RIGHT. The holders of Series A convertible preferred stock may convert each share of Series A convertible preferred stock into common stock at an initial conversion price of $0.113157 ($4.00 post-split). The conversion price will be adjusted for stock dividends, stock splits and similar events. AUTOMATIC CONVERSION. Each share of Series A convertible preferred stock will automatically be converted into shares of common stock at the conversion price at the time in effect if (i) we consummate an underwritten public offering of our common stock giving us at least $30 million in net proceeds, (ii)(A) the closing price of our common stock equals or exceeds $0.2828934 ($10.00 post-split) (as adjusted) for the twenty (20) consecutive-trading-day period ending within two (2) days of the date on which we provide notice of such conversion as hereinafter provided and (B) either a registration statement registering for resale the shares of common stock issuable upon conversion of the Series A convertible preferred stock has been declared effective and remains effective and available for resale for the twenty (20)-day period, or Rule 144(k) under the Securities Act of 1933, as amended, is available for the resale of such shares, or (iii) by consent of at least 67% of the then-outstanding shares of Series A convertible preferred stock. PROTECTIVE PROVISIONS. So long as at least 1,750,000 shares of Series A convertible preferred stock are outstanding (subject to adjustment for stock splits, combinations and the like), the holders of a majority of the outstanding shares of Series A convertible preferred stock shall be required (in addition to any consent or approval otherwise required by law) for us to take certain actions, including (1) the liquidation, dissolution or wind up of our company, (2) the amendment, alteration or repeal of any provision of our certificate of incorporation so as to affect the rights, preferences or privileges of the Series A convertible preferred stock, (3) the creation of a new class of preferred stock or any increase in the number of shares of Series A convertible preferred stock that can be issued, or (4) the purchase or redemption, or the payment or declaration of any dividend or the making of any distribution on, any securities junior in priority to the Series A convertible preferred stock; or (5) making any change in the size of our board of directors. 16. WARRANTS In conjunction with the issuance of preferred stock discussed in Note 15, the Company issued warrants for the purchase of 3,450,000 shares of its common stock. Also in conjunction with the issuance of preferred stock, the Company issued warrants to purchase 345,000 units at an initial exercise price of $8.00 per unit. The units that may be acquired upon exercise of such warrants consist of two shares of Series A convertible preferred stock and one warrant to purchase one share of common stock at an initial exercise price per share of $5.00. These warrants, if fully exercised and converted, would require the issuance of 1,035,000 common shares. 18 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 16. WARRANTS (continued) On June 15, 2006, in conjunction with a one year consulting agreement, the Company issued three year warrants to purchase 100,000 common shares at a price of $6.50 per share. The warrants vest monthly over a one year period. These warrants were accounted for using the fair value method, with the expense being recognized ratably over the requisite service period of one year. Consulting expense related to the warrants amounted to $3,190 for the six months ended June 30, 2006. Stock warrant transactions are summarized as follows: Warrants 6/30/2006 12/31/2005 --------- ---------- Outstanding - beginning of year -- -- Granted 4,585,000 -- Exercised -- -- Forfeited -- -- --------- ---------- Outstanding - end of year 4,585,000 -- ========= ========== The following table provides certain information with respect to the above referenced warrants outstanding at June 30, 2006: Weighted Weighted Number Average Average Life - Exercise Price Outstanding Exercise Price Years -------------- ----------- -------------- -------------- Warrants $4.00 - $6.50 4,585,000 $4.88 4.55 The following table provides certain information with respect to stock options exercisable at June 30, 2006: Number Weighted Average Exercise Price Outstanding Exercise Price -------------- ----------- -------------- Warrants $4.00 - $6.50 4,497,000 $4.85 The weighted average fair value at date of grant for warrants granted during 2006 was $0.38, and was estimated using the Black-Scholes option valuation model with the following assumptions: Expected life in years 3 Interest rate 4% Volatility 6.1% Dividend yield 0% 17. SEGMENT REPORTING We operate in two business segments: pork and pork products, and vegetables and fruits. Our pork and pork products segment is involved primarily in the processing of live market hogs into fresh, frozen and processed pork products. Our pork and pork products segment markets its products domestically to our branded stores and to food retailers, foodservice distributors, restaurant operators and 19 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 17. SEGMENT REPORTING (Continued) noncommercial foodservice establishments, such as schools, hotel chains, healthcare facilities, the military and other food processors, as well as to international markets. Our vegetables and fruits segment is involved primarily in the processing of fresh vegetables and fruits. We contract with more than 120 farms in Henan Province and nearby areas to produce high-quality vegetable varieties and fruits suitable for export purposes. The proximity of the contracted farms to our operations ensures freshness from harvest to processing. We contract to grow more than 20 categories of vegetables and fruits, including asparagus, sweet corn, broccoli, mushrooms, lima beans and strawberries. SALES BY SEGMENT (U.S. DOLLAR IN MILLIONS) THREE MONTHS THREE MONTHS PERCENTAGE ENDED ENDED NET CHANGE CHANGE JUNE 30, 2006 JUNE 30, 2005 2006/2005 2006/2005 ------------- ------------- ---------- ---------- Pork and Pork Products .... $30.30 $18.09 $12.21 67% Vegetables and Fruits ..... 1.48 0.50 0.98 196% ------ ------ ------ Total ............. $31.78 $18.59 $13.19 71% ====== ====== ====== SALES BY SEGMENT (U.S. DOLLAR IN MILLIONS) SIX MONTHS SIX MONTHS PERCENTAGE ENDED ENDED NET CHANGE CHANGE JUNE 30, 2006 JUNE 30, 2005 2006/2005 2006/2005 ------------- ------------- ---------- ---------- Pork and Pork Products .... $60.07 $32.36 $27.71 86% Vegetables and Fruits ..... 2.20 0.64 1.56 244% ------ ------ ------ Total ............. $62.27 $33.00 $29.27 89% ====== ====== ====== OPERATING INCOME BY SEGMENT (U.S. DOLLARS IN MILLIONS) THREE THREE OPERATING OPERATING MONTHS MONTHS MARGIN MARGIN ENDED ENDED THREE MONTHS THREE MONTHS JUNE 30, JUNE 30, CHANGE ENDED ENDED 2006 2005 2006/2005 JUNE 30, 2006 JUNE 30, 2005 ------- ------- --------- ------------- ------------- Pork and Pork Products ..... $2.27 $2.37 ($0.10) 7.49% 13.10% Vegetables and Fruits ........ 0.16 0.04 0.12 10.81% 8.00% ----- ----- ----- Total ....... $2.43 $2.41 $0.02 7.65% 12.96% ===== ===== ===== 20 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 17. SEGMENT REPORTING (Continued) OPERATING INCOME BY SEGMENT (U.S. DOLLARS IN MILLIONS) SIX SIX OPERATING OPERATING MONTHS MONTHS MARGIN MARGIN ENDED ENDED SIX MONTHS SIX MONTHS JUNE 30, JUNE 30, CHANGE ENDED ENDED 2006 2005 2006/2005 JUNE 30, 2006 JUNE 30, 2005 ------- ------- --------- ------------- ------------- Pork and Pork Products ..... $5.08 $4.37 $0.71 8.46% 13.50% Vegetables and Fruits ........ 0.23 0.05 0.18 10.45% 7.81% ----- ----- ----- Total ....... $5.31 $4.42 $0.89 8.53% 13.39% ===== ===== ===== 18. RESTATEMENT Subsequent to filing our restated financial statements for the six months ended June 30, 2006, we reinterpreted the language relating to the liquidated damages payable by us under an agreement that requires us to effect the registration of our common stock issuable upon the conversion of our Series A convertible preferred stock and the exercise of certain of our stock purchase warrants. See Note 11. Commitments and Contingencies. As a result of such reinterpretation, we accrued for this contingency a liability in the month of June 2006 in the amount of $414,000 plus $138,000 (10/30 times $414,000) plus interest in the amount of $1,380 because the loss is reasonably possible and a loss amount can reasonably be determined. As a result, general and administrative expenses for both the three- and six-month periods ended June 30, 2006 were increased by $553,380 and net income for both periods has been decreased by the same amount. The change in diluted earnings per share for the six months ended June 30, 2006 due to the restatement was $0.02 per share and the change in basic earnings per share for the three- and six-month periods ended June 30, 2006, and in diluted earnings per share for the three-month period ended June 30, 2006, due to the restatement was $0.03 per share. 21 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS THE STATEMENTS CONTAINED IN THIS REPORT WITH RESPECT TO OUR FINANCIAL CONDITION, RESULTS OF OPERATIONS AND BUSINESS THAT ARE NOT HISTORICAL FACTS ARE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"). WE INTEND SUCH FORWARD-LOOKING STATEMENTS TO BE COVERED BY THE SAFE HARBOR PROVISIONS FOR FORWARD-LOOKING STATEMENTS CONTAINED IN SECTION 21E OF THE EXCHANGE ACT. FORWARD-LOOKING STATEMENTS CAN BE IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY, SUCH AS "ESTIMATES," "PROJECTS," "PLANS," "BELIEVES," "EXPECTS," "ANTICIPATES," "INTENDS," OR THE NEGATIVE THEREOF OR OTHER VARIATIONS THEREON, OR BY DISCUSSIONS OF STRATEGY THAT INVOLVE RISKS AND UNCERTAINTIES. MANAGEMENT WISHES TO CAUTION THE READER OF THE FORWARD-LOOKING STATEMENTS THAT SUCH STATEMENTS, WHICH ARE CONTAINED IN THIS REPORT, REFLECT OUR CURRENT BELIEFS WITH RESPECT TO FUTURE EVENTS AND INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS, INCLUDING, BUT NOT LIMITED TO, ECONOMIC, COMPETITIVE, REGULATORY, TECHNOLOGICAL, KEY EMPLOYEE, AND GENERAL BUSINESS FACTORS AFFECTING OUR OPERATIONS, MARKETS, GROWTH, SERVICES, PRODUCTS, LICENSES AND OTHER FACTORS DISCUSSED IN OUR OTHER FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION, AND THAT THESE STATEMENTS ARE ONLY ESTIMATES OR PREDICTIONS. NO ASSURANCES CAN BE GIVEN REGARDING THE ACHIEVEMENT OF FUTURE RESULTS, AS ACTUAL RESULTS MAY DIFFER MATERIALLY AS A RESULT OF RISKS FACING OUR COMPANY, AND ACTUAL EVENTS MAY DIFFER FROM THE ASSUMPTIONS UNDERLYING THE STATEMENTS THAT HAVE BEEN MADE REGARDING ANTICIPATED EVENTS. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO NUMEROUS ASSUMPTIONS, RISKS AND UNCERTAINTIES THAT MAY CAUSE OUR ACTUAL RESULTS TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS EXPRESSED OR IMPLIED BY US IN THOSE STATEMENTS. SOME OF THESE RISKS ARE DESCRIBED IN "RISK FACTORS" IN ITEM 1A OF OUR ANNUAL REPORT ON FORM 10-K, AS AMENDED, FOR THE TRANSITION PERIOD FROM JUNE 30, 2005 TO DECEMBER 31, 2005. THESE RISK FACTORS SHOULD BE CONSIDERED IN CONNECTION WITH ANY SUBSEQUENT WRITTEN OR ORAL FORWARD-LOOKING STATEMENTS THAT WE OR PERSONS ACTING ON OUR BEHALF MAY ISSUE. ALL WRITTEN AND ORAL FORWARD LOOKING STATEMENTS MADE IN CONNECTION WITH THIS REPORT THAT ARE ATTRIBUTABLE TO OUR COMPANY OR PERSONS ACTING ON OUR BEHALF ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THESE CAUTIONARY STATEMENTS. GIVEN THESE UNCERTAINTIES, WE CAUTION INVESTORS NOT TO UNDULY RELY ON OUR FORWARD-LOOKING STATEMENTS. WE DO NOT UNDERTAKE ANY OBLIGATION TO REVIEW OR CONFIRM ANALYSTS' EXPECTATIONS OR ESTIMATES OR TO RELEASE PUBLICLY ANY REVISIONS TO ANY FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE OF THIS REPORT OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS. FURTHER, THE INFORMATION ABOUT OUR INTENTIONS CONTAINED IN THIS REPORT IS A STATEMENT OF OUR INTENTION AS OF THE DATE OF THIS REPORT AND IS BASED UPON, AMONG OTHER THINGS, THE EXISTING REGULATORY ENVIRONMENT, INDUSTRY CONDITIONS, MARKET CONDITIONS AND PRICES, THE ECONOMY IN GENERAL AND OUR ASSUMPTIONS AS OF SUCH DATE. WE MAY CHANGE OUR INTENTIONS, AT ANY TIME AND WITHOUT NOTICE, BASED UPON ANY CHANGES IN SUCH FACTORS, IN OUR ASSUMPTIONS OR OTHERWISE. GENERAL During the period from March 31, 2005 to January 30, 2006, we did not generate any significant revenue, and accumulated no significant assets, as we explored various business opportunities. On January 30, 2006, in exchange for a controlling interest in our publicly-held "shell" corporation, we acquired all of the issued and outstanding capital stock of Falcon Link Investment Limited ("Falcon Link"). This transaction is commonly referred to as a "reverse acquisition." For financial reporting purposes, Falcon Link was considered the acquirer in such transaction. As a result, our historical financial statements for all periods prior to January 30, 2006 included in this Report are those of Falcon Link. 22 We are principally engaged in the meat and food processing business in The People's Republic of China (the "PRC"). Currently, we have five processing plants located in Henan Province in the PRC, with a total of seven production lines. Our current total production capacity for chilled pork and frozen pork is 345 metric tons per day, based on an 8-hour working day, or approximately 132,000 metric tons on an annual basis. We began construction of a third fully-dedicated case-ready plant in Zhongpin Industrial Park in fiscal 2005. This plant was put into production on February 23, 2006. On a daily 8-working-hour basis, an average of 2,000 pigs (approximately 145 metric tons) are butchered and processed at this location. We expect to increase the meat processing capacity at this plant by 60,000 metric tons on an annual basis. We also have production capacity for prepared meats of 40 metric tons per 8-hour day (or approximately 14,400 metric tons on an annual basis) and for fruits and vegetables of 35 metric tons per 8-hour day (or approximately 12,600 metric tons on an annual basis). We utilize state-of-the-art equipment in all of our abattoirs and processing facilities. On June 7, 2006, our subsidiary, Henan Zhongpin Food Share Co. Limited, formed a wholly-owned subsidiary, Zhumadian Zhongpin Food Limited, through which we plan to invest approximately $14 million to construct a new production facility in southern Henan Province that will be designed with a production capacity for chilled or frozen pork of 200 metric tons per 8-hour working day, or approximately 72,000 metric tons on an annual basis. We plan to put this new plant into production in the second quarter of fiscal 2007. Our products are sold under the "Zhongpin" and "Shengpin" brand names. Our customers include over 11 international or domestic fast food companies in the PRC, over 31 export-registered processing factories and over 1,360 school cafeterias, factory canteens, army posts and national departments. We also sell directly to approximately 2,300 retail outlets, including supermarkets, within the PRC. Since 2001, we have been one of the "leading agricultural industrial enterprises" in the PRC and are currently ranked by the China Meat Association as the sixth largest producer in the national meat industry. During the past five years, our growth rate has exceeded 43% percent in terms of revenues and 60% in terms of net profits. We have established distribution networks in more than 20 provinces and four cities with special legal status in the North, East, South and South Midland of the PRC, and also have formed strategic partnerships with leading supermarket chains and the catering industry in the PRC. In addition, we export products to the European Union, Southeast Asia and Russia. CRITICAL ACCOUNTING POLICIES Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We evaluate, on an on-going basis, our estimates for reasonableness as changes occur in our business environment. We base our estimates on experience, the use of independent third-party specialists, and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Critical accounting policies are defined as those that are reflective of significant judgments, estimates and uncertainties, and potentially result in materially different results under different assumptions and conditions. Management believes the following are our critical accounting policies: 23 ACCOUNTS RECEIVABLE. We state accounts receivable at cost, net of allowance for doubtful accounts. Based on our past experience and current practice in the PRC, management provides for an allowance for doubtful accounts equivalent to those accounts that are not collected within one year plus 5% of receivables less than one year old. As of June 30, 2006, we were successful in collecting approximately $0.5 million, or approximately 66%, of doubtful accounts that were outstanding at December 31, 2005 for longer than one year. It is management's belief that the current bad debt allowance adequately reflects an appropriate estimate based on management's judgment. INVENTORY VALUATION. We value our pork inventories at the lower of cost, determined on a weighted average basis, or market price. When the carcasses are disassembled and transferred from primary processing to various manufacturing departments, we adjust the net realizable value for product specifications and further processing, which becomes the basis for calculating inventory values. In addition, substantially all inventory expenses, packaging and supplies are valued by the weighted average method. GOODWILL AND OTHER INTANGIBLES. Our identifiable intangible assets are amortized over their useful life, unless the useful life is determined to be indefinite. The useful life of an identifiable intangible asset is based on an analysis of several factors, including contractual, regulatory or legal obligations, demand, competition and industry trends. Goodwill and indefinite-lived intangible assets are not amortized, but are tested annually for impairment. Our goodwill impairment test is a two-step process. First, the fair value of each reporting unit is compared with the carrying amount of the reporting unit, including goodwill. The estimated fair value of the reporting unit is determined on the basis of discounted cash flow. If the carrying value exceeds fair value of the reporting unit, then a second step must be completed in order to determine the amount of goodwill impairment that should be recorded. In the second step, the implied fair value of the reporting unit's goodwill is determined by allocating the reporting unit's fair value to all of its assets and liabilities other than goodwill in a manner similar to a purchase price allocation. The resulting implied fair value of the goodwill that results from the application of this second step is then compared to the carrying amount of the goodwill and an impairment charge is recorded for the difference. Annual impairment testing for indefinite-lived intangible assets compares the fair value and carrying value of the intangible. The fair value of indefinite-lived intangible assets is determined on the basis of discounted cash flows. If the carrying value exceeds fair value, the indefinite-lived intangible asset is considered impaired and an impairment charge is recorded for the difference. Intangible assts that are subject to amortization are evaluated for impairment using a process similar to that used to evaluate elements of long-lived assets. The assumptions used in the estimate of fair value are consistent with historical performance and the estimates and assumptions used in determining future profit plans for each reporting unit. We review product growth patterns, market share information, industry trends, changes in distribution channels and economic indicators in determining the estimates and assumptions used to develop cash flow and profit plan assumptions. INCOME TAXES. We account for income taxes in accordance with Statement of Financial Accounting Standard No. 109, "Accounting for Income Taxes." We compute our provision for income taxes based on the statutory tax rates and tax planning opportunities available to us in the PRC. Significant judgment is required in evaluating our tax positions and determining our annual tax position. RESULTS OF OPERATIONS In fiscal 2006, we intend to continue to focus on the implementation of our strategic plan to continue the growth we have experienced in the last four years. As discussed above, we have completed 24 the construction of a new, fresh-chilled and frozen meat processing facility in Zhongpin Industrial Park II and are expanding its capability in temperature-controlled, physical logistic systems. On January 30, 2006, we received gross proceeds of $27.6 million from the sale of our Series A convertible preferred stock and warrants. We expect to continue to expand our capital base, to scale up operations and to develop new markets, streamline supply chain management, invest in training and human resources development and accelerate revenue and profit growth. In fiscal 2006, we expect the results of the pork and pork products segment of our business to remain strong. We currently expect our raw material supply to be ample and we anticipate strong demand for pork products throughout fiscal 2006. We anticipate operating income will be slightly impacted in fiscal 2006 by higher energy costs. We also believe the prepared food and vegetables and fruits segment of our business will achieve accelerated growth. We anticipate increasing market share in the meat and meat products segment of our business in target markets in fiscal 2006. 25 The following table sets forth, for the periods indicated, certain statement of operations data. THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------- ----------------- 2006 2005 2006 2005 ------- ------- ------- ------- (U.S. dollars in thousands) Revenues: Sales revenues ....................... $31,777 $18,591 $62,271 $32,996 Cost of sales ........................ 27,053 15,574 52,967 27,383 ------- ------- ------- ------- Gross profit ..................... 4,724 3,017 9,304 5,613 Operating expenses: General and administrative expenses ........................... 1,580 277 2,479 500 Operating expenses ................... 716 327 1,520 693 ------- ------- ------- ------- Total operating expenses ......... 2,296 604 3,999 1,193 ------- ------- ------- ------- Income from operations ................. 2,429 2,413 5,305 4,420 Other income (expense): Interest income ...................... 150 40 245 89 Other income ......................... 24 (18) 36 (3) Allowance income ..................... 1,114 5 1,227 44 Exchange gain (loss) ............... 4 (31) 18 (42) Interest expense ................... (228) (458) (608) (808) ------- ------- ------- ------- Total other income (expense) ...................... 1,064 (462) 918 (721) ------- ------- ------- ------- Net income before taxes ................ 3,493 1,951 6,224 3,700 Provision for income taxes ........... 172 123 317 123 ------- ------- ------- ------- Net income after taxes ................. 3,321 1,828 5,906 3,577 Minority interest in gain (loss) ..... 9 7 19 19 ------- ------- ------- ------- Net income ............................. 3,312 1,821 5,887 3,558 Foreign currency translation adjustment ......................... 124 -- 265 -- ------- ------- ------- ------- Comprehensive income ................... $ 3,436 $ 1,821 $ 6,152 $ 3,558 ======= ======= ======= ======= 26 COMPARISON OF THREE MONTHS ENDED JUNE 30, 2006 AND JUNE 30, 2005 REVENUE. Total revenue increased by $13.19 million, or approximately 71%, for the three months ended June 30, 2006, from $18.59 million for the three months ended June 30, 2005 to $31.78 million for the three months ended June 30, 2006. The increase in revenues was primarily due to increased sales in our meat and meat products segment resulting from the effects of the continued increase in the amount of branded stores sales and increased sales to restaurants and non-commercial customers. During the second quarter in 2006, 37 new "branded" retail stores were opened and we expanded our marketing and sales efforts to include six additional second-tier cities and 13 additional third-tier cities domestically. During the three months ended June 30, 2006, revenues from sales to branded stores increased to $15.6 million, which represented an increase of $6.7 million, or approximately 75%, as compared to the three months ended June 30, 2005. During the three months ended June 30, 2006, revenues from sales to food service distributors increased to $4.8 million, which represented an increase of $1.7 million, or approximately 55%, as compared to the three months ended June 30, 2005. During the three months ended June 30, 2006, revenues from sales to restaurants and non-commercial customers increased to $8.8 million, which represented an increase of $4.1 million, or approximately 87%, as compared to the three months ended June 30, 2005. During the three months ended June 30, 2006, revenues from export sales increased to $2.5 million, which represented an increase of $0.6 million, or approximately 32%. COST OF SALES. Cost of sales increased by $11.48 million, or approximately 74%, for the three months ended June 30, 2006, from $15.57 million for the three months ended June 30, 2005 to $27.05 million for the three months ended June 30, 2006. As a percentage of revenue, total cost of sales increased approximately 1% from approximately 84% for the three months ended June 30, 2005 to approximately 85% in the quarter ended June 30, 2006. The increase in cost of sales was primarily due to an increase in the cost of raw materials. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased by $1.30 million, or approximately 464%, for the three months ended June 30, 2006, from $0.28 million for the three months ended June 30, 2005 to $1.58 million for the three months ended June 30, 2006. As a percentage of revenues, general and administrative expenses increased from 1.49% for the three months ended June 30, 2005 to 4.97% for the three months ended June 30, 2006. The increase in general and administrative expenses was the result of the accrual of a liability in the amount of $0.55 million or approximately 1.74% of the total revenue for the three months ended June 30, 2006, that may be payable to the holders of our Series A convertible preferred stock and related purchase warrants because of our failure to register in a timely manner for resale under the Securities Act of 1933, as amended, the shares of our common stock issuable upon the conversion or exercise of such securities. We will continue to accrue a liability in the amount of $414,000 per month plus interest until our registration statement relating to such shares is declared effective by the Securities and Exchange Commission. In addition, the increase in general and administrative expenses was primarily the result of the overall expansion of our operations and the additional expenses we are now incurring as a publicly-traded company that is reporting under the U.S. federal securities laws. During the second quarter of 2006, we incurred $0.44 million of legal, accounting and consulting fees and other expenses relating primarily to our registration under the U.S. federal securities laws of certain outstanding shares for resale in the public markets and our periodic reporting obligations under the U.S. federal securities laws. In addition, during such period, our management compensation expense increased $0.14 million as compared to the comparable 2005 period primarily due to the addition of senior executives and technical experts to our management team. OPERATING EXPENSES. Operating expenses increased by $0.39 million, or approximately 119%, for the three months ended June 30, 2006, from $0.33 million for the three months ended June 30, 2005 to $0.72 million for the three months ended June 30, 2006. As a percentage of revenue, operating expenses increased from 1.76% for the three months ended June 30, 2005 to 2.25% for the three months ended June 30, 2006. The increase in operating expenses was primarily the result of increased transportation expenses of $0.32 million due to the increased price of gasoline and an increase of $0.11 million in compensation expenses within our sales department. INTEREST EXPENSE. Interest expense decreased by $0.23 million, or approximately 50%, during the three months ended June 30, 2006, from $0.46 million for the three months ended June 30, 2005 to $0.23 27 million for the three months ended June 30, 2006. The decrease in interest expense was primarily a result of having adequate cash flow from the equity private placement we consummated in the first quarter of 2006, which enabled us to pay back and reduce our higher-interest-bearing bank loans. During the three months ended June 30, 2006, our weighted average bank debt outstanding decreased by approximately $9.08 million, from $24.28 million for the three months ended June 30, 2005 to $15.20 million for the three months ended June 30, 2006. Our overall weighted average borrowing rate decreased from 7.56% in the second quarter of fiscal 2005 to 6.00% in the second quarter of fiscal 2006. INTEREST INCOME, ALLOWANCE INCOME, OTHER INCOME AND EXCHANGE GAIN (LOSS). Interest income, allowances income, other income and exchange gain (loss) increased by $1.30 million during the three months ended June 30, 2006, from an expense of $4,000 for the three months ended June 30, 2005 to $1.29 million for the three months ended June 30, 2006, primarily due to an increase of $1.11 million in allowance income and an increase of $0.12 million in interest income during the 2006 period. The cash grant in the amount of $2.23 million we received from the Chinese central government for the construction of a pork production line in Zhongpin Industrial Park II was recorded as a long-term liability in the fiscal 2005 period. When the construction was partly completed and the facility was placed into operation during the second quarter of 2006, the liability was reduced by $1.12 million, which was recorded as allowance income. INCOME TAXES. The effective tax rate in the PRC on income generated from the sale of prepared products is 33% and there is no income tax on income generated from the sale of raw products. The increase of $0.05 million in the provision for income taxes for the three months ended June 30, 2006 over the three months ended June 30, 2005 resulted from an increase of $0.15 million in our income from the sale of prepared products for the three months ended June 30, 2006. COMPARISON OF SIX MONTHS ENDED JUNE 30, 2006 AND JUNE 30, 2005 REVENUE. Total revenue increased by $29.27 million, or approximately 89%, for the six months ended June 30, 2006, from $33.00 million for the six months ended June 30, 2005 to $62.27 million for the six months ended June 30, 2006. The increase in revenues was primarily due to increased sales in our meat and meat products segment resulting from the effects of the continued increase in the amount of branded stores sales and increased sales to restaurants and non-commercial customers. During the first six months of 2006, 197 new "branded" retail stores were opened and we expanded our marketing and sales efforts to include 15 additional second-tier cities and 63 additional third-tier cities domestically. During the six months ended June 30, 2006, revenues from sales to branded stores increased to $30.5 million, which represented an increase of $14.7 million, or approximately 93%, as compared to the six months ended June 30, 2005. During the six months ended June 30, 2006, revenues from sales to food service distributors increased to $9.8 million, which represented an increase of $4.3 million, or approximately 78%, as compared to the six months ended June 30, 2005. During the six months ended June 30, 2006, revenues from sales to restaurants and non-commercial customers increased to $16.5 million, which represented an increase of $8.2 million, or approximately 99%, as compared to the six months ended June 30, 2005. During the six months ended June 30, 2006, revenues from export sales increased to $5.5 million, which represented an increase of $2.1 million, or approximately 62%, as compared to the six months ended June 30, 2005. COST OF SALES. Cost of sales increased by $25.59 million, or approximately 93%, for the six months ended June 33, 2006, from $27.38 million for the six months ended June 30, 2005 to $52.97 million for the six months ended June 30, 2006. As a percentage of revenue, total cost of sales increased approximately 2% from approximately 83% for the six months ended June 30, 2005 to approximately 85% for the six months ended June 30, 2006. The increase in cost of sales was primarily due to an 28 increase in raw material costs for the six months ended June 30, 2006 as compared to the six months ended June 30, 2005. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased by $1.98 million, or approximately 396%, for the six months ended June 30, 2006, from $0.50 million for the six months ended June 30, 2005 to $2.48 million for the six months ended June 30, 2006. As a percentage of revenues, general and administrative expenses increased from 1.52% for the six months ended June 30, 2005 to 3.98% for the six months ended June 30, 2006. As discussed above, the increase in general and administrative expenses resulted from the accrual of a liability of $0.55 million, or approximately 0.89% of total revenue for the six months ended June 30, 2006, due to our failure to register in a timely manner the resale of the common stock underlying our outstanding Series A convertible preferred stock and related purchase warrants. In addition, the increase in general and administrative expenses was the result of an increase of $0.64 million in legal and accounting fees and other expenses relating to our private placement of equity securities, our reverse acquisition of a controlling interest in a publicly-held "shell" company and our on-going public reporting obligations under the U.S. Federal securities laws. In addition, during the 2006 period, we incurred $0.52 million of additional management compensation expense due to the addition of senior executives and technical experts to our management team. OPERATING EXPENSES. Operating expenses increased by $0.83 million, or approximately 120%, for the six months ended June 30, 2006, from $0.69 million for the six months ended June 30, 2005 to $1.52 million for the six months ended June 30, 2006. As a percentage of revenue, operating expenses increased from 2.10% for the six months ended June 30, 2005 to 2.44% for the six months ended June 30, 2006. The increase in operating expenses was primarily the result of additional compensation expenses in the amount of $0.38 million we incurred in our sales department and additional transportation expenses in the amount of $0.36 million we incurred due to our increased sales, the expansion of our distribution network and the increased price of gasoline. INTEREST EXPENSE. Interest expense decreased by $0.20 million, or approximately 25%, during the six months ended June 30, 2006, from $0.81 million for the six months ended June 30, 2005 to $0.61 million for the six months ended June 30, 2006. At June 30, 2006, total bank debt had declined by approximately $0.79 million from the amount of bank debt that existed at December 31, 2005. The average debt outstanding was approximately $17.47 million for the six months ended June 30, 2006 and $22.10 million for the six months ended June 30, 2005. Our overall weighted average borrowing rate decreased from 7.32% in the six months ended June 30, 2005 to 6.96% in the six months ended June 30, 2006. INTEREST INCOME, ALLOWANCE INCOME, OTHER INCOME AND EXCHANGE GAIN (LOSS). Interest income, allowances income, other income and exchange gain (loss) increased by $1.44 million, or approximately 1,539%, for the six months ended June 30, 2006, from $0.09 million for the six months ended June 30, 2005 to $1.53 million for the six months ended June 30, 2006. The increase was primarily the result of an increase of $1.18 million in allowance income and an increase of $0.16 million in interest income. In addition, as discussed above, $1.12 million of the $2.23 million cash grant we received from the Chinese central government for the construction of an additional pork production line was recharacterized from a long-term liability to allowance income when the production line was partially completed and placed into operation during the second quarter of 2006. INCOME TAXES. The effective tax rate in the PRC on income generated from the sale of prepared products is 33% and there is no income tax on income generated from the sale of raw products including raw meat products and raw fruits and vegetable products. The increase of $0.19 million in the provision for income taxes for the six months ended June 30, 2006 over the six months ended June 30, 2005 resulted from an increase of $0.59 million in our income from the sale of prepared products during the 2006 period. 29 SEGMENT INFORMATION We operate in two business segments: pork and pork products, and vegetables and fruits. Our pork and pork products segment is involved primarily in the processing of live market hogs into fresh, frozen and processed pork products. Our pork and pork products segment markets its products domestically to our branded stores, food retailers, foodservice distributors, restaurant operators and noncommercial foodservice establishments, such as schools, hotel chains, healthcare facilities, the military and other food processors, as well as to international markets. Our vegetables and fruits segment is involved primarily in the processing of fresh vegetables and fruits. We contract with more than 120 farms in Henan Province and nearby areas to produce high-quality vegetable varieties and fruits suitable for export purposes. The proximity of the contracted farms to our operations ensures freshness from harvest to processing. We contract to grow more than 20 categories of vegetables and fruits, including asparagus, sweet corn, broccoli, mushrooms, lima beans and strawberries. The following tables set forth our revenues, sales in metric tons, operating income and production processed in metric tons by segment for the six months ended June 30, 2006 and 2005 and the six months ended June 30, 2006 and 2005, and the percentage increases for each segment between fiscal periods. The data for the six-month periods ended June 30, 2006 are not necessarily indicative of the results to be expected for the entire year, for any other interim period or for any future year. SALES BY SEGMENT (U.S. DOLLARS IN MILLIONS) THREE MONTHS THREE MONTHS PERCENTAGE ENDED ENDED NET CHANGE CHANGE JUNE 30, 2006 JUNE 30, 2005 2006/2005 2006/2005 ------------- ------------- ---------- ---------- Pork and Pork Products .... $30.30 $18.09 $12.21 67% Vegetables and Fruits ..... 1.48 0.50 0.98 196% ------ ------ ------ Total ............. $31.78 $18.59 $13.19 71% ====== ====== ====== SALES BY SEGMENT (U.S. DOLLARS IN MILLIONS) SIX MONTHS SIX MONTHS PERCENTAGE ENDED ENDED NET CHANGE CHANGE JUNE 30, 2006 JUNE 30, 2005 2006/2005 2006/2005 ------------- ------------- ---------- ---------- Pork and Pork Products .... $60.07 $32.36 $27.71 86% Vegetables and Fruits ..... 2.20 0.64 1.56 244% ------ ------ ------ Total ............. $62.27 $33.00 $29.27 89% ====== ====== ====== 30 SALES BY SEGMENT (IN METRIC TONS) THREE MONTHS THREE MONTHS PERCENTAGE ENDED ENDED NET CHANGE CHANGE JUNE 30, 2006 JUNE 30, 2005 2006/2005 2006/2005 ------------- ------------- ---------- ---------- Pork and Pork Products .... 25,767 16,687 9,080 54% Vegetables and Fruits ..... 1,450 552 898 163% ------ ------ Total ............. 27,217 17,239 ====== ====== SALES BY SEGMENT (IN METRIC TONS) SIX MONTHS SIX MONTHS PERCENTAGE ENDED ENDED NET CHANGE CHANGE JUNE 30, 2006 JUNE 30, 2005 2006/2005 2006/2005 ------------- ------------- ---------- ---------- Pork and Pork Products .... 52,184 30,645 21,539 70% Vegetables and Fruits ..... 2,471 857 1,614 188% ------ ------ Total ............. 54,655 31,502 ====== ====== OPERATING INCOME BY SEGMENT (U.S. DOLLARS IN MILLIONS) THREE THREE OPERATING OPERATING MONTHS MONTHS MARGIN MARGIN ENDED ENDED NET THREE MONTHS THREE MONTHS JUNE 30, JUNE 30, CHANGE ENDED ENDED 2006 2005 2006/2005 JUNE 30, 2006 JUNE 30, 2005 ------- ------- --------- ------------- ------------- Pork and Pork Products ... $ 2.27 $ 2.37 ($ 0.10) 7.49% 13.10% Vegetables and Fruits ...... 0.16 0.04 0.12 10.81% 8.00% ------ ------ ------ Total....... $ 2.43 $ 2.41 $ 0.02 7.65% 12.96% ====== ====== ====== OPERATING INCOME BY SEGMENT (U.S. DOLLARS IN MILLIONS) SIX SIX OPERATING OPERATING MONTHS MONTHS MARGIN MARGIN ENDED ENDED NET SIX MONTHS SIX MONTHS JUNE 30, JUNE 30, CHANGE ENDED ENDED 2006 2005 2006/2005 JUNE 30, 2006 JUNE 30, 2005 ------- ------- --------- ------------- ------------- Pork and Pork Products ... $ 5.08 $ 4.37 $ 0.71 8.46% 13.50% Vegetables and Fruits ...... 0.23 0.05 0.18 10.45% 7.81% ------ ------ ------ Total ..... $ 5.31 $ 4.42 $ 0.89 8.53% 13.39% ====== ====== ====== 31 PRODUCTION PROCESSED BY SEGMENT (IN METRIC TONS) THREE MONTHS THREE MONTHS PERCENTAGE ENDED ENDED NET CHANGE CHANGE JUNE 30, 2006 JUNE 30, 2005 2006/2005 2006/2005 ------------- ------------- ---------- ---------- Pork and Pork Products .... 27,049 16,822 10,227 61% Vegetables and Fruits ..... 1,135 485 650 134% ------ ------ Total ............. 28,184 17,307 ====== ====== PRODUCTION PROCESSED BY SEGMENT (IN METRIC TONS) SIX MONTHS SIX MONTHS PERCENTAGE ENDED ENDED NET CHANGE CHANGE JUNE 30, 2006 JUNE 30, 2005 2006/2005 2006/2005 ------------- ------------- ---------- ---------- Pork and Pork Products .... 55,036 30,775 24,261 79% Vegetables and Fruits ..... 2,872 737 2,135 290% ------ ------ Total ............. 57,908 31,512 ====== ====== ADDITIONAL OPERATING DATA In assessing our existing operations and planning our future growth and the development of our business, management considers, among other factors, our revenue growth and growth in sales volume by market segment, as well as our sales by distribution channel and geographic market coverage. The following table sets forth our revenues by sales channel for the three months ended June 30, 2006 and 2005 and the six months ended June 30, 2006 and 2005. SALES BY DISTRIBUTION CHANNEL (U.S. DOLLARS IN MILLIONS)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ----------------------------------- ---------------------------------- DISTRIBUTION CHANNEL 2006 2005 2006 2005 -------------------- ---------------- ---------------- --------------- ---------------- AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT ------ ------- ------ ------- ------ ------- ------ ------- Branded stores.......... $ 15.6 49.2% $ 8.9 48.0% $ 30.5 48.9% $ 15.8 48.0% Food services distributors.......... 4.8 15.2 3.1 16.8 9.8 15.7 5.5 16.8 Restaurants and non-commercial........ 8.8 27.6 4.7 25.0 16.5 26.6 8.3 25.0 Export.................. 2.5 8.0 1.9 10.2 5.5 8.8 3.4 10.2 ------ ----- ------ ----- ------ ----- ------ ----- Total............... $ 31.7 100.0% $ 18.6 100.0% $ 62.3 100.0% $ 33.0 100.0% ====== ===== ====== ===== ====== ===== ====== =====
The following table sets forth information with respect to the average number of products offered by our company, the average number of stores in our retail network and the number of provinces and cities in the PRC in which we offered and sold our products for each of the three years ended December 31, 2003, 2004 and 2005 and the three- and six-month periods ended June 30, 2006. 32
YEAR ENDED DECEMBER 31, THREE MONTHS SIX MONTHS ------------------------- ENDED ENDED 2003 2004 2005 JUNE 30, 2006 JUNE 30, 2006 ---- ---- ---- ------------ ------------- No. of products................. 107 125 168 189 196 No. of retail stores............ 712 978 2,100 2,260 2,297 Expansion of Market Coverage No. of Provinces.............. 20 20 20 20 20 No. of first-tier cities...... 21 23 29 29 29 No. of second-tier cities..... 32 36 44 53 59 No. of third-tier cities...... 85 109 142 192 205
LIQUIDITY AND CAPITAL RESOURCES We financed our operations over the six months ended June 30, 2006 primarily through cash from an equity financing and borrowings under our lines of credit with various lending banks in the PRC. In January 2006, we completed a private placement of our Series A convertible preferred stock and common stock purchase warrants and received net proceeds of approximately $23.11 million. At June 30, 2006, we had cash and cash equivalents of $14.52 million, an increase of approximately $4.38 million and $1.07 million compared to the balances of cash and cash equivalents at December 31, 2005 and June 30, 2005, respectively. Net cash provided by (used in) operating activities was ($3.74) million in the six months ended June 30, 2006. Net cash provided by operating activities in the six months ended June 30, 2006 consisted primarily of net profit of $5.89 million due to increased revenue. Net cash used in operating activities for the six months ended June 30, 2006 was primarily attributable to an increase of $4.10 million in accounts receivable, which consisted of an increase of $5.54 million in accounts receivable due to increased sales and a reduction of $1.43 million in other accounts receivable, and an increase of $4.01 million in inventory due to increased sales. During the first half of 2006, management focused on reducing the average age of our accounts receivable and increasing the rate at which we turn our inventory. Our average accounts receivable turnover decreased from approximately 45 days during the six months ended June 30, 2005 to approximately 36 days during the six months ended June 30, 2006. In addition, our average inventory turnover rate decreased from approximately 23 days during the 2005 period to approximately 14 days during the 2006 period. Net cash used in investing activities was $8.44 million in the six months ended June 30, 2006. In the six months ended June 30, 2006, construction in progress in the amount of $8.12 million for the construction of Zhongpin Industrial Park II was completed and transferred to fixed assets. During the six months ended June 30, 2006, we expended $4.67 million for the purchase of fixed assets. In addition, we expended $3.78 million for an investment in land use rights during the first six months of 2006. Net cash provided by financing activities was $16.28 million in the six months ended June 30, 2006. In the six months ended June 30, 2006, cash provided by financing activities included net proceeds from the issuance of Series A convertible preferred stock and common stock purchase warrants of $23.11 million, and the net cash used in financing activities included the repayment of short-term indebtedness in the aggregate amount of $6.05 million and the repayment of bank overdrafts of $0.62 million. At June 30, 2006, Henan Zhongpin had short-term bank and governmental loans in the aggregate amount of $12.94 million with an average interest rate per annum of 6.96%, and lines of credit with aggregate credit availability of $78.63 million, as follows: 33 MAXIMUM CREDIT AMOUNT INTEREST MATURITY BANK AVAILABILITY BORROWED RATE DATE ------------ ------------- -------- ---------- Agriculture Bank of China ... $ 18,722,000 $ 750,413 6.70% 8/1/2006 800,440 3.00 9/29/2006 1,138,126 6.70 12/11/2006 187,603 6.70 12/29/2006 500,275 6.70 12/30/2006 787,933 7.02 4/27/2007 Industrial and Commercial Bank of China ............. 6,241,000 1,876,032 5.85% 3/30/2007 1,250,688 6.14 4/30/2007 1,876,032 5.85 5/24/2007 -- Bank of China ............... 7,489,000 625,344 6.70% 7/15/2006 China Construction Bank ..... 11,233,000 625,344 6.42% 12/22/2006 625,344 6.42 12/23/2006 625,344 6.42 1/16/2007 Agriculture Development Bank of China ............. 14,978,000 -- Shanghai Pudong Development Bank of China ............. 3,744,000 -- CITIC Industrial Bank ....... 6,241,000 -- Commercial Bank of China .... 6,241,000 -- Guangdong Development Bank .. 3,744,000 1,250,688 6.14% 9/16/2006 City Finance -short-term .... -- 25,013 0.00% 4/1/2007 ------------ ------------ Total......... $ 78,633,000 $ 12,944,619 ============ ============ Canadian Government Transfer Loan ............. 1,853,275 * 5/15/2043 City Finance................. 253,890 0.00% None ---------- * 58% of the principal amount of this loan bears interest at the rate of 6.02% per annum and the remaining principal amount of this loan is interest free. All repayments are applied first to the interest-bearing portion of this loan. Of our outstanding short-term indebtedness at June 30, 2006, $3.24 million aggregate principal amount of loans was secured by our land and production facilities located in the PRC. We believe our existing cash and cash equivalents and our available lines of credit, which totaled approximately $78.63 million at June 30, 2006, will be sufficient to finance our operating requirements and anticipated capital expenditures of approximately $13.09 million over the next 12 months. 34 CONTRACTUAL COMMITMENTS The following table summarizes our contractual obligations at June 30, 2006 and the effect those obligations are expected to have on our liquidity and cash flow in future periods. PAYMENTS DUE BY PERIOD (U.S. DOLLARS IN THOUSANDS) LESS THAN MORE THAN CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS ------------------------------- ------ --------- --------- --------- -------- Long-Term Debt Obligations .... $2,254 $219 $292 $292 $1,451 Capital Lease Obligations ..... -- -- -- -- -- Operating Lease Obligations ... -- -- -- -- -- Purchase Obligations .......... -- -- -- -- -- Other Obligations ............. -- -- -- -- -- ------ ---- ---- ---- ------ Total ................. $2,254 $219 $292 $292 $1,451 ====== ==== ==== ==== ====== INFLATION AND SEASONALITY While demand for our products, in general, is relatively high before the Chinese New Year in January or February each year and lower thereafter, we do not believe our operations have been materially affected by inflation or seasonality. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK. We may be exposed to changes in financial market conditions in the normal course of business. Market risk generally represents the risk that losses may occur as a result of movements in interest rates and equity prices. We currently do not use financial instruments in the normal course of business that are subject to changes in financial market conditions. CURRENCY FLUCTUATIONS AND FOREIGN CURRENCY RISK. 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 Chinese 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. Substantially all of our revenues and expenses are denominated in Renminbi. However, we use the United States dollar for financial reporting purposes. Conversion of Renminbi into foreign currencies is regulated by the People's Bank of China through a unified floating exchange rate system. Although the PRC government has stated its intention to support the value of the Renminbi, there can be no assurance that such exchange rate will not again become volatile or that the Renminbi will not devalue significantly against the U.S. dollar. Exchange rate fluctuations may adversely affect the value, in U.S. dollar terms, of our net assets and income derived from our operations in the PRC. INTEREST RATE RISK. We do not have significant interest rate risk, as our debt obligations are primarily short-term in nature, with fixed interest rates. 35 CREDIT RISK. We have not experienced significant credit risk, as most of our customers are long-term customers with superior payment records. Our receivables are monitored regularly by our credit managers. ITEM 4. CONTROLS AND PROCEDURES DISCLOSURE CONTROLS AND PROCEDURES. Our management, with the participation our chief executive officer and chief financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, our chief executive officer and chief financial officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act. INTERNAL CONTROL OVER FINANCIAL REPORTING. There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 36 ZHONGPIN INC. PART II - OTHER INFORMATION ITEM 6. EXHIBITS The exhibits required by this item are set forth on the Exhibit Index attached hereto. 37 ZHONGPIN INC. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, we have duly caused this report to be signed on our behalf by the undersigned thereunto duly authorized. ZHONGPIN INC. (Company) Date: November 14, 2006 By: /s/ Xianfu Zhu --------------------------------- Xianfu Zhu Chief Executive Officer By: /s/ Yuanmei Ma --------------------------------- Yuanmei Ma Chief Financial Officer 38 EXHIBIT INDEX EXHIBIT NUMBER EXHIBIT TITLE --------- ----------------------------------------------------------------- 31.1* Certification of our Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2* Certification of our Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1* Certification of our Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2* Certification of our Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * filed herewith 39