10-Q 1 c48433_10q.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2007 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 (I.R.S. Employer Identification No.) of incorporation or organization) 21 Changshe Road, Changge City, Henan Province, 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 |X| Non-accelerated filer |_| 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 May 1, 2007, 13,753,170 shares of the registrant's common stock, and 5,279,141 shares of the registrant's Series A preferred stock, each such share convertible into one share of the registrant's common stock, were outstanding. ZHONGPIN INC. FORM 10-Q INDEX
PART I FINANCIAL INFORMATION PAGE ------ --------------------- ---- Item 1. Unaudited Financial Statements: Consolidated Balance Sheets as of March 31, 2007 (unaudited) and December 31, 2006.......................................................... 2 Consolidated Statements of Operations and Comprehensive Income (unaudited) for the three months ended March 31, 2007 and 2006.................................................................. 3 Consolidated Statement of Changes in Stockholders' Equity (unaudited) for the three months ended March 31, 2007...................................... 4 Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2007 and 2006........................................... 5 Notes to Consolidated Financial Statements (unaudited).............................. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...................................................... 22 Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................... 33 Item 4. Controls and Procedures............................................................. 33 PART II OTHER INFORMATION ------- ----------------- Item 1. Legal Proceedings................................................................... 34 Item 1A. Risk Factors........................................................................ 34 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds......................... 34 Item 3. Defaults Upon Senior Securities..................................................... 34 Item 4. Submission of Matters to a Vote of Security Holders................................. 34 Item 5. Other Information................................................................... 34 Item 6. Exhibits ........................................................................... 35 SIGNATURES................................................................................................ 36
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 for the year ended December 31, 2006. The results of operations for the three-month period ended March 31, 2007 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)
MARCH 31, 2007 DECEMBER 31, 2006 -------------- ----------------- ASSETS (Unaudited) Current assets Cash and cash equivalents $ 25,917,698 $ 21,692,814 Accounts receivable and other receivables (net) 17,047,013 13,471,450 Purchase deposits 336,695 -- Prepaid expenses and deferred charges 273,391 200,436 Inventories 11,464,847 10,077,479 Tax refund receivables 1,243,277 1,079,002 ------------- ------------- Total current assets 56,282,921 46,521,181 Property, plant and equipment (net) 32,679,396 32,597,150 Related party receivables -- Other receivables 2,445,994 2,056,642 Construction contracts 21,551,169 12,016,823 Intangible assets 9,070,043 9,030,077 ------------- ------------- Total assets $ 122,029,523 $ 102,221,873 ============= ============= LIABILITIES AND EQUITY Current liabilities Accounts payable and other payables $ 23,874,118 $ 20,712,794 Accrued liabilities 1,942,162 1,597,557 Short term loans payable 32,996,302 23,845,198 Taxes payable 1,044,359 378,705 Deposits from clients 2,039,645 683,814 Research and development grants payable 249,034 248,572 Long term loans payable-current portion 145,671 145,671 ------------- ------------- Total current liabilities 62,291,291 47,612,311 Long term loans payable 1,913,614 1,912,343 ------------- ------------- Total liabilities 64,204,905 49,524,654 Equity Preferred stock: par value $0.001; 10,000,000 authorized; 5,478,754 and 6,900,000 shares issued and outstanding 5,479 6,900 Common stock: par value $0.001; 25,000,000 authorized; 13,553,557 and 12,132,311 shares issued and outstanding 13,554 12,133 Additional paid in capital 32,548,105 32,538,535 Retained earnings 23,029,172 18,456,884 Accumulated other comprehensive income 2,228,308 1,682,767 ------------- ------------- Total equity 57,824,618 52,697,219 ------------- ------------- Total liabilities and equity $ 122,029,523 $ 102,221,873 ============= =============
The accompanying notes are an integral part of these consolidated financial statements. 2 ZHONGPIN INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (AMOUNT IN U.S. DOLLARS) (UNAUDITED)
THREE MONTHS ENDED MARCH 31, ------------------------------- 2007 2006 ---- ---- Revenues Sales revenues $ 55,791,778 $ 30,493,507 Cost of sales 48,049,622 25,914,155 ------------- ------------ Gross profit 7,742,156 4,579,352 Operating expenses General and administrative expenses 1,404,719 899,024 Operating expenses 1,125,945 804,146 ------------- ------------ Total operating expenses 2,530,664 1,703,170 ------------- ------------ Income from operations 5,211,492 2,876,182 Other income (expense) Interest income 21,904 95,690 Other income (expenses) (4,428) 12,392 Allowances income -- 113,184 Exchange gain 3,484 13,709 Interest expense (442,811) (380,228) ------------- ------------ Total other income (expense) (421,851) (145,253) ------------- ------------ Net income before taxes 4,789,641 2,730,929 Provision for income taxes 217,353 145,245 ------------- ------------ Net income after taxes 4,572,288 2,585,684 Minority interest -- 10,720 ------------- ------------ Net income $ 4,572,288 $ 2,574,964 ============= ============ Foreign currency translation adjustment $ 545,541 $ 141,150 ------------- ------------ Comprehensive income $ 5,117,829 $ 2,716,114 ============= ============ Basic earnings per common share $ 0.24 $ 0.16 Diluted earnings per common share $ 0.22 $ 0.13 Basic weighted average shares outstanding 12,627,854 11,752,568 Diluted weighted average shares outstanding 20,982,304 19,342,568
The accompanying notes are an integral part of these consolidated financial statements. 3 ZHONGPIN INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (AMOUNT IN U.S. DOLLARS) (UNAUDITED)
Accumulated Additional Other Preferred Stock Common Stock Paid In Retained Comprehensive Shares Par Value Shares Par Value Capital Earnings Income Total ------ --------- ------ --------- ------- -------- ------ ----- January 1, 2006 -- $ -- 11,752,568 $11,753 $ 2,102,933 $12,097,834 $ 303,748 $14,516,268 Increase in Common Stock 379,740 380 380 Increase in Preferred Stock 6,900,000 6,900 -- -- -- -- -- 6,900 Warrant expense -- -- -- -- 22,330 -- -- 22,330 Net income for the period -- -- -- -- -- 6,359,051 -- 6,359,051 Increase in additional paid in capital -- -- -- -- 30,413,272 -- 30,413,272 Foreign currency translation adjustment -- -- -- -- -- -- 1,379,019 1,379,019 --------- ------- ---------- ------- ----------- ----------- ---------- ----------- Balance December 31, 2006 6,900,000 6,900 12,132,318 12,133 32,538,535 18,456,885 1,682,767 52,697,219 Preferred stock converted to common (1,421,246) (1,421) 1,421,246 1,421 -- -- -- -- Warrant expense -- -- -- -- 9,570 -- -- 9,570 Net income for the period -- -- -- -- -- 4,572,288 -- 4,572,288 Foreign currency translation adjustment -- -- -- -- -- -- 545,541 545,541 --------- ------- ---------- ------- ----------- ----------- ---------- ----------- Balance March 31, 2007 5,478,754 $ 5,479 13,553,557 $13,554 $32,548,105 $23,029,172 $2,228,308 $57,824,618 ========= ======= ========== ======= =========== =========== ========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 4 ZHONGPIN INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (AMOUNT IN U.S. DOLLARS) (UNAUDITED)
THREE MONTHS ENDED MARCH 31, ----------------------------- 2007 2006 ---- ---- Cash flows from operating activities: Net income $ 4,572,288 $ 2,574,964 Adjustments to reconcile net income to net cash provided by (used in) operations: Minority interest -- 10,720 Depreciation 415,186 145,734 Amortization 47,177 10,017 Warrant expense 9,570 -- Changes in operating assets and liabilities: Accounts receivable and other receivables (3,964,914) (5,180,997) Purchase deposits (336,695) 78,557 Prepaid expense and deferred charges (72,955) 4,645 Inventories (1,387,368) (2,364,754) Tax refunds receivable (164,275) 492,903 Accounts payable and other payable 3,161,786 1,084,766 Accrued liabilities 344,605 -- Taxes payable 665,654 118,537 Deposits from clients 1,355,831 79,636 ------------ ------------ Net cash provided by operating activities 4,645,890 (2,945,272) Cash flows from investing activities: Construction in progress (9,534,346) (3,725,926) Additions to fixed assets (497,433) (236,210) Additions to intangible assets (87,143) -- ------------ ------------ Net cash used in investing activities (10,118,922) (3,962,136) Cash flows from financing activities: Repayment of Bank overdraft -- (619,579) Proceeds from short-term loans 11,724,610 -- Proceeds from long-term loans 1,271 -- Repayment of short-term loans (2,573,506) (7,976,527) Proceeds from preferred stock -- 23,110,703 Net cash provided by financing activities 9,152,375 14,514,597 Effect of rate changes on cash 545,541 136,367 ------------ ------------ Increase (decrease) in cash and cash equivalents 4,224,884 7,743,556 Cash and cash equivalents, beginning of period 21,692,814 10,142,394 ------------ ------------ Cash and cash equivalents, end of period $ 25,917,698 $ 17,885,950 ============ ============ Supplemental disclosures of cash flow information: Cash paid for interest $ 428,320 $ 352,002 Cash paid for income taxes $ 106,925 $ 186,567
The accompanying notes are an integral part of these consolidated financial statements. 5 ZHONGPIN INC. NOTES TO CONSOLIATED FINANCIAL STATEMENTS 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 11,250,000 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 Renminbi ("RMB") ($2,528,986) to the stockholders of HZFC, who also were the stockholders 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 stockholders of Food Share, who were also the stockholders 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 our subsidiaries. On January 30, 2006, we consummated an agreement with the shareholders of Falcon whereby we issued 11,250,000 shares of our common stock in exchange for all of the issued and outstanding stock of Falcon. Immediately prior to the transaction there were 502,568 shares outstanding as compared to 11,752,568 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 CONSOLIATED FINANCIAL STATEMENTS 1. ORGANIZATION AND NATURE OF OPERATIONS (continued) In conjunction with our 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 one common share at a purchase price of $5.00 per share. Each preferred share is convertible into one common share. The outstanding shares of Series A convertible preferred stock are convertible into an aggregate of 6,900,000 common shares and the outstanding warrants are exercisable to purchase an aggregate of 3,450,000 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 11,752,568 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. These financial statements have been adjusted to show all stock transactions using post-split amounts. In June 2006, Zhumadian Zhongpin Food Company Limited was registered with a registered capital of 5,000,000 RMB ($625,344), which is 100%-owned by Henan Zhongpin Food Share Company Limited. In August 2006, Anyang Zhongpin Food Company Limited was registered with a registered capital of 4,800,000 RMB ($606,927), which is 100%-owned by Henan Zhongpin Food Share Company Limited. In September 2006, Henan Zhongpin Fresh Food Logistics Company Limited, Deyang Zhongpin Food Company Limited and Henan Zhongpin Business Development Company Limited were registered with the registered capitals of 1,500,000 RMB ($189,665), 1,000,000 RMB ($126,443) and 5,000,000 RMB ($632,215), respectively, which are all 100%-owned by Henan Zhongpin Food Share Company Limited. In October 2006, Heilongjiang Zhongpin Food Company Limited was registered with a registered capital of 1,000,000 RMB ($126,406), which is 100%-owned by Henan Zhongpin Food Share Company Limited. Details of Food Share's subsidiaries are as follows:
DOMICILE/DATE OF REGISTERED PERCENTAGE NAME INCORPORATION CAPITAL OF OWNERSHIP ---- ------------- ------- ------------ Henan Zhongpin Industrial Company PRC/Jan. 17, 2004 18,000,000 RMB 100.00% Limited ($2,173,913) Henan Zhongpin Import and Export Trading PRC/Aug. 11, 2004 5,060,000 RMB 100.00% Company ($611,111) Zhumadian Zhongpin Food Company Limited PRC/June 7, 2006 5,000,000 RMB 100.00% ($625,344)
7 ZHONGPIN INC. NOTES TO CONSOLIATED FINANCIAL STATEMENTS
DOMICILE/DATE OF REGISTERED PERCENTAGE NAME INCORPORATION CAPITAL OF OWNERSHIP ---- ------------- ------- ------------ Anyang Zhongpin Food Company Limited PRC/Aug 21, 2006 4,800,000 RMB 100.00% ($606,927) Henan Zhongpin Fresh Food Logistics PRC/Sep 14, 2006 1,500,000 RMB 100.00% Company Limited ($189,665) Deyang Zhongpin Food Company Limited PRC/Sep 25, 2006 1,000,000 RMB 100.00% ($126,443) Henan Zhongpin Business Development PRC/Sep 27, 2006 5,000,000 RMB 100.00% Company Limited ($632,215) Heilongjiang Zhongpin Food Company Limited PRC/Oct.17, 2006 1,000,000 RMB 100.00% ($126,406)
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, Zhumadian Zhongpin Food Company Limited, Anyang Zhongpin Food Company Limited, Henan Zhongpin Business Development Company Limited, Henan Zhongpin Fresh Food Logistics Company Limited, Deyang Zhongpin Food Company Limited and Heilongjiang 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 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. The Renminbi of the People's Republic of China (RMB) 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. 8 ZHONGPIN INC. NOTES TO CONSOLIATED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) 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 2004, Henan Zhongpin Industrial Company Limited increased its registered capital from 5,000,000 RMB ($603,864) to 18,000,000 RMB ($2,173,913), which required the minority holders to increase their investment by 1,560,000 RMB ($188,406), effectively increasing the minority interest shown on our balance sheet by $188,406. In November 2006, Henan Zhongpin Food Share Co. Limited acquired the minority interest shares of Henan Zhongpin Industrial Company Limited and Henan Zhongpin Import and Export Trading Company and became the 100% owner of Henan Zhongpin Industrial Company Limited and Henan Import and Export Trading Company. 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. 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 9 ZHONGPIN INC. NOTES TO CONSOLIATED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) 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 Statement of Financial Accounting Standard ("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 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. 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. 10 ZHONGPIN INC. NOTES TO CONSOLIATED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Diluted EPS is calculated by using the treasury stock method, assuming conversion of all potentially dilutive securities, such as stock options and warrants. Under this method, (i) exercise of options and warrants is assumed at the beginning of the period and shares of common stock are assumed to be issued, (ii) the proceeds from exercise are assumed to be used to purchase common stock at the average market price during the period, and (iii) the incremental shares (the difference between the number of shares assumed issued and the number of shares assumed purchased) are included in the denominator of the diluted EPS computation. The numerators and denominators used in the computations of basic and diluted EPS are presented in the following table:
Three Months Ended March 31, -------------------------- 2007 2006 ---- ---- NUMERATOR FOR BASIC AND DILUTED EPS Net income (numerator for Diluted EPS) $ 4,572,288 $ 2,574,964 Net income allocated to preferred stock 1,538,575 724,340 ----------- ----------- Net income to common stockholders (Basic) $ 3,033,713 $ 1,850,624 =========== =========== DENOMINATORS FOR BASIC AND DILUTED EPS Common stock outstanding after recapitalization and 1:35.349 reverse stock split 12,627,854 11,752,568 ----------- ----------- DENOMINATOR FOR BASIC EPS 12,627,854 11,752,568 Add: Weighted average preferred as if converted 6,404,457 4,600,000 Add: Weighted average stock warrants outstanding 1,949,993 2,990,000 ----------- ----------- DENOMINATOR FOR DILUTED EPS 20,982,304 19,342,568 =========== =========== EPS - Basic $ 0.24 $ 0.16 EPS - Diluted $ 0.22 $ 0.13
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 $575,000 and $228,000 for the three months ended March 31, 2007 and 2006, respectively. Handling costs are included in costs of sales, which ere approximately $261,000 and $175,000 for the three months ended March 31, 2007 and 2006, respectively. ADVERTISING COSTS Advertising costs are expensed as incurred. Advertising expenses were approximately $207,000 and $26,000 for the three months ended March 31, 2007 and 2006, respectively. 11 ZHONGPIN INC. NOTES TO CONSOLIATED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) 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 $385,000 and $325,000 for the three months ended March 31, 2007 and 2006, 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 related group of assets, may be based on appraisals, 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 SFAS No. 109, "Accounting for Income Taxes," these deferred taxes are measured by applying currently-enacted tax laws. We recorded income tax expenses of $217,353 and $145,245 for the three months ended March 31, 2007 and 2006, respectively. 12 ZHONGPIN INC. NOTES TO CONSOLIATED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) 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 On August 11, 2004, Food Share formed Henan Zhongpin Import and Export Trading Company as a joint venture with Li Jun Wei, an individual, to facilitate exporting of our goods. Initially, Food Share owned 88.93% of Henan Zhongpin Import and Export Trading Company. In November 2006, Food Share acquired Li Jun Wei's share interest in, and became the 100% owner of, Henan Zhongpin Import and Export Trading Company. During 2001, Food Share acquired Yanlin Meat Factory and established Zhongpin Industrial Company Limited as a joint venture with three individuals. Initially, Food Share owned 88% of Zhongpin Industrial Company Limited. In November 2006, Food Share acquired the three individuals' share interest in, and became the 100% owner of, Zhongpin Industrial Company Limited. 4. ACCOUNTS RECEIVABLE AND OTHER RECEIVABLES We accrue an allowance for bad debts related to our receivables. The receivable and allowance balances at March 31, 2007 and 2006 were as follows: MARCH 31, 2007 DECEMBER 31, 2006 -------------- ----------------- Accounts receivable $ 17,341,634 $ 13,763,260 Other receivables 2,567,368 2,176,858 Allowance for bad debts (415,995) (412,026) ------------ ------------ $ 19,493,007 $ 15,528,092 ============ ============ Current $ 17,047,013 $ 13,471,450 Non-current 2,445,994 2,056,642 ------------ ------------ $ 19,493,007 $ 15,528,092 ============ ============ Other receivables consist primarily of cash advances to suppliers to ensure preferential pricing and delivery. These 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 repaid within one year are classified as non-current. 5. INVENTORIES Inventories at March 31, 2007 and December 31, 2006 consisted of: MARCH 31, 2007 DECEMBER 31, 2006 -------------- ----------------- Raw materials $ 236,948 $ 307,202 Low value consumables & packaging 530,767 401,177 Work-in-progress 728,072 487,930 Finished goods 9,969,060 8,881,170 ----------- ----------- Provision for loss of pricing -- -- ----------- ----------- Net inventories $11,464,847 $10,077,479 =========== =========== 13 ZHONGPIN INC. NOTES TO CONSOLIATED FINANCIAL STATEMENTS 6. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment at cost at March 31, 2007 and December 31, 2006 consisted of: MARCH 31, 2007 DECEMBER 31, 2006 -------------- ----------------- Machinery and equipment $ 12,603,046 $ 12,453,177 Furniture and office equipment 549,199 434,128 Motor vehicles 420,491 416,479 Buildings 22,812,594 22,584,113 ------------ ------------ Subtotal 36,385,330 35,887,897 Less: Acquisition gain (93,402) (92,510) Less: Accumulated depreciation (3,612,532) (3,198,237) ------------ ------------ Net property and equipment $ 32,679,396 $ 32,597,150 ============ ============ Depreciation expense was $415,186 and $145,734 for the three months ended March 31, 2007 and 2006, respectively. 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 March 31, 2007 and December 31, 2006 consisted of the following: MARCH 31, 2007 DECEMBER 31, 2006 -------------- ----------------- Land use rights $ 9,339,902 $ 9,250,410 Accumulated amortization (269,859) (220,333) ----------- ----------- $ 9,070,043 $ 9,030,077 =========== =========== Amortization expense was $47,177 and $10,017 for the three months ended March 31, 2007 adn 2006, respectively. 8. CONSTRUCTION IN PROGRESS Construction in progress at March 31, 2007 and December 31, 2006 consisted of:
COMPLETION OR ESTIMATED CONSTRUCTION PROJECT COMPLETION DATE MARCH 31, 2007 DECEMBER 31, 2006 -------------------- --------------- -------------- ----------------- Production line for chilled pork May 2007 $ 11,949,453 $ 9,313,544 (in Zhumadian) Production line for chilled pork August 2007 5,936,904 1,161,339 (in Anyang) Land use right of Industrial Park No.4 land December 2007 1,104,928 970,147 Production line for prepared pork (in industrial plant) April 2007 2,530,301 542,493 Logistic Software July 2007 29,583 29,300 $ 21,551,169 $ 12,016,823 ============ ============
14 ZHONGPIN INC. NOTES TO CONSOLIATED FINANCIAL STATEMENTS 9. LOANS PAYABLE SHORT-TERM LOANS Short-term loans are due within one year. Of the $33.00 million aggregate principal amount of short-term loans at March 31, 2007, loans in the principal amount of $4.65 million were secured by our land and plants located in the PRC and loans in the aggregate principal amount of $28.32 million were guaranteed by Henan Zhongpin Industry Co., Ltd. These loans bear interest at prevailing lending rates in the PRC ranging from 5.85% to 7.34% per annum. At March 31, 2007, there was approximately $122.18 million in available unused lines of credit. LONG-TERM LOANS Our long-term loan bears interest at the rate of 6.02% per annum. The balances of loans payable at March 31, 2007 and December 31, 2006 were as follows: MARCH 31, 2007 DECEMBER 31, 2006 -------------- ----------------- Short-Term Loans Payable $32,996,302 $23,845,198 Total Long-Term Loans Payable 2,059,285 2,058,014 ----------- ----------- $35,055,587 $25,903,212 =========== =========== Long-Term Repayment Schedule Payments due in 2007 - current portion $ 145,671 Payments due in 2008 145,671 Payments due in 2009 145,671 Payments due in 2010 145,671 Payments due in 2011 145,671 Payments due thereafter 1,330,930 ---------- $2,059,285 ========== 10. COMMITMENTS AND CONTINGENCIES LEGAL PROCEEDINGS From time to time, we have disputes that arise in the ordinary course of our business. As of March 31, 2007, 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 effected by June 29, 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 (approximately $414,000 per month) until the registration statement we filed with the 15 ZHONGPIN INC. NOTES TO CONSOLIATED FINANCIAL STATEMENTS 10. COMMITMENTS AND CONTINGENCIES (continued) Securities and Exchange Commission (the "SEC") to effect such registration was declared effective by the SEC. On June 29, 2006, such registration statement had not become effective, and in July 2006 we began to accrue a liability in the amount of $414,000 per month for this contingency because a loss was reasonably possible and a loss amount could reasonably be estimated. On December 22, 2006, we amended the registration rights agreement and agreed to pay an aggregate of $1,044,357 in cash and to issue an aggregate of 379,743 shares of our common stock to settle in full our obligations under such agreement to have the registration statement required thereunder declared effective by the SEC in an timely manner. At the same time, in order to obtain the consent of investors to remove from such registration statement certain shares of common stock underlying our stock purchase warrants, we issued to such investors warrants to purchase an aggregate of 884,796 shares of common stock with an exercise price of $5.50 per share. The total expenses related to the penalty were $1,044,357 in cash, $2,848,073 related to the shares of common stock and $4,461,775 related to the warrants. On February 2, 2007, the initial registration statement we filed pursuant to the registration rights agreement was declared effective by the SEC. 11. 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 for the three months ended March 31, 2007 and 2006 as follows: THREE MONTHS ENDED MARCH 31, ---------------------------- 2007 2006 ---- ---- Allowances income -- $113,184 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. 12. FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS 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. 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 during the three months ended March 31, 2007 or during fiscal 2006 or 2005. 16 ZHONGPIN INC. NOTES TO CONSOLIATED FINANCIAL STATEMENTS 13. NEW ACCOUNTING PRONOUNCEMENTS In February 2007, the Financial Accounting Standards Board ("FASB") issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities - an amendment of FASB Statement No. 115." This statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This Statement is expected to expand the use of fair value measurement, which is consistent with the Board's long-term measurement objectives for accounting for financial instruments. We expect the Statement will have no material impact on our consolidated financial statements. In September 2006, Financial Accounting Standards Board ("FASB") issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106 and 132(R)." This Statement improves financial reporting by requiring an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income of a business entity or changes in unrestricted net assets of a not-for-profit organization. This Statement also improves financial reporting by requiring an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. We expect the Statement will have no material impact on our consolidated financial statements. In September 2006, Financial Accounting Standards Board ("FASB") issued SFAS No. 157, "Fair Value Measurements." This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. However, for some entities, the application of this Statement will change current practice. We expect the Statement will have no material impact on our consolidated financial statements. In March 2006, Financial Accounting Standards Board ("FASB") issued SFAS No. 156, "Accounting for Servicing of Financial Assets--an amendment of FASB Statement No. 140." This Statement provides an approach to simplify efforts to obtain hedge-like (offset) accounting. This new Statement amends FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. We expect the Statement will have no material impact on our consolidated financial statements. 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 17 ZHONGPIN INC. NOTES TO CONSOLIATED FINANCIAL STATEMENTS 13. NEW ACCOUNTING PRONOUNCEMENTS (continued) 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. 14. 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. 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 18 ZHONGPIN INC. NOTES TO CONSOLIATED FINANCIAL STATEMENTS 14. PREFERRED STOCK (continued) 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 $4.00. 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 $10.00 (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. 15. WARRANTS In conjunction with the issuance of preferred stock discussed in Note 14, we issued warrants for the purchase of 3,450,000 shares of our common stock. Also in conjunction with the issuance of preferred stock, we 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 shares of common stock. On June 15, 2006, in conjunction with a one-year consulting agreement, we issued three-year warrants to purchase 100,000 shares of common stock 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 $9,570 for the three months ended March 31, 2007. 19 ZHONGPIN INC. NOTES TO CONSOLIATED FINANCIAL STATEMENTS 15. WARRANTS (continued) On December 22, 2006, in conjunction with an amendment to a registration rights agreement, we issued to investors warrants to purchase 884,796 shares of common stock at a price of $5.50 per share. The warrants were accounted for using the fair value method. Penalty expense related to the warrants amounted to $4,461,775 for the year ended December 31, 2006. There was no penalty expense accrued for the three months ended March 31, 2007. The following table provides certain information with respect to the above-referenced warrants outstanding at March 31, 2007:
WEIGHTED AVERAGE WEIGHTED AVERAGE EXERCISE PRICE NUMBER OUTSTANDING EXERCISE PRICE LIFE - YEARS -------------- ------------------ -------------- ------------ Warrants $4.00 - $6.50 5,469,796 $4.98 3.95
The following table provides certain information with respect to warrants exercisable at March 31, 2007:
WEIGHTED AVERAGE EXERCISE PRICE NUMBER OUTSTANDING EXERCISE PRICE -------------- ------------------ -------------- Warrants $4.00 - $6.50 5,445,796 $4.98
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 - 5 Interest rate 4% - 4.52% Volatility 6.1% - 68.5% Dividend yield 0% 16. 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 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. 20 ZHONGPIN INC. NOTES TO CONSOLIATED FINANCIAL STATEMENTS 16. SEGMENT REPORTING (continued)
SALES BY SEGMENT (U.S. DOLLARS IN MILLIONS) THREE MONTHS ENDED MARCH 31, PERCENTAGE ------------------------------ NET CHANGE CHANGE 2007 2006 2007/2006 2007/2006 ---- ---- --------- --------- Pork and Pork Products........... Chilled Pork................ $ 28.48 $ 10.34 $ 18.14 175% Frozen Pork................. 20.29 16.17 4.12 25% Prepared Pork Products...... 5.85 3.27 2.58 79% Vegetables and Fruits............ 1.17 0.72 0.45 63% ------- ------- ------- Total................. $ 55.79 $ 30.50 $ 25.29 83% ======= ======= =======
OPERATING INCOME BY SEGMENT (U.S. DOLLARS IN MILLIONS) OPERATING MARGIN THREE MONTHS THREE MONTHS ENDED ENDED MARCH 31, CHANGE MARCH 31, ------------------- --------- -------------------- 2007 2006 2007/2006 2007 2006 ---- ---- --------- ---- ---- Pork and Pork Products Chilled Pork ................... $2.48 $0.96 $1.52 8.71% 9.28% Frozen Pork..................... 1.75 1.44 0.31 8.62% 8.91% Prepared Pork Products.......... 0.85 0.41 0.44 14.53% 12.54% Vegetables and Fruits............... 0.13 0.07 0.06 11.11% 9.72% ----- ----- ----- Total.................... $5.21 $2.88 $2.33 9.34% 9.44% ===== ===== =====
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 FOR THE YEAR ENDED DECEMBER 31, 2006. 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 OVERVIEW We are principally engaged in the meat and food processing and distribution business in the PRC. Currently, we have six processing plants located in Henan and Heilongjiang Provinces in the PRC, with a total of nine production lines. Our current total production capacity for chilled pork and frozen pork, including the average production capacity of approximately 167 metric tons per day from OEM partners, is 493 metric tons per day, including the average production capacity from OEM partners, based on an 8-hour working day, or approximately 177,480 metric tons on an annual basis. We also have production capacity for prepared meats of 70 metric tons per 8-hour day (or approximately 25,200 metric tons on an annual basis) and for fruits and vegetables, including the average production capacity of OEM partners, of 43 metric tons per 8-hour day including the average production capacity of approximately eight metric tons per day supported by OEM partners (or approximately 15,480 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, 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. On August 21, 2006, Henan Zhongpin formed a new wholly-owned subsidiary, Anyang Zhongpin Food Company Limited, through which we plan to invest approximately $13.5 million to construct a new facility in northern Henan Province with a production capacity of 175 metric tons per 8-hour working day, or approximately 63,000 metric tons on an annual basis. Approximately 60% of the production capacity will be designed for the production of chilled pork and approximately 40% will be designed for the production of frozen pork. We plan to put the new plant into operation in the third quarter of fiscal 2007. On April 26, 2007, Henan Zhongpin formed a new wholly-owned subsidiary, Luoyang Zhongpin Food Company Limited, for the purpose of constructing a production facility to be located in western Henan Province. We plan to invest approximately $14.5 million to construct this facility, which is planned to have a production capacity of 195 metric tons per 8-hour working day, or approximately 70,000 metric tons on an annual basis. Approximately 60% of the production capacity will be designed for the chilled pork and the remaining approximately 40% will be designed for the frozen pork. We plan to put the new facility into operation in the first quarter of fiscal 2008. Our products are sold under the "Zhongpin" brand name. Our customers include over 17 international or domestic fast food companies in the PRC, over 39 export-registered processing factories and over 1,546 school cafeterias, factory canteens, army posts and national departments. We also sell directly to over 2,813 retail outlets, including supermarkets, within the PRC. Since 2001, we have been one of the "leading agricultural industrial enterprises" in the PRC. Over the past five fiscal years, we achieved a compound annual growth rate of 56% in terms of revenues and 57% in terms of net profits. We have established distribution networks in more than 24 provinces, including 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, Russia and South Africa. 23 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 are believed 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. We believe the following are our critical accounting policies: 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 March 31, 2007, we were successful in collecting $73,800, or approximately 36%, of doubtful accounts that were outstanding at December 31, 2006 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, and net realizable value (the estimated 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. The 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, 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 24 impairment charge is recorded for the difference. Intangible assets 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 2007, we intend to continue to focus on the implementation of our strategic plan to continue the growth we have experienced in the last five years. In February 2006, we completed the construction of a new, fresh-chilled meat processing facility in the Zhongpin Industrial Park II. In November 2006, we added an additional processing plant by leasing a meat processing plant in Heilongjiang Province and we are currently constructing additional processing facilities in Henan Province. We also are expanding our capability in temperature-controlled, physical logistic systems. We expect to continue to expand our capital base, to scale up operations and to develop new markets, streamline our supply chain management, continue the development of our information technology systems, invest in training and human resources development and accelerate revenue and profit growth. In fiscal 2007, we expect the results of the pork and pork products segment of our business to remain strong. While supply is expected to be ample, live hog prices are expected to remain at their current relatively-high levels. We anticipate that our gross profit margin will decrease slightly during the remainder of fiscal 2007 due to the increase in the prices of raw materials. We anticipate strong demand for pork throughout the remainder of fiscal 2007. We also expect to increase our market share in the meat and meat products segment in our target markets in fiscal 2007. 25 The following table sets forth, for the periods indicated, certain statement of operations data: THREE MONTHS ENDED MARCH 31, ------------------------- 2007 2006 ---- ---- (U.S. dollars in thousands) Revenues: Sales revenues $ 55,792 $ 30,494 Cost of sales 48,050 25,914 -------- -------- Gross profit 7,742 4,580 Operating expenses: General and administrative expenses 1,405 899 Operating expenses 1,126 804 -------- -------- Total operating expenses 2,531 1,703 -------- -------- Income from operations 5,211 2,876 Other income (expense): Interest income 22 96 Other income (4) 12 Allowance income -- 113 Exchange gain 3 14 Interest expense (443) (380) -------- -------- Total other income (expense) (422) (145) -------- -------- Net income before taxes 4,790 2,731 Provision for income taxes 217 145 -------- -------- Net income after taxes 4,572 2,586 Minority interest in gain (loss) -- 11 -------- -------- Net income 4,572 2,575 Foreign currency translation adjustment 546 141 -------- -------- Comprehensive income $ 5,118 $ 2,716 ======== ======== COMPARISON OF THREE MONTHS ENDED MARCH 31, 2007 AND MARCH 31, 2006 REVENUE. Total revenue increased from $30.49 million for the three months ended March 31, 2006 to $55.79 million for the three months ended March 31, 2007, which represented an increase of $25.30 million, or approximately 83%. 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 food service distributors. During the three months ended March 31, 2007, nine new showcase stores, 29 new "branded" retail stores and 54 new supermarket 26 counters were opened and we expanded our marketing and sales efforts to include six additional second-tier cities and 20 additional third-tier cities domestically. During the three months ended March 31, 2007, revenues from sales to branded stores increased to $26.1 million, which represented an increase of $11.2 million, or approximately 75%, as compared to the three months ended March 31, 2006. During the three months ended March 31, 2007, revenues from sales to food service distributors increased to $10.5 million, which represented an increase of $5.5 million, or approximately 110%, as compared to the three months ended March 31, 2006. During the three months ended March 31, 2007, revenues from sales to restaurants and non-commercial customers increased to $14.3 million, which represented an increase of $6.6 million, or approximately 86%, as compared to the three months ended March 31, 2006. During the three months ended March 31, 2007, revenues from export sales increased to $4.9 million, which represented an increase of $2.0 million, or approximately 69%, as compared to the three months ended March 31, 2006. COST OF SALES. Cost of sales increased from $25.91 million for the three months ended March 31, 2006 to $48.05 million for the three months ended March 31, 2007, which represented an increase of $22.14 million, or approximately 85%. The increase of cost of sales was primarily due to the corresponding increase in sales. The gross profit margin (gross profit divided by total sales revenue) decreased from 15.02% for the three months ended March 31, 2006 to 13.88% for the three months ended March 31, 2007. The decrease in gross profit margin was primarily due to an increase in the cost of raw materials, which was offset, in part, by a slight increase in the market prices for pork products during the three months ended March 31, 2007. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased from $0.90 million for the three months ended March 31, 2006 to $1.40 million for the three months ended March 31, 2007, which represented an increase of $0.50 million, or approximately 56%. As a percentage of revenues, general and administrative expenses decreased from 2.95% for the three months ended March 31, 2006 to 2.52% for the three months ended March 31, 2007. The increase in the net amount of general and administrative expenses was primarily the result of the expansion of our operations and the additional expenses we incurred as a publicly-traded company that is reporting under the U.S. federal securities laws. OPERATING EXPENSES. Operating expenses increased from $0.80 million for the three months ended March 31, 2006 to $1.13 million for the three months ended March 31, 2007, which represented an increase of $0.33 million, or approximately 41%. As a percentage of revenue, operating expenses decreased from 2.64% for the three months ended March 31, 2006 to 2.02% for the three months ended March 31, 2007. The increase in net amount of operating expenses was primarily the result of the increased scale of our operations. INTEREST EXPENSE. Interest expense increased from $0.38 million for the three months ended March 31, 2006 to $0.44 million for the three months ended March 31, 2007, which represented an increase of $0.06 million, or approximately 16%. The increase in interest expense was primarily a result of increased short-term bank loans. Our average outstanding bank debt increased by approximately $9.38 million from $20.75 million for the three months ended March 31, 2006 to $30.13 million for the three months ended March 31, 2007. Our weighted average borrowing rate decreased from 7.32% for the three months ended March 31, 2006 to 5.88% for the three months ended March 31, 2007. INTEREST INCOME, ALLOWANCE INCOME, OTHER INCOME AND EXCHANGE GAIN (LOSS). Interest income, allowances income, other income and exchange gain (loss) decreased from $0.23 million for the three months ended March 31, 2006 to $0.02 million for the three months ended March 31, 2007, which 27 represented a decrease of $0.21 million, or approximately 91%. This decrease was primarily due to a decrease in 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 including raw meat products and raw fruits and vegetable products. The increase of $0.07 million in the provision for income taxes for the three months ended March 31, 2007 over the three months ended March 31, 2006 resulted from an increase of $0.22 million in our income from the sale of prepared products for the three months ended March 31, 2007. 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, strawberries and capsicum. The following tables set forth our revenues, sales in metric tons, operating income and production processed in metric tons by segment for the three months ended March 31, 2007 and 2006, and the percentage increases for each segment between two periods. The data for the three months ended March 31, 2007 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 ENDED MARCH 31, PERCENTAGE ------------------------------ NET CHANGE CHANGE 2007 2006 2007/2006 2007/2006 ---- ---- --------- --------- Pork and Pork Products Chilled Pork................ $ 28.48 $ 10.34 $ 18.14 175% Frozen Pork................. 20.29 16.17 4.12 25% Prepared Pork Products...... 5.85 3.27 2.58 79% Vegetables and Fruits............ 1.17 0.72 0.45 63% ------- ------- ------- Total................. $ 55.79 $ 30.50 $ 25.29 83% ======= ======= =======
28
SALES BY SEGMENT (IN METRIC TONS) THREE MONTHS ENDED MARCH 31, PERCENTAGE ---------------------------- NET CHANGE CHANGE 2007 2006 2007/2006 2007/2006 ---- ---- --------- --------- Pork and Pork Products Chilled Pork................... 23,348 9,398 13,950 148% Frozen Pork.................... 16,803 14,783 2,020 14% Prepared Pork Products......... 3,338 2,236 1,102 49% Vegetables and Fruits............ 2,183 1,021 1,162 114% ------ ------ ------ Total................. 45,672 27,438 18,234 66% ====== ====== ======
OPERATING INCOME BY SEGMENT (U.S. DOLLARS IN MILLIONS) OPERATING THREE MONTHS ENDED MARGIN THREE MONTHS MARCH 31, ENDED MARCH 31, ------------------- NET CHANGE -------------------- 2007 2006 2007/2006 2007 2006 ---- ---- --------- ---- ---- Pork and Pork Products Chilled Pork ................... $2.48 $0.96 $1.52 8.71% 9.28% Frozen Pork..................... 1.75 1.44 0.31 8.62% 8.91% Prepared Pork Products.......... 0.85 0.41 0.44 14.53% 12.54% Vegetables and Fruits............... 0.13 0.07 0.06 11.11% 9.72% ----- ----- ----- Total.................... $5.21 $2.88 $2.33 9.34% 9.44% ===== ===== =====
PRODUCTION BY SEGMENT (IN METRIC TONS) THREE MONTHS ENDED MARCH 31, PERCENTAGE ------------------------------ NET CHANGE CHANGE 2007 2006 2007/2006 2007/2006 ---- ---- --------- --------- Pork and Pork Products Chilled Pork................... 23,154 10,003 13,151 131% Frozen Pork.................... 16,805 15,683 1,122 7% Prepared Pork Products......... 3,357 2,301 1,056 46% Vegetables and Fruits............ 3,117 1,737 1,380 79% ------ ------ ------ Total................. 46,433 29,724 16,709 56% ====== ====== ======
29 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 March 31, 2007 and 2006. SALES BY DISTRIBUTION CHANNEL (U.S. DOLLARS IN MILLIONS)
THREE MONTHS ENDED MARCH 31, ----------------------------------------------------- DISTRIBUTION CHANNEL 2007 2006 -------------------- ---------------------- ---------------------- AMOUNT PERCENT AMOUNT PERCENT ------ ------- ------ ------- Branded stores...................... $ 26.1 46.8% $ 14.9 49.0% Food services distributors.......... 10.5 18.9 5.0 16.3 Restaurants and non-commercial...... 14.3 25.6 7.7 25.3 Export.............................. 4.9 8.7 2.9 9.4 ------ ----- ------ ----- Total.......................... $ 55.8 100.0% $ 30.5 100.0% ====== ===== ====== =====
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, 2004, 2005 and 2006 and the three months ended March 31, 2007.
YEAR ENDED DECEMBER 31, ---------------------------------- THREE MONTHS ENDED 2004 2005 2006 MARCH 31, 2007 ---- ---- ---- -------------- No. of products........................... 125 168 229 235 No. of retail stores...................... 978 2,100 2,721 2,813 Expansion of Market Coverage No. of Provinces....................... 23 24 24 24 No. of first-tier cities............... 23 29 29 29 No. of second-tier cities.............. 36 44 75 81 No. of third-tier cities............... 109 142 226 246
LIQUIDITY AND CAPITAL RESOURCES We have financed our operations over the three years ended December 31, 2006 and the three months ended March 31, 2007 primarily through cash from operating activities 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 December 31, 2004, 2005 and 2006 and at March 31, 2007 we had cash and cash equivalents of $5.20 million, $10.14 million, $21.69 million and $25.92 million, respectively. Net cash provided by operating activities was $4.62 million in the three months ended March 31, 2007. Net cash provided by operating activities in the three months ended March 31, 2007 consisted 30 primarily of net profit of $4.57 million due to increased revenue and an increase of $3.16 million in accounts payable and other payables due to improved payment terms to suppliers. Net cash used in operating activities for the three months ended March 31, 2007 was primarily attributable to an increase of $3.96 million in accounts receivable and other receivable and an increase of $1.39 million in inventory. The increase in both accounts receivable and inventory levels during the period was primarily due to our increased sales. Over the past year, management has focused on reducing the average age of our accounts receivable. Our average accounts receivable turnover days decreased from approximately 36 days during the three months ended March 31, 2006 to approximately 25 days during the three months ended March 31, 2007. However, our average inventory turnover days increased from approximately 12 days during the three months ended March 31, 2006 to approximately 20 days during the three months ended March 31, 2007 because we had an unusually small inventory level at December 31, 2005. Net cash used in investing activities was $10.09 million in the three months ended March 31, 2007. At March 31, 2007, our investment in facility construction in progress increased by approximately $9.53 million as compared to the amount of such investment at December, 31, 2006. During the three months ended March 31, 2007, a total of $0.46 million was invested in the purchase of fixed assets. In addition, we expended an additional $0.09 million for an investment in land use rights during the three months ended March 31, 2007. Net cash provided by financing activities was $9.15 million in the three months ended March 31, 2007. During the three months ended March 31, 2007, cash provided by financing activities included the net proceeds from short-term loans of $11.72 million. The net cash used in financing activities included the repayment of short-term indebtedness in the aggregate amount of $2.57 million. At March 31, 2007, Henan Zhongpin had short-term bank and governmental loans in the aggregate amount of $33.00 million with a weighted average interest rate per annum of 6.24%, and lines of credit with aggregate credit availability of $122.18 million, as follows:
MAXIMUM CREDIT BANK AVAILABILITY AMOUNT BORROWED INTEREST RATE MATURITY DATE ---- ------------ --------------- ------------- ------------- Agriculture Bank of China.................... $ 23,273,254 $ 2,456,621 7.34% 09/10/2007 2,585,917 7.34 12/25/2007 905,071 7.34 12/29/2007 Industrial and Commercial Bank of China...... 25,859,171 1,939,438 5.85% 05/24/2007 1,939,438 5.85 05/30/2007 1,939,438 6.12 10/11/2007 China Construction Bank...................... 11,636,627 2,585,917 6.12% 01/10/2008 2,327,325 6.12 01/17/2009 CITIC Industrial Bank........................ 6,464,793 5,171,834 5.85% 07/16/2007 Agriculture Development Bank of China........ 62,062,010 3,878,876 5.85% 07/03/2007 2,585,917 5.85 07/17/2007
31
MAXIMUM CREDIT BANK AVAILABILITY AMOUNT BORROWED INTEREST RATE MATURITY DATE ---- ------------ --------------- ------------- ------------- Shanghai Pudong development Bank of China..................................... 6,464,793 775,775 6.12% 01/18/2008 3,878,876 6.39 03/29/2008 Bank of China................................ 10,343,668 -- Commercial Bank of China..................... 5,171,834 -- Guangdong Development Bank................... 3,878,876 -- City Finance -short-term..................... -- 25,859 0.00% Extendable ------------- ------------ Total...................... $ 155,155,026 $ 32,996,302 ============= ============ Canadian Government Transfer Loan............ $ 1,780,440 * 05/15/2043 Canadian Government Transfer Loan -Current portion.......................... $ 145,671 6.02% 05/15/2008 City Finance................................. $ 133,175 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 March 31, 2007, $4.65 million aggregate principal amount of loans was secured by our land and plants located in the PRC and $28.32 million aggregate principle amount of loans was guaranteed by Henan Zhongpin Industrial Co., Ltd. We believe our existing cash and cash equivalents, together with our available lines of credit, will be sufficient to finance our investment to the new facilities, operating requirements and anticipated capital expenditures of approximately $27.5 million over the next 12 months. However, we also expect to sell additional debt or equity securities in fiscal 2007 to raise funds for additional capital projects or strategic acquisitions that will enable us to strengthen our market position and accelerate our growth. CONTRACTUAL COMMITMENTS The following table summarizes our contractual obligations at March 31, 2007 and the effect those obligations are expected to have on our liquidity and cash flow in future periods.
PAYMENTS DUE BY PERIOD (IN THOUSANDS) ----------------------------------------------------- LESS THAN MORE THAN CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS ----------------------- ----- ------ --------- --------- ------- Long-term debt obligations............... $2,047 $146 $292 $292 $1,317 Capital lease obligations................ -- -- -- -- -- Operating lease obligations.............. 721 250 471 -- -- Purchase obligations..................... -- -- -- -- -- Other obligations........................ -- -- -- -- -- ------ ---- ---- ---- ------ Total........................... $2,768 $396 $763 $292 $1,317 ====== ==== ==== ==== ======
32 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 DISCLOSURES ABOUT 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 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. 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. 33 ZHONGPIN INC. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None. ITEM 1A. RISK FACTORS During the three months ended March 31, 2007, there were no material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2006, except as follows: RECENT AMENDMENTS TO THE CORPORATE INCOME TAX LAW IN THE PRC MAY INCREASE THE INCOME TAXES PAYABLE BY OUR OPERATING SUBSIDIARIES LOCATED IN THE PRC, WHICH COULD ADVERSELY AFFECT OUR PROFITABILITY. On March 16, 2007, the National People's Congress of the PRC adopted a new corporate income tax law in its fifth plenary session. The new corporate income tax law unifies the application scope, tax rate, tax deduction and preferential policy for both domestic and foreign-invested enterprises. The new corporate income tax law will be effective on January 1, 2008. According to the new corporate income tax law, the applicable income tax rate for our operating subsidiaries is subject to change. As the implementation detail has not yet been announced, we cannot be sure of the potential impact of such new corporate income tax law on our financial position or operating results. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS (a) None. (b) Not Applicable. (c) None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not Applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable. ITEM 5. OTHER INFORMATION (a) None. (b) None. 34 ITEM 6. EXHIBITS The exhibits required by this item are set forth on the Exhibit Index attached hereto. 35 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: May 10, 2007 By: /s/ Xianfu Zhu --------------------------------- Xianfu Zhu Chief Executive Officer By: /s/ Yuanmei Ma --------------------------------- Yuanmei Ma Chief Financial Officer 36 EXHIBIT INDEX EXHIBIT NUMBER EXHIBIT TITLE ------ ----------------------------------------------------------------- 10.1 Amended and Restated 2006 Equity Incentive Plan of Zhongpin Inc., incorporated by reference to Annex A to our Proxy Statement dated May 7, 2007 filed with the Commission on April 30, 2007. 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 37