20-F 1 f20f2018_tdhholdingsinc.htm FORM 20-F

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

FORM 20-F

 

(Mark one)

☐ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

 

OR

 

☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2018

 

OR

 

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

OR

 

☐ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

for the transition period from ____________to ____________

 

Commission file number 001-38206

 

TDH Holdings, Inc.

(Exact name of the Registrant as specified in its charter)

 

British Virgin Islands

(Jurisdiction of incorporation or organization)

 

c/o Qingdao Tiandihui Foodstuffs Co. Ltd.,

Room 1809, Financial Square,

197 Shuangzhu Road, Huangdao District, Qingdao, Shandong Province

People’s Republic of China

Tel: +86-532-8591-9267

(Address of principal executive offices)

 

Cui Rongfeng, Chief Executive Officer
c/o Qingdao Tiandihui Foodstuffs Co. Ltd.,

Room 1809, Financial Square,

197 Shuangzhu Road, Huangdao District, Qingdao, Shandong Province

People’s Republic of China

Tel: +86-532-8591-9267

(Name, Telephone, E-mail and/or Facsimile Number and Address of Company Contact Person)

 

Securities registered or to be registered pursuant to Section 12(b) of the Act:

 

Title of each class   Name of each exchange on which registered
SHARES, PAR VALUE $0.001   The NASDAQ Stock Market LLC

 

Securities registered or to be registered pursuant to Section 12(g) of the Act:

None.

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None.

 

On May 15, 2019, the issuer had 12,516,662 shares outstanding.

 

 

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

 

Yes ☐ No ☒

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

 

Yes ☐ No ☒

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

Yes ☐ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or an “emerging growth company.” See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

☐ Large Accelerated filer ☐ Accelerated filer ☒ Non-accelerated filer

 

Emerging growth company ☒

 

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

☒ US GAAP ☐ International Financial Reporting Standards as issued by the International Accounting Standards Board ☐ Other

 

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

 

☐ Item 17 ☐ Item 18

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes ☐ No ☒

 

 

 

 

 

 

Table of Contents

 

      Page
PART I      
       
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS   1
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE   1
ITEM 3. KEY INFORMATION   1
ITEM 4. INFORMATION ON THE COMPANY   21
ITEM 4A. UNRESOLVED STAFF COMMENTS   36
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECT   36
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES   57
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS   64
ITEM 8. FINANCIAL INFORMATION   68
ITEM 9. THE OFFER AND LISTING   69
ITEM 10. ADDITIONAL INFORMATION   70
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK   77
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES   77
       
PART II      
       
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES   78
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS   78
ITEM 15. CONTROLS AND PROCEDURES   78
ITEM 16. RESERVED   79
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT.   79
ITEM 16B. CODE OF ETHICS.   79
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES.   79
ITEM 16D.  EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES.   80
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS.   80
ITEM 16F. CHANGES IN REGISTRANT’S CERTIFYING ACCOUNTANT.   80
ITEM 16G. CORPORATE GOVERNANCE   80
       
PART III      
       
ITEM 17. FINANCIAL STATEMENTS   81
ITEM 18. FINANCIAL STATEMENTS   81
ITEM 19. EXHIBITS   81

 

i

 

CERTAIN INFORMATION

 

In this Annual Report on Form 20-F (the “Annual Report”), unless otherwise indicated, numerical figures included in this Annual Report have been subject to rounding adjustments. Accordingly, numerical figures shown as totals in various tables may not be arithmetic aggregations of the figures that precede them.

 

For the sake of clarity, this Annual Report follows the English naming convention of first name followed by last name, regardless of whether an individual’s name is Chinese or English.

 

Except where the context otherwise requires and for purposes of this Annual Report only:

 

  ● Depending on the context, the terms “we,” “us,” “our company,” and “our” refer to TDH Holdings, Inc., a British Virgin Islands company; TDH HK Limited, a Hong Kong company wholly-owned by TDH Holdings, Inc.; TDH Group BVBA, a Belgium company wholly-owned by TDH Holdings, Inc.; TDH JAPAN, a Japanese company wholly-owned by TDH Holdings, Inc.; Qingdao Tiandihui Foodstuffs Co., Ltd., a Chinese limited liability company; TDH Petfood LLC, Beijing Chongai Jiujiu Cultural Communication Co., Ltd., Qingdao Kangkang Development Co., Ltd., Qingdao Lingchong Information Technology Co., Ltd., Qingdao Lile Foodstuffs Co., Ltd.; and Yichong Technology (Qingdao) Co., Ltd.

 

  ● “shares” and “common shares” refer to our shares, $0.001 par value per share;

 

  ● “China” and “PRC” refer to the People’s Republic of China, excluding, for the purposes of this Annual Report only, Macau, Taiwan and Hong Kong; and

 

  ● all references to “RMB,” and “Renminbi” are to the legal currency of China, all references to “USD,” and “U.S. Dollars” are to the legal currency of the United States., all references to “Yen” and “¥” is to the legal currency of Japan, and all references to “Euro” and “€” are to the legal currency of Belgium.

 

FORWARD-LOOKING STATEMENTS

 

This Report contains “forward-looking statements” that represent our beliefs, projections and predictions about future events. All statements other than statements of historical fact are “forward-looking statements” including any projections of earnings, revenue or other financial items, any statements of the plans, strategies and objectives of management for future operations, any statements concerning proposed new projects or other developments, any statements regarding future economic conditions or performance, any statements of management’s beliefs, goals, strategies, intentions and objectives, and any statements of assumptions underlying any of the foregoing. Words such as “may”, “will”, “should”, “could”, “would”, “predicts”, “potential”, “continue”, “expects”, “anticipates”, “future”, “intends”, “plans”, “believes”, “estimates” and similar expressions, as well as statements in the future tense, identify forward-looking statements.

 

These statements are necessarily subjective and involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements, or industry results, to differ materially from any future results, performance or achievements described in or implied by such statements. Actual results may differ materially from expected results described in our forward-looking statements, including with respect to correct measurement and identification of factors affecting our business or the extent of their likely impact, the accuracy and completeness of the publicly available information with respect to the factors upon which our business strategy is based on the success of our business.

 

Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of whether, or the times by which, our performance or results may be achieved. Forward-looking statements are based on information available at the time those statements are made and management’s belief as of that time with respect to future events, and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements. Important factors that could cause such differences include, but are not limited to, those factors discussed under the headings “Risk Factors”, “Operating and Financial Review and Prospects,” “Information on the Company” and elsewhere in this Annual Report.

 

This Annual Report should be read in conjunction with our audited financial statements and the accompanying notes thereto, which are included in Item 18 of this Annual Report.

 

ii

 

PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

Not required.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

 

Not required.

 

ITEM 3. KEY INFORMATION

  

  A. Selected financial data

 

In the table below, we provide you with summary financial data of our company. The selected consolidated statement of income and other comprehensive income data for the years ended December 31, 2015, 2016, 2017 and 2018 and the selected consolidated balance sheet data as of December 31, 2015, 2016, 2017 and 2018 are derived from our audited consolidated financial statements, which are included elsewhere in this Annual Report. Historical results are not necessarily indicative of the results that may be expected for any future period. When you read this historical selected financial data, it is important that you read it along with the historical statements and notes included elsewhere in this Annual Report.

 

Selected Consolidated Financial Data

Selected Consolidated Statement of Income and Other Comprehensive Income Data

 

   For The Years Ended December 31, 
   2018   2017   2016   2015 
(In U.S. dollars)                
Total revenues  $23,674,037   $28,979,511   $24,443,736   $16,312,274 
Cost of revenues   27,726,833    20,682,498    17,368,249    12,289,773 
Gross profit   (4,052,796)   8,297,013    7,075,487    4,022,501 
Total operating expenses   9,990,976    8,029,708    5,924,198    3,345,769 
Income (loss) from operations   (14,043,772)   267,305    1,151,289    676,732 
Other income (expenses)                    
Government subsidies   81,882    414    21,912    22,116 
Other income   20,242    19,305    51,535    156,908 
Other expenses   (26,992)   (144,069)   (23,490)   (2,056)
Interest expenses   (233,101)   (82,946)   (102,274)   (117,366)
Loss from equity method investments   (17,524)   -    -    - 
Total other income (expenses)   (175,493)   (207,296)   (52,317)   59,602 
Income (loss) before income taxes provision   (14,219,265)   60,009    1,098,972    736,334 
Income tax provision (benefit)   -    (55,102)   89,801    269,581 
Net income (loss)   (14,219,265)   115,111    1,009,171    466,753 
Earnings (loss) per common share attributable to TDH Holdings, Inc. – basic and diluted  $(1.49)  $0.01   $0.13   $0.06 

 

1

 

Selected Balance Sheet Data

 

   As of December 31, 
   2018   2017   2016   2015 
(In U.S. dollars)                
Cash and cash equivalents  $893,020   $2,346,109   $1,145,103   $651,680 
Total current assets   7,803,062    15,579,344    9,822,363    6,647,263 
Total non-current assets   9,626,344    4,231,396    3,417,556    3,592,356 
Total assets   17,429,406    19,810,740    13,239,919    10,239,619 
Total current liabilities   19,143,578    8,656,648    8,973,372    7,562,217 
Total non-current liabilities   222,395    5,810    13,795    - 
Total liabilities   19,365,973    8,662,458    8,987,167    7,562,217 
Total equity (deficit)   (1,936,567)   11,148,282    4,252,752    2,677,402 
Total liabilities and shareholders’ equity (deficit)  $17,429,406   $19,810,740   $13,239,919   $10,239,619 

 

The following table sets forth information concerning exchange rates between the RMB and the U.S. dollar for the periods indicated. On May 6, 2019, the buying rate announced by the Federal Reserve Statistical Release was RMB 6.7282 to $1.00.

 

   Spot Exchange Rate 
Period  Period Ended   Average (1)   Low   High 
   (RMB per US$1.00) 
2017                
January   6.8767    6.9008    6.8360    6.9575 
February   6.8665    6.8727    6.8517    6.8821 
March   6.8821    6.8940    6.8700    6.9132 
April   6.8937    6.888    6.8944    6.9060 
May   6.8098    6.8843    6.8098    6.9060 
June   6.7793    6.8066    6.7793    6.8382 
July   6.7240    6.7694    6.7240    6.8039 
August   6.5888    6.6670    6.5918    6.7272 
September   6.6533    6.5690    6.4773    6.6591 
October   6.6328    6.6254    6.5712    6.6498 
November   6.6090    6.6200    6.5967    6.6385 
December   6.5063    6.5932    6.5063    6.6210 
2018                    
January   6.2841    6.4233    6.2841    6.5263 
February   6.3280    6.3183    6.2649    6.3471 
March   6.2726    6.3174    6.2685    6.3565 
April   6.2945    6.2859    6.2722    6.3045 
May   6.4070    6.3694    6.3610    6.4193 
June   6.6191    6.4625    6.3889    6.6191 
July   6.8174    6.7137    6.6171    6.8174 
August   6.8317    6.8445    6.8110    6.9145 
September   6.8666    6.8529    6.8299    6.8801 
October   6.9695    6.9173    6.8679    6.9695 
November   6.9470    6.9359    6.8910    6.9555 
December   6.8764    6.8666    6.8407    6.9568 
2019                    
January   6.7006    6.7894    6.7006    6.8764 
February   6.6850    6.7381    6.6840    6.7765 
March   6.7111    6.7109    6.6886    6.7315 
April   6.7346    6.7147    6.6922    6.7370 

 

Source: Federal Reserve Statistical Release.

 

(1) Monthly averages, lows, and highs are calculated using the average of the daily rates during the relevant period.

 

2

 

  B. Capitalization and Indebtedness

 

Not required.

 

  C. Reasons for the Offer and Use of Proceeds

 

Not required.

 

  D. Risk factors

 

You should carefully consider the following risk factors, together with all of the other information included in this Annual Report.

 

Risk Related to Our Business

 

We have incurred losses and anticipate continuing to incur losses in the future.

 

Our net losses were $14,219,265 in 2018. As of December 31, 2018, we had an accumulated deficit of approximately $13.35 million. We anticipate that we will continue to incur losses. We cannot guarantee that going forward we will operate profitably. In order to achieve profitability, among other factors, management must successfully execute our growth and operations in the markets on which we are focused. If we are unable to successfully take necessary steps, we may be unable to sustain or increase our profitability in the future.

 

We may need to secure additional capital, or reduce and/or cease our operations.

 

To date, we have funded our operations primarily through the initial public offering proceeds and our lines of credit. We anticipate incurring additional losses and may not regain profitability. Additionally, even if we raise sufficient capital through equity or debt financing, strategic alliances or otherwise, there can be no assurances that the revenue or capital infusion will be sufficient to enable us to develop our business to a level where it will be profitable or generate positive cash flow.

 

The report of our independent registered public accounting firm expresses substantial doubt about the Company’s ability to continue as a going concern.

 

Our consolidated financial statements have been prepared assuming we will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. However, for the year ended December 31, 2018, the Company has incurred a net loss of approximately $14.2 million and working capital deficit of approximately $11.3 million and its cash balance and revenues generated are not currently sufficient and cannot be projected to cover operating expenses and meet the Company’s obligations as they become due for the next twelve months after the date that our financial statements are issued. These factors raise substantial doubt about the Company’s ability to continue as a going concern.

 

Management’s plan to alleviate the substantial doubt about the Company’s ability to continue as a going concern include attempting to improve its business profitability, its ability to generate sufficient cash flow from its operations to meet its operating needs on a timely basis, obtain additional working capital funds through debt and equity financings to eliminate inefficiencies in order to meet its anticipated cash requirements. However, there can be no assurance that these plans and arrangements will be sufficient to fund the Company’s ongoing capital expenditures, working capital, and other requirements. If we are unable to achieve these goals, our business would be jeopardized and the Company may not be able to continue. If we ceased operations, it is likely that all of our investors would lose their investment. 

 

3

 

If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. As a result, current and potential shareholders could lose confidence in our financial reporting, which would harm our business and the trading price of our stock.

 

Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. As of the end of the most recently completed fiscal year ended December 31, 2018, our SOX certifying officers concluded that, as of December 31, 2018, our disclosure controls and procedures were not effective due to the presence of material weaknesses in internal control over financial reporting (Refer to Item 15 of this Annual Report). We intend to carry out a number of measures to address and remediate the material weakness in our internal controls. This work is ongoing and we intend to complete it on or before December 31, 2019. If we cannot provide financial reports or prevent fraud, our business reputation and operating results could be harmed. Inferior internal controls also could cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock.

 

The turnaround of our business depends on our ability to accurately predict consumer trends and demand and successfully introduce new products and product line extensions and improve existing products.

 

Our turnaround depends, in part, on our ability to successfully introduce new products and product line extensions and improve and reposition our existing products to meet the requirements of pet owners and the dietary needs of their pets. This, in turn, depends on our ability to predict and respond to evolving consumer trends, demands and preferences. The development and introduction of innovative new products and product line extensions involve considerable costs. In addition, it may be difficult to establish new supplier relationships and determine appropriate product selection when developing a new product or product line extension. Any new product or product line extension may not generate sufficient customer interest and sales to become a profitable product or to cover the costs of its development and promotion and may reduce our operating income. In addition, any such unsuccessful effort may adversely affect our brand. If we are not able to anticipate, identify or develop and market products that respond to changes in requirements and preferences of pet parents and their pets or if our new product introductions or repositioned products fail to gain consumer acceptance, we may not grow our business as anticipated, our sales may decline and our business, financial condition and results of operations may be materially adversely affected.

 

We may not be able to successfully implement our turning loss into profits strategy on a timely basis or at all.

 

Our future success depends, in large part, on our ability to implement our turning loss into profits strategy, including expanding distribution and improving placement of our products in the stores of our retail partners, attracting new consumers to our brands, introducing new products and product line extensions and expanding into new markets. Our ability to implement this strategy depends, among other things, on our ability to:

 

  ● enter into distribution and other strategic arrangements with retailers and other potential distributors of our products;

 

  ● continue to effectively compete in our distribution channels;

 

  ● increase our brand recognition by effectively implementing our marketing strategy and advertising initiatives;

 

  ● expand and maintain brand loyalty;

 

  ● develop new products and product line extensions that appeal to consumers;

 

  ● maintain and, to the extent necessary, improve our high standards for product quality, safety and integrity;

 

4

 

  ● maintain sources for the required supply of quality raw ingredients to meet our growing demand; and

 

  ● identify and successfully enter and market our products in new geographic markets and market segments.

  

We may not be able to successfully implement our turning loss into profits strategy and may need to change our strategy. If we fail to implement our turning loss into profits strategy or if we invest resources in a turning loss into profits strategy that ultimately proves unsuccessful, our business, financial condition and results of operations may be materially adversely affected.

 

Any damage to our reputation or our brand may materially adversely affect our business, financial condition and results of operations.

 

Maintaining our strong reputation with consumers, our retail partners and our suppliers is critical to our success. Our brands may suffer if our marketing plans or product initiatives are not successful. The importance of our brands may increase if competitors offer more products with formulations similar to ours. Further, our brands may be negatively impacted due to real or perceived quality issues or if consumers perceive us as being untruthful in our marketing and advertising, even if such perceptions are not accurate. Product contamination, the failure to maintain high standards for product quality, safety and integrity, including raw materials and ingredients obtained from suppliers, or allegations of product quality issues, mislabeling or contamination, even if untrue or caused by our third-party contract manufacturers or raw material suppliers, may reduce demand for our products or cause production and delivery disruptions. We maintain guidelines and procedures to ensure the quality, safety and integrity of our products. However, we may be unable to detect or prevent product and/or ingredient quality issues, mislabeling or contamination, particularly in instances of fraud or attempts to cover up or obscure deviations from our guidelines and procedures. If any of our products become unfit for consumption, cause injury or are mislabeled, we may have to engage in a product recall and/or be subject to liability. Damage to our reputation or our brands or loss of consumer confidence in our products for any of these or other reasons could result in decreased demand for our products and our business, financial condition and results of operations may be materially adversely affected.

 

Our business is dependent on trends that may change or not continue, and our historical growth may not be indicative of our future results.

 

The growth of the global pet food industry and the market in China, in particular, depends primarily on the continuance of current trends in humanization of pets and premiumization of pet foods as well as on general economic conditions, the size of the pet population and average dog size. These trends may not continue or may change. In the event of a decline in the overall number or average size of pets, a change in the humanization, premiumization or health and wellness trends or during challenging economic times, we may be unable to persuade our customers and consumers to purchase our branded products instead of lower-priced products, and our business, financial condition and results of operations may be materially adversely affected.

 

There may be decreased spending on pets globally in a challenging economic climate.

 

Our business, financial condition and results of operations may be materially adversely affected by a challenging economic climate, including adverse changes in interest rates, volatile commodity markets and inflation, contraction in the availability of credit in the market and reductions in consumer spending. In addition, a slow-down in the general economy and/or PRC economy or a shift in consumer preferences for economic reasons or otherwise to less expensive products may result in reduced demand for our products which may affect our profitability. The keeping of pets and the purchase of pet-related products may constitute discretionary spending for some of our consumers and any material decline in the amount of consumer discretionary spending may reduce overall levels of pet ownership or spending on pets. As a result, a challenging economic climate may cause a decline in demand for our products which could be disproportionate as compared to competing pet food brands since our products command a price premium. In addition, we cannot predict how current or worsening economic conditions in the PRC and globally will affect our partners, suppliers and distributors. If economic conditions result in decreased spending on pets and have a negative impact on our retail partners, suppliers or distributors, our business, financial condition and results of operations may be materially adversely affected.

 

5

 

Our business depends, in part, on the sufficiency and effectiveness of our marketing and trade promotion programs.

 

Due to the competitive nature of our industry, we must effectively and efficiently promote and market our products through advertisements as well as trade promotions and incentives to sustain our competitive position in our market. Marketing investments may be costly. In addition, we may, from time to time, change our marketing strategies and spending, including the timing or nature of our trade promotions and incentives. We may also change our marketing strategies and spending in response to actions by our competitors and other pet food companies. The sufficiency and effectiveness of our marketing and trade promotions and incentives are important to our ability to retain and/or improve our market share and margins. If our marketing and trade promotions and incentives are not successful or if we fail to implement sufficient and effective marketing and trade promotions and incentives or adequately respond to changes in our competitors’ marketing strategies, our business, financial condition and results of operations may be adversely affected.

 

If we are unable to maintain or increase prices, we may fail to generate a positive margin.

 

We rely in part on price increases to offset cost increases and improve the profitability of our business. Our ability to maintain prices or effectively implement price increases may be affected by a number of factors, including competition, effectiveness of our marketing programs, the continuing strength of our brands, market demand and general economic conditions, including inflationary pressures. In particular, in response to increased promotional activity by other pet food companies, we have increased our promotional spending, which has resulted in a lower average price per pound for our products and has adversely impacted our gross margins. During challenging economic times, consumers may be less willing or able to pay a price premium for our branded products and may shift purchases to lower-priced or other value offerings, making it more difficult for us to maintain prices and/or effectively implement price increases. In addition, our retail partners and distributors may pressure us to rescind price increases that we have announced or already implemented, whether through a change in list price or increased promotional activity. If we are unable to maintain or increase prices for our products or must increase promotional activity, our margins may be adversely affected. Furthermore, price increases generally result in volume losses, as consumers purchase fewer units. If such losses are greater than expected or if we lose distribution due to a price increase, our business, financial condition and results of operations may be materially adversely affected.

 

If our products are alleged to cause injury or illness or fail to comply with PRC or other applicable governmental regulations, we may need to recall our products and may experience product liability claims.

 

Our products may be exposed to product recalls, including voluntary recalls or withdrawals, if they are alleged to pose a risk of injury or illness, or if they are alleged to have been mislabeled, misbranded or adulterated or to otherwise be in violation of governmental regulations. We may also voluntarily recall or withdraw products in order to protect our brand or reputation if we determine that they do not meet our standards, whether for palatability, appearance or otherwise. If there is any future product recall or withdrawal, it could result in substantial and unexpected expenditures, destruction of product inventory, damage to our reputation and lost sales due to the unavailability of the product for a period of time, and our business, financial condition and results of operations may be materially adversely affected. We also may be subject to claims if the consumption or use of our products is alleged to cause injury or illness. If there is a judgment against us or a settlement agreement related to a claim, our business, financial condition and results of operations may be materially adversely affected.

 

6

 

We are dependent on a limited number of retailer customers for a significant portion of our sales.

 

We sell our products to retail partners and distributors in specialty channels. Our ten largest retail partners, accounted for 69% of our net sales for the year ended December 31, 2016, and 56% of our net sales for the year ended December 31, 2017, respectively; in 2018, they accounted for 54%. If we were to lose any of our key customers, if any of our retail partners reduce the amount of their orders or if any of our key customers consolidate, reduce their store footprint and/or gain greater market power, our business, financial condition and results of operations may be materially adversely affected. In addition, we may be similarly adversely impacted if any of our key customers experience any operational difficulties or generate less traffic.

 

Failure to make adequate contributions to Housing Provident Fund for some of the employees could adversely affect our financial condition and we may be subject to labor dispute or complaint.

 

Pursuant to the Regulations on Management of Housing Provident Fund (HPF) which was promulgated by the State Council on April 3, 1999 and was amended on March 24, 2002, PRC enterprises must register with relevant HPF management center, open special HPF accounts at a designated bank and make timely HPF contributions for their employees. In accordance with Regulations on Management of Housing Provident Fund and Implementation Measures for the Administration of Housing Provident Fund in Qingdao, if an enterprise fails to pay in full or in part its HPF contributions, such enterprise will be ordered by the HPF enforcement authorities to make such contributions, and may be compelled by the people’s court that has jurisdiction over the matter to make such contributions. Furthermore, if the Company fails to make adequate contributions to HPF for some of its employees, such failure may give rise to a private cause of action by such individual(s) against the Company. There is a certain discrepancy between interpretation and enforcement of such regulations on the national and local level such that local and national enforcement practices at times vary significantly. HPF contributions are only required for employees with urban housing registration; for employees with rural registration contributions are voluntary and are not required. The Company has registered with relevant HPF authority in the PRC, but has not made adequate contributions to the fund for some of its employees. The Company’s failures to make such contributions were due to the inadvertent oversight of the Company’s staff. The Company estimates such amounts for the last three years would not to exceed US$104,000. As of the date of this Annual Report, the Company has not received any demand or order from the competent authorities with respect to settling the balance of the fund contributions. Mr. Cui and Ms. Wang have executed a deed of indemnity in favor of the Company’s subsidiaries in the PRC on July 7, 2017 pursuant to which they agreed to indemnify the Company’s subsidiaries in the PRC in full against any losses and penalties which they may suffer as a result of the Company’s non-payment of the fund contributions. To the extent the Company is required to make such payments in full, such payments may have adverse financial or operational impact on the Company. The Company may also be subject to labor dispute or complaint from its employees.

 

We rely upon a limited number of contract manufacturers to provide a significant portion of our supply of products.

 

There is limited available manufacturing capacity that meets our quality standards. We have agreements with a network of contract manufacturers that require them to provide us with specific finished products. Most of our agreements with our contract manufacturers are up to three years. During the years ended December 31, 2016, 2017 and 2018 approximately 29%, 31% and 58% of our cost of sales, respectively, was derived from products purchased from contract manufacturers. The manufacture of our products may not be easily transferable to other sites in the event that any of our contract manufacturers experience breakdown, failure or substandard performance of equipment, disruption of supply or shortages of raw materials and other supplies, labor problems, power outages, adverse weather conditions and natural disasters or the need to comply with environmental and other directives of governmental agencies. From time to time, a contract manufacturer may experience financial difficulties or other business disruptions, which could disrupt our supply of finished goods or require that we incur additional expense by providing financial accommodations to the contract manufacturer or taking other steps to seek to minimize or avoid supply disruption, such as establishing a new contract manufacturing arrangement with another provider. The loss of any of these contract manufacturers or the failure for any reason of any of these contract manufacturers to fulfill their obligations under their agreements with us, including a failure to meet our quality controls and standards, may result in disruptions to our supply of finished goods. We may be unable to locate an additional or alternate contract manufacturing arrangement that meets our quality controls and standards in a timely manner or on commercially reasonable terms, if at all.

 

7

 

To the extent our retailer customers purchase products in excess of consumer consumption in any period, our sales in a subsequent period may be adversely affected as our customers seek to reduce their inventory levels.

 

From time to time, our retailer customers may purchase more product than they expect to sell to consumers during a particular time period. Our retailer customers may grow their inventory in anticipation of, or during, our promotional events, which typically provide for reduced prices during a specified time or other customer or consumer incentives. Our retailer customers may also grow inventory in anticipation of a price increase for our products, or otherwise over-order our products as a result of overestimating demand for our products. If a retailer customer increases its inventory during a particular reporting period as a result of a promotional event, anticipated price increase or otherwise, then sales during the subsequent reporting period may be adversely impacted as our customers seek to reduce their inventory to customary levels. This effect may be particularly pronounced when the promotional event, price increase or other event occurs near the end or beginning of a reporting period or when there are changes in the timing of a promotional event, price increase or similar event, as compared to the prior year. To the extent our retailer customers seek to reduce their usual or customary inventory levels or change their practices regarding purchases in excess of consumer consumption, our net sales and results of operations may be materially adversely affected in that period.

 

We operate in a highly competitive industry and may lose market share or experience margin erosion if we are unable to compete effectively.

 

We compete on the basis of product quality and palatability, brand awareness and loyalty, product variety and ingredients, interesting product names, product packaging and package design, reputation, price and promotional efforts. We compete with a significant number of companies of varying sizes, including divisions or subsidiaries of larger companies who may have greater financial resources and larger customer bases than we have. As a result, these competitors may be able to identify and adapt to changes in consumer preferences more quickly than us due to their resources and scale. They may also be more successful in marketing and selling their products, better able to increase prices to reflect cost pressures and better able to increase their promotional activity, which may impact us and the entire pet food industry. If these competitive pressures cause our products to lose market share or experience margin erosion, our business, financial conditions and results of operations may be materially adversely affected.

 

We may face issues with respect to raw materials and other supplies, including increased costs, disruptions of supply, shortages, contaminations, adulterations or mislabeling.

 

The Company’s key raw material ingredients include meat and fish. We and our contract manufacturers use various raw materials and other supplies in our business, including ingredients, packaging materials and fuel. We maintain one raw material procurement center which provides a single-source supply for all our manufacturing facilities to maintain quality control throughout the production facilities. The prices of our raw materials and other supplies are subject to fluctuations attributable to, among other things, changes in supply and demand of crops or other commodities, weather conditions, agricultural uncertainty or governmental incentives and controls. We generally do not have long-term supply contracts with our ingredient suppliers. The length of the contracts is fixed for a period of time, typically up to a year or for a season and/or a crop year. In addition, some of our raw materials are sourced from a limited number of suppliers. We may not be able to renew or enter into new contracts with our existing suppliers following the expiration of such contracts on commercially reasonable terms, or at all. If commodity prices increase, we may not be able to increase our prices to offset these increased costs. Moreover, our competitors may be better able than we are to implement productivity initiatives or effect price increases or to otherwise pass along cost increases to their customers. Some of the raw materials we use are vulnerable to adverse weather conditions and natural disasters, such as floods, droughts, frosts, earthquakes and pestilences and may be impacted by climate change and other factors. Adverse weather conditions and natural disasters can reduce crop size and crop quality, which in turn could reduce supplies of raw materials, increase the prices of raw materials, increase costs of storing raw materials and interrupt or delay our production schedules if harvests are delayed. Our competitors may not be impacted by such weather conditions and natural disasters depending on the location of their suppliers and operations. If any of our raw materials or supplies are alleged or proven to include contaminants affecting the safety or quality of our products, we may need to find alternate materials or supplies, delay production of our products, discard or otherwise dispose of our products, or engage in a product recall, all of which may have a materially adverse effect on our business, financial condition and results of operations. We may be unable to detect or prevent the use of ingredients which do not meet our quality standards if our ingredient suppliers engage in fraud or attempt to cover up or obscure deviations from our guidelines and procedures. Any such conduct by any of our suppliers may result in a loss of consumer confidence in our brand and products and a reduction in our sales if consumers perceive us as being untruthful in our marketing and advertising and may materially adversely affect our brand, reputation, business, financial condition and results of operations. If our sources of raw materials and supplies are terminated or affected by adverse prices, weather conditions or quality concerns, we may not be able to identify alternate sources of raw materials or other supplies that meet our quality controls and standards to sustain our sales volumes or on commercially reasonable terms, or at all.

 

8

 

We may not be able to manage our manufacturing and supply chain effectively which may adversely affect our results of operations.

 

We must accurately forecast demand for our products in order to ensure we have adequate available manufacturing capacity. Our forecasts are based on multiple assumptions which may cause our estimates to be inaccurate and affect our ability to obtain adequate manufacturing capacity (whether our own manufacturing capacity or contract manufacturing capacity) in order to meet the demand for our products, which could prevent us from meeting increased customer or consumer demand and harm our brand and our business. However, if we overestimate our demand and overbuild our capacity, we may have significantly underutilized assets and may experience reduced margins. If we do not accurately align our manufacturing capabilities with demand, our business, financial condition and results of operations may be materially adversely affected. In addition, we must continuously monitor our inventory and product mix against forecasted demand. If we underestimate demand, we risk having inadequate supplies. We also face the risk of having too much inventory on hand that may reach its expiration date and become unsaleable, and we may be forced to rely on markdowns or promotional sales to dispose of excess or slow-moving inventory. If we are unable to manage our supply chain effectively, our operating costs could increase and our profit margins could decrease.

   

Our market size estimate may prove to be inaccurate.

 

Data for the PRC and global pet food retail sales is collected for most, but not all channels, and as a result, it is difficult to estimate the size of the market and predict the rate at which the market for our products will grow, if at all. While our market size estimate was made in good faith and is based on assumptions and estimates we believe to be reasonable, this estimate may not be accurate.

 

Relocating some of our production facilities may adversely affect our results of operations.

 

The Company’s Canning Facility and Pude Facility are located in the old city of Huangdao District, Qingdao. The Company has learned that the local governmental authorities proposed plans to redevelop certain portions of the old city to allow for more residential dwellings in the area. In March 2018, we terminated the lease of the Canning facility in light of the implementation of this plan. The relocation of Canning facility had adverse material effect on the Company’s operations by, among other things, causing a decrease in our production capacity from 18 tons per day to 12 tons per day since March 2018. If and to the extent we may be required to relocate the Pude Facility in the future, our results of operations may also be adversely affected.

 

9

 

We may face difficulties as we expand into countries in which we have no prior operating experience.

 

We intend to continue to expand our domestic and global footprint by entering into new markets. As we expand our business in China and into new countries we may encounter foreign economic, political, regulatory, personnel, technological, language barriers and other risks that increase our expenses or delay our ability to become profitable in such countries. These risks include:

 

  ● fluctuations in currency exchange rates;

 

  ● the difficulty of enforcing agreements and collecting receivables through some foreign legal systems;

 

  ● customers in some foreign countries potentially having longer payment cycles;

 

  ● changes in local tax laws, tax rates in some countries that may exceed those of the United States or Canada and lower earnings due to withholding requirements or the imposition of tariffs, exchange controls or other restrictions;

 

  ● seasonal reductions in business activity;

 

  ● the credit risk of local customers and distributors;

 

  ● general economic and political conditions;

 

  ● unexpected changes in legal, regulatory or tax requirements;

 

  ● differences in language, culture and trends in foreign countries with respect to pets and pet care;

 

  ● the risk that certain governments may adopt regulations or take other actions that would have a direct or indirect adverse impact on our business and market opportunities, including nationalization of private enterprise; and

 

  ● non-compliance with applicable currency exchange control regulations, transfer pricing regulations or other similar regulations.

 

In addition, our expansion into new countries may require significant resources and the efforts and attention of our management and other personnel, which will divert resources from our existing business operations. We may seek to grow our business through acquisitions of or investments in new or complementary businesses, facilities, technologies or products, or through strategic alliances, and the failure to manage acquisitions, investments or strategic alliances, or the failure to integrate them with our existing business, could have a material adverse effect on us. From time to time we may consider opportunities to acquire or make investments in new or complementary businesses, facilities, technologies or products, or enter into strategic alliances, that may enhance our capabilities, expand our manufacturing network, complement our current products or expand the breadth of our markets.

 

Potential and completed acquisitions and investments and other strategic alliances involve numerous risks, including:

 

  ● problems assimilating the purchased business, facilities, technologies or products;

 

  ● issues maintaining uniform standards, procedures, controls and policies;

 

  ● unanticipated costs associated with acquisitions, investments or strategic alliances;

 

  ● diversion of management’s attention from our existing business;

 

  ● adverse effects on existing business relationships with suppliers, contract manufacturers, retail partners and distribution customers;

 

  ● risks associated with entering new markets in which we have limited or no experience;

 

  ● potential loss of key employees of acquired businesses; and

 

  ● increased legal and accounting compliance costs.

 

We do not know if we will be able to identify acquisitions or strategic relationships we deem suitable, whether we will be able to successfully complete any such transactions on favorable terms or at all or whether we will be able to successfully integrate any acquired business, facilities, technologies or products into our business or retain any key personnel, suppliers or customers. Our ability to successfully grow through strategic transactions depends upon our ability to identify, negotiate, complete and integrate suitable target businesses, facilities, technologies and products and to obtain any necessary financing. These efforts could be expensive and time-consuming and may disrupt our ongoing business and prevent management from focusing on our operations. If we are unable to integrate any acquired businesses, facilities, technologies and products effectively, our business, results of operations and financial condition could be materially adversely affected.

 

10

 

Our online activities are dependent on our ability to access the Internet and operate online in a fast, secure and reliable manner.

 

We utilize online sale and multi-brand, multi-store brand sale strategies which use Tmall.com, jd.com, 1688.com, alibaba.com, yhd.com, and Amazon as our marketing platforms. Our PRC marketing group has established a comprehensive network of various brand shops. In addition, our cross-border marketing/sales group mainly relies on the Tiandihui Amazon and eBay platforms as well as direct sale websites in Europe and the U.S. to operate its marketing and sales efforts. Our online activities are dependent on our ability to operate online in a fast, secure and reliable manner which may be adversely affected as a result of PRC governmental regulations of e-commerce and other services, electronic devices, and competition and restrictive governmental actions. In addition, we may face risks relating to the governmental laws and regulations regarding consumer and data protection, privacy, network security, payments, and restrictions on pricing or discounts, as well as lower levels of consumer access, use of and spending on the Internet. Occurrence of any of the foregoing events (or a combination thereof) could have a material adverse effect on our ability to conduct online business, our financial condition and results of operations.

 

Failure to protect our intellectual property could harm our competitive position or require us to incur significant expenses to enforce our rights.

 

Our trademarks are valuable assets that support our brand and consumers’ perception of our products. We rely on trademark, copyright, trade secret, patent and other intellectual property laws, as well as nondisclosure and confidentiality agreements and other methods, to protect our trademarks, trade names, proprietary information, technologies and processes. Our non-disclosure agreements and confidentiality agreements may not effectively prevent disclosure of our proprietary information, technologies and processes and may not provide an adequate remedy in the event of unauthorized disclosure of such information, which could harm our competitive position. In addition, effective patent, copyright, trademark and trade secret protection may be unavailable or limited for some of our trademarks and patents in some foreign countries. We may need to engage in litigation or similar activities to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of proprietary rights of others. Any such litigation could require us to expend significant resources and divert the efforts and attention of our management and other personnel from our business operations. If we fail to protect our intellectual property, our business, financial condition and results of operations may be materially adversely affected.

 

We may be subject to intellectual property infringement claims or other allegations, which could result in substantial damages and diversion of management’s efforts and attention.

 

While we believe that our products do not infringe in any material respect upon proprietary rights of other parties and/or that meritorious defenses would exist with respect to any assertions to the contrary, we may from time to time be found to infringe on the proprietary rights of others. If patents later issue on these applications, we may be found liable for subsequent infringement. Any claims that our products or processes infringe these rights, regardless of their merit or resolution, could be costly and may divert the efforts and attention of our management and technical personnel. We may not prevail in such proceedings given the complex technical issues and inherent uncertainties in intellectual property litigation. If such proceedings result in an adverse outcome, we could, among other things, be required to:

 

  ● pay substantial damages;

 

  ● cease the manufacture, use or sale of the infringing products;

 

11

 

  ● discontinue the use of the infringing processes;

 

  ● expend significant resources to develop non-infringing processes; and

 

  ● enter into licensing arrangements from the third party claiming infringement, which may not be available on commercially reasonable terms, or may not be available at all.

 

If any of the foregoing occurs, our ability to compete could be affected or our business, financial condition and results of operations may be materially adversely affected.

 

Our success depends on our ability to attract and retain key employees and the succession of senior management.

 

Our continued growth and success require us to hire, retain and develop our leadership bench. If we are unable to attract and retain talented, highly qualified senior management and other key executives, as well as provide for the succession of senior management, our growth and results of operations may be adversely impacted.

 

We are dependent on the state of the PRC’s economy and a general economic downturn, a recession or a sudden disruption in business conditions in the PRC would have a material adverse effect on our business, financial condition and results of operations.

 

Significant slowdowns in the PRC economy may cause our customers to reduce expenditures on our products. This may in turn lead to a decline in the demand for the services we provide. Any such decline would have a material adverse effect on our business, financial condition and results of operations. Consumer spending is generally affected by a number of factors, including general economic conditions, the level of unemployment, inflation, interest rates, energy costs, gasoline prices and consumer confidence generally, all of which are beyond our control. Consumer purchases of discretionary items tend to decline during recessionary periods, when disposable income is lower, and may impact sales of our services. In addition, sudden disruption in business conditions as a result of a terrorist attack, retaliation and the threat of further attacks or retaliation, war, adverse weather conditions and climate changes or other natural disasters, pandemic situations or large scale power outages can have a short or, sometimes, long-term impact on consumer spending. A downturn in the economy in the PRC, including any recession or a sudden disruption of business conditions in the PRC, could adversely affect our business, financial condition or results of operation.

 

Since our operations and assets are located in the PRC, shareholders may find it difficult to enforce a U.S. judgment against the assets of our company, our directors and executive officers.

 

Our operations and assets are located in the PRC. In addition, most of our executive officers and directors are non-residents of the U.S., and substantially all the assets of such persons are located outside the U.S. As a result, it could be difficult for investors to effect service of process in the U.S., or to enforce a judgment obtained in the U.S. against us or any of these persons.

 

We hold the majority of our cash balances in RMB in uninsured bank accounts in China

 

We maintain the majority of our 2018 cash and deposit balances in bank accounts at financial institutions in China which accounts which are not insured. While we have not experienced any losses in uninsured bank deposits and do not believe that we are exposed to significant risks on cash held in bank accounts, if and to the extent we do experience such losses in the future, our access to financial liquidity and working capital could be adversely affected.

 

12

 

We may subject to PRC regulatory limitations on merger and acquisition (M&A) activities

 

Foreign enterprises that engage in M&A activities inside and outside China are subject to different regulatory limitations under Chinese laws and regulations. The key regulations governing such activities within PRC are Wholly Foreign-Owned Enterprise Law, the Interim Provisions on the Domestic Investment of Foreign-Funded Enterprise, the Catalogue for the Guidance of Foreign Investment Industries (amended in 2017) and other relevant Chinese laws and regulations. Under these laws and regulations, conducting M&A in China requires that our WFOE be profitable, and a timely application with and approval by of local regulatory agencies of any proposed M&A transaction. The M&A activities outside the PRC are governed by several rules and regulations, including PRC Administrative Measures on Offshore Investment, the Regulation on Foreign Exchange Administration of the PRC, the Notice of the State Administration of Foreign Exchange on Issuing the Provisions on the Foreign Exchange Administration of the Overseas Direct Investment of Domestic Institutions, the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Resident’s Financing and Round-trip Investment Through Offshore Special Purpose Vehicles. Under these laws and regulations, our WFOE must get approval from the PRC Ministry of Commerce or its branch offices for any proposed offshore M&A transaction, and complete its foreign exchange registration. We cannot offer any assurance that in the event we seek such approvals or registrations we will be able to secure them in a timely fashion or will be able to receive them at all; negative feedback from the regulatory agencies or our failure to register such proposed transactions may have material adverse impact on our business expansion and could materially affect our business operation and finance condition. In addition, since approval and/or registration procedures required time to complete, these processes may cause additional delays to our onshore or offshore M&A projects, which, in turn, may have adverse impact on our business and operations.

  

Fluctuation of the Renminbi may indirectly affect our financial condition by affecting the volume of cross-border money flow.

 

The value of the RMB fluctuates and is subject to changes in the PRC’s political and economic conditions. We do not currently engage in hedging activities to protect against foreign currency risks. Even if we choose to engage in such hedging activities, we may not be able to do so effectively. Future movements in the exchange rate of the RMB could adversely affect our financial condition as we may suffer financial losses when transferring money raised outside of China into the country or paying vendors for services performed outside of China. The value of the Renminbi against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an appreciation of the Renminbi against the U.S. dollar. While the international reaction to the Renminbi revaluation has generally been positive, there remains international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more rapid appreciation of the Renminbi against the U.S. dollar. Any material revaluation of Renminbi may materially and adversely affect our cash flows, revenues, earnings and financial position, and the value of, and any dividends payable on, our common shares in U.S. dollars. For example, an appreciation of Renminbi against the U.S. dollar would make any new Renminbi denominated investments or expenditures more costly to us, to the extent that we need to convert U.S. dollars into Renminbi for such purposes.

 

If any dividend is declared in the future and paid in a foreign currency, you may be taxed on a larger amount in U.S. dollars than the U.S. dollar amount that you will actually ultimately receive.

 

If you are a United States holder, you will be taxed on the U.S. dollar value of your dividends, if any, at the time you receive them, even if you actually receive a smaller amount of U.S. dollars when the payment is in fact converted into U.S. dollars. Specifically, if a dividend is declared and paid in a foreign currency, the amount of the dividend distribution that you must include in your income as a U.S. holder will be the U.S. dollar value of the payments made in the foreign currency, determined at the spot rate of the foreign currency to the U.S. dollar on the date the dividend distribution is includible in your income, regardless of whether the payment is in fact converted into U.S. dollars. Thus, if the value of the foreign currency decreases before you actually convert the currency into U.S. dollars, you will be taxed on a larger amount in U.S. dollars than the U.S. dollar amount that you will actually ultimately receive.

 

13

 

We may become a passive foreign investment company, which could result in adverse U.S. tax consequences to U.S. investors.

 

Based on the nature of our business activities, we may be classified as a passive foreign investment company (“PFIC”), by the U.S. Internal Revenue Service (“IRS”), for U.S. federal income tax purposes. Such characterization could result in adverse U.S. tax consequences to you if you are a U.S. investor. For example, if we are a PFIC, a U.S. investor will become subject to burdensome reporting requirements. The determination of whether or not we are a PFIC is made on an annual basis and will depend on the composition of our income and assets from time to time. Specifically, we will be classified as a PFIC for U.S. tax purposes if either:

 

  ● 75% or more of our gross income in a taxable year is passive income; or

 

  ● the average percentage of our assets by value in a taxable year that produce or are held for the production of passive income (which includes cash) is at least 50%.

 

The calculation of the value of our assets is based, in part, on the then market value of our common shares, which is subject to change. We cannot assure that we will not be a PFIC for any taxable year.

 

Introduction of new laws or changes to existing laws by the PRC government may adversely affect our business.

 

The PRC legal system is a codified legal system made up of written laws, regulations, circulars, administrative directives and internal guidelines. Unlike common law jurisdictions such as the U.S., decided cases (which may be taken as reference) do not form part of the legal structure of the PRC and thus have no binding effect. Furthermore, in line with its transformation from a centrally planned economy to a more market-oriented economy, the PRC government is still in the process of developing a comprehensive set of laws and regulations. As the legal system in the PRC is still evolving, laws and regulations or their interpretation may be subject to further changes. Such uncertainty and prospective changes to the PRC legal system could adversely affect our results of operations and financial condition.

 

Governmental control of currency conversion may affect the value of your investment.

 

The PRC government imposes controls on the convertibility of the Renminbi into foreign currencies and, in certain cases, the remittance of currency out of the PRC, which may take as long as six months in the ordinary course. We receive the majority of our revenues in Renminbi. Under our current corporate structure, our income is derived from payments from WFOE. The October 8, 2016 Provisional Measures for Filling Administration of Establishment and Changes of Foreign-Investment Enterprise (the “Establishment and Changes Provision”) promulgated by the PRC Ministry of Commerce and was amended on July 30, 2017, regulates the recordation procedures with respect to the establishment and changes of a foreign-invested enterprise which do not fall within the scope of special administration measures for foreign investment admission as stipulated by the state; for those entities that do fall within the regulatory reach of special administration measures must go through approval procedures according to relevant laws and regulations governing foreign investment. We do not believe that such measures will have any impact on our income derived from payment from our WFOE because:

 

  ● As a pet food producer and seller, we do not fall within the scope of special access administrative measures for foreign investment admission as stipulated by the state, and therefore are not required to go through approval procedures.

 

  ● The Establishment and Changes Provision regulates the recordation procedures relating to the establishment and changes of a foreign-invested enterprise, which including but not limited to: (i) the changes of company name, registered address, duration of operation, business scope, registered capital, total investment, shareholders, merger, division and termination of the enterprise; and (ii) the corporate name change, domicile or place of incorporation, subscribed capital, investment period. Based on the foregoing and our current corporate structure, our income is derived from payment from our WFOE, but the Establishment and Changes Provisions do not regulate our origin of income or dividend policy, and therefore will not have any impact on our dividend distribution.

 

14

 

Shortages in the availability of foreign currency may restrict the ability of WFOE to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy their foreign currency denominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from trade-related transactions, can be made in foreign currencies without prior approval from the PRC SAFE by complying with certain procedural requirements. However, approval from appropriate PRC government authorities is required where Renminbi is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of bank loans denominated in foreign currencies. The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay dividends in foreign currencies to our shareholders.

 

PRC’s labor law restricts our ability to reduce our workforce in the PRC in the event of an economic downturn and may increase our production costs.

 

In June 2007, the National People’s Congress of the PRC enacted new labor law legislation called the Labor Contract Law, which became effective on January 1, 2008 and was amended on December 28, 2012, to clarify certain details in connection with the implementation of the Labor Contract Law, the PRC State Council promulgated the Implementing Rules for the Labor Contract Law on September 18, 2008, which came into effect immediately (collectively as “new laws”). The legislation formalized workers’ rights concerning overtime hours, pensions, layoffs, employment contracts and the role of trade unions. Considered one of the strictest labor laws in the world, among other things, these new laws provide for specific standards and procedures for the termination of an employment contract and places the burden of proof on the employer. In addition, the new laws require the payment of a statutory severance pay upon the termination of an employment contract in most cases, including the case of the expiration of a fixed-term employment contract. Further, the new laws require an employer to conclude an “employment contract without a fixed-term” with any employee who either has worked for the same employer for 10 consecutive years or more or has had two consecutive fixed-term contracts with the same employer. An “employment contract without a fixed term” can no longer be terminated on the ground of the expiration of the contract, although it can still be terminated pursuant to the standards and procedures set forth under the new laws. Because of the lack of precedent for the enforcement of such a law, the standards and procedures set forth under the new laws in relation to the termination of an employment contract have raised concerns among foreign investment enterprises in the PRC that such an “employment contract without a fixed term” might in fact become a “lifetime, permanent employment contract.” Finally, under the new laws, downsizing of either more than 20 people or more than 10% of the workforce may occur only under specified circumstances, such as a restructuring undertaken pursuant to the PRC’s Enterprise Bankruptcy Law, or where a company suffers serious difficulties in production and/or business operations, or where there has been a material change in the objective economic circumstances relied upon by the parties at the time of the conclusion of the employment contract, thereby making the performance of such employment contract not possible. To date, there has been very little guidance or precedent as to how such specified circumstances for downsizing will be interpreted and enforced by the relevant PRC authorities. All of our employees working for us exclusively within the PRC are covered by the new laws and thus, our ability to adjust the size of our operations when necessary in periods of recession or less severe economic downturns may be curtailed. Accordingly, if we face future periods of decline in business activity generally or adverse economic periods specific to our business, these new laws can be expected to exacerbate the adverse effect of the economic environment on our results of operations and financial condition.

  

15

 

Changes in PRC’s political and economic policies could harm our business.

 

Our results of operations, financial condition and prospects are subject to economic, political and legal developments in the PRC. China’s economy differs from the economies of most developed countries in many respects, including with respect to the amount of government involvement, level of development, growth rate, and control of foreign exchange and allocation of resources. The PRC economy has historically been a planned economy subject to governmental plans and quotas and has, in certain aspects, been transitioning to a more market-oriented economy. Although we believe that the economic reform and the macroeconomic measures adopted by the PRC government have had a positive effect on the economic development of PRC, we cannot predict the future direction of these economic reforms or the effects these measures may have on our business, financial position or results of operations. In addition, the PRC economy differs from the economies of most countries belonging to the Organization for Economic Cooperation and Development (“OECD”). These differences include, without limitation:

 

  ● economic structure;

 

  ● level of government involvement in the economy;

 

  ● level of development;

 

  ● level of capital reinvestment;

 

  ● control of foreign exchange;

 

  ● methods of allocating resources; and

 

  ● balance of payments position.

  

As a result of these differences, our business may not develop in the same way or at the same rate as might be expected if the PRC economy were similar to those of the OECD member countries. Since 1979, the Chinese government has promulgated many new laws and regulations covering general economic matters. Despite these efforts to develop a legal system, the PRC’s system of laws is not yet complete. Even where adequate law exists in the PRC, enforcement of existing laws or contracts based on existing law may be uncertain or sporadic, and it may be difficult to obtain swift and equitable enforcement or to obtain enforcement of a judgment by a court of another jurisdiction. The relative inexperience of the PRC’s judiciary, in many cases, creates additional uncertainty as to the outcome of any lawsuit. In addition, interpretation of statutes and regulations may be subject to government policies reflecting domestic political changes. Our activities in the PRC will also be subject to administration review and approval by various national and local agencies of the PRC’s government. Because of the changes occurring in the PRC’s legal and regulatory structure, we may not be able to secure the requisite governmental approval for our activities. Although we have obtained all required governmental approvals to operate our business as currently conducted, to the extent we are unable to obtain or maintain required governmental approvals, the PRC government may, in its sole discretion, prohibit us from conducting our business.

 

If relations between the United States and China worsen, our share price may decrease and we may have difficulty accessing U.S. capital markets.

 

At various times during recent years, the United States and China have had disagreements over political and economic issues. Controversies may arise in the future between these two countries. Any political or trade controversy between the United States and China could adversely affect the market price of our common shares and our ability to access U.S. capital markets.

 

The Chinese government could change its policies toward private enterprise or even nationalize or expropriate private enterprises, which could result in the total loss of our investment in that country.

 

Our business is subject to political and economic uncertainties and may be adversely affected by political, economic and social developments in the PRC. Over the past several years, the PRC government has pursued economic reform policies including the encouragement of private economic activity and greater economic decentralization. The PRC government may not continue to pursue these policies or may alter them to our detriment from time to time with little, if any, prior notice. Changes in policies, laws and regulations or in their interpretation or the imposition of confiscatory taxation, restrictions on currency conversion, restrictions or prohibitions on dividend payments to shareholders, devaluations of currency or the nationalization or other expropriation of private enterprises could have a material adverse effect on our business. Nationalization or expropriation could even result in the total loss of our investment in the PRC and in the total loss of any investment in us.

 

16

 

Because our operations are located in the PRC, information about our operations is not readily available from independent third-party sources.

 

Our shareholders may have greater difficulty in obtaining information about them on a timely basis than would shareholders of a U.S.-based company. Their operations will continue to be conducted in the PRC and shareholders may have difficulty in obtaining information about them from sources other than the companies themselves. Information available from newspapers, trade journals, or local, regional or national regulatory agencies such as issuance of construction permits and contract awards for development projects will not be readily available to shareholders and, where available, will likely be available only in Chinese. Shareholders will be dependent upon management for reports of their progress, development, activities and expenditure of proceeds.

 

If our financial condition deteriorates as a NASDAQ listed company, we may not meet continued listing standards on the NASDAQ Capital Market.

 

On August 30, 2017, we received a listing approval letter approving our initial listing application to list our common shares on the NASDAQ Capital Market. The NASDAQ Capital Market also requires companies to fulfill specific requirements in order for their shares to continue to be listed. If our shares are listed on the NASDAQ Capital Market but are delisted from the NASDAQ Capital Market at some later date, our shareholders could find it difficult to sell our shares. In addition, if our common shares are delisted from the NASDAQ Capital Market at some later date, we may apply to have our common shares quoted on the Bulletin Board or in the “pink sheets” maintained by the National Quotation Bureau, Inc. The Bulletin Board and the “pink sheets” are generally considered to be less efficient markets than the NASDAQ Capital Market. In addition, if our common shares are not so listed or are delisted at some later date, our common shares may be subject to the “penny stock” regulations. These rules impose additional sales practice requirements on broker-dealers that sell low-priced securities to persons other than established customers and institutional accredited investors and require the delivery of a disclosure schedule explaining the nature and risks of the penny stock market. As a result, the ability or willingness of broker-dealers to sell or make a market in our common shares might decline. If our common shares are delisted from the NASDAQ Capital Market at some later date or become subject to the penny stock regulations, it is likely that the price of our shares would decline and that our shareholders would find it difficult to sell their shares.

 

We are a “foreign private issuer,” and our disclosure obligations differ from those of U.S. domestic reporting companies. As a result, we may not provide you the same information as U.S. domestic reporting companies or we may provide information at different times, which may make it more difficult for you to evaluate our performance and prospects.

 

We are a foreign private issuer and, as a result, we are not subject to the same requirements as U.S. domestic issuers. Under the Exchange Act, we will be subject to reporting obligations that, to some extent, are more lenient and less frequent than those of U.S. domestic reporting companies. For example, we will not be required to issue quarterly reports or proxy statements. We will not be required to disclose detailed individual executive compensation information. Furthermore, our directors and executive officers will not be required to report equity holdings under Section 16 of the Exchange Act and will not be subject to the insider short-swing profit disclosure and recovery regime. As a foreign private issuer, we will also be exempt from the requirements of Regulation FD (Fair Disclosure) which, generally, are meant to ensure that select groups of investors are not privy to specific information about an issuer before other investors. However, we will still be subject to the anti-fraud and anti-manipulation rules of the SEC, such as Rule 10b-5 under the Exchange Act. Since many of the disclosure obligations imposed on us as a foreign private issuer differ from those imposed on U.S. domestic reporting companies, you should not expect to receive the same information about us and at the same time as the information provided by U.S. domestic reporting companies.

 

17

 

As a relatively new public company, we incur increased costs and are subject to additional regulations and requirements, and our management is required to devote substantial time to new compliance matters, which could lower our profits or make it more difficult to run our business.

 

As a relatively newly public company, we incur significant legal, accounting and other expenses that we have not incurred as a private company, including costs associated with public company reporting requirements and costs of recruiting and retaining non-executive directors. We also have incurred and will incur costs associated with the Sarbanes-Oxley Act and related rules implemented by the Securities and Exchange Commission, or the SEC, and NASDAQ. The expenses incurred by public companies generally for reporting and corporate governance purposes have been increasing. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costlier, although we are currently unable to estimate these costs with any degree of certainty. Our management will need to devote a substantial amount of time to ensure that we comply with all of these requirements. These laws and regulations also could make it more difficult or costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. These laws and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our Board of Directors, our board committees or as our executive officers. Furthermore, if we are unable to satisfy our obligations as a public company, we could be subject to delisting of our common shares, fines, sanctions and other regulatory action and potentially civil litigation.

 

The market price of shares may be volatile, which could cause the value of your investment to decline.

 

Worldwide market volatility, as well as general economic, market or political conditions, could reduce the market price of shares of our stock in spite of our operating performance. In addition, our results of operations could be below the expectations of public market analysts and investors due to a number of potential factors, including variations in our quarterly results of operations, additions or departures of key management personnel, failure to meet analysts’ earnings estimates, publication of research reports about our industry, litigation and government investigations, changes or proposed changes in laws or regulations or differing interpretations or enforcement thereof affecting our business, adverse market reaction to any indebtedness we may incur or securities we may issue in the future, changes in market valuations of similar companies or speculation in the press or investment community, announcements by our competitors of significant contracts, acquisitions, dispositions, strategic partnerships, joint ventures or capital commitments, adverse publicity about our industry in or individual scandals, and in response the market price of our common shares could decrease significantly. In the past few years, stock markets have experienced extreme price and volume fluctuations. In the past, following periods of volatility in the overall market and the market price of a company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources, or at all.

  

As the rights of shareholders under British Virgin Islands law differ from those under U.S. law, you may have fewer protections as a shareholder.

 

Our corporate affairs will be governed by our memorandum and articles of association, the BVI Business Companies Act, 2004 (as amended), referred to below as the “BVI Act”, and the common law of the British Virgin Islands. The rights of shareholders to take legal action against our directors, actions by minority shareholders and the fiduciary responsibilities of our directors under British Virgin Islands law are governed by the BVI Act and the common law of the British Virgin Islands. The common law of the British Virgin Islands is derived in part from comparatively limited judicial precedent in the British Virgin Islands as well as from the common law of England and the wider Commonwealth, which has persuasive, but not binding, authority on a court in the British Virgin Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under British Virgin Islands law are largely codified in the BVI Act, but are potentially not as clearly established as they would be under statutes or judicial precedents in some jurisdictions in the United States. In particular, the British Virgin Islands has a less developed body of securities laws as compared to the United States, and some states (such as Delaware) have more fully developed and judicially interpreted bodies of corporate law. As a result of all of the above, holders of our shares may have more difficulty in protecting their interests through actions against our management, directors or major shareholders than they would as shareholders of a U.S. company.

 

18

 

British Virgin Islands companies may not be able to initiate shareholder derivative actions, thereby depriving shareholders of the ability to protect their interests.

 

Shareholders of British Virgin Islands companies may not have standing to initiate a shareholder derivative action in a federal court of the United States Shareholders of a British Virgin Islands company could, however, bring a derivative action in the British Virgin Islands courts, and there is a clear statutory right to commence such derivative claims under Section 184C of the BVI Act. The circumstances in which any such action may be brought, and the procedures and defenses that may be available in respect to any such action, may result in the rights of shareholders of a British Virgin Islands company being more limited than those of shareholders of a company organized in the United States. Accordingly, shareholders may have fewer alternatives available to them if they believe that corporate wrongdoing has occurred. The British Virgin Islands courts are also unlikely to recognize or enforce against us judgments of courts in the United States based on certain liability provisions of U.S. securities law; and to impose liabilities against us, in original actions brought in the British Virgin Islands, based on certain liability provisions of U.S. securities laws that are penal in nature. There is no statutory recognition in the British Virgin Islands of judgments obtained in the United States, although the courts of the British Virgin Islands will generally recognize and enforce the non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits. This means that even if shareholders were to sue us successfully, they may not be able to recover anything to make up for the losses suffered.

 

The laws of the British Virgin Islands may provide less protection for minority shareholders than those under U.S. law, so minority shareholders may have less recourse than they would under U.S. law if the shareholders are dissatisfied with the conduct of our affairs.

 

Under the laws of the British Virgin Islands, the rights of minority shareholders are protected by provisions of the BVI Act dealing with shareholder remedies and other remedies available under common law (in tort or contractual remedies). The principal protection under statutory law is that shareholders may bring an action to enforce the constitutional documents of the company (i.e. the memorandum and articles of association) as shareholders are entitled to have the affairs of the company conducted in accordance with the BVI Act and the memorandum and articles of association of the company. A shareholder may also bring an action under statute if he feels that the affairs of the company have been or will be carried out in a manner that is unfairly prejudicial or discriminating or oppressive to him. The BVI Act also provides for certain other protections for minority shareholders, including in respect of investigation of the company and inspection of the company books and records. There are also common law rights for the protection of shareholders that may be invoked, largely dependent on English common law, since the common law of the British Virgin Islands for business companies is limited.

  

We may not be able to pay any dividends on our shares in the future due to British Virgin Islands law.

 

Under British Virgin Islands law, we may only pay dividends to our shareholders if the value of our assets exceeds our liabilities and we are able to pay our debts as they become due. We cannot give any assurance that we will declare dividends of any amounts, at any rate or at all in the future. Future dividends, if any, will be at the discretion of our board of directors, and will depend upon our results of operations, cash flows, financial condition, payment to us of cash dividends by our subsidiaries, capital needs, future prospects and other factors that our directors may deem appropriate.

 

19

 

We are an “emerging growth company” and we cannot be certain if the reduced disclosure requirements applicable to “emerging growth companies” will make our shares less attractive to investors.

 

We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions and relief from various reporting requirements that are applicable to other public companies that are not “emerging growth companies.” In particular, while we are an “emerging growth company” (1) we will not be required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, (2) we will be exempt from any rules that may be adopted by the PCAOB requiring mandatory audit firm rotations or a supplement to the auditor’s report on financial statements, (3) we will be subject to reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and (4) we will not be required to hold nonbinding advisory votes on executive compensation or stockholder approval of any golden parachute payments not previously approved. We currently intend to take advantage of the reduced disclosure requirements regarding executive compensation. If we remain an “emerging growth company” after fiscal 2017, we may take advantage of other exemptions, including the exemptions from the advisory vote requirements and executive compensation disclosures under the Dodd-Frank Wall Street Reform and Customer Protection Act, or the Dodd-Frank Act, and the exemption from the provisions of Section 404(b) of the Sarbanes-Oxley Act. In addition, Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards, meaning that the company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards and, therefore, will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies. We may remain an “emerging growth company” until the fiscal year-end following the fifth anniversary of the completion of our initial public offering, though we may cease to be an “emerging growth company” earlier under certain circumstances, including (1) if we become a large accelerated filer, (2) if our gross revenue exceeds $1.07 billion in any fiscal year or (3) if we issue more than $1.0 billion in non-convertible notes in any three year period. The exact implications of the JOBS Act are still subject to interpretations and guidance by the SEC and other regulatory agencies, and we cannot assure you that we will be able to take advantage of all of the benefits of the JOBS Act. In addition, investors may find our shares less attractive if we rely on the exemptions and relief granted by the JOBS Act. If some investors find our shares less attractive as a result, there may be a less active trading market for our shares and our stock price may decline and/or become more volatile.

 

Our current common share price could not meet the $1.00 per share Nasdaq continued listing requirement. It is possible that we are delisted from Nasdaq in the near future if we are not able to improve our financial condition and raise stock price.

 

On January 7, 2019, TDH Holdings, Inc. (the “Company”) received a notification letter from Nasdaq Listing Qualifications advising the Company that based upon the closing bid price for the Company’s common shares for the past 30 consecutive business days, the Company no longer met the minimum $1.00 per share Nasdaq continued listing requirement set forth in Nasdaq Listing Rule 5555(a)(2). The notification also stated that the Company would be provided 180 calendar days, or until July 8, 2019, to regain compliance with the foregoing listing requirement. To do so, the bid price of the Company’s common stock must close at or above $1.00 per share for a minimum of 10 consecutive business days prior to that date.

 

If the Company does not regain compliance by the compliance deadline, the Company may be eligible for additional time to regain compliance. To qualify, the Company will be required to meet the continued listing requirement for market value of publicly held shares and all other initial listing standards for The Nasdaq Capital Market, with the exception of the bid price requirement, and will need to provide written notice of its intention to cure the deficiency during the second compliance period, by effecting a reverse stock split, if necessary. If the Company meets these requirements, the Nasdaq staff will inform the Company that it has been granted an additional 180 calendar days. However, if it appears to the Nasdaq staff that the Company will not be able to cure the deficiency, or if the Company is otherwise not eligible, the staff will provide notice that its securities will be subject to delisting.

 

The Company cannot provide any assurance that its common shares will trade at levels necessary to regain and maintain compliance with the above-referenced bid price rule before the compliance deadline. The Company intends to continue to monitor the bid price for its common stock. If the Company’s common shares do not trade at a level that is likely to regain compliance with the Nasdaq requirements, the Company’s Board of Directors will consider other options that may be available to achieve compliance.

 

20

 

We lack sufficient internal controls to manage manufacturing plant relocation due to an unfavorable event which caused decrease in product quality that led to sales return and inventory write-down.

 

During the period covered by this annual report on Form 20-F, we identified material weakness in the company’s internal control that have materially affected, or are reasonably likely to materially affect our company’s internal control over financial reporting.

 

Following our lease term expiration at the end of 2017, the Company has attempted to negotiate a new lease term with the local government, but ultimately failed to do so. As a result, the Company was forced to relocate its production facility to another location in March 2018. As the Company had no prior experience in large scale production facility relocation, it did not take sufficient quality control measures in managing the relocation process. This plant relocation resulted in decreased quality of the finished product based on production testing. In addition, during the Shanghai Cooperation Organization summit which was held in June 2018, the local government limited our production activity and electric power supply, which negatively impacted the production of finished products and resulted in an increase of per unit cost basis of our products. The quality of our products suffered and the percentage of lower quality product compared to our total output has increased from March to June. Discarding products and certain packing materials, cancellation of orders due to shortage of quality products, as well as the reduction of production capacity due to the relocation of the Canning facility impacted our results of operation negatively. We intend to complete the remediation effort on or before the end of the 2019 fiscal year and will conduct periodic assessments of the state of the Company’s financial reporting measures and systems, as a whole. Our inability to address this deficiency in a timely fashion or at all may have adverse effects on our ability to prepare and deliver timely public reports and the results of our operations.

 

ITEM 4. INFORMATION ON THE COMPANY

 

  A. History and Development of the Company

 

We started our company in 2002 in Qingdao, Shandong Province, PRC. Our growth has been driven by two key factors: (i) a significant increase in the number of pet owners and in the size of the pet food market in China which translated into expansion opportunities for us, and (ii) a fundamental change in Chinese society towards pets, pet ownership and care, such that the trends of pet humanization and consumer concerns for pet health and wellness have created a dynamically growing industry for pet food and products. We price our products to be accessible to the average consumer, providing us with broad demographic appeal and allowing us to penetrate multiple market segments. Founded on these building blocks, as well as on our in-depth research and development, production, and sales capabilities, we believe we are well prepared to be one of the leading producers of pet food in the PRC and beyond.

 

21

  

Overseas sales refer to overseas wholesale sales. Our overseas sales have decreased from approximately $21.2 million to $15.8 million, or by approximately 25%, from the year ended December 31, 2017 to 2018. The decrease was due to: (1) the decline in production capacity, and (2) loss of some key customers.

 

Domestic sales refer to domestic wholesale sales. Our domestic sales were approximately $4.1 million and $2.1 million for the years ended December 31, 2018 and 2017, respectively, which accounted for approximately 17% and 7% of our total revenues in 2018 and 2017. We expect our domestic sales growth to continue in the future.

 

Electronic commerce sales, including overseas and domestic electronic commerce sales, decreased from $5.7 million to $3.8 million, or by approximately 34%, from the year ended December 31, 2017 to 2018. The decrease was due to the rising raw material costs and our production costs. We have to stop selling unprofitable line products to avoid further worsen our balance sheets.

 

As the PRC pet food consumption continues to grow, we see significant opportunities for future growth by leveraging key elements of our business:

 

  ● Strength and variety of our brands – we offer in excess of 200 products, including dry meat treats, pet biscuits, canned food and other products (including non-food items like dog leashes, pet toys, etc.) under multiple brands that are well-established and recognizable by consumers in the PRC, Asia and Europe.

 

  ● Product research & development – we believe our products are differentiated from those of our competitors in the PRC markets due to our in-depth research and development effort, our proprietary recipes, cooking and packing techniques developed over the last decade. Currently, we have been granted 20 invention and utility model patents, and have applied for 5 more patents.

 

  ● Sales and marketing distribution – our domestic and overseas multi-platform sales approach connects our production output to customers in the PRC, Asia, Europe and North America. In addition to the traditional sales approach, we utilize cross-border e-commerce platforms that contribute to the expansion of our business, including, among others, Amazon (US, UK, France, Germany), Ebay (US and UK) and Aliexpress.

 

  ● Experienced and committed management team – our workforce is highly skilled in animal nutrition, sales and marketing.

 

Our product line in excess of 200 products, including dry meat treats, pet biscuits, canned food and other products (including non-food items, e.g., dog leashes, etc.) under multiple brands in various geographical markets. Our products are available in multiple forms, including slice and serve rolls, strips, tubs, etc. All of our products are sold under several different brand names, including, among others, Pet Cuisine, Hum & Cheer, Like, TDH, Tiandihui and Dog Zone Sasami.

 

Currently, we offer 6 product lines: 

 

  ● Pet chews represent approximately 26.5% of our production and include various bones, rawhide and similar products,

 

  ● Dried pet snacks represent approximately 57.5% of our production and include various fillets, strips and jerkies (chicken, duck, pork, lamb, etc.),

 

  ● Wet canned pet foods represent approximately 11.8% of our production and include various fillets, strips and jerkies (chicken, duck, pork, lamb, etc.),

 

  ● Dental health snacks foods account for approximately 2.1% of our production, and

 

  ● Baked pet biscuits account for 0.4% of our overall production.

 

  ● Others account for 2.0% of our overall production.

 

22

  

These food products vary from those consisting of a single protein ingredient (e.g., duck jerky) to those consisting of a combination of protein and other ingredients (e.g., twisted cod and chicken sandwich roll that includes chicken, cod and Vitamin E). Our proprietary recipes include fresh meat (beef, chicken, fish, duck and lamb) and varying combinations of vitamin-rich vegetables and anti-oxidant rich fruits. We believe our products appeal to diverse consumer needs and resonate across a broad cross-section of pet owner demographics.

 

We manufacture these products at 8 production lines: 4 at the Canning facility (dried meat, chews, wet canned and dentifrice products), 2 at the Pude facility (dried meat and biscuits), 1 at each of the Haiqing and Zhangjialou facility (dried meat at both facilities), respectively. In March 2018, we ceased to lease Canning facility. We have purchased a new facility, Lingang factory, in 2018, and planned to put into production at the end of 2019. We’ve outsourced products for manufacturing, and set up joint-venture factories during the year ended December 31, 2018.

 

In addition, we strategically partner with a select group of contract manufacturers to supplement and enhance our production capabilities, as needed. Currently, we have outsourcing agreements with 11 pet food manufacturers for the duration of up to 3 years, to secure additional production capabilities to address peak or high demand for our products. Under the terms of these agreements, our suppliers must meet all of our manufacturing requirements, including, among others, those relating to quality control, staffing, training and equipment. All manufacturing under these agreements is made in accordance with our demands, timing and specifications. These facilities are, at all times, staffed and supervised by our personnel.

 

We employ approximately 204 full-time employees at our facilities. With the exception of our subsidiary’s offices located in Beijing, all of our production, executive, sales/marketing and customer service facilities covering the PRC and overseas markets are located in Shandong Province, PRC. Our daily production capacity for all of our production facilities is approximately 12 tons. The following is a summary description of our production facilities (not including any of the outsourcing facilities used to support our production needs):

 

  ● The Canning facility has a production area of 50,590 sq. feet, and 20 years of export processing history. We maintain ISO9001, Hazard Analysis Critical Control Point (HACCP), British Retail Consortium (BRC) and International Featured Standards (IFS) certifications, as well as EU registration for this facility. Our daily production capacity at this facility is approximately 6.3 tons. In March 2018, the Canning facility stopped production due to the expiration of lease.

 

  ● The Pude facility maintains a production area of 30,558 sq. feet and was formerly registered as a Japanese agriculture, forestry and fishing production facility. This facility makes products specifically for the Japanese market. Our daily production capacity at this facility is approximately 8.4 tons.

 

  ● The Haiqing facility has a production area of 100,233 sq. feet and maintains an export commodity inspection registration from Shandong Huangdao Bureau of Inspection and Quarantine. Our daily production capacity at this facility is approximately 1.3 tons.

 

  ● The Zhangjialou facility has a usage area of 21,528 sq. feet. Our daily production capacity at this facility is approximately 1.5 tons.
     
  ● The Jiaozhou facility has production area of 30,062 square feet. Our daily production capacity at this facility is approximately 0.8 ton.

  

In addition to our production facilities, we maintain a non-exclusive one year agreement with Kangkang Family Farm in Jiaonan city, Shandong province, an organic food farm and a raw materials supplier to the Company. This farm is owned by Cui Runrang, our CEO’s father. During the year ended December 31, 2018 and 2017, the Company purchased from Kangkang Family Farm in the amount of $0 and $30,191, respectively. While the Company has a non-exclusive supply arrangement with this farm, the Company does not own title to the land or maintain the food farm.

 

We also maintain a call service center in Qingdao with approximately 8 trained, multilingual personnel to address customer service matters arising from our sales in the PRC and abroad.

 

23

 

Our sales and marketing team consists of 2 integral groups – an original design manufacturer (ODM) domestic (PRC) marketing group, and an ODM overseas marketing group. We operate a B2F (business-2-factory) business model which is focused on the needs of the business market. Our model relies on our R&D strength to devise product lines to cater to this market, providing our customers with personalized and customized products. Our marketing team works in tandem with our brand promotion team which focuses on brand promotion. As a part of our ODM production process, we continuously accumulate a large amount of market information about our customers, in the PRC and abroad, which assists us in making appropriate selection of products. We utilize online sale and multi-brand, multi-store brand sale strategies. Using Tmall.com, jd.com, 1688.com, alibaba.com, yhd.com, and Amazon as our marketing platforms, our PRC marketing group has established a comprehensive network of various brand shops. In addition, our cross-border marketing/sales group mainly relies on the Tiandihui Amazon and eBay platforms as well as direct sale websites in Europe and the U.S. to operate its marketing and sales efforts.

  

The following chart reflects our organizational structure as of the filling date:

 

 

On September 20, 2018, the Board has approved acquisitions by the Company of TDH Group BVBA, a company established under the laws of Belgium and TDH JAPAN, a company established under the laws of Japan. In connection with the foregoing transactions the Company executed Share Sale and Purchase Agreements (together, the “Agreements”) pursuant to which the Company agreed to pay approximately USD$ 936,782 and USD $156,130 (RMB 6 million and RMB 1 million), respectively, to acquire all of outstanding securities of TDH Group BVBA and TDH JAPAN, respectively, from the sole shareholder of each entity, Rongfeng Cui, the Company’s CEO. The purchase consideration under the Agreements was paid by issuance of 936,782 and 156,130 restricted common shares of the Company, respectively. Rongfeng Cui incorporated TDH Group BVBA in 2012 and TDH JAPAN in 2017 to develop and maintain all the clients in Europe and Japan, and to distribute and expand product sales in European and Japanese markets.

 

The Initial Public Offering

 

On September 25, 2017, we completed our initial public offering of 1,325,000 common shares at $4.25 per share, for total gross proceeds of approximately $5.63 million. In addition, on September 28, 2017, we announced that ViewTrade Securities, Inc., who acted as the managing underwriter and sole book-runner of our IPO, had exercised the full over-allotment option to purchase an additional 198,750 shares at the IPO price per share. As a result, the Company has raised gross proceeds of approximately $844,688, in addition to the previously announced IPO gross proceeds of approximately $5.63 million, before underwriting discounts and commissions and offering expenses. Our common shares began trading on the NASDAQ Capital Market on September 21, 2017 under the ticker symbol “PETZ”.

 

24

 

  B. Business Overview

 

Overview

 

We started our company in 2002 in Qingdao, Shandong Province, PRC with a single mission of becoming a premier producer of high-quality pet food for pet owners in China and worldwide. Our growth has been driven by two key factors: a significant increase in the number of pet owners and in the size of the pet food market in China which translated into expansion opportunities for us, and a fundamental change in Chinese society towards pets, pet ownership and care, such that the trends of pet humanization and consumer concerns for pet health and wellness have created a dynamically growing industry for pet food and products. We price our products to be accessible to the average consumer, providing us with broad demographic appeal and allowing us to penetrate multiple market segments. Founded on these building blocks, as well as on our in-depth research and development, production, and sales capabilities, we believe we are well prepared to be one of the leading producers of pet food in the PRC and beyond.

 

We employ approximately 204 full-time employees at our facilities. With the exception of our subsidiary’s offices located in Beijing, all of our production, executive, sales/marketing and customer service facilities covering the PRC and overseas markets are located in Shandong Province, PRC.

 

Our Industry and Market

 

China Pet Food Industry

 

While the global pet food market is well-established worldwide, in China it is a relatively new industry. China’s economy has shown steady growth over the last decade, from a GDP per capita of $1,509 in 2004 to $9,780 in 2018. According to the National Bureau of Statistics of China (NBS China) and GfK, in 2015, China ranked (i) 3rd in the world in the number of registered pet dogs (27.4 million dogs), following the U.S. and Brazil, and (ii) 2nd in the number of registered pet cats (58.1 million cats), following the U.S. With an increase in the number of pets in most households in China, the pet food industry in China has been and remains poised for significant growth. Pet food consumption in China increased from approximately RMB 5.26 billion in 2010 to RMB 9.74 billion in 2016, representing a growth rate of 85.2%. The average price per kilogram of pet food and treats rose to about RMB45 (US$6.77) in April 2016, a 12.5% increase since 2013, reflecting the nascent yet increasing premiumization of the market, projected to reach approximately RMB 11.82 billion (US$1.77 billion) by the end of 2016, representing approximately 19% growth, year over year. At this rate, we expect for the industry consumption rates to increase to approximately RMB 238 billion. On the production side, production volume reached 1,000,000 metric tons in 2016.  

  

The growth in this industry is largely a function of consumer education and increased awareness of pet food products, product ingredients, quality, brand awareness and loyalty. We consider pet humanization to be another driving factor behind the growth trend, i.e., where pet owners view their pets as members of the family. As pets are increasingly viewed as companions, friends, and family members, pet owners spare no expense for their pets, driving premiumization across pet categories. This trend is reflected in food purchasing decisions such that pet owners are as concerned about the quality of their pet’s food as they are about their own. The PRC consumers are becoming more discerning when it comes to quality of pet food for their pets, especially when it comes to food specific to particular breed needs, etc. In addition, (i) an increase in living standards of urban population which resulted from the growth of the PRC economy at large and the corresponding accelerated rates of urban development and expansion, and (ii) higher rates of aging population in major urban areas in the PRC which tend to encourage more independent lifestyles (e.g. the proportion of the PRC population over 65 has continued to grow, with the rate reaching over 10% in 2014), cause more people to view and treat their pets as their close companions. In China, most people who have pet dogs or cats in China are, in fact, elderly. According to the NBS China, approximately 61% of the 65+ age group live with a pet, as compared with the national average of 44%; only the 25-29 age group exhibits similar levels of pet ownership. We anticipate that these trends will continue in the foreseeable future.

 

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While the multinational brands still dominate the Chinese pet food market, the market growth is being driven by local brands, especially in pet shops, with 81% growth for domestic cat food brands overall and 85% in pet shops (though cat food represents just 31% of the market). With dog food, sales increase for domestic brands are more modest—about 9% overall and nearly 10% in pet shops—but the average price per kilogram of domestic dog foods brands is growing much closer to that of multinational brands. 

 

Aside from rapid growth, the China pet food market is also characterized by increasing online sales as the share of overall sales, with 62% of all sales in 2017 to be made online. In 2016, online pet food sales in China have reached RMB 4.2 billion. In addition, China’s sales skew heavily toward specialized retailers (80%) as contrasted with mass merchants in the rest of the world (e.g. in Western Europe, the breakdown is almost exactly the reverse). 

 

Our Competitive Strengths

 

In 2019, we believe the following strengths differentiate us from our competitors in our market in China:

 

  ● Strength and variety of our brands – we offer in excess of 200 products, including dry meat treats, pet biscuits, canned food and other non-food products (e.g. dog leashes, pet toys etc.) under multiple brands that are well-established and recognizable by consumers in the PRC, Asia and Europe.

 

  ● Product research & development – we believe that our products are differentiated from those of our competitors in the PRC markets due to our in-depth research and development effort and our proprietary recipes and cooking techniques developed over the last decade.

 

  ● Sales and marketing distribution – our multi-platform sales approach connects our production output to customers in the PRC, Asia, Europe and North America.

 

  ● Experienced and committed management team - Tiandihui’s workforce is a highly skilled with specialized training designed to address complex customer care engagements; our entrepreneurial management team includes employees who have significant experience in animal nutrition, sales and marketing, among others. Led by Cui Rongfeng, our founder, Chairman and Chief Executive Officer, our management team is comprised of an experienced group of executives, many of whom have many years of operating experience.

 

We intend to continue capitalizing on our strengths and growing net sales and profitability.

 

Our History and Corporate Structure

 

We are a holding company incorporated in the British Virgin Islands (incorporated on September 30, 2015) that owns all of the outstanding capital stock of TDH HK Limited, our wholly-owned Hong Kong subsidiary (TDH HK), and holds a 99% interest in TDH Petfood LLC, a Nevada limited liability company. TDH HK, in turn, owns all of the outstanding capital stock of Qingdao Tiandihui Foodstuffs Co., Ltd., our operating subsidiary based in Qingdao City, Shandong Province, China, incorporated in April 2002 as a PRC limited liability company (Tiandihui). As of the date of this Annual Report, Tiandihui has the following subsidiaries:

 

  ● Beijing Chongai Jiujiu Cultural Communication Co., Ltd. (incorporated on March 3, 2011),
     
  ● Qingdao Kangkang Development Co., Ltd. (incorporated on August 9, 2016),

 

  ● Yichong (Qingdao) Technology Co., Ltd. (incorporated on November 14, 2017),

 

  ● Qingdao Lingchong Information Technology Co., Ltd. (incorporated on November 29, 2017), and

 

  ● Qingdao Lile Pet Foodstuffs Co., Ltd (incorporated on January 3, 2018).

 

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On September 20, 2018, the Board approved acquisitions by the Company of TDH Group BVBA, a company established under the laws of Belgium and TDH JAPAN, a company established under the laws of Japan. In connection with the foregoing transactions the Company executed Share Sale and Purchase Agreements (together, the “Agreements”) pursuant to which the Company agreed to pay approximately USD$ 936,782 and USD $156,130 (RMB 6 million and RMB 1 million), respectively, to acquire all of outstanding securities of TDH Group BVBA and TDH JAPAN, respectively, from the sole shareholder of each entity, Rongfeng Cui, the Company’s CEO. The purchase consideration under the Agreements was paid by issuance of 936,782 and 156,130 restricted common shares of the Company, respectively. Rongfeng Cui incorporated TDH Group BVBA in 2012 and TDH JAPAN in 2017 to develop and maintain all the clients in Europe and Japan, and to distribute and expand product sales in European and Japanese markets.

 

Our Products

 

The pet food market consists of dog food and cat food sales. Food sales are further categorized as dry food, wet food and treats:

 

  ● Dry food is the primary food form for both dogs and cats, with the same formula typically purchased regularly. Veterinarians recommend dry food for healthy pets as the main meal, which is better for pets’ teeth, has better economic value and is more convenient to handle and store

 

  ● Wet food has higher penetration among cats as compared to dogs, as it helps to ensure that cats meet their required water intake. Most cat owners feed their cats a combination of dry and wet foods as main meals, while most dog owners feed their dogs wet foods as a treat or topper to provide variety

 

  ● Treats are typically impulse purchases by pet owners made alongside staple, main meal dry and wet food purchases. Many treats have dental and training benefits and also serve as nutritional supplements. Dog and cat treats have been growing rapidly over the last decade driven by the humanization trend with pet owners indulging their pets more, including by purchasing treats as gifts.

 

Product research and innovation is pivotal to our growth strategy. Our experienced team of marketing and R&D professionals is in constant contact with our outside collaborators and experts. The success of our approach is evidenced by our broad product portfolio today. For the year ended December 31, 2017, new product introductions represented 74% of our net sales; those numbers were to 40% in 2018. We strive to maintain a strong innovation pipeline that expands the breadth of our current product offerings. We expect for the innovation trend to continue.

 

We offer in excess of 200 products, including dry meat treats, pet biscuits, canned food and other products (including non-food items like dog leashes and pet toys) under multiple brands in various geographical markets. Currently, we offer 6 product lines including the following:

 

  ● Pet chews represent approximately 26.5% of our output and include various bones, rawhide and similar products

 

  ● Dried pet snacks represent approximately 57.5% of our output and include various fillets, strips and jerkies (chicken, duck, pork, lamb, etc.)

 

  ● Wet canned pet foods represent approximately 11.8% of our output and include various fillets, strips and jerkies (chicken, duck, pork, lamb, etc.)

 

  ● Dental health snack foods account for approximately 2.1% of our output

 

  ● Baked pet biscuits account for only 0.4% of our overall production output. 

 

  ● The other account for 2.0% of the total products.

 

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We manufacture these products at 8 production lines: 4 – at the Canning facility, 2 – at the Pude facility, 1 at each of the Haiqing and Zhangjialou facilities, respectively. In March, 2018, we ceased to lease Canning facility. We have purchased a new facility, Lingang factory in 2018, and planned to put into production at the end of 2019. We’ve outsourced products for manufacturing, and set up joint-venture factories during the year ended December 31, 2018.

 

These food products vary from those consisting of a single protein ingredient (e.g., duck jerky) to those consisting of a combination of protein and other ingredients (e.g., twisted cod and chicken sandwich roll that includes chicken, cod and Vitamin E). Our proprietary recipes include fresh meat (beef, chicken, lamb, and fish) and varying combinations of vitamin-rich vegetables, and anti-oxidant rich fruits. We believe our products appeal to diverse consumer needs and resonate across a broad cross-section of pet owner demographics. Our products are available in multiple forms, including slice and serve rolls, strips, tubs, etc. All of our products are sold under several different brand names, including, among others, Pet Cuisine, Hum & Cheer, Like, TDH, Tiandihui and Dog Zone Sasami.

 

Supply Chain

 

Manufacturing

 

All of our products are manufactured in the PRC. We own and operate several facilities in the Shandong province for a total production area of approximately 191,300 square feet built to high quality food production standards. In 2018, 2017 and 2016, 42%, 69% and 71%, respectively, of our product volume was manufactured by us. We also strategically partner with a select group of contract manufacturers that manufacturing facilities to supplement our production needs. Namely, as of the date of this Annual Report, we have executed outsourcing agreements (up to 3 years) with seven provincial pet food manufacturers for the purposes of securing additional production capabilities to address peak or high demand for our products. Under the terms of these agreements, our suppliers must meet all of our manufacturing requirements, including, among others, those relating to quality control, staffing, training and equipment. All manufacturing under these agreements is made in accordance with our demands, timing and specifications. These facilities are, at all times, staffed and supervised by our personnel. These agreements have no automatic renewal provisions. In our review and engagement of such third-party manufacturers, we apply rigorous review of manufacturing and quality control practices at the facilities of such manufacturers to ensure compliance of such practices with those employed by our company at various stages of production at all of our production facilities. Any loss of these supplemental production arrangements could significantly impact our revenue and profits.

 

Ingredients and Packaging

 

Our products are made with fresh ingredients including meat (chicken, beef, lamb, fish, etc.), vegetables, fruits, vitamins and minerals. We use quality food grade plastic packaging materials and maintain rigorous overall standards for ingredient quality and safety. In addition, we maintain one raw material procurement center which provides a single-source supply for all our manufacturing facilities to maintain quality control throughout the production facilities. Also, in order to retain operating flexibility and negotiating leverage, we do not enter into exclusivity agreements or long-term commitments with any of our suppliers. All of our suppliers are established PRC companies that have the scale to support our growth. For every ingredient, we have sources of supply that meet our quality and safety standards.

 

Distribution

 

Our facilities are located in the coastal city of Qingdao, near Qingdao International Airport and the international Qingdao harbor, which proximity ensures efficient international transportation by sea/air. Outbound transportation from our facility is primarily handled through transportation by sea, which deliver our products to our customers. As our volumes grow, we expect to be able to leverage our distribution costs.

 

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Quality Control

 

We are committed to the highest quality of products that leave our facilities. To that end, we have implemented a rigid quality control system and devote significant attention to quality control procedures at every stage of our process, including spot testing of finished products. Our entire food processing chain, from sourcing of raw materials to the finished products, is closely monitored to ensure that all pet food products meet the highest level of global hygienic and quality standards. We monitor our manufacturing process closely and conduct performance and reliability testing to ensure our products meet our end-user customer expectations. Our quality control group as of December 2018 included 17 employees that implement various management systems to improve product quality programs, most of whom are trained in quality control and nutrition. We spot test and inspect our raw materials to ensure compliance with quality standards. We also evaluate the quality and delivery performance of each supplier periodically and adjust quantity allocations accordingly. We also monitor in-process and outgoing stages of our processes.

 

We have established control points throughout the entire supply chain from ingredient sourcing to finished goods to ensure compliance with our quality program. We require our contract and owned manufacturing facilities to maintain the same quality standards as those at our facilities and pass our own quality system and food safety inspections. We ensure that all of our ingredients are rigorously tested prior to being approved for use in our products. Testing certifications which confirm that the ingredient meets our specifications as to quality and safety, accompany every shipment. In addition, our food safety and quality program include strict guidelines for incoming ingredients, batching, processing, packaging and finished goods. However, despite our strict quality controls, it is possible that there may be from time to time, as there has been in the past, issues or concerns with respect to our products.

 

Quality Certifications and Accreditations

 

In a continuous effort to meet various international production and quality manufacturing standards, we have a number of certifications and accreditations. We have secured these certifications and accreditations to show evidence of high-quality manufacturing standards that we apply to our production and managements processes and to access domestic and foreign markets. We believe that maintaining objectively verifiable quality standards fosters consumer confidence and loyalty and maximizes customer satisfaction and recognition.

 

Sales and Marketing

 

Our sales and marketing team consists of two integral groups – an original design manufacturer (ODM) domestic (PRC) marketing group, and an ODM overseas marketing group. We operate a B2F (business-to-factory) business model which is focused on the needs of the business market. It relies on our R&D strength to devise product line to cater to this market, providing our customers with personalized and customized products. Our marketing team works in tandem with our brand promotion team which focuses on the cross-border brand promotion domestically and overseas. As a part of our ODM production process, we continuously accumulate a large amount of market information about our customers, in the PRC and abroad, which assists us in selecting the appropriate selection of products. We utilize online sale and multi-brand, multi-store brand sale strategies. Namely, using Tmall.com, Jingdong, 1688, YHD, and Amazon as our marketing platforms, our PRC marketing group has established a comprehensive network of various brand shops. In addition, our cross-border marketing/sales group mainly relies on the Tiandihui Amazon and eBay platforms as well as direct sale websites in Europe and the U.S. to operate its marketing and sales efforts.

 

We maintain a call service center in Qingdao with approximately 8 trained, multilingual personnel to address customer service matters arising from our sales in the PRC and abroad.

 

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Competition

 

The market for pet food and related products in the PRC is emerging and highly competitive. In prior years, Chinese pet food manufacturers were viewed in the pet food industry as suppliers of cheaper food and snack products for pets which were almost always delivered under Western brand name products. The competitive landscape is changing now as a number of PRC-based manufacturers operate and compete domestically and worldwide alongside with other major industry players. The PRC market is characterized by price competition, product quality and the presence of a number of medium to large companies, as discussed below. Relatively high barriers of entry for new participants into this industry include relatively large initial capital outlays, uncertain regulatory environment, scarcity of suitable production, raw material supply sources, and skilled management. Thus, we believe all of the foregoing fortifies our competitive positions in the industry.

 

Mars Foods (China) Co. Pvt. Ltd., Royal Canin Au Yu (Shanghai) Pet Food Co Ltd. and Nestle (China) are three largest players in the PRC pet food industry. In recent years, Royal Canin Au Yu (Shanghai) Pet Food Co Ltd. consolidated its leadership in the category with a market share of 28% in 2015, which represented an increase of one percentage point over 2014. Royal Canin enjoys a widespread nationwide distribution network. In addition, the company runs an official flagship store on the largest B2C online platform in China, Tmall.com, to reach out to wider range of consumers.

 

We compete primarily on the basis of our product range, reputation, product quality, brand loyalty, and total value delivered. We are subject to pricing pressures and may experience a decline in average selling prices for our products. We attempt to mitigate these pricing pressures by differentiating ourselves from our competition based on the value we bring to our clients through the quality and variety of our products.

 

Our competitors include the following PRC-based manufacturers:

 

  ● Yantai China Pet Foods Co., Ltd. - Established in 1998, Yantai China Pet Foods Co., Ltd. is one of the leading manufacturers of pet snacks in China. This company is publicly traded in Shenzhen stock exchange (002891.SZ), which offers approximately 500 products in eleven product lines with products distributed to the UK, the US, Japan, Germany, Korea, Hong Kong, Singapore, Russia, France, the Netherlands, Czech Republic, the Middle East, Australia, New Zealand, and other countries and regions.

 

  ● Wenzhou Peidi Pet Products Co., Ltd. – Founded in 2002, Wenzhou Peidi is a Shenzhen stock exchange (300673.SZ) publicly traded large-scale manufacturer of pet products and food in Zhejiang Province, China. It specializes in rawhide chews, leather collars and leashes, as well as nutritional pet food, treats, toys and gifts and markets these products on a worldwide basis.

 

  ● Shouguang Xincheng Food Co., Ltd. – A privately held pet food producer in Shandong province offers approximately 200 products that are exported to USA, Canada, Germany, Japan, Korea, and Southeast Asia.

 

Seasonality

 

Overall pet food sales experience modest seasonality during the fourth quarter, which is when pet owners tend to spend more on pet treats as gifts, being approximately 22% higher than during summer months.

 

Research & Development

 

Our research and development team works to improve our existing and develop future pet food products. Our production processes are developed based upon a number of in-house developed technologies. The primary focus of such technologies is on customer needs, which allows us to maintain an effective market-oriented research and development model. We strive to attract and retain highly educated and skilled R&D personnel. Presently, our R&D team is comprised of 28 technical personnel, including, 6 members who hold Master’s degrees, 7 Bachelor’s degrees and 7 Associate’s degrees as well as 1 member of our external advisory team who hold Doctorate degree. We also work with external technical experts and suppliers to help us stay at the forefront of technological developments and advancements.

 

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In order to strengthen its R&D capabilities, Tiandihui entered into several collaboration and research sharing agreements with leading PRC universities and research institutions in joint research projects, including China Agricultural University (March 2016), Shandong Agricultural University (August 2015), Shandong Academy of Agricultural Sciences (March 2016), and Qingdao Agricultural University (March 2016). For instance, as a part of our collaboration project with the Shandong Agricultural University, we share the use of the University’s Laboratory and Physiochemical Property Analysis Room, as well as the Microbiological Examination Room. In addition to these collaboration arrangements, we also gather and collect data on product customization for each pet species to develop our internal research capabilities in devising scientifically balanced of pet nutrition. Research and development costs of the years ended December 31, 2017 and 2018 were $1,051,665 and $1,062,582, respectively. These expenses include personnel costs, testing costs and expenses related to outside services.

 

Having built a scaled research and development infrastructure with a strong go-to-market model, we believe we are well positioned to supplement our internal product development platform by incorporating new technologies or product forms through joint ventures and collaboration arrangements. We will take a thoughtful approach to our business development efforts in this area and intend to be selective in pursuing incremental opportunities aligned with our mission and strategy.

 

Intellectual Property

 

The PRC has domestic laws for the protection of rights in copyrights, patents, trademarks and trade secrets. The PRC is also a signatory to all of the world’s major intellectual property conventions, including:

 

  ● Convention establishing the World Intellectual Property Organization (June 3, 1980);
     
  ● Paris Convention for the Protection of Industrial Property (March 19, 1985);
     
  ● Patent Cooperation Treaty (January 1, 1994); and
     
  ● Agreement on Trade-Related Aspects of Intellectual Property Rights (November 11, 2001).

 

The PRC Trademark Law, adopted in 1982 and revised in 2013, with its implementation rules adopted in 2014, protects registered trademarks. The Trademark Office of the State Administration of Industry and Commerce of the PRC, handles trademark registrations and grants trademark registrations for a term of ten years.

 

Our primary trademark portfolio consists of 31 registered trademarks (with 14 trademarks currently under review). Our trademarks are valuable assets that reinforce the distinctiveness of our brand and our consumers’ favorable perception of our products. The current registrations of these trademarks are effective for varying periods of time and may be renewed periodically, provided that we, as the registered owner, comply with all applicable renewal requirements including, where necessary, the continued use of the trademarks in connection with similar goods. In addition to trademark protection, we own 10 URL designations/domain names, including qdkangkang.com, tdhpet.cn, tdhpet.com, cnlikepet.cn, cnlikepet.com, tdhpetfood.com, chongai99.com, chongai99.net, chongai99.org and dogzonesasami.cn. We also own 1 copyright, the name of which is the Mascot of Chongai Jiujiu-Huihui, and will expire on December 31, 2064.

 

On September 1, 2016, we entered into an exclusive 10-year trademark using agreement with TDH Group BVBA, a limited liability company organized under the laws of Belgium (TDH BVBA), under which agreement we have secured right to the exclusive usage of “ Pet Cuisine” and “Hum & Cheer” trademarks worldwide, from September 1, 2016 to August 31, 2026 in consideration for the exclusive fee of 5% of the total sales of such products which used those two trademarks, payable every six months. In November 2018, we completed acquisition of TDH BVBA.

 

Patents in China are principally protected under the Patent Law of China. The duration of a patent right is either 10 years (utility model or design) or 20 years (invention) from the date of application, depending on the type of patent rights.

 

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Currently, we hold the following design patents pertaining to the pet food products:

 

No.   Name of Patent   Patent Number     Types   Date of authorization  
1   A chicken cartilage composite functional dog food and preparation method     201310653084.4     Invention     May 20, 2015  
2   A pet dog food and its preparation method     201310651439.6     Invention     August 5, 2015  
3   A preparation method of beef flavor nutrition canned food canned food     201310651598.6     Invention     May 20, 2015  
4   A full price nutritive semi wet pet dog food and preparation method     201310654269.7     Invention     May 20, 2015  
5   A vegetarian dog bite     2017104659172     Invention     September 26, 2017  
6   A duck meat round piece of dog food     2017104646420     Invention     September 22, 2017  
7   A kind of soft puffed pet food     2017104659191     Invention     September 15, 2017  
8   A hermaphrodite breeding device for pet dog     201520651073.7     utility model     January 6, 2016  
9   A pet dog’s molars knot bone     201520651112.3     utility model     March 2, 2016  
10   A new kind of pet food     201520651920.X     utility model     March 2, 2016  
11   A pet cat bone cleaning bone     201520649912.1     utility model     June 1, 2016  
12   A pet dog snack     201520651084.5     utility model     April 27, 2016  

 

Our intellectual property rights are important to our business. We rely on a combination of trade secrets, confidentiality procedures and contractual provisions to protect our intellectual property. We also rely on and protect unpatented proprietary expertise, recipes and formulations, continuing innovation and other trade secrets to develop and maintain our competitive position.

 

We enter into confidentiality agreements with most of our employees and consultants, and control access to and distribution of our documentation and other licensed information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use our technology without authorization, or to develop similar technology independently. Since the Chinese legal system in general, and the intellectual property regime in particular, is relatively weak, it is often difficult to enforce intellectual property rights in China. Policing unauthorized use of our technology is difficult and the steps we take may not prevent misappropriation or infringement of our proprietary technology. In addition, litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others, which could result in substantial costs and diversion of our resources and could have a material adverse effect on our business, results of operations and financial condition.

 

We require our employees to enter into non-disclosure agreements to limit access to and distribution of our proprietary and confidential information. These agreements generally provide that any confidential or proprietary information developed by us or on our behalf must be kept confidential. These agreements also provide that any confidential or proprietary information disclosed to third parties in the course of our business must be kept confidential by such third parties. In the event of trademark infringement, the State Administration for Industry and Commerce has the authority to fine the infringer and to confiscate or destroy the infringing products.

 

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Properties

 

Under Chinese law, all of the land in China is either state-owned or collectively-owned, depending on its location and the specific laws governing such land. Collectively-owned land is owned by rural collectives and generally cannot be used for non-agricultural purposes unless approved by the Chinese government. Collectively-owned land cannot be transferred, leased or mortgaged to non-collectives without first being converted into state-owned land. Individuals and entities may acquire rights to use state-owned land, or land-use-rights, for commercial, industrial or residential purposes by means of mutual agreement, tender, auction or listing for sale from local land authorities or an existing holder of a land-use-right. Land-use-rights granted for commercial, industrial and residential purposes may be granted for a period of up to 40, 50 or 70 years, respectively. This period may be renewed at the expiration of the initial and any subsequent terms, subject to compliance with relevant laws and regulations. Land-use-rights are transferable and may be used as security for borrowings and other obligations.

 

Our principal executive office is located at Qingdao Tiandihui Foodstuffs Co. Ltd., Room 1809, Financial Square, 197 Shuangzhu Road, Huangdao District, Qingdao, Shandong Province, People’s Republic of China; tel: +86 532-8591-9267, fax: +86 532 -8591-9284. We lease the premise at the annual rate of RMB 140,000 net after tax; the lease term expires on December 31, 2019.

 

In addition, the Company manages and operates several other facilities, including three export subsidiaries/factories and one PRC product processing factory that are located in Qingdao. Our facilities are located in the coastal city of Qingdao, near Qingdao International Airport and the international Qingdao harbor, which proximity ensures efficient international transportation by sea/air. Our facilities are used for customer service, sales and marketing, R&D and administrative functions. We believe our facilities are adequate for our current needs.

 

A summary description of our facilities is as follows (this list does not include any of the outsourcing facilities that we may, from time to time, use to support our production needs):

 

      Capacity Ton per day   Location  Total area (square feet)   rent/owned
1  Lingang facility   N/A   Building 10, 1388 Taifa Road, Huangdao District, Qingdao City   211,047   owned
2  Pude facility   5.8   West point, Jueshan Road, Huangdao District, Qingdao City   30,565   owned
3  Haiqing facility   1.6   Haiqing Town, Huangdao District, Qingdao City   109,145   rent
4  Zhangjialou facility   3.6   Big Cuijia Village, Zhangjialou Town, Huangdao District, Qingdao City   21,528   rent
5  Jiaozhou facility   1   Shiqian Village, Ducun Town, Jiaozhou City, Shandong Province   30,062   rent
   Total   12.0       402,347    

 

Our daily production capacity for all of our production facilities is approximately 12 tons.

 

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The Lingang facility was purchased in December 2018 with a consideration of approximately $6,238,700 (RMB 42,900,000) in order to make up for the loss of Canning facility production capacity. The purchase was financed by bank loans and seller financing. It is a five story building with a total space of 211,047 square feet. It is expected to commence production at the end of 2019.  

 

We own the Pude facility which formerly was registered as a Japanese agriculture, forestry and fishing factory. This facility makes products specifically for the Japanese market. Our daily production capacity at this facility is approximately 5.8 tons.

 

We lease our Haiqing facility from the government of Haiqing Town under the terms of 50-year lease agreement, which term commenced on December 31, 2011 and will expire on December 31, 2061. The lease payment of RMB700,000 was paid in lump sum in the beginning of the lease. This facility has a production area of 100,233 square feet and 8,912 square feet of office space, and maintains export commodity inspection registration from Shandong Huangdao Bureau of Inspection and Quarantine. Our daily production capacity at this facility is approximately 1.6 tons.

 

We lease the Zhangjialou facility under the terms of 3-year lease agreement from January 1, 2015 to December 31, 2017. This facility has production area of 21,528 square feet. Our daily production capacity at this facility is approximately 3.6 tons. We lease this space from Cui Runrang, CEO’s father. We renewed the lease on January 1, 2018 with a lease term of three years.

 

We lease the Jiaozhou facility under the terms of 10-year lease agreement from September 11, 2017 to September 10, 2027. This facility has production area of 30,062 square feet. Our daily production capacity at this facility is approximately one ton. We lease this space from Qingdao Saike Environmental Technology Co., Ltd.

 

Certain of the properties listed above are leased from our related parties.

 

Government Regulation

 

In the U.S., the Food and Drug Administration regulates both content and labeling of all animal food, China does not have a significant body of pet food laws, rules or regulations. Various regulatory agencies (e.g., the Ministry of Agriculture, the General Administration for Quality Supervision, Inspection and Quarantine) administer a set of standards, but there appears to be no single regulatory or administrative agency that is fulfills the comprehensive regulatory function. We are also subject to PRC labor and employment laws, laws governing advertising and other laws. We monitor changes in these laws and believe that our operations are in compliance in all material aspects with all PRC rules and regulations applicable to pet food production. However, many such rules and regulations are subject to extensive interpretive power of governmental agencies and commissions, and there is substantial uncertainty regarding the future interpretation and application of these laws or regulations.

  

Regulation of Foreign Currency Exchange and Dividend Distribution

 

Foreign Currency Exchange. The principal regulations governing foreign currency exchange in China are the Foreign Exchange Administration Regulations (1996), as amended on August 5, 2008, the Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996) and the Interim Measures on Administration on Foreign Debts (2003). Under these regulations, Renminbi are freely convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions, but not for most capital account items, such as direct investment, loans, repatriation of investment and investment in securities outside China, unless the prior approval of State Administration of Foreign Exchange (SAFE) or its local counterparts is obtained. In addition, any loans to an operating subsidiary in China that is a foreign-invested enterprise, cannot, in the aggregate, exceed the difference between its respective approved total investment amount and its respective approved registered capital amount. Furthermore, any foreign loan must be registered with SAFE or its local counterparts for the loan to be effective. Any increase in the amount of the total investment and registered capital must be approved by the PRC Ministry of Commerce or its local counterpart. We may not be able to obtain these government approvals or registrations on a timely basis, if at all, which could result in a delay in the process of making these loans. The dividends paid by the subsidiary to its shareholder are deemed shareholder income and are taxable in China. Pursuant to the Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), foreign-invested enterprises in China may purchase or remit foreign exchange, subject to a cap approved by SAFE, for settlement of current account transactions without the approval of SAFE. Foreign exchange transactions under the capital account are still subject to limitations and require approvals from, or registration with, SAFE and other relevant PRC governmental authorities.

 

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Dividend Distribution. The principal regulations governing the distribution of dividends by foreign holding companies include the Company Law of the PRC (1993), as amended in 2013, the Foreign Investment Enterprise Law (1986), as amended in 2000 and 2016 respectively, and the Administrative Rules under the Foreign Investment Enterprise Law (1990), as amended in 2001 and 2014 respectively. Under these regulations, wholly foreign-owned investment enterprises in China may pay dividends only out of their retained profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, wholly foreign-owned investment enterprises in China are required to allocate at least 10% of their respective retained profits each year, if any, to fund certain reserve funds unless these reserves have reached 50% of the registered capital of the enterprises. These reserves are not distributable as cash dividends, and a wholly foreign-owned enterprise is not permitted to distribute any profits until losses from prior fiscal years have been offset.

 

Circular 37. On July 4, 2014, SAFE issued Circular 37, which became effective as of July 4, 2014. According to Circular 37, PRC residents shall apply to SAFE and its branches for going through the procedures for foreign exchange registration of overseas investments before contributing the domestic assets or interests to a SPV. An amendment to registration or filing with the local SAFE branch by such PRC resident is also required if the registered overseas SPV’s basic information such as domestic individual resident shareholder, name, operating period, or major events such as domestic individual resident capital increase, capital reduction, share transfer or exchange, merger or division has changed. Although the change of overseas funds raised by overseas SPV, overseas investment exercised by overseas SPV and non-cross-border capital flow are not included in Circular 37, we may be required to make foreign exchange registration if required by SAFE and its branches. Moreover, Circular 37 applies retroactively. As a result, PRC residents who have contributed domestic assets or interests to a SPV, but failed to complete foreign exchange registration of overseas investments as required prior to implementation of Circular 37, are required to send a letter to SAFE and its branches for explanation. Under the relevant rules, failure to comply with the registration procedures set forth in Circular 37 may result in receiving a warning from SAFE and its branches, and may result in a fine of up to RMB 300,000 for an organization or up to RMB 50,000 for an individual. PRC residents who control our company are required to register with SAFE in connection with their investments in us. If we use our equity interest to purchase the assets or equity interest of a PRC company owned by PRC residents in the future, such PRC residents will be subject to the registration procedures described in Circular 37.

  

New M&A Regulations and Overseas Listings

 

On August 8, 2006, six PRC regulatory agencies, including the Ministry of Commerce, the State Assets Supervision and Administration Commission, the State Administration for Taxation, the State Administration for Industry and Commerce, China Security Regulation Commission (CSRC) and SAFE, jointly issued the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the New M&A Rule, which became effective on September 8, 2006 and was amended on June 22, 2009. This New M&A Rule, among other things, includes provisions that purport to require that an offshore special purpose vehicle formed for purposes of overseas listing of equity interests in PRC companies and controlled directly or indirectly by PRC companies or individuals obtain the approval of CSRC prior to the listing and trading of such special purpose vehicle’s securities on an overseas stock exchange. On September 21, 2006, CSRC published on its official website procedures regarding its approval of overseas listings by special purpose vehicles. The CSRC approval procedures require the filing of a number of documents with the CSRC and it would take several months to complete the approval process. The application of this new PRC regulation remains unclear with no consensus currently existing among leading PRC law firms regarding the scope of the applicability of the CSRC approval requirement. Our PRC counsel has advised us that, based on their understanding of the current PRC laws and regulations:

 

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  ● We currently control the Operating Companies by virtue of TDH HK Holding acquiring 100% of the equity interests of Qingdao Tiandihui, which are regulated by the New M&A Rule. According to the New M&A Rule, when a domestic company or a domestic natural person, through an overseas company established or controlled by it, to acquire a domestic company’s equity interest which is related to or connected with it, approval from Ministry of Commerce is required. At the time of our equity interest acquisition, as the acquiree, Qingdao Tiandihui was not related to or connected with the foreign investor, or the acquirer, TDH HK Holding. Accordingly, we did not need the approval from Ministry of Commerce. In addition, we have received all relevant approvals and certificates required for the acquisition; and

 

  ● The CSRC approval under the New M&A Rule only applies to overseas listings of SPVs that have used their existing or newly issued equity interest to acquire existing or newly issued equity interest in Chinese domestic companies, or a SPV-domestic company share swap. TDH Holdings, Inc. does not constitute a SPV that is required to obtain approval from the CSRC for overseas listing under the New M&A Rule because there has not been any SPV-domestic company share swap in our corporate history; and

 

Notwithstanding the above analysis, the CSRC has not issued any definitive rule or interpretation regarding whether offerings like the one contemplated by this Annual Report are subject to the New M&A Rule.

 

Regulations on Offshore Parent Holding Companies’ Direct Investment in and Loans to Their PRC Subsidiaries

 

An offshore company may invest equity in a PRC company, which will become the PRC subsidiary of the offshore holding company after investment. Such equity investment is subject to a series of laws and regulations generally applicable to any foreign-invested enterprise in China, which include the Wholly Foreign-owned Enterprise Law, the Sino-foreign Equity Joint Venture Enterprise Law, the Sino-foreign Contractual Joint Venture Enterprise Law, all as amended from time to time, and their respective implementing rules; the Administrative Provisions on Foreign Exchange in Domestic Direct Investment by Foreign Investors; and the Notice of the State Administration on Foreign Exchange on Further Improving and Adjusting Foreign Exchange Administration Policies for Direct Investment.

 

Under the aforesaid laws and regulations, the increase of the registered capital of a foreign-invested enterprise is subject to the prior approval by the original approval authority of its establishment. In addition, the increase of registered capital and total investment amount shall both be registered with SAIC, MOFCOM and SAFE. Shareholder loans made by offshore parent holding companies to their PRC subsidiaries are regarded as foreign debts in China for regulatory purpose, which is subject to a number of PRC laws and regulations, including the PRC Foreign Exchange Administration Regulations, the Interim Measures on Administration on Foreign Debts, the Tentative Provisions on the Statistics Monitoring of Foreign Debts and its implementation rules, and the Administration Rules on the Settlement, Sale and Payment of Foreign Exchange. Under these regulations, the shareholder loans made by offshore parent holding companies to their PRC subsidiaries shall be registered with SAFE. Furthermore, the total amount of foreign debts that can be borrowed by such PRC subsidiaries, including any shareholder loans, shall not exceed the difference between the total investment amount and the registered capital amount of the PRC subsidiaries, both of which are subject to the governmental approval.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

 

Not applicable.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Overview

 

We started our company in 2002 in Qingdao, Shandong Province, PRC with a single mission of becoming a premier producer of high-quality pet food for pet owners in China and worldwide. Our growth has been driven by two key factors: a significant increase in the number of pet owners and in the size of the pet food market in China which translated into expansion opportunities for us, and a fundamental change in Chinese society towards pets, pet ownership and care, such that the trends of pet humanization and consumer concerns for pet health and wellness have created a dynamically growing industry for pet food and products. We price our products to be accessible to the average consumer, providing us with broad demographic appeal and allowing us to penetrate multiple market segments. Founded on these building blocks, as well as on our in-depth research and development, production, and sales capabilities, we believe we are well prepared to be one of the leading producers of pet food in the PRC and beyond.

   

We are a holding company incorporated in the British Virgin Islands in September 2015. We own all of the outstanding capital stock of TDH HK Limited, our wholly owned Hong Kong subsidiary, which, in turn, owns all of the outstanding capital stock of Qingdao Tiandihui Foodstuffs Co., Ltd., our operating subsidiary based in Qingdao City, Shandong Province, China, which subsidiary incorporated in April 2002 as a domestic Chinese limited liability company. As of the date of this filing, we hold a 99% interest in TDH Petfood LLC, a Nevada limited liability company. We conduct all of our business through Tiandihui, which has three wholly-owned subsidiaries: Beijing Chongai Jiujiu Cultural Communication Co., Ltd. (incorporated on March 3, 2011), Qingdao Kangkang Development Co., Ltd. (incorporated on August 9, 2016) and Qingdao Lile Foodstuffs Co., Ltd.; and two majority-owned subsidiaries: Yichong (Qingdao) Technology Co., Ltd. (incorporated on November 14, 2017) and Qingdao Lingchong Information Technology Co., Ltd. (incorporated on November 29, 2017). In addition, TDH Group BVBA, a Belgium company was wholly-owned by TDH Holdings, Inc.; TDH JAPAN, a Japanese company was wholly-owned by TDH Holdings, Inc.

 

Our principal executive office is located at c/o Qingdao Tiandihui Foodstuffs Co. Ltd., Room 1809, Financial Square, 197 Shuangzhu Road, Huangdao District, Qingdao, Shandong Province, PRC. Our telephone number is +86 532-8591-9267. Our website address is www.tdhpet.com. The information on our website is not part of this Annual Report.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our audited consolidated financial statements and the related notes included elsewhere in this annual filing. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this annual filing.

 

Overview

 

We specialize in the development, manufacture and sale of a variety of pet food products under multiple brands that are well-established and recognizable by consumers in the PRC, Asia, Europe and North America. We offer in excess of 200 products, which are classified into 6 product lines: pet chews, dried pet snacks, wet canned pet food, dental health snacks, and baked pet biscuits (as well as non-food items like dog leashes, pet toys, etc.), and the others. Our multi-platform sales approach connects our production output to customers in the PRC, Asia, Europe and North America. Our rapid growth businesses, especially our most promising business of cross-border e-commerce and domestic e-commerce, is moving us forward to be one of the leading manufacturers of pet snacks in China and beyond.

 

Products research and development play an important role in our business. Our production processes are developed based upon a number of in-house developed technologies. The primary focus of such technologies is on customer needs, which allows us to maintain an effective market-oriented research and development model. Currently, we have been granted 20 invention and utility model patents, and applied 5 more patents. Because of our in-depth research and development effort and our proprietary recipes, cooking techniques and packaging developed over the last decade, we are able to provide differentiated pet food products to consumers throughout the world.

 

We own two facilities and lease three others, built to high quality food production standards, all of which are located at the areas with developed transport facilities in the coastal city of Qingdao City Shandong Province, PRC.  Our total daily production capacity at these facilities is approximately 12 tons.

 

We also maintain a call service center in Qingdao with approximately 8 trained, multilingual personnel to address customer service matters arising from our sales in the PRC and abroad.

 

We employ approximately 204 full-time employees at our facilities. With the exception of our subsidiary’s offices located in Beijing, all of our production, executive, sales/marketing and customer service facilities covering the PRC and overseas markets are located in Shandong Province, PRC.

 

Our workforce is highly skilled in animal nutrition, sales and marketing. Led by Cui Rongfeng, our founder, chairman and chief executive officer, our management team is comprised of an experienced group of executives, with have many years of operating experience in their respective departments.

 

We actively pursue markets in which our products can make a substantial difference to customers. Our current capabilities allow us to develop new and innovative products and obtain new distribution channels for existing and potential markets. Starting from 2013, we utilize online sale and multi-brand, multi-store brand sale strategies. We use Tmall.com, JD.com, 1688, YHD, eBay, and Amazon as our marketing platforms and establish a comprehensive network of various brand shops in China, and set up direct sale website in Europe and US. Our products are available in multiple forms, including slice and serve rolls, strips, tubs, etc. All of our products are sold under several different brand names, including, among others, Pet Cuisine, Hum & Cheer, Like, TDH, Tiandihui and Dog Zone Sasami.

 

Our sales and marketing team consists of 2 integral groups – an original design manufacturer (ODM) domestic (PRC) marketing group, and ODM overseas marketing group. We operate a B2F (business-2-factory) business model. Our model relies on our R&D strength to devise product lines and provide our customers with personalized and customized products. As a part of our ODM production process, we continuously accumulate a large amount of market information about our customers, in the PRC and abroad, which assists us in making appropriate selection of products. We utilize online sale and multi-brand, multi-store brand sale strategies. Using Tmall.com, JD.com, 1688.com, Alibaba.com, YHD.com, and Amazon as our marketing platforms, our PRC marketing group has established a comprehensive network of various brand shops. In addition, our cross-border marketing/sales group mainly relies on Amazon and eBay platforms as well as direct sale websites in Europe and the U.S. to operate its marketing and sales efforts.

 

We operate our business in China through our wholly-owned and majority-owned subsidiaries, Tiandihui, Chongai Jiujiu, Kangkang Development, Lile, Yichong and Lingchong.

 

Revenues

 

We derive our revenues from wholesale and retail of pet food, mainly through our oversea and domestic agents, and electronic commerce platforms. Revenue consists of the invoiced value for the sales, net of value-added tax (“VAT”), business tax, applicable local government levies and returns.

 

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The following factors affect the revenues we derive from our operations.

 

Maintain our competitive advantages. Based on our strength in research and development, we can provide more than 200 pet snack products which give our customers more choices and a greater sense of satisfaction. We focus on the needs of the market and provide our customers with personalized and customized products. We have formed our own unique and competitive advantages. However, the market conditions and consumer preferences change rapidly. If we fail to maintain our reputation and competitiveness, customers demand for our products could decline.

 

Competition. The market of pet food is very competitive. The number of pet food manufacturers is increasing due to the growth of actual and predicted demand for pet food products and the relatively low barriers to entry. Moreover, Our PRC market is characterized by price competition, product quality and the presence of a number of medium to large companies. We are subject to pricing pressure and may experience a decline in average selling prices for our products. We compete with a significant number of companies of varying sizes, including divisions or subsidiaries of larger companies who may have greater financial resources and larger customer bases than we have. As a result, these competitors may be able to identify and adapt to changes in consumer preferences more quickly than us due to their resources and scale. They may also be more successful in marketing and selling their products, better able to increase prices to reflect cost pressures and better able to increase their promotional activity, which may impact us and the entire pet food industry. In order to mitigate the pricing pressure, we have to differentiate ourselves from our competitors based on the value we bring to our customers through the quality and variety of our products. If we fail to attract and retain customers in our target markets for our current and future products, we will be unable to maintain or increase our revenues and market share. 

 

Some of our competitors have established more prominent market positions. We believe that our principal competitors include the following companies: Yantai China Pet Foods Co., Ltd., Wenzhou Peidi Pet Products Co., Ltd. and Shouguang Xincheng Food Co., Ltd.

 

Expansion of E-commerce sales. Our E-commerce business contributed approximately 16.05%, 19.79% and 18.25% of our 2018, 2017 and 2016 total revenue, respectively. The amount was $3,800,668 for the year ended December 31, 2018 from $5,734,121 for the year ended December 31, 2017, representing a decrease of 33.72%. If we fail to expand our E-commerce business, our total revenue could continue to decrease.

 

Loss of key personnel. Our revenue was derived from our competitive advantages in our products. We rely heavily on the expertise and leadership of our senior management to maintain our core competence. The loss of the service of any of our key personnel could adversely affect our business. We have obtained non-compete agreements and confidentiality agreements from our scientist and technique staffs in our research and development and manufacturing departments.

 

Potential trade protection action. Trade protectionism actions in the United States, the European Union or elsewhere around the world could result in additional duties and tariffs on the importation of pet food from China to each respective national market.  Any determination of duties and tariffs against importation of our modules into the United States and Europe could adversely affect our ability to sell products in these countries that could impact our sales, business operations, competitiveness, and profitability.

 

Group boycott initiated by the local pet food association. We continue to rely on the local agents to expand our sales in overseas market. It has been our experience that pet food associations in certain countries are influential in local markets. It is possible that these associations may boycott our pet snack products for the reasons such as low prices and other market specific concerns. If and to the extent that happens, our revenues will be adversely affected.

 

Macro-economic conditions. Our business, financial condition and results of operations may be materially adversely affected by a challenging economic climate, including adverse changes in interest rates, volatile commodity markets and inflation, contraction in the availability of credit in the market and reductions in consumer spending. A macroeconomic downturn, which decreases the disposal personal income and reduces the need for luxury goods, may contribute to decreased sales of our pet food products. Conversely, the economic growth may result in more sales of our pet food products.

 

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Costs and Expenses

 

We primarily incur the following costs and expenses:

 

Costs of revenues. Cost of revenues consists primarily of direct raw materials, direct payroll of workshop staff, utility and supply costs consumed in the manufacturing process, manufacturing labor, depreciation expense and overhead expenses necessary to manufacture finished goods as well as distribution costs such as inbound freight charges.

 

Selling, general and administrative expenses. Selling, general and administrative expenses consist primarily of compensation expense for our corporate staff in supporting departments, communication costs, gasoline, shipping and handling cost, welfare expenses, education expenses, professional fees (including consulting, audit and legal fees), travel and business hospitality expenses.

 

Income tax expense. We account for income taxes under the provisions of Section 740-10-30 of the FASB Accounting Standards Codification, which is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the financial statements or tax returns.

 

The following factors affect our cost of revenues and expense.

 

Price fluctuation of raw materials. The purchase of raw materials accounts for the majority of cost of goods sold. The price of raw materials is out of our control and the fluctuation of materials may significantly affect our operating results. Although our current materials supply is stable, we could be impacted by material price fluctuation in coming years.

  

Prevailing salary levels. Our cost of revenues is impacted by prevailing salary levels. Although we have not been subject to significant wage inflation in China, a significant increase in the market rate for wages could harm our operating results and our operating margin. Our ability to attract, retain, and expand our senior management and our professional and technical staff is an important factor in determining our future success. The market for qualified scientists and researchers is competitive. From time to time, it may be difficult to attract and retain qualified individuals with the required expertise at a fair wage. An increase in compensation of our scientists and researchers may increase our operating cost.

 

Depreciation. Our depreciation expenses are mainly driven by the net value of machinery equipment, motor vehicles, buildings and other items. Depreciation of property, plant and equipment is calculated based on cost, less their estimated residual value, if any, using the straight-line method over estimated useful life from 5 years to 50 years. Any change of the depreciation accounting policy or impairment of our property may affect our operating results.

 

Shipping and handling expense. Our shipping and handling expense includes domestic freight, oversea freight, domestic express fee, distribution cost in European Union and North America. Our domestic express fee accounted for approximately 15.76% of the related revenue, and our distribution cost inside European Union and North America, which was outsourced to Amazon, reached 78.00% of the related revenue. In order to reduce handling cost in sales, we try to decrease the domestic express fee by larger scale and closer cooperation with express company, and set up our own distribution department to replace the Amazon.

 

Research and Development expense. Due to the uncertainty for the result of our R&D activities, we expensed all of our R&D expenditure. The R&D expense for the years ended December 31, 2018, 2017 and 2016 was $1,062,582, $1,051,665 and $1,076,568 respectively. We expected more R&D projects would be approved and implemented, in the coming years to maintain our competitive advantage.

 

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Results of Operations

 

For the years ended December 31, 2018, 2017 and 2016

 

   December 31,         
   2018   2017   2016   2018 vs 2017   2017 vs 2016 
   $   $   $         
Net revenues   22,154,506    28,473,016    24,443,736    -22.19%   16.48%
Net revenues-related parties   1,519,531    506,495    -    200.01%   100%
Cost of revenues   26,278,300    20,283,321    17,368,249    29.56%   16.78%
Cost of revenues-related parties   1,448,533    399,177    -    262.88%   100%
Gross profit   (4,052,796)   8,297,013    7,075,487    -148.85%   17.26%
Gross margin   -17.12%   28.63%   28.95%   N/A   N/A
Selling expense   4,535,945    4,882,367    3,439,843    -7.10%   41.94%
R&D expense   1,062,582    1,051,665    1,076,568    1.04%   -2.31%
General and administrative expense   2,792,858    2,095,676    1,407,787    33.27%   48.86%
Impairment of goodwill   1,599,591    -    -    100 %    - 
                          
Operating income (loss)   (14,043,772)   267,305    1,151,289    -5353.84%   -76.78%

 

Revenues.

 

Our revenue was $23,674,037, $28,979,511 and $24,443,736 for the years ended December 31, 2018, 2017 and 2016, respectively, a decrease of $5,305,474, and an increase $4,535,775, respectively. In 2018, we experienced an increase in the costs of raw materials which increased our production costs. While we attempted to pass such increases onto our customers, we were largely unsuccessful in this effort as it rendered our sale prices noncompetitive. As a result, our revenues for the fiscal year 2018 decreased as compared with the fiscal year 2017.

 

The following table displays our revenue by different marketing channels.

 

   For the Years Ended         
   December 31,         
   2018   2017   2016   2018 vs 2017   2017 vs 2016 
Overseas sales  $15,832,362   $21,190,063   $18,882,589    -25%   12%
Domestic sales   4,102,457    2,086,462    1,129,133    97%   85%
Electronic commerce   3,800,668    5,734,121    4,461,504    -34%   29%
Less: Sale tax and addition   (61,450)   (31,135)   (29,490)   97%   6%
Total net revenues  $23,674,037   $28,979,511   $24,443,736    -18%   19%

 

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Year Ended December 31, 2018 Compared to Year Ended December 31, 2017

 

For the year ended December 31, 2018, our overseas sales and E-commerce sales decreased by $5,357,701 and $1,933,453, respectively, compared with the year ended December 31, 2017. The decrease was mainly due to heavy competition, resulting in decreased demand on our products. In addition, the Company experienced the Shanghai Cooperation Organization summit and relocation of Canning facility during 2018, and the production capacity and productivity had been adversely impacted.

 

For the year ended December 31, 2018, our domestic sales increased by $2,015,995, compared with the year ended December 31, 2017. The increase was mainly due to our effort on expanding domestic market.

 

Year Ended December 31, 2017 Compared to Year Ended December 31, 2016

 

For the year ended December 31, 2017, our overseas sales and E-commerce sales increased by $2,307,474 and $1,272,617, respectively, compared with the year ended December 31, 2016. The increase was due to our competitive products price and extensive marketing promotions.

 

For the year ended December 31, 2017, our domestic sales increased by $957,329, compared with the year ended December 31, 2016. The increase was mainly due to our effort on expanding domestic market.

 

The following table displays our revenue by different products lines.

 

   For the Years Ended         
   December 31,         
   2018   2017   2016   2018 vs 2017   2017 vs 2016 
Pet chews  $6,271,777   $9,614,426   $10,316,841    -35%   -7%
Dried pet snacks   13,611,010    14,851,868    11,204,517    -8%   33%
Wet canned pet food   2,782,382    3,035,196    1,926,455    -8%   58%
Dental health snacks   495,581    856,875    606,648    -42%   41%
Baked pet biscuits   95,169    8,226    123,898    1057%   -93%
Others   479,568    644,055    294,867    -26%   118%
Less: Sale tax and addition   (61,450)   (31,135)   (29,490)   97%   6%
Total net revenues  $23,674,037   $28,979,511   $24,443,736    -18%   19%

 

Year Ended December 31, 2018 Compared to Year Ended December 31, 2017

 

Revenue generated from Pet chews pet foods decreased by $3,342,649 or 35%, from the year ended December 31, 2017 to the year ended December 31, 2018. Revenue generated from dried pet snacks decreased by $1,240,858 or 8%, from the year ended December 31, 2017 to the year ended December 31, 2018. Revenue generated from wet canned pet foods decreased by $252,814 or 8%, from the year ended December 31, 2017 to the year ended December 31, 2018. These decreases were mainly due to the fact that (1) we did not renew certain sale contracts as the selling prices offered were too low to make a profit. and (2) our total daily production capacity decreased from 16 tons to 12 tons in 2018 due to the lease expiration for the Canning facility in 2018. 

 

Year Ended December 31, 2017 Compared to Year Ended December 31, 2016

 

Revenue generated from dried pet snacks increased by $3,647,351 or 33%, from the year ended December 31, 2016 to the year ended December 31, 2017.

 

Revenue generated from wet canned pet foods increased by $1,108,741 or 58%, from the year ended December 31, 2016 to the year ended December 31, 2017. The increase was mainly due to the promotion of some new canned food products, such as intestine products.

 

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The revenue generated from different countries are set forth as following:

 

   For the Years Ended         
   December 31,         
   2018   2017   2016   2018 vs 2017   2017 vs 2016 
South Korea  $2,870,998   $5,397,982   $5,299,721    -47%   2%
China   6,569,382    6,553,715    5,073,272    0%   29%
United Kingdom   2,415,043    3,213,303    3,227,619    -25%   0%
Germany   2,522,149    3,585,535    3,204,314    -30%   12%
Other countries   9,357,915    10,260,111    7,668,300    -9%   34%
Less: Sale tax and addition   (61,450)   (31,135)   (29,490)   97%   6%
Total net revenues  $23,674,037   $28,979,511   $24,443,736    -18%   19%

 

“Other countries” is comprised of all countries whose revenues, individually, were less than 10% of the Company’s revenues. 

 

Year Ended December 31, 2018 Compared to Year Ended December 31, 2017

 

Revenue generated from South Korea decreased by $2,526,984 or 47%, which resulted from the loss of a big customer in 2018.

 

As the production cost and oversea delivery cost increased significantly, some sales contract could not cover the related total cost. We did not accept these kinds of orders, which resulted in the decrease of revenue from some countries in 2018, for example, the United Kingdom and Germany.

 

Year Ended December 31, 2017 Compared to Year Ended December 31, 2016 

 

Revenue generated from China increased by $1,480,443 or 29%, from the year ended December 31, 2016 to the year ended December 31, 2017. The increase was due to the greater demand for our products in Chinese market.

 

Revenue generated from other countries increased by $2,591,811 or 34%, from the year ended December 31, 2016 to the year ended December 31, 2017. The increase was due to the fact that our businesses have developed to additional overseas marketplaces for the year ended December 31, 2017.

 

42

 

Cost of revenues

 

Our cost of revenues is primarily comprised of the cost of our raw materials, labor and factory overhead. Our cost of revenues, increased by $7,044,335, or 34.06%, for the year ended December 31, 2018 compared to the year ended December 31, 2017. This dollar increase in cost of revenues was mainly due to increased raw material costs, such as chicken, beef and pork, write-down of obsolete inventories and low productivity after the relocation of one of our main production facilities. Our cost of revenues as a percentage of revenue was 117.12%, and 71.37% for the years ended December 31, 2018, and 2017, respectively.

 

Our cost of revenues, increased by $3,314,249, or 19.08%, for the year ended December 31, 2017 compared to the year ended December 31, 2016. This increase in cost of revenues was mainly due to the 18.56% increase in our total net revenue for the year ended December 31, 2017. Our cost of revenues as a percentage of revenue was 71.37% and 71.05% for the years ended December 31, 2017, and 2016, respectively.

 

Gross margin

 

Our gross margin was negative 17.12% for the year ended December 31, 2018, and decreased by 45.75%, from 28.63% for the year ended December 31, 2017. This sharply decrease in 2018 was primarily due to the fact that the significant decrease in revenue due to the heavy competition and the significant increase in price of raw materials due to market price fluctuations. In particular, the reasons could be concluded as follows:

 

  ● Unit price for our main raw materials increased significantly in 2018. For example, the average unit price for big chicken breasts increased to RMB11.69 in 2018 from RMB9.33 in 2017, representing an increase of 20%, and the average unit price for small chicken breast increased to RMB10.93 in 2018 from RMB9.33 in 2017, representing an increase of 17%. We could not pass the rising raw material costs to our customers. In addition, after we raised prices on new orders, we saw some of our customers, including a few significant ones, cease purchasing from us.  

 

  ● The relocation of our largest factory, the Canning facility, resulted in reducing our total production capacity from 18 tons to 12 tons per day. The relocation of Canning facility resulted in more inventory damage, and low productivity led to more materials consumed.

 

  ● Parts of our completed and semi-finished products were damaged by the summer rainstorms. We had to dispose of damaged inventory at a much lower price or scrap the inventory and record as cost. 

 

Our gross margin was 28.63%, maintained stable for the year ended December 31, 2017, compared with 28.95% for the year ended December 31, 2016. Our semi-finished goods from outsourcing factories accounted for 24.55% of our total purchasing amount in 2017, compared to 39.13% in 2016. The significant increase in outsourcing production contributed to our conversion cost as a percentage of revenue decreased by 2.51%, from 11.07% for the year ended December 31, 2016, to 8.56% for the year ended December 31, 2017, while the direct materials cost as percentage of revenue decreased by 4.68%, from 69.10% for the year ended December 31, 2016, to 64.42% for the year ended December 31, 2017.

 

Our gross margin for third parties was 28.75% for the year ended December 31, 2017. And the gross margin for related party was 21.19% for the year ended December 31, 2016.

 

Operating expenses.

 

Operating expenses were $9,990,976, and $8,029,708 for the years ended December 31, 2018, and 2017 respectively, an increase of $1,961,268, or 24.43%. Accordingly, the ratio of operating expenses as a percentage of revenue increased year by year, from 24.24% for the year of 2016, 27.71% for the year of 2017, to 42.20% for the year ended December 31, 2018.

 

Selling expense was $4,535,945, and $4,882,367 for the years ended December 31, 2018, and 2017, respectively, a decrease of $346,422, or negative 7.10%. Some related expense was saved due to the decline of sales in 2018, such as distribution cost, which decreased the total selling expense for the year ended December 31, 2018.  

 

General and administrative expenses was $2,792,858, and $2,095,676 for the years ended December 31, 2018, and 2017 respectively, representing an increase of $697,182, or 33.27%. The increase was mainly resulted from increase in overall payroll level and increase in rental expenses.

 

Impairment of goodwill was $1,599,591 for the year ended December 31, 2018. We took full impairment provision for the goodwill generated in connection with the acquisition of TDH JAPAN and TDH Group BVBA.

 

43

 

The research and development expense remained stable for the years ended December 31, 2018, and 2017, which were $1,062,582, and $1,051,665, respectively.

 

Operating expenses were $8,029,708, and $5,924,198 for the years ended December 31, 2017, and 2016, respectively, an increase of $2,105,510, or 35.54%. Therefore, the scale of increase in operating expenses was larger than the increase in revenue. Accordingly, the ratio of operating expenses as a percentage of revenue increased from 24.24% for the year of 2016, to 27.71% for the year ended December 31, 2017.

 

Selling expense was $4,882,367, and $3,439,843 for the years ended December 31, 2017, and 2016, respectively, an increase of $1,442,524, or 41.94%. The increase in selling expense was mainly due to the increase in e-commerce promotion expenses, e-commerce platform commission, shipping and handling expenses and payroll expenses for marketing personnel. As it was the Company’s strategy to expand e-commerce business for the year ended December 31, 2017.

 

General and administrative expenses was $2,095,676, and $1,407,787 for the years ended December 31, 2017, and 2016, respectively, representing an increase of $687,889, or 48.86%. The increase was mainly due to the additional professional fee related to the IPO and the increase in management’s compensation.

 

The research and development expense remained stable for the years ended December 31, 2017 and 2016. Meanwhile, we obtained three invention patents in 2017, and were applying for ten patents as of December 31, 2017.

   

Income (loss) from operations.

 

Our loss from operations was $14,043,772 for the year ended December 31, 2018, while our income from operations was $267,305 for the year ended December 31, 2017. Our operating loss as a percentage of total revenues was negative 59.32%, and positive 0.92% for the years ended December 31, 2018 and 2017, respectively. The significant deficit from operation was due to the fact that the raw material cost and manufacturing cost increased significantly, resulted in adverse bargaining position of the Company and loss of customers in 2018.

 

Our income from operations was $267,305, and $1,151,289 for the years ended December 31, 2017, and 2016, respectively. Our operating income as a percentage of total revenues was 0.92%, and 4.71% for the years ended December 31, 2017, and 2016 respectively. The decrease in our income from operations mainly resulted from the scale of increase in operating expenses was larger than the increase in revenue for the year ended December 31, 2017.

 

Income taxes expense (benefit).

 

We incurred income tax expense of $0 for the year ended December 31, 2018 and incurred income tax benefit of $55,102 for the years ended December 31, 2017. We did not incur any income tax expense due to the deficit in 2018.

 

We incurred income tax benefit of $55,102 for the year ended December 31, 2017 and incurred income tax expense of $89,801 for the years ended December 31, 2016. Due to the additional deduction of R&D expense and less net income, we incurred income tax benefit for the year ended December 31, 2017.

 

Net income (loss).

 

Our net loss was $14,219,265 for the year ended December 31, 2018, compared to the net income of $115,111 for the year ended December 31, 2017. The large deficit was due to the negative margin and larger operating expense incurred in 2018.

 

Our net income was $115,111, and $ 1,009,171 for the years ended December 31, 2017, and 2016, respectively, representing a decrease of $894,060. The decrease in net income for the year ended December 31, 2017 was mainly due to the 41.94% increase in selling expense and the 48.86% increase in general and administrative expenses.

 

44

 

Liquidity and Capital Resources

 

For the years ended December 31, 2018, 2017 and 2016

 

Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations and otherwise operate on an ongoing basis. At December 31, 2018, our working capital was negative $11,340,516, compared to working capital of $6,922,696 at December 31, 2017.

 

Our cash and cash equivalents balance totaled $893,020, $2,346,109, and $1,145,103 at December 31, 2018, 2017 and 2016 respectively.

 

During the year ended December 31, 2018, we used cash in operating activities of $2,173,742, used cash in investing activities of $6,594,458, provided cash by financing activities of $7,728,120, and had the positive effect of prevailing exchange rates on our cash of $96,808. During the year ended December 31, 2017, we used cash in operating activities of $2,674,936, used cash in investing activities of $847,283, provided cash by financing activities of $5,258,773, and had positive effect of prevailing exchange rates on our cash of $55,000.

 

Net cash used in operating activities for the year ended December 31, 2018 totaled $2,173,742. The activities were mainly comprised of a net loss of $14,219,265, depreciation and amortization of $395,355, impairment of goodwill of $1,599,591, inventory write-down of $1,668,508, a decrease in net accounts receivable of $1,302,573, a decrease in net inventory of $4,203,927, an increase in notes payable of $1,204,910, an increase in account payable of $1,870,157, and offset by an increase in account receivable- related party of $778,516, an increase in prepayment and other current asset of $291,336.

 

Net cash used in operating activities for the year ended December 31, 2017 totaled $2,674,936. The activities were mainly comprised of an increase in net inventory of $2,658,359, an increase in net accounts receivable of $971,831, an increase in net accounts receivable – related party of $10,817, a decrease in advance from customers of $601,855, and offset by our net income of $115,111, depreciation and amortization expense of $364,170, an increase in account payable of $1,174,363, a decrease in advance to suppliers of $121,360, an increase in account payable - related parties of $32,440, an increase of advance from customers – related party of $7,241.

 

Net cash used in investing activities for the year ended December 31, 2018 totaled $6,594,458. The activities were primarily comprised of $5,627,422 payment to purchase property and equipment, payment to purchase of land use right of $854,221, loan of $132,147 offered to related parties, payment for long term investment of $235,605, and offset by collections from related parties of $235,049.

 

Net cash used in investing activities for the year ended December 31, 2017 totaled $847,283. The activities were primarily comprised of loan of $533,242 offered to related parties, payments to acquire property and equipment of $227,900, payments to acquire intangible assets of $103,596, and offset by repaid loan of $15,443 from related parties.

 

For the year ended December 31, 2018, net cash provided by financing activities was $7,728,120. We received these funds from borrowing of short term bank loan of $8,400,090, and borrowing of short term loan-related parties of $1,176,690, offset by repayment to related parties of $385,420 and repayment of short term loan of $1,508,056.

 

For the year ended December 31, 2017, net cash provided by financing activities was $5,258,773. We received these funds from borrowings from related parties of $1,073,961, borrowings from short term loan of $2,077,219, proceeds from issuing common shares of $5,542,047, proceeds from shares subscription of $827,730, offset by repayment of short term loan of $2,494,793, and repayment to related parties of $1,767,391.

 

45

 

Going Concern

 

Our consolidated financial statements have been prepared assuming we will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. However, for the year ended December 31, 2018, the Company has incurred a net loss of approximately $14.2 million and working capital deficit of approximately $11.3 million and its cash balance and revenues generated are not currently sufficient and cannot be projected to cover operating expenses and meet the Company’s obligations as they become due for the next twelve months after the date that our financial statements are issued. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plan to alleviate the substantial doubt about the Company’s ability to continue as a going concern include attempting to improve its business profitability, its ability to generate sufficient cash flow from its operations to meet its operating needs on a timely basis, obtain additional working capital funds through debt and equity financings to eliminate inefficiencies in order to meet its anticipated cash requirements. However, there can be no assurance that these plans and arrangements will be sufficient to fund the Company’s ongoing capital expenditures, working capital, and other requirements. The accompanying consolidated financial statements do not include any adjustments related to the recoverability or classification of asset-carrying amount or the amounts and classification of liabilities that may result should the Company be unable to continue as a going concern.

 

We believe that our current cash to be generated from our operations will not be sufficient to meet our working capital needs for the next twelve months. We expect to finance our working capital needs and planned facilities improvements and expansion from cash generated from operations, borrowings under our revolving line of credit, public or private equity or debt capital. However, we can make no assurance that we will raise sufficient capital at all. We may need to seek sources of financing, such as additional borrowings or public or private equity or debt capital. If and to the extent we cannot raise such additional capital in amounts required to finance our operations, we may have to significantly curtail or even shut down our operations.

 

In 2016, 2017 and 2018, we secured the following revolving lines of credit:

 

On January 8, 2015, we entered a line of credit of approximately $576,062 (RMB 4,000,000) from China Postal Savings Bank - Qingdao Branch. The borrowing under the line of credit was guaranteed by Rongfeng Cui and his wife, Yanjuan Wang. Under the term of the loan documentation, the loan term commenced on the date the borrowed capital was transferred to the borrower and continued until the all principal and accrued interest thereon are repaid in full. On November 28, 2016, we drew down the full amount of this loan; the term of this loan is one-year, the loan maturity date is November 27, 2017, with this loan bearing interest at approximately 125% of the prevailing PRC prime rate. The outstanding balance of this loan was $0 as of December 31, 2018.

 

On August 10, 2016, we obtained a line of credit of approximately $705,676 (RMB 4,900,000) from Industrial & Commercial Bank of China - Qingdao Shinan Second Branch. The borrowing under the line of credit was guaranteed by Rongfeng Cui and his wife, Yanjuan Wang. Under the term of the loan documentation, the loan term commenced on the date the borrowed capital was transferred to the borrower and continued until the all principal and accrued interest thereon were repaid in full. On June 6, 2017, we drew down the full amount of this loan; the term of this loan is 15-day, with this loan bearing interest at approximately 120% of the prevailing PRC prime rate. On July 6, 2017, this loan was repaid in full. On July 12, 2017, we obtained a new line of credit of approximately $412,371 (RMB 2,800,000) with the same lender. On July 14, 2017, we drew down the full amount of this loan. The loan maturity date is July 10, 2018 with annual interest rate of 5.22%. On July 9, 2018, this loan was repaid in full and the line of credit was recovered. On August 2, 2018, we drew down the full amount of this loan. The loan maturity date is July 16, 2019 with annual interest rate of 5.22%. The outstanding balance on this loan was approximately $407,000 (RMB 2,800,000) as of December 31, 2018.

 

On March 25, 2017, we obtained a line of credit of approximately $290,361 (RMB 2,000,000) from China Postal Savings Bank – Qingdao Weihai Road Sub Branch. The borrowing under the line of credit was guaranteed by Rongfeng Cui and his wife, Yanjuan Wang. Under the term of the loan documentation, the loan term commenced on the date the borrowed capital was transferred to the borrower and continued until the all principal and accrued interest thereon are repaid in full. On March 29, 2017, we drew down the full amount of this loan. The loan maturity date is March 28, 2018, bearing interest at approximately 140% of the prevailing PRC prime rate. On March 16, 2018, this loan was repaid in full and the line of credit is recovered. On March 21, 2018, we drew down the full amount of this loan. The loan maturity date is March 19, 2019 with annual interest rate of 6.96%. We made partial repayment of this loan during the year ended December 31, 2018 and the outstanding balance on this loan was approximately $147,000 (RMB 1,008,675) as of December 31, 2018.

  

On November 23, 2017, we obtained a line of credit of approximately $614,779 (RMB 4,000,000) from China Postal Savings Bank – Qingdao Weihai Road Sub Branch. The borrowing under the line of credit was guaranteed by Rongfeng Cui and his wife, Yanjuan Wang. Under the term of the loan documentation, the loan term commenced on the date the borrowed capital was transferred to the borrower and continued until the all principal and accrued interest thereon are repaid in full. On December 13, 2017, we drew down the full amount of this loan. The loan maturity date is December 12, 2018 with annual interest rate of 5.655%. On November 14, 2018, this loan was repaid in full and the line of credit is recovered. On November 19, 2018, we drew down the full amount of this loan. The loan maturity date is November 18, 2019 with annual interest rate of 5.22%. The outstanding balance on this loan was approximately $582,000 (RMB 4,000,000) as of December 31, 2018.

 

On April 27, 2018, the above line of credit from China Postal Savings Bank – Qingdao Weihai Road Sub Branch increased from approximately $582,000 (RMB 4,000,000) to approximately $1,439,700 (RMB 9,900,000). On May 8, 2018, we drew down the full amount of this loan. The loan maturity date is May 7, 2019 with annual interest rate of 5.8725%. The full amount of this loan was outstanding as of December 31, 2018.

 

Our long-term future capital requirements will depend on many factors, including our level of revenue, the timing and extent of our spending to support the maintenance and growth of our operations, the expansion of our sales and the continued market acceptance of our products and projects. Compared to $1,402,514 short-term loans outstanding as of December 31, 2017, we had $8,263,038 short-term loans outstanding as of December 31, 2018.

  

46

 

We expect to incur additional costs associated with being a reporting company in the United States, primarily due to increased expenses that we incur to comply with the requirements of the Sarbanes-Oxley Act of 2002, as well as costs related to accounting and tax services, legal expenses and investor and stockholder-related expenses. These additional long-term expenses may require us to seek other sources of financing, such as additional borrowings or public or private equity or debt capital. The availability of these other sources of financing will depend upon our financial condition and results of operations as well as prevailing market conditions, and may not be available on terms reasonably acceptable to us or at all.

 

Regulatory Restrictions on Capital Injections

  

We are using proceeds from our initial public offering to fund our business. Accordingly, the following regulations have to be followed, regarding capital injections to foreign-invested enterprises.  

 

Chinese regulations relating to investments in offshore companies by Chinese residents. SAFE promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Financing and Round-trip Investment through Offshore Special Purpose Vehicles, or SAFE Circular 37, on July 4, 2014. SAFE Circular 37 requires Chinese residents to register and update certain investments in companies incorporated outside of China with their local SAFE branch. SAFE also subsequently issued various guidance and rules regarding the implementation of SAFE Circular 37, which imposed obligations on Chinese subsidiaries of offshore companies to coordinate with and supervise any Chinese-resident beneficial owners of offshore entities in relation to the SAFE registration process.

 

We may not be aware of the identities of all of our beneficial owners who are Chinese residents. We do not have control over our beneficial owners and cannot assure you that all of our Chinese -resident beneficial owners will comply with SAFE Circular 37 and subsequent implementation rules. The failure of our beneficial owners who are Chinese residents to register or amend their SAFE registrations in a timely manner pursuant to SAFE Circular 37 and subsequent implementation rules, or the failure of future beneficial owners of our Company who are Chinese residents to comply with the registration procedures set forth in SAFE Circular 37 and subsequent implementation rules, may subject such beneficial owners or our Chinese subsidiaries to fines and legal sanctions, which may be substantial. Failure to register may also limit our ability to contribute additional capital to our Chinese subsidiaries and limit our Chinese subsidiaries’ ability to distribute dividends to our Company. These risks may have a material adverse effect on our business, financial condition and results of operations.

 

China regulates loans to and direct investment in Chinese entities by offshore holding companies and there is governmental control of currency conversion. We are an offshore holding company conducting our operations in China through our wholly owned subsidiary Tiandihui. As an offshore holding company, we may make loans and additional contributions to Tiandihui subject to approval from government authorities.

 

Any loan to Tiandihui, which is treated as a foreign-invested enterprise under Chinese law, is subject to Chinese regulations and foreign exchange loan registrations. In January 2003, the China State Development and Reform Commission, SAFE and Ministry of Finance jointly promulgated the Circular on the Interim Provisions on the Management of Foreign Debts, or the Circular 28, limiting the total amount of foreign debt a foreign-invested enterprise may incur to the difference between the amount of total investment approved by the Ministry of Commerce or its local counterpart for such enterprise and the amount of registered capital of such enterprise, and requiring registration of any such loans with SAFE. As of December 31, 2016, the amount of approved total investment of Tiandihui was $2,707,490 (RMB 18,800,000) and TDH HK have invested the same amount of $2,707,490 (RMB 18,800,000) into Tiandihui, which means Tiandihui needs to obtain additional approval for total investment amount from the local counterpart of Ministry of Commerce. During 2017, we have successfully obtained the investment approval from Ministry of Commerce for our proceeds of IPO.

 

47

 

In March 2015, SAFE issued the Circular Concerning the Reform of the Administration of the Settlement of Foreign Currency Capital of Foreign-Invested Enterprises, or SAFE Circular 19, which became effective in June 2015. SAFE Circular 19 regulates the conversion by a foreign-invested enterprise of foreign currency registered capital into RMB by restricting how the converted RMB may be used. Furthermore, SAFE promulgated a circular in June 2016, SAFE Circular 16, which further revises some clauses in the SAFE Circular 19. SAFE Circular 19 and 16 provide that the capital-account foreign exchange incomes of a domestic enterprise shall not be directly or indirectly used for expenditures that are forbidden by relevant laws and regulations, for purposes that are not included in the business scope approved by the applicable government authority, shall not be directly or indirectly used for investments in securities or for any other kind of wealth-managing investments than banks’ principal-secured products unless otherwise prescribed by other laws and regulations, shall not be directly or indirectly used for issuing RMB entrusted loans (unless expressly permitted in the business scope approved by the competent governmental authorities) or repaying inter-enterprise loans (including advances by the third party) or repaying bank loans in RMB which have been sub-lent to third parties, shall not be used for granting loans to non-affiliated enterprises unless expressly permitted in the business scope and shall not be used for the construction or purchase of real estate not for self-use (except for real estate enterprises). In addition, SAFE supervises the flow and use of the RMB capital converted from foreign currency registered capital of a foreign-invested company by further focusing on ex post facto supervision and violations. These two circulars may limit our ability to use the net proceeds from this offering to invest in or acquire any other Chinese companies in China, which may adversely affect our liquidity and our ability to fund and expand our business in China.

 

Capital Resources

 

As of December 31, 2018, and 2017

 

The following table provides certain selected balance sheets comparisons between years ended December 31, 2018 and 2017:

 

    For years ended December 31,              
    2018     2017     Fluctuation     %  
                         
ASSETS                  
Cash and cash equivalents   $ 893,020     $ 2,346,109       (1,453,089 )     -62 %
Restricted cash, current     1,807,485       797,668       1,009,817       127 %
Accounts receivable, net     845,800       1,932,924       (1,087,124 )     -56 %
Accounts receivable - related party     435,513       -       435,513       100 %
Advances to suppliers     77,280       633,554       (556,274 )     -88 %
Inventories     3,019,804       9,135,332       (6,115,528 )     -67 %
Due from related parties     43,554       361,961       (318,407 )     -88 %
Prepayment and other current assets     680,606       371,796       308,810       83 %
Total current assets     7,803,062       15,579,344       (7,776,282 )     -50 %
Restricted cash, non-current     -       500,000       (500,000 )     -100 %
Property, plant and equipment, net     8,410,525       3,520,373       4,890,152       139 %
Land use rights, net     1,014,538       211,023       803,515       381 %
Long-term investments     201,281       -       201,281       100 %
Total non-current assets     9,626,344       4,231,396       5,394,948       127 %
Total assets   $ 17,429,406     $ 19,810,740       (2,381,334 )     -12 %
                                 
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)                                
Accounts payable   $ 6,220,375     $ 4,734,110       1,486,265       31 %
Accounts payable - related parties     125,126       152,298       (27,172 )     -18 %
Notes payable     2,462,044       1,377,106       1,084,938       79 %
Advances from customers     160,828       231,230       (70,402 )     -30 %
Advances from customers - related party     -       7,520       (7,520 )     -100 %
Short term loans     8,263,038       1,402,514       6,860,524       489 %
Short term loans - related parties     1,061,360       -       1,061,360       100 %
Long-term loans - related party, current portion     68,673       -       68,673       100 %
Taxes payable     44,319       13,562       30,757       227 %
Due to related parties     45,146       345,873       (300,727 )     -87 %
Other current liabilities     692,669       392,435       300,234       77 %
Total current liabilities     19,143,578       8,656,648       10,486,930       121 %
                                 
Long term loans - related party     217,466       -       217,466       100 %
Deferred tax liabilities     4,929       5,810       (881 )     -15 %
Total liabilities   $ 19,365,973     $ 8,662,458       10,703,515       124 %

 

48

 

We maintain cash and cash equivalents in mainland China, Hong Kong, Belgium, Japan and America. On December 31, 2018 and 2017, bank deposits were as follows:

  

   December 31, 
Country  2018   2017 
China (Mainland)  $825,176   $2,158,590 
China (Hongkong)   -    138,379 
Japan   3,056    - 
Belgium   275    - 
America   10,960    10,960 
Total  $839,467   $2,307,929 

 

The majority of our cash balances at December 31, 2018 and December 31, 2017 are in the form of RMB and held in bank accounts at financial institutions located in China. Cash held in banks in China is not insured. In 1996, the Chinese government introduced regulations relaxing restrictions on the conversion of the RMB; however restrictions still remain, including restrictions on foreign-invested entities. Foreign-invested entities may only buy, sell or remit foreign currencies after providing valid commercial documents at only those banks authorized to conduct foreign exchanges. Furthermore, the conversion of RMB for capital account items, including direct investments and loans, is subject to China government approval. Chinese entities are required to establish and maintain separate foreign exchange accounts for capital account items. We cannot be certain Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the RMB, especially with respect to foreign exchange transactions. Accordingly, cash on deposit in banks in China is not readily deployable by us for use outside of China.

 

Cash, cash equivalents and restricted cash

 

As of December 31, 2018, balance of cash, cash equivalents and restricted cash were $2,700,505, compared to $3,643,777 at December 31, 2017. The components of this decrease of $943,272 are reflected below.

 

   Years Ended
December 31,		 
   2018   2017 
Net cash used in operating activities  $(2,173,742)  $(2,674,936)
Net cash used in investing activities   (6,594,458)   (847,283)
Net cash provided by financing activities   7,728,120    5,258,773 
Exchange rate effect on cash, cash equivalents and restricted cash   96,808    55,000 
           
Net cash inflow (outflow)  $(943,272)  $1,791,554 

 

We had current restricted cash of $1,807,485 and $797,668 as of December 31, 2018 and 2017, respectively. This restricted cash represents the bank deposit balance for issuing bank acceptance and bank letters of credit, except for $500,000 of the balance as of December 31, 2018 was from escrow deposit in connection with IPO. The balances of notes payable were $2,462,044 and $1,377,106 as of December 31, 2018 and 2017 respectively. As the deposit was provided and only used by us as pledge for its bank acceptance notes and bank letters of credit, could not be used for other purposes during the term of the notes, and directly used to settle the liabilities when the bank acceptance notes and bank letters of credit became due, it was recorded as restricted cash as of December 31, 2018 and 2017.

 

We had long term restricted cash of $0 and $500,000 as of December 31, 2018 and 2017, respectively. This long-term restricted cash represents the deposit in escrow account to satisfy the potential indemnification obligation for two years starting from September 25, 2017.

 

Accounts receivable

  

Accounts receivable, net as of December 31, 2018 was $845,800, a decrease of $1,087,124 compared to $1,932,924 as of December 31, 2017. Most of our customers are overseas reputable agents, with whom we have maintained good working relationships. Usually, we collected our account receivable within 3 months. No allowance for account receivable was provided as of December 31, 2018 and 2017.

  

Inventories

 

As of December 31, 2018, our inventory balance was $3,019,804, a decrease of $6,115,528, or 66.94%, compared to $9,135,332, as of December 31, 2017. The decrease was due to the fact that (1) the increasing raw material prices prevented us from storing extra inventory for the year ended December 31, 2018, (2) we changed the manufacturing model from large scale manufacturing to small scale manufacturing according to the order, which decreased the daily inventory balance and (3) some damaged and slow-moving inventory was written off in 2018.

 

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Due from related parties

 

As of December 31, 2018, the balances of due from related parties were $43,554, a decrease of $318,407, compared to $361,961 on December 31, 2017. 

 

Due to related parties

 

As of December 31, 2018, the balances of due to related parties were $45,146, a decrease of $300,727, compared to $345,873 on December 31, 2017. The balance of due to related parties represented expenses incurred by related parties in the ordinary course of business, expense paid by related parties on behalf of the Company as well as the loans the Company obtained from related parties for working capital purpose. The loans owed to the related parties are interest free, unsecured and repayable on demand.

  

Property, plant and equipment, net

 

Property, plant and equipment as of December 31, 2018 were $8,410,525, an increase of $4,890,152 compared to $3,520,373, as of December 31, 2017. The company did not dispose of property for the year ended December 31, 2018. The increase in cost was mainly due to the purchase of Lingang factory. Depreciation expense for the years ended December 31, 2018 and 2017 was $388,256 and $349,887, respectively.

 

Land use rights, net

 

Land use rights, net as of December 31, 2018 were $1,014,538, an increase of $803,515, compared to $211,023 as of December 31, 2017. The increase represents the additional land use right of Lingang factory, which was acquired in 2018. During the years ended December 31, 2018 and 2017, amortization expense amounted to $7,099 and $14,283, respectively.

 

Accounts payable and Notes payable

 

Accounts payable represents our commercial credit offered to the suppliers. And Notes payable was the bank acceptance notes to suppliers.

 

Accounts payable increased by $1,486,265, to $6,220,375 as of December 31, 2018, from $4,734,110 as of December 31, 2017.

 

Notes payable increased by $1,084,938 to $2,462,044 as of December 31, 2018, from $1,377,106 as of December 31, 2017.

  

Short term loan

 

Balance of short-term loan as of December 31, 2018 was $8,263,038, representing an increase of $6,860,524, or 489%, compared with balance of $1,402,514 as of December 31, 2017.

 

Tabular Disclosure of Contractual Obligations

 

We have certain potential commitments that include future estimated payments. Changes in our business needs, cancellation provisions, changing interest rates, and other factors may result in actual payments differing from the estimates. We cannot provide certainty regarding the timing and amounts of payments.

 

The following table summarizes our contractual obligations as of December 31, 2018, and the effect of these obligations expected to have on our liquidity and cash flows in future periods:

 

2019  $207,943 
2020   187,876 
2021   58,723 
2022   61,423 
2023   64,285 
Thereafter   231,790 
Total  $812,040 

 

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Off-Balance Sheet Arrangements

 

Under SEC regulations, we are required to disclose off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, such as changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. An off-balance sheet arrangement means a transaction, agreement or contractual arrangement to which any entity that is not consolidated with us is a party, under which we have:

 

  ● Any obligation under certain guarantee contracts,
     
  ● Any retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets,
     
  ● Any obligation under a contract that would be accounted for as a derivative instrument, except that it is both indexed to our stock and classified in shareholder equity in our statement of financial position, and
     
  ● Any obligation arising out of a material variable interest held by us in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to us, or engages in leasing, hedging or research and development services with us.

 

We do not have any off-balance sheet arrangements that we are required to disclose pursuant to these regulations. In the ordinary course of business, we enter into operating lease commitments, and other contractual obligations. These transactions are recognized in our financial statements in accordance with generally accepted accounting principles in the United States.

 

Trend Information

 

Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events for the period since January 1, 2018 that are reasonably likely to have a material adverse effect on our net revenues, income, profitability, liquidity or capital resources, or that would cause the disclosed financial information to be not necessarily indicative of future operating results or financial conditions.

  

Critical Accounting Policies

 

The discussion and analysis of our financial condition and results of operations are based upon our audited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these audited consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We evaluate our estimates on an ongoing basis, including those related to revenue recognition and income taxes. We base our estimates on our historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making the judgments we make about the carrying values of our assets and liabilities that are not readily apparent from other sources. Because these estimates can vary depending on the situation, actual results may differ from the estimates.

 

The critical accounting policies summarized in this section are discussed in further detail in the notes to the audited consolidated financial statements appearing elsewhere in this Annual Report. Management believes that the application of these policies on a consistent basis enables us to provide useful and reliable financial information about our operating results and financial condition.

 

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Use of Estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities on the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company bases its estimates and judgments on historical experience and on various other assumptions and information that are believed to be reasonable under the circumstances. Estimates and assumptions of future events and their effects cannot be perceived with certainty and, accordingly, these estimates may change as new events occur, as more experience is acquired, as additional information is obtained and as our operating environment changes. Significant estimates and assumptions by management include, among others, useful lives and impairment of long-lived assets and goodwill, write-down in value of inventories and income taxes including the valuation allowance for deferred tax assets, and allowance for sales return. While the Company believes that the estimates and assumptions used in the preparation of the financial statements are appropriate, actual results could differ from those estimates. Estimates and assumptions are periodically reviewed and the effects of revisions are reflected in the financial statements in the period they are determined to be necessary.

 

Revenue Recognition

 

On January 1, 2018, the Company adopted ASC Topic 606, Revenue from Contracts with Customers, using the modified retrospective method applied to those contracts that were not completed as of January 1, 2018. Results for the reporting period beginning after January 1, 2018 are presented under ASC Topic 606, while prior period amounts have not been adjusted and continue to be reported in accordance with the Company’s historic accounting under ASC Topic 605.

 

Revenue for sale of products is derived from contracts with customers, which primarily include the sale of pet food products. The Company recognizes revenue upon transfer of control of promised goods in a contract with a customer in an amount that reflects the consideration the Company expects to receive in exchange for those products. Transfer of control occurs once the customer has the contractual right to use the product, generally upon shipment or once delivery and risk of loss has transferred to the customer.

 

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Revenue is recognized net of any taxes collected from customers that are subsequently remitted to governmental authorities, including value-added tax (“VAT”), business tax, applicable local government levies. At the time revenue is recognized, allowances are recorded, with the related reduction to revenue, for estimated sales returns based upon historical experience and related terms of customer arrangements.

 

The allowance for sales returns recorded by the Company is $0.89 million, $0 and $0 for the years ended December 31, 2018, 2017 and 2016, respectively. The Company does not provide rebate, pricing protection or any other concessions to its customers.

 

The Company elected to account for shipping and handling fees that occur after the customer has obtained control of goods, for instance, free onboard shipping point arrangements, as a fulfillment cost and accrues for such costs.

 

Management has concluded that the disaggregation level is the same under both the revenue standard and the segment reporting standard. Revenue under the segment reporting standard is measured on the same basis as under the revenue standard. See Note 12 for information regarding revenue disaggregation by product lines, marketing channels and countries.

 

Contract liabilities are recorded when consideration is received from a customer prior to transferring the goods to the customer or other conditions under the terms of a sales contract. As of December 31, 2018 and 2017, the Company recorded contract liabilities of $160,828 and $238,750, respectively, which was presented as advances from customers and advances from customers-related party on the accompanying consolidated balance sheets. During the year ended December 31, 2018, the Company recognized $238,750 of contract liabilities included in the opening balances of advance from customers and advance from customers-related party.

 

Foreign Currency Translation

 

The accompanying consolidated financial statements are presented in United States dollar (“$”), which is the reporting currency of the Company. The functional currency of TDH Holdings, TDH HK and TDH Petfood LLC is United States dollar. The functional currency of Tiandihui, Chongai Jiujiu, Kangkang Development, Yichong, Lingchong and Lile is Renminbi (“RMB”). The functional currency of TDH Group BVBA is Euro (“€”). The functional currency of TDH JAPAN is Yen (“¥”). For the subsidiaries whose functional currencies are RMB, Euro and Yen, results of operations and cash flows are translated at average exchange rates during the period, assets and liabilities are translated at the unified exchange rate at the end of the period, and equity is translated at historical exchange rates. The resulting translation adjustments are included in determining other comprehensive income or loss. Transaction gains and losses are reflected in the consolidated statements of operations.

 

The exchange rates used to translate amounts in RMB into U.S. Dollars for the purpose of preparing the consolidated financial statements were as follows (USD$1=RMB): 

 

Period Covered  Balance Sheet
Date Rates		   Average Rates 
         
Year ended December 31, 2018   6.8764    6.6146 
Year ended December 31, 2017   6.5064    6.7570 

 

The exchange rates used to translate amounts in Euro into U.S. Dollars for the purpose of preparing the consolidated financial statements were as follows (USD$1=€): 

 

Period Covered  Balance Sheet
Date Rate		   Average Rate 
           

Period from acquisition completion date to December 31, 2018

   0.8737    0.8789 

 

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The exchange rates used to translate amounts in Yen into U.S. Dollars for the purpose of preparing the consolidated financial statements were as follows (USD$1=¥): 

 

Period Covered  Balance Sheet
Date Rate		   Average Rate 
           

Period from acquisition completion date to December 31, 2018

   110.0039    112.1693 

 

Fair Value of Financial Instruments

 

Accounting guidance defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurement for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and it considers assumptions that market participants would use when pricing the asset or liability.

 

The Company measures certain financial assets, including the investment under the measurement alternative method and equity method on other-than-temporary basis, intangible assets, goodwill and fixed assets at fair value when an impairment charge is recognized.

 

Accounting guidance establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Accounting guidance establishes three levels of inputs that may be used to measure fair value:

 

Level 1 — Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

Level 2 — Include other inputs that are directly or indirectly observable in the marketplace.

 

Level 3 — Unobservable inputs which are supported by little or no market activity.

 

Accounting guidance also describes three main approaches to measuring the fair value of assets and liabilities: (1) market approach; (2) income approach and (3) cost approach. The market approach uses prices and other relevant information generated from market transactions involving identical or comparable assets or liabilities. The income approach uses valuation techniques to convert future amounts to a single present value amount. The measurement is based on the value indicated by current market expectations about those future amounts. The cost approach is based on the amount that would currently be required to replace an asset.

 

For certain of the Company’s financial instruments, including cash and cash equivalents, restricted cash, current, accounts receivable, advances to suppliers, prepayments and other current assets, accounts payable and notes payables, advances from customers, taxes payable, other current liabilities, short-term loans, the carrying amounts approximate their fair values due to the short maturities.

 

Recently Issued Accounting Pronouncements

 

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)” and issued subsequent amendments to the initial guidance or implementation guidance including ASU 2017-13, 2018-01, 2018-10, 2018-11, 2018-20 and 2019-01 (collectively, including ASU 2016-02, “ASC 842”). Under ASC 842, lessees will be required to recognize all leases at the commencement date including a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use (ROU) asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.

 

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The standard will be effective for the Company beginning January 1, 2019, with early adoption permitted. The Company plans to adopt the standard on January 1, 2019 on a modified retrospective basis and will not restate comparable periods. The Company will elect the package of practical expedients permitted under the transition guidance, which allows the Company to carry forward the historical lease classification, the assessment whether a contract is or contains a lease and initial direct costs for any leases that exist prior to adoption of the new standard. The Company will also elect the short-term lease exemption for contracts with lease terms of 12 months or less. The Company estimates that approximately $0.67 million would be recognized as total right-of-use assets and total lease liabilities on the consolidated balance sheets as of January 1, 2019. However, the Company does not expect the adoption to have a material impact to the consolidated statements of operations and comprehensive income (loss) and cash flows. 

 

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820), – Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement,” which makes a number of changes meant to add, modify or remove certain disclosure requirements associated with the movement amongst or hierarchy associated with Level 1, Level 2 and Level 3 fair value measurements. The amendments in this Update modify the disclosure requirements on fair value measurements based on the concepts in FASB Concepts Statement, Conceptual Framework for Financial Reporting—Chapter 8: Notes to Financial Statements, including the consideration of costs and benefits. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The amendments are effective for all entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the potential impacts of ASU 2018-13 on its consolidated financial statements.

 

Recently adopted accounting pronouncements

 

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (ASC 606)”. Under ASU 2014-09, revenue is recognized when a customer obtains control of promised goods or services and is recognized in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. ASU 2014-09 is effective for fiscal years and interim periods within those years beginning after December 15, 2017, and early adoption is permitted for periods beginning after December 15, 2016. The Company elected adopting the standard using the modified retrospective method on January 1, 2018. The Company recognized the cumulative effect of applying the new revenue standard as an adjustment to the opening balance of retained earnings at the date of adoption. The comparative information has not been restated and continues to be reported under the accounting standards in effect for the periods presented. See Note 2 - Revenue recognition, for additional accounting policy and transition disclosures.

 

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In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities,” which improves the recognition and measurement of financial instruments. The new guidance requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income and separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements. The ASU allows a measurement alternative for equity investments without readily determinable fair value and do not qualify for the existing practical expedient in ASC 820, Fair Value Measurements and Disclosures, at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transaction for identical or similar investments of the same issuer, if any.

 

ASU 2016-01 was further amended in February 2018 by ASU 2018-03, “Technical Corrections and Improvements to Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” This update was issued to clarify certain narrow aspects of guidance concerning the recognition of financial assets and liabilities established in ASU 2016-01. This includes an amendment to clarify that an entity measuring an equity security using the measurement alternative may change its measurement approach to a fair valuation method in accordance with Topic 820, Fair Value Measurement, through an irrevocable election that would apply to that security and all identical or similar investments of the same issued.

 

ASU 2016-01 and 2018-03 are effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company adopted the ASU effective January 1, 2018. The adoption did not have a material impact on our consolidated financial statements.

 

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash”. These amendments require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. As a result, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments do not provide a definition of restricted cash or restricted cash equivalents. The amendments in this ASU are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. The Company has adopted the standard retrospectively effective January 1, 2018. As a result, balance of net cash used in investing activities in the year ended December 31, 2017 and the balance of net cash provided by investing activities in the year ended December 31, 2016 were adjusted to exclude the change in restricted cash, resulting in a decrease in such balance of $541,426 and $96,337, respectively.

 

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Impact of Inflation

 

We do not believe the impact of inflation on our Company is material. Our operations are in China and China’s inflation rates have been relatively stable in the last three years: 3.1% in 2018, 7.5% in 2017, and 2.0% in 2016.

 

Impact of Foreign Currency Fluctuations

 

We do not believe the impact of foreign currency fluctuations on our Company is material. Regarding purchase of raw materials, we are subject to commodity price risks arising from price fluctuations in the market prices of the raw materials. We have generally been able to pass on cost increases through price adjustments. However, the ability to pass on these increases depends on market conditions influenced by the overall economic conditions in China.

 

Most of our oversea sales are denominated in US dollars, for which our oversea sales are exempted from the risk of foreign currency fluctuation.

 

We have not had any foreign currency investments hedged by currency borrowings or other hedging instruments. We manage our price risks through productivity improvements and cost-containment measures.

 

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

 

  A. Directors and senior management

 

The following table sets forth our executive officers and directors, their ages and the positions held by them:

 

Name   Age   Position
         
Rongfeng Cui   47   Chairman, President and Chief Executive Officer, Class A Director
Rongbing Cui   50   Chief Financial Officer, Corporate Secretary
Lei Wang (1) (2) (3)   35   Class B Director, independent
Qiu Li (1) (2) (3)   58   Class B Director, independent
Dandan Liu   31   Class A Director
Owens Meng (1) (2) (3)   41   Class C Director, independent

 

(1)Member of the Audit Committee.

 

(2)Member of the Compensation Committee.

 

(3)Member of the Nominating and Corporate Governance Committee.

 

Rongfeng Cui is the founder of our Company. He has served as our Chairman of the Board of Directors, President and Chief Executive Officer since July 2006. From May 2004 to June 2006, he served in the capacity of the Company’s General Manager. From 1994 to 2004, he held several managerial positions at various Qingdao based companies. Mr. Cui holds an undergraduate degree in International Trade from the Central Radio and Television University and an EMBA degree from Peking University. The Board of Directors determined that Mr. Cui should continue serving as our Chairman given his pivotal role in the Company’s founding, day-to-day operations and long-term vision.

 

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Rongbing Cui is our Chief Financial Officer. He has served as our Chief Financial Officer since January 2015. From October 1998 to December 2014, he held the office of General Manager at Qingdao Yinghe Jiutian Information Technology Co., Ltd. Mr. Cui holds a Master’s degree in population and development from the Chinese Academy of Social Sciences. Mr. Cui is our Chairman’s brother. 

 

On January 28, 2019, Rongbing Cui delivered to the Board his resignation letters as Board members effective as of January 28, 2019. The foregoing resignations were not for any disagreements with the Company, its management or the Board. Nevertheless, Rongbing Cui remained serving as the CFO of the Company.

 

Lei Wang is an independent director. Ms. Wang has been manager of KPMG Advisory (China) Limited since October 2014. Between October 2008 and October 2014, Ms. Wang was senior manager of Marcum LLP. Between July 2006 and October 2008, Ms. Wang was senior auditor of Deloitte Touche Tohmatsu China Certified Public Accountants LLP. Ms. Wang is an American Institute of Certified Public Accountants (AICPA). Ms. Wang holds a Bachelor’s degree in Economics from University of International Business and Economics. The Board of Directors determined that Ms. Wang should serve as our director based on her accounting and financial reporting experience and expertise.

 

Qiu Li is an independent director. Ms. Li has been Senior Consultant of Hangzhou Guohan Financial Holding Co., Ltd. since November 2015. Between March 2010 and October 2015, Ms. Li was director of audit of Hengfeng Bank Hangzhou Branch. Between November 1987 and March 2010, Ms. Li held several managerial positions at Hengfeng Bank headquarter. Ms. Li is a China Certified Public Accountants (CPA). Ms. Li holds a Bachelor’s degree in Management from Shandong Cadres Correspondence University. The Board of Directors determined that Ms. Li should serve as our director based on her experience in business and accounting matters.

 

Owens Meng is an independent director. Since September 2013, Owens Meng has been the managing director of Beijing Songlin Xinya Financial Consultants, Ltd. From November 2007 to September 2013, he served as chief representative of Sherb Consulting LLC Beijing Representative Office, and managing director of Sherb & Co, LLP, a mid-sized accounting firm which has audited more than 25 China-based, US publicly traded companies. From July 2003 to October 2007, Mr. Meng worked as an audit manager for Grant Thornton Beijing. Mr. Meng received his CPA permit from the state of Delaware, and is a member of China Institute of Certified Public Accountants (CICPA), and a Certified Internal Auditor of the Institute of Internal Auditors. Mr. Meng holds a Bachelor’s degree in accounting and economics from Beijing Technology and Business University. Mr. Meng has served as an independent director of China Customer Relations Centers, Inc. (Nasdaq: CCRC) since September 2014. Mr. Meng was nominated as a director because of his experience in auditing, US GAAP and compliance issues.

 

Dandan Liu has served as a director of our board since February 2019. Ms. Liu founded Beijing Houxin Investments Co., Ltd. in June 2012 and has served as its CEO and Chairman since its inception. Ms. Liu has served as the Chairman of Hillshine Capital Management Limited since 2017. Ms. Liu was nominated as a director because of her diverse experiences in financial management and investment.

 

Under British Virgin Islands law, our directors have a duty to act honestly, in good faith and with a view to our best interests. Our directors also have a duty to exercise the care, diligence and skills that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty of care to us, our directors must ensure compliance with our memorandum and articles of association. We have the right to seek damages if a duty owed by our directors is breached. The functions and powers of our board of directors include, among others:

 

  ● appointing officers and determining the term of office of the officers;

 

  ● authorizing the payment of donations to religious, charitable, public or other bodies, clubs, funds or associations as deemed advisable;

 

  ● exercising the borrowing powers of the company and mortgaging the property of the company;

 

  ● executing checks, promissory notes and other negotiable instruments on behalf of the company; and maintaining or registering a register of mortgages, charges or other encumbrances of the company.

 

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A director may vote, attend a board meeting or sign a document on our behalf with respect to any contract or transaction in which he or she is interested. A director must promptly disclose the interest to all other directors after becoming aware of the fact that he or she is interested in a transaction we have entered into or are to enter into. A general notice or disclosure to the board or otherwise contained in the minutes of a meeting or a written resolution of the board or any committee of the board that a director is a shareholder, director, officer or trustee of any specified firm or company and is to be regarded as interested in any transaction with such firm or company will be sufficient disclosure, and, after such general notice, it will not be necessary to give special notice relating to any particular transaction.

 

The directors may receive such remuneration as our board of directors may determine from time to time. Each director is entitled to be repaid or prepaid for all traveling, hotel and incidental expenses reasonably incurred or expected to be incurred in attending meetings of our board of directors or committees of our board of directors or shareholder meetings or otherwise in connection with the discharge of his or her duties as a director. The compensation committee will assist the directors in reviewing and approving the compensation structure for the directors. Our board of directors may exercise all the powers of the company to borrow money and to mortgage or charge our undertakings and property or any part thereof, to issue debentures, debenture stock and other securities whenever money is borrowed or as security for any debt, liability or obligation of the company or of any third party.

 

A director is not required to hold shares as a qualification to office.

  

  B. Compensation

 

The following table shows the annual compensation paid by us for the years ended December 31, 2018 and 2017 to Cui Rongfeng and Cui Rongbing, our principal executive officers. No officer had a salary during either of the previous two years of more than $100,000.

 

Name and principal position  Year  Salary
($)		   Bonus
($)		   Total Paid 
($)		 
                
Cui Rongfeng,  2018   32,057    -    20,310 
Chairman, President and CEO  2017   21,311    -    14,729 
                   
Cui Rongbing,  2018   21,898    9,071    20,648 
CFO and director(1)  2017   16,164    1,924    18,847 

 

(1)Cui Rongbing resigned from director from January 28, 2019.

 

Compensation Committee Interlocks and Insider Participation

 

None of our officers currently serves, or has served during the last completed fiscal year, on the compensation committee or board of directors of any other entity that has one or more officers serving as a member of our board of directors.

 

Director Compensation

 

Employee directors do not receive any compensation for their services. Non-employee directors are entitled to receive compensation for their actual travel expenses for each Board meeting attended. We paid $10,000 compensation to each of our non-employee directors during each of the years ended December 31, 2018 and 2017.

 

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Limitation of Director and Officer Liability

 

Under British Virgin Islands law, each of our directors and officers, in performing his or her functions, is required to act honestly and in good faith with a view to our best interests and exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. Our memorandum and articles of association provide that, to the fullest extent permitted by British Virgin Islands law or any other applicable laws, our directors will not be personally liable to us or our shareholders for any acts or omissions in the performance of their duties. Such limitation of liability does not affect the availability of equitable remedies such as injunctive relief or rescission. These provisions will not limit the liability of directors under United States federal securities laws.

 

We may indemnify any of our directors or anyone serving at our request as a director of another entity against all expenses, including legal fees, and against all judgments, fines and amounts paid in settlement and reasonably incurred in connection with legal, administrative or investigative proceedings. We may only indemnify a director if he or she acted honestly and in good faith with the view to our best interests and, in the case of criminal proceedings, the director had no reasonable cause to believe that his or her conduct was unlawful. The decision of our board of directors as to whether the director acted honestly and in good faith with a view to our best interests and as to whether the director had no reasonable cause to believe that his or her conduct was unlawful, is in the absence of fraud sufficient for the purposes of indemnification, unless a question of law is involved. The termination of any proceedings by any judgment, order, settlement, conviction or the entry of no plea does not, by itself, create a presumption that a director did not act honestly and in good faith and with a view to our best interests or that the director had reasonable cause to believe that his or her conduct was unlawful. If a director to be indemnified has been successful in defense of any proceedings referred to above, the director is entitled to be indemnified against all expenses, including legal fees, and against all judgments, fines and amounts paid in settlement and reasonably incurred by the director or officer in connection with the proceedings.

  

Insofar as indemnification for liabilities arising under the Securities Act may be permitted for our directors or officers under the foregoing provisions, we have been informed that in the opinion of the SEC, such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable as a matter of United States law.

 

Retirement Benefits

 

As of December 31, 2018, we have contributed to the government-mandated employee welfare and retirement benefit plan and provided pension, retirement or similar benefits to its employees. The PRC regulations require us to pay the local labor administration bureau a monthly contribution at a stated contribution rate based on the monthly basic compensation of qualified employees. The local labor administration bureau, which manages various investment funds, will take care of employee retirement, medical and other fringe benefits. We have no further commitments beyond our monthly contribution.

 

Employment Agreements

 

Employment agreement with Cui Rongfeng, CEO

 

On September 1, 2016, Qingdao Tiandihui entered into an employment agreement with Cui Rongfeng to serve in the role of Chief Executive Officer for the initial period of 3 years (commencing as of September 1, 2016 and terminating on August 31, 2019), which term may be extended for another 2 years unless either party to the agreement terminates the agreement at least 60 days prior to the expiration of the term. Under the terms of this agreement, Mr. Cui’s annual salary is RMB 240,000 payable in 12 equal monthly installments. The executive may be eligible to receive an annual bonus in the amount of 50% of his annual base salary, subject to completion of corporate and individual performance goals set forth by the Compensation Committee in consultation with the executive. The Compensation Committee will have the sole discretion whether the executive is entitled to the bonus and the amount of the payment, if any. The employment agreement may be terminated by either party upon 60 day advance notice to the other party. The Company will reimburse Mr. Cui for all reasonable out of pocket expenses in connection with travel, entertainment and other expenses incurred in the performance of his duties. The agreement also contains certain confidentiality, non-disclosure and other provisions that are customary to the agreements of this nature.

 

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Employment agreement with Cui Rongbing, CFO

 

On September 1, 2016, Qingdao Tiandihui entered into an employment agreement with Cui Rongbing to serve in the role of Chief Financial Officer and Corporate Secretary for the initial period of 3 years, (commencing as of September 1, 2016 and terminating on August 31, 2019), which term may be extended for another 2 years unless either party to the agreement terminates the agreement at least 60 days prior to the expiration of the term. Under the terms of this agreement, Mr. Cui’s annual salary is RMB 144,000 payable in 12 equal monthly installments. The employment agreement may be terminated by either party upon 60-day advance notice to the other party. The Company will reimburse Mr. Cui for all reasonable out of pocket expenses in connection with travel, entertainment and other expenses incurred in the performance of his duties. The agreement also contains certain confidentiality, non-disclosure and other provisions that are customary to the agreements of this nature.

 

  C. Board Practices

 

Composition of Board; Risk Oversight

 

Our Board of Directors presently consists of five directors. The Board membership is divided into three classes, Class A, B and C, respectively, as nearly equal in number as the total number of directors permits. Class A directors will face re-election at our next annual meeting of shareholders and every three years thereafter. Class B directors will face re-election at our second annual meeting of shareholders and every three years thereafter. Class C directors will face re-election at our third annual meeting of shareholders and every three years thereafter.

 

Except as noted above, there are no family relationships between any of our executive officers and directors. Officers are elected by, and serve at the discretion of, the board of directors. Our board of directors shall hold meetings on at least a quarterly basis. As a smaller reporting company under the NASDAQ rules we are only required to maintain a board of directors comprised of at least 50% independent directors, and an audit committee of at least two members, comprised solely of independent directors who also meet the requirements of Rule 10A-3 under the Securities Exchange Act of 1934. There are no membership qualifications for directors. Further, there are no share ownership qualifications for directors unless so fixed by us in a general meeting. There are no other arrangements or understandings pursuant to which our directors are selected or nominated. Our board plays a significant role in our risk oversight. The board makes all relevant Company decisions. As such, it is important for us to have our Chief Executive Officer serve on the board as he plays key roles in the risk oversight or the Company. As a smaller reporting company with a small board of directors, we believe it is appropriate to have the involvement and input of all of our directors in risk oversight matters.

 

Director Independence

 

Our board has reviewed the independence of our directors, applying the NASDAQ independence standards. Based on this review, the board determined that each of Lei Wang, Qiu Li, and Owens Meng are “independent” within the meaning of the NASDAQ rules. In making this determination, our board considered the relationships that each of these non-employee directors has with us and all other facts and circumstances our board deemed relevant in determining their independence. As required under applicable NASDAQ rules, we anticipate that our independent directors will meet on a regular basis as often as necessary to fulfill their responsibilities, including at least annually in executive session without the presence of non-independent directors and management.

 

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Board Committees

 

Currently, three committees have been established under the board: the Audit Committee, the Compensation Committee and the Nominating Committee.

 

The Audit Committee is responsible for overseeing the accounting and financial reporting processes of our company and audits of the financial statements of our company, including the appointment, compensation and oversight of the work of our independent auditors. The Compensation Committee of the board of directors reviews and makes recommendations to the board regarding our compensation policies for our officers and all forms of compensation, and also administers our incentive compensation plans and equity-based plans (but our board retains the authority to interpret those plans). The Nominating Committee of the board is responsible for the assessment of the performance of the board, considering and making recommendations to the board with respect to the nominations or elections of directors and other governance issues. The nominating committee considers diversity of opinion and experience when nominating directors.

 

Audit Committee

 

The Audit Committee will be responsible for, among other matters:

 

  ● appointing, compensating, retaining, evaluating, terminating, and overseeing our independent registered public accounting firm;

 

  ● discussing with our independent registered public accounting firm the independence of its members from its management;

 

  ● reviewing with our independent registered public accounting firm the scope and results of their audit;

 

  ● approving all audit and permissible non-audit services to be performed by our independent registered public accounting firm;

 

  ● overseeing the financial reporting process and discussing with management and our independent registered public accounting firm the interim and annual financial statements that we file with the SEC;

 

  ● reviewing and monitoring our accounting principles, accounting policies, financial and accounting controls, and compliance with legal and regulatory requirements;

 

  ● coordinating the oversight by our board of directors of our code of business conduct and our disclosure controls and procedures;

 

  ● establishing procedures for the confidential and/or anonymous submission of concerns regarding accounting, internal controls or auditing matters; and

 

  ● reviewing and approving related-party transactions.

 

Our Audit Committee consists of Lei Wang, Qiu Li, and Owens Meng, with Lei Wang serving as chair of the Audit Committee. Our board has affirmatively determined that each of the members of the Audit Committee meets the definition of “independent director” for purposes of serving on an Audit Committee under Rule 10A-3 of the Exchange Act and NASDAQ rules. In addition, our board has determined that Lei Wang qualifies as an “audit committee financial expert” as such term is currently defined in Item 407(d)(5) of Regulation S-K and meets the financial sophistication requirements of the NASDAQ rules.

 

Compensation Committee

 

The Compensation Committee will be responsible for, among other matters:

 

  ● reviewing and approving, or recommending to the board of directors to approve the compensation of our CEO and other executive officers and directors;

 

  ● reviewing key employee compensation goals, policies, plans and programs;

 

  ● administering incentive and equity-based compensation;

 

  ● reviewing and approving employment agreements and other similar arrangements between us and our executive officers; and

 

  ● appointing and overseeing any compensation consultants or advisors.

 

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Our Compensation Committee consists of Lei Wang, Qiu Li, and Owens Meng, with Qiu Li serving as chair of the Compensation Committee. Our board has affirmatively determined that each of the members of the Compensation Committee meets the definition of “independent director” for purposes of serving on Compensation Committee under NASDAQ rules.

 

Nominating Committee

 

The Nominating Committee will be responsible for, among other matters:

 

  ● selecting or recommending for selection candidates for directorships;

 

  ● evaluating the independence of directors and director nominees;

 

  ● reviewing and making recommendations regarding the structure and composition of our board and the board committees;

 

  ● developing and recommending to the board corporate governance principles and practices;

 

  ● reviewing and monitoring the Company’s Code of Business Conduct and Ethics; and

 

  ● overseeing the evaluation of the Company’s management

 

Our Nominating Committee consists of consists of Lei Wang, Qiu Li, and Owens Meng, with Owens Meng serving as chair of the Nominating Committee. Our board has affirmatively determined that each of the members of the Nominating Committee meets the definition of “independent director” for purposes of serving on a Nominating Committee under NASDAQ rules.

 

Duties of Directors

 

Under British Virgin Islands law, our directors have a duty to act honestly, in good faith and with a view to our best interests. Our directors also have a duty to exercise the care, diligence and skills that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty of care to us, our directors must ensure compliance with our memorandum and articles of association. We have the right to seek damages if a duty owed by our directors is breached. The functions and powers of our board of directors include, among others:

 

  ● appointing officers and determining the term of office of the officers;

 

  ● authorizing the payment of donations to religious, charitable, public or other bodies, clubs, funds or associations as deemed advisable;

 

  ● exercising the borrowing powers of the company and mortgaging the property of the company;

 

  ● executing checks, promissory notes and other negotiable instruments on behalf of the company; and maintaining or registering a register of mortgages, charges or other encumbrances of the company.

 

A director may vote, attend a board meeting or sign a document on our behalf with respect to any contract or transaction in which he or she is interested. A director must promptly disclose the interest to all other directors after becoming aware of the fact that he or she is interested in a transaction we have entered into or are to enter into. A general notice or disclosure to the board or otherwise contained in the minutes of a meeting or a written resolution of the board or any committee of the board that a director is a shareholder, director, officer or trustee of any specified firm or company and is to be regarded as interested in any transaction with such firm or company will be sufficient disclosure, and, after such general notice, it will not be necessary to give special notice relating to any particular transaction.

 

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The directors may receive such remuneration as our board of directors may determine from time to time. Each director is entitled to be repaid or prepaid for all traveling, hotel and incidental expenses reasonably incurred or expected to be incurred in attending meetings of our board of directors or committees of our board of directors or shareholder meetings or otherwise in connection with the discharge of his or her duties as a director. The compensation committee will assist the directors in reviewing and approving the compensation structure for the directors. Our board of directors may exercise all the powers of the company to borrow money and to mortgage or charge our undertakings and property or any part thereof, to issue debentures, debenture stock and other securities whenever money is borrowed or as security for any debt, liability or obligation of the company or of any third party.

 

Limitation on Liability and Other Indemnification Matters

 

British Virgin Islands law does not limit the extent to which a company’s memorandum and articles of association may provide for indemnification of officers and directors, except to the extent any such provision may be held by the British Virgin Islands courts to be contrary to public policy, such as to provide indemnification against civil fraud or the consequences of committing a crime. Under our memorandum and articles of association, we may indemnify our directors, officers and liquidators against all expenses, including legal fees, and against all judgments, fines and amounts paid in settlement and reasonably incurred in connection with civil, criminal, administrative or investigative proceedings to which they are party or are threatened to be made a party by reason of their acting as our director, officer or liquidator. To be entitled to indemnification, these persons must have acted honestly and in good faith with a view to the best interest of the company and, in the case of criminal proceedings, they must have had no reasonable cause to believe their conduct was unlawful. Insofar as indemnification for liabilities arising under the Securities Act may be permitted for our directors or officers under the foregoing provisions, we have been informed that in the opinion of the SEC, such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable as a matter of United States law.

 

  D. Employees

 

The table below provides information as to the total number of employees at the end of the last three fiscal years. We have no contracts or collective bargaining agreements with labor unions and have never experienced work stoppages due to labor dispute. We consider our relations with our employees to be good.

 

   2016   2017   2018 
Number of Employees   240    213    204 

 

  E. Share Ownership

 

See Item 7 below.

 

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

 

  A. Major shareholders

 

The following table sets forth certain information regarding beneficial ownership of our shares by each person who is known by us to beneficially own more than 5% of our shares. The table also identifies the share ownership of each of our directors, each of our named executive officers, and all directors and officers as a group. Except as otherwise indicated, the shareholders listed in the table have sole voting and investment powers with respect to the shares indicated. Our major shareholders do not have different voting rights than any other holder of our shares.

 

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Shares which an individual or group has a right to acquire within 60 days pursuant to the exercise or conversion of options, warrants or other similar convertible or derivative securities are deemed to be outstanding for the purpose of computing the percentage ownership of such individual or group, but are not deemed to be outstanding for the purpose of computing the percentage ownership of any other person shown in the table.

 

Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting and investment power. Except as otherwise indicated below, each beneficial owner holds voting and investment power directly. The percentage of ownership is based on 12,516,662 shares issued and outstanding as of April 30, 2019.  Unless otherwise indicated, the address of each beneficial owner listed in the table below is c/o Qingdao Tiandihui Foodstuffs Co. Ltd., Building 10, 1388 Taifa Road, Huangdao District, Qingdao, Shandong Province, PRC.

 

Name of Beneficial Owner  Shares 
Owned		   Percentage 
         
Cui Rongfeng   2,287,324    18.27%
Cui Rongbing   -    - 
Lei Wang  (1)    -    - 
Qiu Li  (1)   -    - 
Dandan Liu   2,060,588    16.46%
Wang Yanjuan  (2)   1,215,000    9.71%
Owens Meng  (1)   -    - 
Directors & executive officers as a group (7 persons)   5,562,912    44.44%
Zuhua Zou   2,284,462    18.25%

 

Following these appointments, the Board consists of five members: Cui Rongfeng (Chairman), Lei Wang, Qiu Li, Owens Meng and Dandan Liu, of which Lei Wang, Qiu Li, and Owens Meng are deemed “independent” Board members.

 

(1) Independent director.
   

(2)

CEO’s spouse.

 

  B. Related Party Transactions

 

Due from related parties

 

Due from related parties consisted of the following:

 

   December 31,   December 31, 
   2018   2017 
Tide  $44   $46 
TDH Group BVBA   -    329,237 
Rongfeng Cui   43,510    32,678 
Total  $43,554   $361,961 

 

The balance of due from Tide represents operating expenses paid by the Company on behalf of Tide. The balances of due from TDH Group BVBA and Rongfeng Cui represent overseas trade receivables collected by the two parties on behalf of the Company.

 

Due to related parties

 

Due to related parties consisted of the following:

 

   December 31,   December 31, 
   2018   2017 
Saike  $16,470   $6,148 
Phillip Zou   1,000    1,000 
Yanjuan Wang   -    29,878 
Rongfeng Cui   27,676    308,847 
Total  $45,146   $345,873 

 

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The balance of due to related parties represents expenses paid by related parties on behalf of the Company as well as advances the Company obtained from related parties for working capital purposes. The amounts owed to the related parties are unsecured, non-interest bearing and payable on demand.

 

Short term loans from related parties

 

   December 31,   December 31, 
   2018   2017 
Rongfeng Cui  $84,831   $- 
A group of individuals who hold more than 10% voting interest of the Company   876,913                  - 
Rongbing Cui   31,993    - 
Wenbin Pang   29,085    - 
Yan Fu   29,085    - 
Rongjie Cui   4,363    - 
Jichang Zhang   2,909    - 
Fucheng Sun   2,181    - 
Total  $1,061,360   $- 

 

The Company borrowed unsecured short term loans from related parties in the amount of $1,176,690 and $0, during the years ended December 31, 2018 and 2017, respectively. Interest rate for the loans outstanding during the year ended December 31, 2018 ranged from 3% to 25% per annum. The Company made repayment in the amount of $60,490 and $0, during the years ended December 31, 2018 and 2017, respectively.

 

Modification of Loans from related party

 

In January 2018, the Company entered into a loan agreement with an individual. In May 2018, the agreement was amended to, among other things, increase the principal amount from RMB3,000,000 (approximately $466,000) to RMB3,030,000 (approximately $471,000) and increase the interest rate from 3% to 15%. Interest rate will be 24% for the period past due. In March 2019, the agreement was further amended to, among other things, increase the principal amount to RMB3,484,500 (approximately $539,000) and extend the maturity date from January 2019 to May 2019.

 

In June 2018, the Company entered into a loan agreement with another individual. Interest rate was 15% during the loan period and 24% for the period past due. In March 2019, the agreement was amended to, among other things, increase the principal amount from RMB3,000,000 (approximately $462,000) to RMB3,405,000 (approximately $522,000) and extend the maturity date from December 2018 to May 2019.

 

The Company analyzed the amendments under ASC 470-50 and concluded that these amendments did not qualify for debt modification.

 

Long term loans from related party

 

   December 31,   December 31, 
   2018   2017 
Rongfeng Cui  $286,139   $         - 
Less: Rongfeng Cui - current portion   68,673    - 
Non-current portion  $217,466   $- 

 

Long term loans from related party represent loans assumed by the Company in connection with acquisition of TDH Group BVBA. In March 2018, TDH Group BVBA borrowed non-interest bearing, unsecured long term loans from Rongfeng Cui in the aggregate amount of €250,000 (approximately $288,000), of which €60,000 (approximately $69,000), €60,000 (approximately $69,000), €60,000 (approximately $69,000), €60,000 (approximately $69,000), €10,000 (approximately $11,500) and $0 is due in the years ended December 31, 2019, 2020, 2021, 2022, 2023 and thereafter, respectively.

 

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Sales to related parties, purchases from related parties and services provided by related parties

 

   For the Years Ended December 31, 
   2018   2017   2016 
SALES TO:            
Like  $1,167,933   $506,495   $- 
Liujiayi   25,832    -    - 
TDH Group BVBA   325,766    -    - 
Total Sales  $1,519,531   $506,495   $- 
PURCHASES FROM:               
Like  $-   $-   $490,388 
Yinhe Jiutian   -    5,059    138,943 
Kangkang Family Farm   -    30,191    13,818 
Zhenyu   28,872    163,127    - 
TDH Group BVBA   2,689    -    - 
Total Purchases  $31,561   $198,377   $643,149 
SERVICE PROVIDED BY:               
Hanyinhe  $9,373   $-   $- 
TDH Group BVBA   278,396    -    - 
TDH JAPAN   134,181    -    - 
Total Services Consumed  $421,950   $-   $- 

 

For the years ended December 31, 2018, 2017 and 2016, the cost of revenue in connection with sales to related parties were $1,448,533, $399,177 and $0, respectively, which were included in cost of revenue-related parties in the accompanying consolidated statement of operations and comprehensive income (loss).

 

During the years ended December 31, 2018, 2017 and 2016, inventories purchased from related parties in the amount of $26,698, $44,502 and $6,616, respectively, were used and sold and included in cost of revenue in the accompanying consolidated statement of operations and comprehensive income (loss).

 

The Company purchased financial application software from Yinhe Jiutian in the amount of $0, $5,059 and $138,943 during the years ended December 31, 2018, 2017 and 2016, respectively.

 

Accounts receivables from related party

 

   December 31,   December 31, 
   2018   2017 
Like  $435,513   $          - 
Total  $435,513   $- 

 

Advances from related party customer

 

   December 31,   December 31, 
   2018   2017 
Like  $             -   $7,520 
Total  $-   $7,520 

 

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Accounts payable to related parties

 

    December 31,     December 31,  
    2018     2017  
Yinhe Jiutian   $ 113,562     $ 120,020  
Kangkang Family Farm     4,768       31,354  
Zhenyu Trading     6,796       924  
Total   $ 125,126     $ 152,298  

 

Operating lease with related parties

 

The Company leases several office spaces from Rongfeng Cui, Rongbing Cui, Runrang Cui, and Saike under non-cancelable operating lease agreements with lease terms range from one to ten years. The rental expenses were $160,143, $82,927 and $56,652 for the years ended December 31, 2018, 2017 and 2016, respectively.

 

The Company recognizes rental expenses under such arrangements on the straight-line basis over the initial term of the lease. The difference between the straight-line expenses and cash paid for rent was recorded as accrued expense, which was included in the balance of due to related parties on the consolidated balance sheets.

 

  C. Interests of Experts and Counsel

 

Not required.

 

ITEM 8. FINANCIAL INFORMATION

 

  A. Consolidated Statements and Other Financial Information.

 

See Item 18 for our audited consolidated financial statements.

 

Legal Proceedings

 

We are currently not involved in any legal proceedings; nor are we aware of any claims that could have a material adverse effect on our business, financial condition, results of operations or cash flows.

 

Dividend Policy

 

The holders of shares of our common shares are entitled to dividends out of funds legally available when and as declared by our board of directors. Our board of directors has never declared a dividend and does not anticipate declaring a dividend in the foreseeable future. Should we decide in the future to pay dividends, as a holding company, our ability to do so and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiary and other holdings and investments. In addition, the operating companies may, from time to time, be subject to restrictions on their ability to make distributions to us, including as a result of restrictive covenants in loan agreements, restrictions on the conversion of local currency into U.S. dollars or other hard currency and other regulatory restrictions. In the event of our liquidation, dissolution or winding up, holders of our common shares are entitled to receive, ratably, the net assets available to shareholders after payment of all creditors.

  

  B. Significant Changes

 

Except as disclosed elsewhere in this Annual Report, we have not experienced any significant changes since the date of our audited consolidated financial statements included in this Annual Report.

 

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ITEM 9. THE OFFER AND LISTING

 

  A. Offer and Listing Details

 

The following table sets forth, for the calendar quarters indicated and through April 30, 2019, the quarterly high and low sale prices for our shares, as reported on NASDAQ Stock Market.

 

   Shares 
   High   Low 
         
Quarterly and Monthly Highs and Lows        
1st Quarter 2018   6.5119    6.2913 
2nd Quarter 2018   6.5973    6.2796 
3rd Quarter 2018   6.9146    6.6171 
4th Quarter 2018   6.9568    6.8407 
1st Quarter 2019   6.8764    6.6840 
April 2019   6.7370    6.6922 

 

  B. Plan of Distribution

 

Not Applicable.

 

  C. Markets

 

Our shares have been listed on the NASDAQ Stock Market under the symbols PETZ, since September 21, 2017, following the completion of our initial public offering.

 

On January 7, 2019, we received a notification letter from Nasdaq Listing Qualifications advising the Company that based upon the closing bid price for the Company’s common shares for the past 30 consecutive business days, the Company no longer met the minimum $1.00 per share Nasdaq continued listing requirement set forth in Nasdaq Listing Rule 5555(a)(2). The notification also stated that the Company would be provided 180 calendar days, or until July 8, 2019, to regain compliance with the foregoing listing requirement. To do so, the bid price of the Company’s common stock must close at or above $1.00 per share for a minimum of 10 consecutive business days prior to that date. If the Company does not regain compliance by the compliance deadline, the Company may be eligible for additional time to regain compliance. To qualify, the Company will be required to meet the continued listing requirement for market value of publicly held shares and all other initial listing standards for The Nasdaq Capital Market, with the exception of the bid price requirement, and will need to provide written notice of its intention to cure the deficiency during the second compliance period, by effecting a reverse stock split, if necessary. If the Company meets these requirements, the Nasdaq staff will inform the Company that it has been granted an additional 180 calendar days. However, if it appears to the Nasdaq staff that the Company will not be able to cure the deficiency, or if the Company is otherwise not eligible, the staff will provide notice that its securities will be subject to delisting.

 

The Company cannot provide any assurance that its common shares will trade at levels necessary to regain and maintain compliance with the above-referenced bid price rule before the compliance deadline. The Company intends to continue to monitor the bid price for its common stock. If the Company’s common shares do not trade at a level that is likely to regain compliance with the Nasdaq requirements, the Company’s Board of Directors will consider other options that may be available to achieve compliance.

 

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  D. Selling Shareholders

 

Not Applicable.

 

  E. Dilution

 

Not Applicable.

 

  F. Expenses of the Issue

 

Not Applicable.

 

ITEM 10. ADDITIONAL INFORMATION

 

  A. Share Capital

 

Not Applicable.

 

  B. Memorandum and Articles of Association

 

The information required by Item 10.B of Form 20-F is included in the section titled “Description of Share Capital” in our Registration Statement on Form F-1 initially filed with the SEC on August 11, 2017 (File No.: 333-219896), which section is incorporated herein by reference.

 

  C. Material Contracts

 

None

 

  D. Exchange controls

 

Under British Virgin Islands law, there are currently no restrictions on the export or import of capital, including foreign exchange controls or restrictions that affect the remittance of dividends, interest or other payments to nonresident holders of our shares.

 

  E. Taxation

 

PRC Enterprise Income Tax

 

According to the Enterprise Income Tax Law of PRC (the “EIT Law”), which was promulgated on March 16, 2007, last amended in February 2017 and became effective as of January 1, 2008, the income tax for both domestic and foreign-invested enterprises is at a uniform rate of 25%. The Regulation on the Implementation of Enterprise Income Tax Law of the PRC (the “EIT Rules”) was promulgated on December 6, 2007 and became effective on January 1, 2008. On April 14, 2008, the Chinese Ministry of Science and Technology, Ministry of Finance and State Administration of Taxation enacted the Administrative Measures for Certifying High and New Technology Enterprises (the “Certifying Measures”), which retroactively became effective on January 1, 2008 and was amended on January 29, 2016. Under the EIT Law and the Certifying Measures, certain qualified high-tech companies may benefit from a preferential tax rate of 15% if they own their core intellectual properties and are classified into certain industries strongly supported by the Chinese government and set forth by certain departments of the Chinese State Council. Tiandihui was granted the high and new technology enterprise (“HNTE”) qualification valid until the year end of December 2018. There can be no assurance, however, that Tiandihui will continue to meet the qualifications for such a reduced tax rate. In addition, there can be no guaranty that relevant governmental authorities will not revoke Tiandihui’s “high and new technology enterprise” status in the future. Uncertainties exist with respect to how the EIT Law applies to the tax residence status of Tiandihui and our offshore subsidiaries. Under the EIT Law, an enterprise established outside of China with a “de facto management body” within China is considered a “resident enterprise”, which means that it is treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. Although the implementation rules of the EIT Law define “de facto management body” as a managing body that exercises substantive and overall management and control over the production and business, personnel, accounting books and assets of an enterprise, the only official guidance for this definition currently available is set forth in Circular 82 issued by the State Administration of Taxation, at April 22, 2009 which provides that a foreign enterprise controlled by a PRC company or a PRC company group will be classified as a “resident enterprise” with its “de facto management bodies” located within China if the following criteria are satisfied:

 

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  ● the place where the senior management and core management departments that are in charge of its daily operations perform their duties is mainly located in the PRC;

 

  ● its financial and human resources decisions are made by or are subject to approval by persons or bodies in the PRC;

 

  ● its major assets, accounting books, company seals, and minutes and files of its board and shareholders’ meetings are located or kept in the PRC; and

 

  ● more than half of the enterprise’s directors or senior management with voting rights frequently reside in the PRC.

 

We do not believe that we meet the conditions outlined in the preceding paragraph since Tiandihui does not have a PRC enterprise or enterprise group as our primary controlling shareholder. In addition, we are not aware of any offshore holding companies with a corporate structure similar to the Company that has been deemed a PRC “resident enterprise” by the PRC tax authorities.

 

If we are deemed a China resident enterprise, we may be subject to the EIT at the rate of 25% on our global income, except that the dividends we receive from our Chinese subsidiaries may be exempt from the EIT to the extent such dividends are deemed dividends among qualified resident enterprises. If we are considered a resident enterprise and earn income other than dividends from our Chinese subsidiaries, a 25% EIT on our global income could significantly increase our tax burden and materially and adversely affect our cash flow and profitability.

 

PRC Business Tax and VAT

 

Pursuant to the Provisional Regulation of China on Business Tax last amended on November 10, 2008 and effective as of January 1, 2009 and the Detailed Rules for the Implementation of the Provisional Regulation of China on Business Tax last amended on October 28, 2011 and effective as of November 1, 2011, all entities and individuals engaged in providing taxable services, transfer of intangible assets or the sale of real estate are subject to business tax. Pursuant to the Provisional Regulations on Value-added Tax (VAT) of the PRC last amended on February 6, 2016 and became effective from January 1, 2009 and the Detailed Rules for the Implementation of the Provisional Regulation of China on VAT last amended on October 28, 2011 and effective as of November 1, 2011,all entities or individuals in the PRC engaging in the sale of goods, the provision of processing services, repairs and replacement services, and the importation of goods are required to pay VAT. The amount of VAT payable is calculated as “output VAT” minus “input VAT”, and the rates of VAT are 17%, 16%, 11% or 10% for sales of our goods as determined by State Administration of Taxation.

 

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People’s Republic of China Taxation

 

Under the EIT law and EIT Rules, both of which became effective on January 1, 2008, the income tax for both domestic and foreign-invested enterprises is at a uniform rate of 25%, unless they qualify for certain exceptions. On April 14, 2008, the Chinese Ministry of Science and Technology, Ministry of Finance and State Administration of Taxation enacted the Certifying Measures, which retroactively became effective on January 1, 2008 and was amended on January 29, 2016 provide that certain qualified high-tech companies may benefit from a preferential tax rate of 15% if they own their core intellectual properties and are classified into certain industries strongly supported by the Chinese government and set forth by certain departments of the Chinese State Council. Tiandihui was granted the HNTE qualification valid for three years commencing on December 2, 2016. There can be no assurance, however, that Tiandihui will continue to meet the qualifications for such a reduced tax rate. In addition, there can be no guaranty that relevant governmental authorities will not revoke Tiandihui’s “high and new technology enterprise” status in the future. We are a holding company incorporated in the British Virgin Islands and we gain substantial income by way of dividends from our PRC subsidiaries. The EIT Law and Rules provide that China-sourced income of foreign enterprises, such as dividends paid by a PRC Subsidiary to its equity holders that are non-resident enterprises, will normally be subject to PRC withholding tax at a rate of 10%, unless any such foreign investor’s jurisdiction of incorporation has tax treaty with China that provides for a different withholding arrangement.

 

British Virgin Islands Taxation

 

Under the BVI Act as currently in effect, a holder of common shares who is not a resident of the British Virgin Islands is exempt from British Virgin Islands income tax on dividends paid with respect to the common shares and all holders of common shares are not liable to the British Virgin Islands for income tax on gains realized during that year on sale or disposal of such shares. The British Virgin Islands does not impose a withholding tax on dividends paid by a company incorporated or re-registered under the BVI Act. There are no capital gains, gift or inheritance taxes levied by the British Virgin Islands on companies incorporated or re-registered under the BVI Act. In addition, shares of companies incorporated or re-registered under the BVI Act are not subject to transfer taxes, stamp duties or similar charges. There is no income tax treaty or convention currently in effect between the United States and the British Virgin Islands or between China and the British Virgin Islands.

 

United States Federal Income Taxation

 

The following does not address the tax consequences to any particular investor or to persons in special tax situations such as:

 

  ● banks;

 

  ● financial institutions;

 

  ● insurance companies;

 

  ● regulated investment companies;

 

  ● real estate investment trusts;

 

  ● broker-dealers;

 

  ● traders that elect to mark to market;

 

  ● U.S. expatriates;

 

  ● tax-exempt entities;

 

  ● persons liable for alternative minimum tax;

 

  ● persons holding our common shares as part of a straddle, hedging, conversion or integrated transaction;

 

  ● persons that actually or constructively own 10% or more of our voting shares;

 

  ● persons who acquired our common shares pursuant to the exercise of any employee share option or otherwise as consideration; or

 

  ● persons holding our common shares through partnerships or other pass-through entities.

 

Prospective purchasers are urged to consult their tax advisors about the application of the U.S. Federal tax rules to their particular circumstances as well as the state, local, foreign and other tax consequences to them of the purchase, ownership and disposition of our common shares.

 

72

 

Taxation of Dividends and Other Distributions on our Shares

 

Subject to the passive foreign investment company rules discussed below, the gross amount of distributions made by us to you with respect to the common shares (including the amount of any taxes withheld therefrom) will generally be includable in your gross income as dividend income on the date of receipt by you, but only to the extent that the distribution is paid out of our current or accumulated earnings and profits (as determined under U.S. federal income tax principles). With respect to corporate U.S. Holders, to the extent that the amount of the distribution exceeds our current and accumulated earnings and profits (as determined under U.S. federal income tax principles), it will be treated first as a tax-free return of your tax basis in your common shares, and to the extent the amount of the distribution exceeds your tax basis, the excess will be taxed as capital gain. We do not intend to calculate our earnings and profits under U.S. federal income tax principles. Therefore, a U.S. Holder should expect that a distribution will be treated as a dividend even if that distribution would otherwise be treated as a non-taxable return of capital or as capital gain under the rules described above. The dividends will not be eligible for the dividends-received deduction allowed in respect of dividends received from other U.S. corporations.

 

With respect to non-corporate U.S. Holders, including individual U.S. Holders, dividends will be taxed at the lower capital gains rate applicable to qualified dividend income, provided that (1) the common shares are readily tradable on an established securities market in the United States, or we are eligible for the benefits of an approved qualifying income tax treaty with the United States that includes an exchange of information program, (2) we are not a passive foreign investment company (as discussed below) for either our taxable year in which the dividend is paid or the preceding taxable year, and (3) certain holding period requirements are met. Under U.S. Internal Revenue Service authority, our common shares will be considered for purpose of clause (1) above to be readily tradable on an established securities market in the United States when they are listed on the NASDAQ Capital Market. You are urged to consult your tax advisors regarding the availability of the lower rate for dividends paid with respect to our common shares, including the effects of any change in law after the date of this Annual Report.

 

Dividends on our common shares will constitute foreign source income for foreign tax credit limitation purposes. If the dividends are taxed as qualified dividend income (as discussed above), the amount of the dividend taken into account for purposes of calculating the foreign tax credit limitation will be limited to the gross amount of the dividend, multiplied by the reduced rate divided by the highest rate of tax normally applicable to dividends. The limitation on foreign taxes eligible for credit is calculated separately with respect to specific classes of income. For this purpose, dividends distributed by us with respect to our common shares will constitute “passive category income” but could, in the case of certain U.S. Holders, constitute “general category income.”

 

Taxation of Dispositions of Shares

 

Subject to the passive foreign investment company rules discussed below, you will recognize taxable gain or loss on any sale, exchange or other taxable disposition of shares equal to the difference between the amount realized (in U.S. dollars) for the share and your tax basis (in U.S. dollars) in the shares. The gain or loss will be capital gain or loss. If you are a non-corporate U.S. Holder, including an individual U.S. Holder, who has held the common shares for more than one year, you will be eligible for the capital gains tax rate of 20% (or lower for individuals in lower tax brackets). The deductibility of capital losses is subject to limitations. Any such gain or loss that you recognize will generally be treated as United States source income or loss for foreign tax credit limitation purposes.

 

73

 

Passive Foreign Investment Company

 

Based on our current and anticipated operations and the composition of our assets, we do not expect to be a passive foreign investment company, or PFIC, for U.S. federal income tax purposes for our current taxable year ending December 31, 2018. Our actual PFIC status for the current taxable years ending December 31, 2018 will not be determinable until after the close of such year and, accordingly, there is no guarantee that we will not be a PFIC for the current year. PFIC status is a factual determination for each taxable year which cannot be made until the close of the taxable year. A non-U.S. corporation is considered a PFIC for any taxable year if either:

 

  ● at least 75% of its gross income is passive income; or

 

  ● at least 50% of the value of its assets (based on an average of the quarterly values of the assets during a taxable year) is attributable to assets that produce or are held for the production of passive income (the “asset test”).

 

We will be treated as owning our proportionate share of the assets and earning our proportionate share of the income of any other corporation in which we own, directly or indirectly, at least 25% (by value) of the stock. We must make a separate determination each year as to whether we are a PFIC. As a result, our PFIC status may change. In particular, because the value of our assets for purposes of the asset test will generally be determined based on the market price of our common shares, our PFIC status will depend in large part on the market price of our common shares. Accordingly, fluctuations in the market price of the common shares may cause us to become a PFIC. If we are a PFIC for any year during which you hold common shares, we will continue to be treated as a PFIC for all succeeding years during which you hold common shares. However, if we cease to be a PFIC, you may avoid some of the adverse effects of the PFIC regime by making a “deemed sale” election with respect to the common shares.

 

If we are a PFIC for any taxable year during which you hold common shares, you will be subject to special tax rules with respect to any “excess distribution” that you receive and any gain you realize from a sale or other disposition (including a pledge) of the common shares, unless you make a “mark-to-market” election as discussed below. Distributions you receive in a taxable year that are greater than 125% of the average annual distributions you received during the shorter of the three preceding taxable years or your holding period for the common shares will be treated as an excess distribution. Under these special tax rules:

 

  ● the excess distribution or gain will be allocated ratably over your holding period for the common shares;

 

  ● the amount allocated to the current taxable year, and any taxable year prior to the first taxable year in which we were a PFIC, will be treated as ordinary income, and

 

  ● the amount allocated to each other year will be subject to the highest tax rate in effect for that year and the interest charge generally applicable to underpayments of tax will be imposed on the resulting tax attributable to each such year. The tax liability for amounts allocated to such years cannot be offset by any net operating losses for such years, and gains realized on the sale of the common shares cannot be treated as capital, even if you hold the common shares as capital assets.

 

A U.S. Holder of “marketable stock” (as defined below) in a PFIC may make a mark-to-market election for such stock to elect out of the tax treatment discussed above. If you make a mark-to-market election for the common shares, you will include in income each year an amount equal to the excess, if any, of the fair market value of the common shares as of the close of your taxable year over your adjusted basis in such common shares. You are allowed a deduction for the excess, if any, of the adjusted basis of the common shares over their fair market value as of the close of the taxable year. However, deductions are allowable only to the extent of any net mark-to-market gains on the common shares included in your income for prior taxable years. Amounts included in your income under a mark-to-market election, as well as gain on the actual sale or other disposition of the common shares, are treated as ordinary income. Ordinary loss treatment also applies to the deductible portion of any mark-to-market loss on the common shares, as well as to any loss realized on the actual sale or disposition of the common shares, to the extent that the amount of such loss does not exceed the net mark-to-market gains previously included for such common shares. Your basis in the common shares will be adjusted to reflect any such income or loss amounts. If you make a valid mark-to-market election, the tax rules that apply to distributions by corporations that are not PFICs would apply to distributions by us, except that the lower applicable capital gains rate for qualified dividend income discussed above under “Taxation of Dividends and Other Distributions on our Shares” generally would not apply.

 

74

 

The mark-to-market election is available only for “marketable stock”, which is stock that is traded in other than de minimis quantities on at least 15 days during each calendar quarter (“regularly traded”) on a qualified exchange or other market (as defined in applicable U.S. Treasury regulations), including the NASDAQ Capital Market. If the common shares are regularly traded on the NASDAQ Capital Market and if you are a holder of common shares, the mark-to-market election would be available to you were we to be or become a PFIC.

 

Alternatively, a U.S. Holder of stock in a PFIC may make a “qualified electing fund” election with respect to such PFIC to elect out of the tax treatment discussed above. A U.S. Holder who makes a valid qualified electing fund election with respect to a PFIC will generally include in gross income for a taxable year such holder’s pro rata share of the corporation’s earnings and profits for the taxable year. However, the qualified electing fund election is available only if such PFIC provides such U.S. Holder with certain information regarding its earnings and profits as required under applicable U.S. Treasury regulations. We do not currently intend to prepare or provide the information that would enable you to make a qualified electing fund election. If you hold common shares in any year in which we are a PFIC, you will be required to file U.S. Internal Revenue Service Form 8621 regarding distributions received on the common shares and any gain realized on the disposition of the common shares.

 

You are urged to consult your tax advisors regarding the application of the PFIC rules to your investment in our common shares and the elections discussed above.

 

Information Reporting and Backup Withholding

 

Dividend payments with respect to our common shares and proceeds from the sale, exchange or redemption of our common shares may be subject to information reporting to the U.S. Internal Revenue Service and possible U.S. backup withholding at a current rate of 28%. Backup withholding will not apply, however, to a U.S. Holder who furnishes a correct taxpayer identification number and makes any other required certification on U.S. Internal Revenue Service Form W-9 or who is otherwise exempt from backup withholding. U.S. Holders who are required to establish their exempt status generally must provide such certification on U.S. Internal Revenue Service Form W-9. U.S. Holders are urged to consult their tax advisors regarding the application of the U.S. information reporting and backup withholding rules. Backup withholding is not an additional tax. Amounts withheld as backup withholding may be credited against your U.S. federal income tax liability, and you may obtain a refund of any excess amounts withheld under the backup withholding rules by filing the appropriate claim for refund with the U.S. Internal Revenue Service and furnishing any required information.

 

United States Federal Income Taxation

 

The following sets forth the material British Virgin Islands, Chinese and U.S. federal income tax matters related to an investment in our common shares. It is directed to U.S. Holders (as defined below) of our common shares and is based on laws and relevant interpretations thereof in effect as of the date of this Annual Report, all of which are subject to change. This description does not deal with all possible tax consequences relating to an investment in our common shares, such as the tax consequences under state, local and other tax laws. The following brief description applies only to U.S. Holders (defined below) that hold common shares as capital assets and that have the U.S. dollar as their functional currency. This brief description is based on the tax laws of the United States in effect as of the date of this Annual Report and on U.S. Treasury regulations in effect or, in some cases, proposed, as of the date of this Annual Report, as well as judicial and administrative interpretations thereof available on or before such date. All of the foregoing authorities are subject to change, which change could apply retroactively and could affect the tax consequences described below. The brief description below of the U.S. federal income tax consequences to “U.S. Holders” will apply to you if you are a beneficial owner of shares and you are, for U.S. federal income tax purposes:

 

75

 

  ● an individual who is a citizen or resident of the United States;

 

  ● a corporation (or other entity taxable as a corporation for U.S. federal income tax purposes) organized under the laws of the United States, any state thereof or the District of Columbia;

 

  ● an estate whose income is subject to U.S. federal income taxation regardless of its source; or

 

  ● a trust that (1) is subject to the primary supervision of a court within the United States and the control of one or more U.S. persons for all substantial decisions or (2) has a valid election in effect under applicable U.S. Treasury regulations to be treated as a U.S. person.

 

Belgium taxation

 

The current enterprise income tax rate is approximately 34%, which includes 3% additional tax, for Belgium companies. Small and medium-sized enterprises may enjoy preferential tax rate if they meet the requirements.

 

Japan taxation

 

The enterprise income tax includes national income tax and local special tax for companies operated in Japan. The current national enterprise income tax rate is 30%. And the actual income tax burden will be around 35% - 40% given the local special tax was considered.

 

  F. Dividends and paying agents

 

Not required.

 

  G. Statement by experts

 

Not required.

 

  H. Documents on display

 

 

We file annual reports and other information with the Securities and Exchange Commission. We file annual reports on Form 20-F and submit other information under cover of Form 6-K. As a foreign private issuer, we are exempt from the proxy requirements of Section 14 of the Exchange Act and our officers, directors and principal shareholders are exempt from the insider short-swing disclosure and profit recovery rules of Section 16 of the Exchange Act. Annual reports and other information we file with the Commission may be inspected at the public reference facilities maintained by the Commission at Room 1024, 100 F. Street, N.E., Washington, D.C. 20549, and copies of all or any part thereof may be obtained from such offices upon payment of the prescribed fees. You may call the Commission at 1-800-SEC-0330 for further information on the operation of the public reference rooms and you can request copies of the documents upon payment of a duplicating fee, by writing to the Commission. In addition, the Commission maintains a web site that contains reports and other information regarding registrants (including us) that file electronically with the Commission which can be assessed at http://www.sec.gov.

 

  I. Subsidiary Information

 

Not required.

 

76

 

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

Interest Rate Risk

 

Our main interest rate exposure relates to bank borrowings. We manage our interest rate exposure with a focus on reducing our overall cost of debt and exposure to changes in interest rates. In 2018, we had $1.87 million weighted average outstanding bank loans, with weighted average effective interest rate of 6.06%. In the year 2017, we had $1.52 million weight average outstanding bank loans, with weighted average effective interest rate of 6%.

 

As of December 31, 2018, if interest rates increased/decreased by 1%, with all other variables having remained constant, and assuming the amount of bank borrowings outstanding at the end of the year was outstanding for the entire year, profit attributable to equity owners of our company would have been $3,348, lower/higher, respectively, mainly as a result of higher/lower interest income from our cash and cash equivalents and loan receivables.

 

As of December 31, 2017, if interest rates increased/decreased by 1%, with all other variables having remained constant, and assuming the amount of bank borrowings outstanding at the end of the year was outstanding for the entire year, profit attributable to equity owners of our company would have been RMB $2,029 lower/higher, respectively, mainly as a result of higher/lower interest income from our cash and cash equivalents and loan receivables.

 

Foreign Currency Risk

 

Our functional currency is the RMB, Euro and Yen, and our financial statements are presented in U.S. dollar. We mainly use RMB in domestic transaction, and the transaction settled with Euro and Yen are immaterial. The RMB depreciated against the U.S. dollar by 5.6% in 2018 and appreciated by 6.0% in 2017. The change in the value of RMB relative to the U.S. dollar may affect our financial results reported in the U.S. dollar terms without giving effect to any underlying change in our business or results of operation.

 

Currently, our assets, liabilities, revenues and costs are denominated in RMB and in U.S. dollars, our exposure to foreign exchange risk will primarily relate to those financial assets denominated in U.S. dollars. Any significant revaluation of RMB against U.S. dollar may materially affect our earnings and financial position, and the value of, and any dividends payable on, our common shares in U.S. dollars in the future.

 

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

 

Not required. 

 

77

 

PART II

 

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

 

There has been no default of any indebtedness nor is there any arrearage in the payment of dividends.

 

ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

 

None.

 

ITEM 15. CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

As of December 31, 2018 (the “Evaluation Date”), the Company carried out an evaluation, under the supervision of and with the participation of management, including the Company’s chief executive officer and chief financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based on the foregoing, the chief executive officer and chief financial officer concluded that as of the Evaluation Date the Company’s disclosure controls and procedures were not effective as of December 31, 2018.

 

The material weakness identified by our management was a lack of sufficient controls in place to monitor and manage the relocation of the Company’s Canning manufacturing plant in March 2018. Following this relocation, the Company experienced a decrease in product quality which, in turn, led to sales returns and inventory write-downs.

 

Following our lease term expiration at the end of 2017, the Company has attempted to negotiate a new lease term with the local government, but ultimately failed to do so. As a result, the Company was forced to relocate its production facility to another location in March 2018. As the Company had no prior experience in large scale production facility relocation, it did not take sufficient quality control measures in managing the relocation process. This plant relocation resulted in decreased quality of the finished product based on production testing. In addition, during the Shanghai Cooperation Organization summit which was held in June 2018, the local government limited our production activity and electric power supply, which negatively impacted the production of finished products and resulted in an increase of per unit cost basis of our products. The quality of our products suffered and the percentage of lower quality product compared to our total output has increased from March to June. Discarding products and certain packing materials, cancellation of orders due to shortage of quality products, as well as the reduction of production capacity due to the relocation of the Canning facility impacted our results of operation negatively.

 

In order to address the foregoing material weakness, we have put in place additional controls, including:

 

●Introduction of additional management controls and systems to prepare for any future needs to relocate or amend our production capabilities,

 

●Strengthening the training of the Company’s employees in positions of control and oversight, educating the Company’s staff on the Company’s rules and regulations, and

 

●Strengthening communications among all departments within and related parties with the company to eliminate processing errors.

 

78

 

We intend to complete the remediation effort on or before the end of the 2019 fiscal year and will conduct periodic assessments of the state of the Company’s financial reporting measures and systems, as a whole.

 

Changes in Internal Controls over Financial Reporting

 

Other than the changes described above, there were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Exchange Act) during the period covered by this Annual Report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Management’s annual report on internal control over financial reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process designed under the supervision of our chief executive officer and chief financial officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our consolidated financial statements for external reporting purpose in accordance with U.S. generally accepted accounting principles.

 

Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2018. In making this assessment, management used the framework set forth in the report Internal Control – Integrated framework issued in 2013 by the Committee of Sponsoring Organization of the Treadway Commission, or COSO. The COSO framework summarizes each of the components of a company’s internal control system, including (1) the control environment, (2) risk assessment, (3) control activities, (4) information and communication and (5) monitoring.

 

Based on these evaluations, our management concluded that, due to the material weakness described above, our internal control over financial reporting was not effective as of December 31, 2018.

 

ITEM 16. RESERVED

 

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT.

 

Our Board of Directors has determined that Lei Wang is an audit committee financial expert as that term is defined in Item 16A(b) of Form 20-F, and “independent” as that term is defined in the NASDAQ listing standards.

  

ITEM 16B. CODE OF ETHICS.

 

We have adopted a Code of Business Conduct and Ethics that applies to our directors, officers and employees, including our principal executive officer, principal financial officer, and principal accounting officer. A copy of the Code of Business Conduct and Ethics is available on our website, www.tdhpet.com. The information on our corporate website is not a part of this Annual Report.

 

ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES.

 

The following table represents the approximate aggregate fees for services rendered by MaloneBailey LLP for the periods indicated:

 

   December 31,
2018		   December 31,
2017		 
Audit Fees  $294,300   $260,000 
Audit Related Fees   -    - 
Tax Fees   -    - 
All Other Fees   -    - 
Total Fees  $294,300   $260,000 

 

Pre-Approval of Services

 

Our audit committee evaluated and approved in advance the scope and cost of the engagement of an auditor before the auditor rendered its audit and non-audit services.

 

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ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES.

 

None.

 

ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS.

 

No purchases of our securities were made by us or our affiliates in 2018.

 

ITEM 16F. CHANGES IN REGISTRANT’S CERTIFYING ACCOUNTANT.

 

None.

 

ITEM 16G. CORPORATE GOVERNANCE

 

None.

 

ITEM 16H. MINE SAFETY DISCLOSURE

 

Not applicable.

 

80

 

PART III

 

ITEM 17. FINANCIAL STATEMENTS

 

We have elected to provide financial statements pursuant to Item 18.

 

ITEM 18. FINANCIAL STATEMENTS

 

The financial statements are filed as part of this Annual Report beginning on page F-1.

 

ITEM 19. EXHIBITS

 

Exhibit No.   Description
     
1.1   Form of Underwriting Agreement (5)
3.1   Memorandum and Articles of Association (1).
4.1   Specimen Share Certificate (3).
10.1   Employment Agreement between the Registrant and its CEO (5).
10.2   Employment Agreement between the Registrant and its CFO (5).
10.3   Form of Indemnification Escrow Agreement (3).
10.4   English Translation of Sweet Potato Purchase Agreement (2).
10.5   English Translation of 2015 PSBC Facility Agreement (2).
10.6   English Translation of 2017 PSBC Facility Agreement (2).
10.7   English Translation of 2015 PSBC Working Capital Loan Contract (2).
10.8   English Translation of 2017 PSBC Working Capital Loan Contract (2).
10.9   English Translation of ICBC Online Revolving Loan Contract (2).
10.10   English Translation of the Beijing Jingdong Century Trading Co., Ltd. Food Purchase Agreement (3).
10.11   Form of Lockup Agreement (3).
10.12   English Translation of ICBC Revolving Loan Agreement (4).
12.1   Certification of the Chief Executive Officer (Principal Executive Officer) pursuant to Rule 13a-14(a) of the Securities Exchange Act, as amended.
12.2   Certification of the Chief Financial Officer (Principal Financial Officer) pursuant to Rule 13a-14(a) of the Securities Exchange Act, as amended.
13.1   Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
14.1   Code of Conduct and Ethics (3).
21.1   List of Subsidiaries of the Registrant (5).
99.1   Charter of the Audit Committee (3).
99.2   Charter of the Compensation Committee (3).
99.3   Charter of the Nominating Committee (3).
101.INS   XBRL Instance Document
101.SCH   XBRL Taxonomy Extension Schema Document
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document

 

(1) Incorporated by reference from the previously filed as part of the registration statement DRS F-1 filed with the SEC on March 30, 2017.

 

(2) Incorporated by reference from the previously filed as part of the registration statement DRS F-1 filed with the SEC on May 24, 2017.

 

(3) Incorporated by reference from the previously filed as part of the registration statement DRS F-1 filed with the SEC on June 23, 2017.

 

(4) Incorporated by reference from the previously filed as part of the registration statement Form F-1 (File No. 333-219896) filed with the SEC on August 11, 2017.

 

(5) Incorporated by reference from the previously filed as part of the registration statement Form F-1 (File No. 333-219896) filed with the SEC on August 30, 2017.

 

(6) Incorporated by reference from the previously filed as part of the registration statement Form F-1 (File No. 333-219896) filed with the SEC on September 13, 2017.

 

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SIGNATURES

 

The Registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.

 

  TDH Holdings, Inc.
     
May 15, 2019 By: /s/ Cui Rongfeng
    Name:  Cui Rongfeng
    Title: Chief Executive Officer
(Principal Executive Officer)
       
  TDH Holdings, Inc.
     
May 15, 2019 By: /s/ Cui Rongbing
    Name:  Cui Rongbing
    Title: Chief Financial Officer
(Principal Financial and Accounting Officer)

 

82

 

TDH HOLDINGS, INC. AND SUBSIDIARIES

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

Report of Independent Registered Public Accounting Firm   F-2
     
Consolidated Balance Sheets as of December 31, 2018 and 2017   F-3
     
Consolidated Statements of Operations and Comprehensive Income (Loss) for the Years Ended December 31, 2018, 2017 and 2016   F-4
     
Consolidated Statements of Changes in Stockholders’ Equity (Deficit) for the Years Ended December 31, 2018, 2017 and 2016   F-5
     
Consolidated Statements of Cash Flows for the Years Ended December 31, 2018, 2017 and 2016   F-6
     
Notes to the Consolidated Financial Statements   F-7 – F-28

 

F-1

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Shareholders and Board of Directors of

TDH Holdings, Inc. and Subsidiaries

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheets of TDH Holdings, Inc. and Subsidiaries (collectively, the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of operations and comprehensive income (loss), stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2018, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.

 

Adoption of ASU 2014-09

 

As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for revenue from contracts with customers due to the Company’s adoption of ASU 2014-09, Revenue from contracts with customers, effective January 1, 2018.

 

Going Concern Matter

 

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has suffered significant losses from operations and has a substantial net capital deficiency that raises substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

Basis for Opinion

 

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ MaloneBailey, LLP

www.malonebailey.com

We have served as the Company’s auditor since 2016.

Houston, Texas

May 15, 2019

 

F-2

 

TDH HOLDINGS, INC. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

   December 31,   December 31, 
   2018   2017 
         
ASSETS    
CURRENT ASSETS:        
Cash and cash equivalents  $893,020   $2,346,109 
Restricted cash, current   1,807,485    797,668 
Accounts receivable   845,800    1,932,924 
Accounts receivable - related party   435,513    - 
Advances to suppliers   77,280    633,554 
Inventories, net   3,019,804    9,135,332 
Due from related parties   43,554    361,961 
Prepayments and other current assets   680,606    371,796 
Total current assets   7,803,062    15,579,344 
NON-CURRENT ASSETS:          
Restricted cash, non-current   -    500,000 
Property, plant and equipment, net   8,410,525    3,520,373 
Land use rights, net   1,014,538    211,023 
Long-term investments   201,281    - 
Total non-current assets   9,626,344    4,231,396 
Total assets  $17,429,406   $19,810,740 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)          
CURRENT LIABILITIES:          
Accounts payable  $6,220,375   $4,734,110 
Accounts payable - related parties   125,126    152,298 
Notes payable   2,462,044    1,377,106 
Advances from customers   160,828    231,230 
Advances from customers - related party   -    7,520 
Short term loans   8,263,038    1,402,514 
Short term loans - related parties   1,061,360    - 
Current portion of long term loans - related party   68,673    - 
Taxes payable   44,319    13,562 
Due to related parties   45,146    345,873 
Other current liabilities   692,669    392,435 
Total current liabilities   19,143,578    8,656,648 
NON-CURRENT LIABILITIES:          
Deferred tax liabilities   4,929    5,810 
Long term loans - related party, non-current   217,466    - 
Total liabilities   19,365,973    8,662,458 
STOCKHOLDERS’ EQUITY (DEFICIT):          
Common stock ($0.001 par value; 200,000,000 shares authorized; 10,516,662 and 9,423,750 shares issued and outstanding at December 31, 2018 and 2017, respectively)   10,517    9,424 
Additional paid-in capital   10,999,011    9,947,084 
Stock subscription receivable   -    (100,000)
Statutory reserves   160,014    160,014 
Retained earnings (Accumulated deficit)   (13,349,232)   823,474 
Accumulated other comprehensive income   243,470    308,286 
Total TDH Holdings, Inc. stockholders’ equity (deficit)   (1,936,220)   11,148,282 
Noncontrolling interest   (347)   - 
Total stockholders’ equity (deficit)   (1,936,567)   11,148,282 
Total liabilities and stockholders’ equity (deficit)  $17,429,406   $19,810,740 

 

The accompanying notes are an integral part of these consolidated financial statements

 

F-3

 

TDH HOLDINGS, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

 

   For The Years Ended December 31, 
   2018   2017   2016 
             
Net revenue  $22,154,506   $28,473,016   $24,443,736 
Net revenue - related parties   1,519,531    506,495    - 
Total revenue   23,674,037    28,979,511    24,443,736 
Cost of revenue   26,278,300    20,283,321    17,368,249 
Cost of revenue - related parties   1,448,533    399,177    - 
Total cost of revenue   27,726,833    20,682,498    17,368,249 
Gross profit   (4,052,796)   8,297,013    7,075,487 
Operating expenses:               
Selling expense   4,535,945    4,882,367    3,439,843 
General and administrative expense   2,792,858    2,095,676    1,407,787 
Research and development expense   1,062,582    1,051,665    1,076,568 
Impairment of goodwill   1,599,591    -    - 
Total operating expenses   9,990,976    8,029,708    5,924,198 
Income (loss) from operations   (14,043,772)   267,305    1,151,289 
Interest expense   (233,101)   (82,946)   (102,274)
Government subsidies   81,882    414    21,912 
Other income   20,242    19,305    51,535 
Other expense   (26,992)   (144,069)   (23,490)
Loss from equity method investment   (17,524)   -    - 
Total other expenses   (175,493)   (207,296)   (52,317)
Income (loss) before income taxes provision (benefit)   (14,219,265)   60,009    1,098,972 
Income tax provision (benefit)   -    (55,102)   89,801 
Net income (loss)   (14,219,265)   115,111    1,009,171 
Less: Net loss attributable to noncontrolling interest   (40)   -    - 
Net income (loss) attributable to TDH Holdings, Inc.  $(14,219,225)  $115,111   $1,009,171 
Comprehensive income (loss)               
Net income (loss)  $(14,219,265)  $115,111   $1,009,171 
Other comprehensive income (loss)               
Foreign currency translation adjustment   (65,123)   410,642    (221,418)
Total comprehensive income (loss)  $(14,284,388)  $525,753   $787,753 
Less: Comprehensive loss attributable to noncontrolling interest   (347)   -    - 
Comprehensive income (loss) attributable to TDH Holdings, Inc.  $(14,284,041)  $525,753   $787,753 
                
Earnings (loss) per common share attributable to TDH Holdings Inc.               
Basic  $(1.49)  $0.01   $0.13 
Diluted  $(1.49)  $0.01   $0.13 
Weighted average common shares outstanding               
Basic   9,558,493    8,303,853    7,900,000 
Diluted   9,558,493    8,303,853    7,900,000 

 

The accompanying notes are an integral part of these consolidated financial statements

 

F-4

 

TDH HOLDINGS, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)

 

   Number of Shares   Common Shares   Additional Paid-in Capital   Stock Subscription Receivable   Statutory Reserves   Retained Earnings (Accumulated Deficit)   Accumulated Other Comprehensive Income (Loss)   Noncontrolling Interest   Total Stockholders’ Equity (Deficit) 
Balance, January 1, 2016   7,900,000   $7,900   $2,691,234   $-   $39,923   $(180,717)  $119,062   $   -   $2,677,402 
Net income                            1,009,171              1,009,171 
Issuance of common shares             4,687,153                             4,687,153 
Stock subscription receivable                  (927,730)                       (927,730)
Distribution in connection with acquisition of a subsidiary             (2,880,000)                            (2,880,000)
Liabilities assumed in connection with acquisition of a subsidiary             (91,826)                            (91,826)
Statutory Reserve                       100,647    (100,647)             - 
Foreign currency translation adjustment                                 (221,418)        (221,418)
Balance,
December 31, 2016		   7,900,000    7,900    4,406,561    (927,730)   140,570    727,807    (102,356)   -    4,252,752 
Net income                            115,111              115,111 
Issuance of common shares   1,523,750    1,524    5,540,523                             5,542,047 
Collection of stock subscription receivable                  827,730                        827,730 
Liabilities assumed in connection with acquisition of a subsidiary                                             
Statutory Reserve                       19,444    (19,444)             - 
Foreign currency translation adjustment                                 410,642         410,642 
Balance,
December 31, 2017		   9,423,750    9,424    9,947,084    (100,000)   160,014    823,474    308,286    -    11,148,282 
Net loss                            (14,219,225)        (40)   (14,219,265)
Cumulative effect of adoption of ASC Topic 606                            46,519              46,519 
Issuance of common shares for business acquisition   1,092,912    1,093    1,051,927                             1,053,020 
Collection of stock subscription receivable                  100,000                        100,000 
Liabilities assumed in connection with acquisition of a subsidiary                                             
Statutory Reserve                                             
Foreign currency translation adjustment                                 (64,816)   (307)   (65,123)
Balance, December 31, 2018   10,516,662   $10,517   $10,999,011   $-   $160,014   $(13,349,232)  $243,470   $(347)  $(1,936,567)

 

The accompanying notes are an integral part of these consolidated financial statements

 

F-5

 

TDH HOLDINGS, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS 

 

   For The Years Ended December 31, 
   2018   2017   2016 
Cash flows from operating activities            
Net income (loss)  $(14,219,265)  $115,111   $1,009,171 
Adjustments to reconcile net income (loss) to net cash used in operating activities:               
Depreciation and amortization expense   395,355    364,170    256,104 
Loss from equity method investment   17,524    -    - 
Impairment of goodwill   1,599,591    -    - 
Inventory write-down   1,668,508    -    - 
Bad debt provision   -    18,201    - 
Deferred income tax liability   (591)   (8,581)   (127)
Loss on disposal of property, plant and equipment   -    1,783    - 
Changes in operating assets and liabilities:               
Accounts receivable   1,302,573    (971,831)   (609,099)
Accounts receivable - related party   (778,516)   (10,817)   - 
Inventories, net   4,203,927    (2,658,359)   (3,316,762)
Due to related parties   18,142    5,920    - 
Advances to suppliers   569,723    121,360    (610,215)
Prepayments and other current assets   (291,336)   18,197    (223,632)
Accounts payable   1,870,157    1,174,363    1,321,954 
Accounts payable - related parties   19,848    32,440    - 
Interest payable   119,712    -    - 
Notes payable   1,204,910    (127,275)   284,510 
Taxes payable   32,733    (115,219)   (85,139)
Advances from customers   (60,254)   (601,855)   513,456 
Advances from customers - related party   (7,397)   7,241    - 
Other current liabilities   160,914    (39,785)   (29,339)
Net cash used in operating activities   (2,173,742)   (2,674,936)   (1,489,118)
Cash flows from investing activities               
Payments to acquire property, plant and equipment   (5,627,422)   (227,900)   (9,002)
Proceeds from disposal of property, plant and equipment   -    2,012    - 
Payments to acquire land use rights   (854,221)   (103,596)   - 
Acquisition of businesses, net of cash acquired   19,888    -    - 
Loans to related parties   (132,147)   (533,242)   (2,543,946)
Repayments from related parties   235,049    15,443    3,400,799 
Payments for long-term investments   (235,605)   -    - 
Net cash provided by (used in) investing activities   (6,594,458)   (847,283)   847,851 
Cash flows from financing activities               
Proceeds from issuance of common shares   -    5,542,047    3,759,423 
Collection of stock subscription receivable   100,000    827,730    - 
Capital distribution in connection with acquisition of a subsidiary   -    -    (2,880,000)
Proceeds from related parties   5,306    1,073,961    3,503,190 
Repayments to related parties   (385,420)   (1,767,391)   (3,310,849)
Proceeds from short term loans   8,400,090    2,077,219    1,806,411 
Repayments of short term loans   (1,508,056)   (2,494,793)   (1,806,411)
Proceeds from short term loans - related parties   1,176,690    -    - 
Repayments of short term loans - related party   (60,490)   -    - 
Net cash provided by financing activities   7,728,120    5,258,773    1,071,764 
Effect of exchange rate changes on cash, cash equivalents and restricted cash   96,808    55,000    (84,892)
Net change in cash, cash equivalents and restricted cash   (943,272)   1,791,554    345,605 
Cash, cash equivalents and restricted cash, beginning of the year   3,643,777    1,852,223    1,506,618 
Cash, cash equivalents and restricted cash, end of the year  $2,700,505   $3,643,777   $1,852,223 
                
Supplemental cash flow information               
Interest paid  $113,389   $82,234   $102,274 
Income taxes paid  $-   $59,927   $102,036 
                
Non-cash investing and financial activities               
Operating expenses paid by related parties  $157,094   $85,837   $68,679 
Property, plant and equipment transferred from construction in progress  $-   $-   $34,721 
Liabilities assumed in connection with purchase of property, plant and equipment  $38,636   $133,229   $295,280 
Liabilities assumed in connection with acquisition of a subsidiary  $-   $-   $91,826 
Accounts payable settled with loans to related parties  $-   $-   $490,388 
Receivables from related parties settled with payables to related parties  $114,707   $169,906   $92,402 
Shares issuance in connection with acquisition of subsidiaries  $1,053,020   $-   $- 
Reconciliation of cash, cash equivalents, and restricted cash to the consolidated balance sheets               
Cash and cash equivalents  $893,020   $2,346,109   $1,145,103 
Restricted cash, current  $1,807,485   $797,668   $707,120 
Restricted cash, non-current  $-   $500,000   $- 
Total cash, cash equivalents, and restricted cash at end of the year  $2,700,505   $3,643,777   $1,852,223 

 

The accompanying notes are an integral part of these consolidated financial statements

 

F-6

 

TDH HOLDINGS, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1 – ORGANIZATION

 

TDH Holdings, Inc. (“TDH Holdings”) was incorporated on September 30, 2015 under the laws of the British Virgin Islands. On November 4, 2015, TDH Holdings incorporated a wholly owned subsidiary, TDH HK Limited (“TDH HK”) in Hong Kong for the purpose of being a holding company for the equity interest in Qingdao Tiandihui Foodstuffs Co., Ltd. (“Tiandihui”). On September 9, 2016, TDH Holdings incorporated TDH Petfood LLC, a Nevada limited liability company, which TDH Holdings holds 99% equity interest. TDH Petfood LLC does not own any material assets or liabilities. Other than the equity interest in TDH HK and TDH Petfood LLC, TDH Holdings does not conduct any operations or own any material assets or liabilities. TDH HK does not conduct any operations or own any material assets or liabilities except for cash and the 100% of the equity interest of Tiandihui which it acquired on February 21, 2016.

 

Tiandihui was founded in Qingdao City, Shandong Province, People’s Republic of China (“PRC”) on April 22, 2002 as a limited liability company. As of December 31, 2018, Tiandihui had two wholly owned subsidiaries: Beijing Chongai Jiujiu Cultural Communication Co., Ltd. (“Chongai jiujiu”), which was incorporated on March 3, 2011, in Beijing City, the Capital of PRC, and Qingdao Kangkang Development Co., Ltd. (“Kangkang Development”), which was incorporated on August 9, 2016, in Qingdao City, Shandong Province, PRC. Tiandihui and its wholly owned subsidiaries are engaged in the business of development, manufacture, sales of high quality pet food under our own formula patent. Our products are produced at Tiandihui facility and sold to the pet owners in PRC and to the retailers and wholesalers throughout worldwide.

 

On February 21, 2016, TDH HK entered into an equity transfer agreement with Rongfeng Cui and his wife Yanjuan Wang, the shareholders of Tiandihui at the time, to acquire 100% of the equity interests in Tiandihui (“reorganization”).

 

On July 19, 2016, Tiandihui acquired 100% shares of Chongai Jiujiu from Rongfeng Cui and Yanjuan Wang with a consideration of $87,849 (RMB610,000). The acquisition of Chongai Jiujiu is a transaction between entities under common control.

 

Immediately before and after the reorganization, the shareholders of Tiandihui controlled Tiandihui and TDH Holdings. Therefore, for accounting purposes, the reorganization is accounted for as a transaction of entities under common control. Accordingly, the accompanying consolidated financial statements have been prepared as if the current corporate structure had been in existence throughout the periods presented.

 

On November 14, 2017, a 55% owned subsidiary of the Company, Yichong (Qingdao) Technology Co., Ltd. (“Yichong”) was incorporated in Qingdao City, PRC. Yichong had no operation during the year ended December 31, 2018 and 2017.

 

On November 29, 2017, a 55% owned subsidiary of the Company, Qingdao Lingchong Information Technology Co., Ltd. (“Lingchong”) was incorporated in Qingdao City, PRC. Lingchong had no operation during the year ended December 31, 2017.

 

On January 3, 2018, the Company established a wholly-owned subsidiary, Qingdao Lile Pet Foodstuffs Co., Ltd. (“Lile”) in Qingdao City, PRC. Lile had limited operation activities for the year ended December 31, 2018.

 

In November 2018, the Company completed business acquisitions of TDH Group BVBA, a Belgium entity and TDH JAPAN, a Japanese entity.

 

TDH Holdings and its consolidated subsidiaries are collectively referred to herein as the “Company”, “we” and “us”, unless specific reference is made to an entity.

 

Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation and Principles of Consolidation

 

The accompanying audited financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”).

 

This basis of accounting differs in certain material respects from that used for the preparation of the books of account of the Company, which are prepared in accordance with the accounting principles and the relevant financial regulations applicable to enterprises with limited liabilities established in the PRC (“PRC GAAP”), the accounting standards used in the places of their domicile. The accompanying consolidated financial statements reflect necessary adjustments not recorded in the books of account of the Company to present them in conformity with U.S. GAAP.

 

The consolidated financial statements include the accounts of the Company, its wholly-owned and majority-owned subsidiaries.

 

All significant intercompany accounts and transactions have been eliminated upon consolidation. The results of subsidiaries acquired or disposed of during the respective periods are included in the consolidated statements of operations from the effective date of acquisition or up to the effective date of disposal, as appropriate. The portion of the income or loss applicable to noncontrolling interest in subsidiaries is reflected in the consolidated statements of operations.

 

F-7

 

Going Concern

 

Our consolidated financial statements have been prepared assuming we will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. However, for the year ended December 31, 2018, the Company has incurred a net loss of approximately $14.2 million and working capital deficit of approximately $11.3 million and its cash balance and revenues generated are not currently sufficient and cannot be projected to cover operating expenses and meet the Company’s obligations as they become due for the next twelve months after the date that our financial statements are issued. These factors raise substantial doubt about the Company’s ability to continue as a going concern.

 

Management’s plan to alleviate the substantial doubt about the Company’s ability to continue as a going concern include attempting to improve its business profitability, its ability to generate sufficient cash flow from its operations to meet its operating needs on a timely basis, obtain additional working capital funds through debt and equity financings to eliminate inefficiencies in order to meet its anticipated cash requirements. However, there can be no assurance that these plans and arrangements will be sufficient to fund the Company’s ongoing capital expenditures, working capital, and other requirements.

 

The accompanying consolidated financial statements do not include any adjustments related to the recoverability or classification of asset-carrying amount or the amounts and classification of liabilities that may result should the Company be unable to continue as a going concern.

 

Foreign Currency Translation

 

The accompanying consolidated financial statements are presented in United States dollar (“$”), which is the reporting currency of the Company. The functional currency of TDH Holdings, TDH HK and TDH Petfood LLC is United States dollar. The functional currency of Tiandihui, Chongai Jiujiu, Kangkang Development, Yichong, Lingchong and Lile is Renminbi (“RMB”). The functional currency of TDH Group BVBA is Euro (“€”). The functional currency of TDH JAPAN is Yen (“¥”). For the subsidiaries whose functional currencies are RMB, Euro and Yen, results of operations and cash flows are translated at average exchange rates during the period, assets and liabilities are translated at the unified exchange rate at the end of the period, and equity is translated at historical exchange rates. The resulting translation adjustments are included in determining other comprehensive income or loss. Transaction gains and losses are reflected in the consolidated statements of operations.

  

The exchange rates used to translate amounts in RMB into U.S. Dollars for the purpose of preparing the consolidated financial statements were as follows (USD$1=RMB): 

 

Period Covered  Balance Sheet   Average Rates 
   Date Rates     
         
Year ended December 31, 2018   6.8764    6.6146 
Year ended December 31, 2017   6.5064    6.7570 

 

The exchange rates used to translate amounts in Euro into U.S. Dollars for the purpose of preparing the consolidated financial statements were as follows (USD$1=€): 

 

Period Covered  Balance Sheet   Average Rate 
   Date Rate     

Period from acquisition completion date to December 31, 2018

   0.8737    0.8789 

 

The exchange rates used to translate amounts in Yen into U.S. Dollars for the purpose of preparing the consolidated financial statements were as follows (USD$1=¥): 

 

Period Covered  Balance Sheet   Average Rate 
   Date Rate     

Period from acquisition completion date to December 31, 2018

   110.0039    112.1693 

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities on the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company bases its estimates and judgments on historical experience and on various other assumptions and information that are believed to be reasonable under the circumstances. Estimates and assumptions of future events and their effects cannot be perceived with certainty and, accordingly, these estimates may change as new events occur, as more experience is acquired, as additional information is obtained and as our operating environment changes. Significant estimates and assumptions by management include, among others, useful lives and impairment of long-lived assets and goodwill, write-down in value of inventories and income taxes including the valuation allowance for deferred tax assets, and allowance for sales return. While the Company believes that the estimates and assumptions used in the preparation of the financial statements are appropriate, actual results could differ from those estimates. Estimates and assumptions are periodically reviewed and the effects of revisions are reflected in the financial statements in the period they are determined to be necessary.

 

Cash and Cash Equivalents

 

Cash and cash equivalents include cash on hand, cash in time deposits and highly liquid investments purchased with original maturities of three months or less.

 

F-8

 

Restricted Cash

 

Restricted cash, current mainly represents bank deposits used to pledge the bank acceptance notes and bank letters of credit. The Company entered into credit agreements with commercial banks in China (“endorsing banks”) which agree to provide credit within stipulated limits. Within the stipulated credit limits, the Company can issue bank acceptance notes and letters of credit to its suppliers as payments for the purchases. In order to issue bank acceptance notes and letters of credit, the Company is generally required to make initial deposits to the endorsing banks in amounts of certain percentage of the face amount of the bank acceptance notes or letters of credit to be issued by the Company. The cash in such accounts is restricted for use over the terms of the bank acceptance notes and letters of credits, which are normally three to six months.

 

Accounts Receivable

 

Accounts receivable consists principally of amounts due from trade customers. Credit is extended based on an evaluation of the customer’s financial condition and collateral is not generally required.

 

The Company maintains allowances for doubtful accounts for estimated losses. The Company reviews the accounts receivable on a periodic basis and makes general and specific allowances when there is doubt as to the collectability of individual balances. In evaluating the collectability of individual receivable balances, the Company considers many factors, including the age of the balance, a customer’s historical payment history, its current credit-worthiness and current economic trends. Accounts are written off after exhaustive efforts at collection.

 

Inventories

 

Inventories, consisting of raw materials, low-valued consumables, work in progress, goods sold in transit and finished goods, are stated at the lower of cost or net realizable value, with cost computed on a weighted-average basis. The valuation of inventory requires us to estimate excess and slow-moving inventory. We evaluate the recoverability of our inventory based on assumption about expected demand, market conditions, forecasts prepared by its customers, sales contracts and orders in hand.

 

Property, Plant and Equipment

 

Property, plant and equipment, are stated at cost less depreciation. Cost represents the purchase price of the asset and other costs incurred to bring the asset into its existing use. Maintenance, repairs and betterments, including replacement of minor items, are charged to expense; major additions to physical properties are capitalized.

 

Depreciation of property, plant and equipment is calculated based on cost, less their estimated residual value, if any, using the straight-line method over their estimated useful lives. Estimated useful lives are as follows:

 

Machinery equipment     5 - 20 years  
Computer software     10 years  
Electronic equipment     5 - 10 years  
Office equipment     5 - 10 years  
Motor vehicles     5 - 10 years  
Leasehold improvement     Shorter of the lease term or estimated useful life  
Buildings     20 - 50 years  

  

Land Use Rights

 

According to the law of PRC, the government owns all the land in the PRC. Companies or individuals are authorized to possess and use the land only through land use rights granted by the Chinese government for a specified period of time. Land use rights are being amortized using the straight-line method over the periods the rights are granted.

 

Impairment of Long-Lived Assets and Goodwill

 

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable, or at least annually. The Company recognizes an impairment loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount of impairment is measured as the difference between the asset’s estimated fair value and its book value. The Company has not recorded any significant impairment charges on long-lived assets during the years presented.

 

F-9

 

The Company’s goodwill is tested for impairment on an annual basis or whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. In testing for goodwill impairment, the Company compares the fair value of its reporting unit to its carrying value including the goodwill of that unit. If the carrying value, including goodwill, exceeds the reporting unit’s fair value, the Company will recognize an impairment loss for the amount by which the carrying amount exceeds the reporting unit’s fair value. The loss recognized cannot exceed the total amount of goodwill allocated to that reporting unit. The Company recorded an impairment loss on goodwill of $1,599,591 for the year ended December 31, 2018.

 

Long-term Investments

 

The Company’s long-term investments consist of equity investments without readily determinable fair value and equity method investments.

 

In accordance with ASC 323, Investments-Equity Method and Joint Ventures, the Company applies the equity method of accounting to equity investments, over which it has significant influence but does not own a majority equity interests or otherwise control. Significant influence is generally considered to exist when the Company has an ownership interest in the voting stock of the investee between 20% and 50%. Under the equity method, the Company initially records its investment at cost and subsequently adjusts the carrying amount of the investment to recognize the Company’s proportionate share of each equity investee’s net income or loss into earnings after the date of investment.

 

The Company continually reviews its investment under equity method to determine whether a decline in fair value to below the carrying value is other-than-temporary. The primary factors in its determination are the duration and severity of the decline in fair value, the financial condition, operating performance and the prospects of the equity investee, and other company specific information such as recent financing rounds. If the decline in fair value is deemed to be other-than-temporary, the carrying value of the equity investee is written down to fair value.

 

For equity securities without readily determinable fair value and do not qualify for the existing practical expedient in ASC 820, Fair Value Measurements and Disclosures to estimate fair value using the net asset value per share (or its equivalent) of the investment, the Company elected to use the measurement alternative to measure those investments at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer, if any. The Company makes assessment of whether an investment is impaired at each reporting date, and recognizes an impairment loss equal to the difference between the carrying value and fair value in the consolidated statements of operations and comprehensive income (loss) if there is any. The Company makes a qualitative assessment of whether the investments is impaired at each reporting date.

 

No impairment was identified during the year ended December 31, 2018.

 

Fair Value of Financial Instruments

 

Accounting guidance defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurement for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and it considers assumptions that market participants would use when pricing the asset or liability.

 

The Company measures certain financial assets, including the investment under the measurement alternative method and equity method on other-than-temporary basis, intangible assets, goodwill and fixed assets at fair value when an impairment charge is recognized.

 

Accounting guidance establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Accounting guidance establishes three levels of inputs that may be used to measure fair value:

 

Level 1 — Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

Level 2 — Include other inputs that are directly or indirectly observable in the marketplace.

 

Level 3 — Unobservable inputs which are supported by little or no market activity.

 

Accounting guidance also describes three main approaches to measuring the fair value of assets and liabilities: (1) market approach; (2) income approach and (3) cost approach. The market approach uses prices and other relevant information generated from market transactions involving identical or comparable assets or liabilities. The income approach uses valuation techniques to convert future amounts to a single present value amount. The measurement is based on the value indicated by current market expectations about those future amounts. The cost approach is based on the amount that would currently be required to replace an asset.

 

For certain of the Company’s financial instruments, including cash and cash equivalents, restricted cash, current, accounts receivable, advances to suppliers, prepayments and other current assets, accounts payable and notes payables, advances from customers, taxes payable, other current liabilities, short-term loans, the carrying amounts approximate their fair values due to the short maturities.

 

F-10

 

Operating Leases

 

Leases where substantially all the rewards and risks of ownership of assets remain with the leasing company are accounted for as operating leases. Payments made under operating leases are charged to the consolidated statements of income on a straight-line basis over the lease period.

 

Earnings per Share

 

Basic earnings per common share is computed by dividing net earnings attributable to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income attributable to common shareholders by the sum of the weighted average number of common shares outstanding and dilutive potential common shares during the period. Potentially dilutive common shares consist of common shares warrants using the treasury stock method. Common equivalent shares are not included in the denominator of the diluted earnings per share calculation when inclusion of such shares would be anti-dilutive.

 

Revenue Recognition

 

On January 1, 2018, the Company adopted ASC Topic 606, Revenue from Contracts with Customers, using the modified retrospective method applied to those contracts that were not completed as of January 1, 2018. Results for the reporting period beginning after January 1, 2018 are presented under ASC Topic 606, while prior period amounts have not been adjusted and continue to be reported in accordance with the Company’s historic accounting under ASC Topic 605.

 

Revenue for sale of products is derived from contracts with customers, which primarily include the sale of pet food products. The Company recognizes revenue upon transfer of control of promised goods in a contract with a customer in an amount that reflects the consideration the Company expects to receive in exchange for those products. Transfer of control occurs once the customer has the contractual right to use the product, generally upon shipment or once delivery and risk of loss has transferred to the customer.

 

Revenue is recognized net of any taxes collected from customers that are subsequently remitted to governmental authorities, including value-added tax (“VAT”), business tax, applicable local government levies. At the time revenue is recognized, allowances are recorded, with the related reduction to revenue, for estimated sales returns based upon historical experience and related terms of customer arrangements.

 

The allowance for sales returns recorded by the Company is $0.89 million, $0 and $0 for the years ended December 31, 2018, 2017 and 2016, respectively. The Company does not provide rebate, pricing protection or any other concessions to its customers.

 

The Company elected to account for shipping and handling fees that occur after the customer has obtained control of goods, for instance, free onboard shipping point arrangements, as a fulfilment cost and accrues for such costs.

 

Management has concluded that the disaggregation level is the same under both the revenue standard and the segment reporting standard. Revenue under the segment reporting standard is measured on the same basis as under the revenue standard. See Note 12 for information regarding revenue disaggregation by product lines, marketing channels and countries.

 

Contract liabilities are recorded when consideration is received from a customer prior to transferring the goods to the customer or other conditions under the terms of a sales contract. As of December 31, 2018 and 2017, the Company recorded contract liabilities of $160,828 and $238,750, respectively, which was presented as advances from customers and advances from customers-related party on the accompanying consolidated balance sheets. During the year ended December 31, 2018, the Company recognized $238,750 of contract liabilities included in the opening balances of advance from customers and advance from customers-related party.

 

F-11

 

Adoption Impact of ASC Topic 606 on the Opening Balance Sheet as of January 1, 2018

 

The Company adopted ASC Topic 606 using the modified retrospective method. Under the new standard the Company recognized revenue generated from products sold to certain E-commerce platforms when the control has been transferred, generally at the time products are delivered and accepted by the E-commerce platforms rather than when the price is determined and mutually agreed upon between the Company and the E-commerce platforms, usually at a later time after products delivery, under ASC Topic 605. The cumulative impact of applying the new guidance to all contracts with customers that were not completed as of January 1, 2018 was recorded as an adjustment to the opening retained earnings at the date of adoption. The following table summarizes the adjustments made to accounts on the consolidated balance sheet as of January 1, 2018:

 

   As Reported   Adjustments   As Adjusted 
   December 31,
2017		   Revenue Recognition   January 1,
2018		 
Accounts receivable  $1,932,924   $245,788   $2,178,712 
Prepayments and other current assets   371,796    (24,357)   347,439 
Inventories   9,135,332    (174,912)   8,960,420 
Retained earnings  $823,474   $46,519   $869,993 

 

Impact of ASC Topic 606 on Consolidated Financial Statement Line Items

 

The impact of adoption of ASC Topic 606 on our consolidated balance sheet as of December 31, 2018 and our consolidated statement of operations and comprehensive loss and cash flows for the year ended December 31, 2018 was as follows:

 

   December 31, 2018 
   As Reported   Balances without Adoption of ASC Topic 606   Effect of Change Higher (Lower) 
Consolidated Balance Sheet            
Assets:            
Accounts receivable  $845,800   $765,098   $80,702 
Prepayments and other current assets   680,606    688,139    (7,533)
Inventories, net   3,019,804    3,111,334    (91,530)
Stockholders’ Equity (Deficit):               
Accumulated other comprehensive income   243,470    244,196    (726)
Accumulated deficit  $(13,349,232)  $(13,330,145)  $19,087 

 

   Year Ended December 31, 2018 
   As Reported   Balances without Adoption of ASC Topic 606   Effect of Change Higher (Lower) 
Consolidated Statement of Operations and Comprehensive Loss            
Net Revenue  $22,154,506   $22,299,871   $(145,365)
Cost of revenue   26,278,300    26,358,059    (79,759)
Net loss  $14,219,265   $14,153,659   $65,606 

 

   Year Ended December 31, 2018 
   As Reported   Balances without Adoption of ASC Topic 606   Effect of Change 
Consolidated Statement of Cash Flows            
Net loss  $(14,219,265)  $(14,153,659)  $(65,606)
Adjustments to reconcile net loss to net cash used in operating activities               
Accounts receivable  $1,302,573   $1,140,682   $161,891 
Prepayments and other current assets   (291,336)   (274,810)   (16,526)
Inventories, net   4,203,927    4,283,686    (79,759)
Net cash used in operating activities  $(2,173,742)  $(2,173,742)  $- 

 

F-12

 

Government Grants

 

Government grants include cash subsidies as well as other subsidies received from the PRC government by the subsidiaries of the Company. Such subsidies are generally provided as incentives from the local government to encourage the expansion of local business. The government grant is recognized in the consolidated statements of operations and comprehensive income (loss) when cash is received and the relevant performance criteria specified in the grant are met.

 

Research and Development

 

Research and development costs are expensed as incurred. The costs primarily consist of raw materials used and salaries paid for the development and improvement of the Company’s products.

 

Selling Expenses

 

Selling expenses consist primarily of advertising, salaries and shipping and handling costs incurred during the selling activities. Advertising and transportation expenses are charged to expense as incurred.

 

Shipping and handling expenses amounted to $741,816, $1,162,827 and $836,561 for the years ended December 31, 2018, 2017 and 2016, respectively.

 

Advertising costs amounted to $150,154, $215,399 and $84,667 for the years ended December 31, 2018, 2017 and 2016, respectively.

 

Income Taxes

 

The Company accounts for income taxes under the provision of FASB ASC 740-10, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

 

Comprehensive Income/Loss

 

ASC 220 “Comprehensive Income” established standards for reporting and display of comprehensive income/loss, its components and accumulated balances. Components of comprehensive income/loss include net income/loss and foreign currency translation adjustment. As of December 31, 2018, 2017 and 2016, the only component of accumulated other comprehensive income/loss was foreign currency translation adjustment.

 

Concentration of Credit Risk

 

Financial instruments that potentially subject the Company to concentrations of credit risk are cash, restricted cash, and accounts receivable arising from its normal business activities. The Company places its cash in what it believes to be credit-worthy financial institutions. The Company routinely assesses the financial strength of the customers and, based upon factors surrounding the credit risk, establishes an allowance, if required, for uncollectible accounts and, as a consequence, believes that its accounts receivable credit risk exposure beyond such allowance is limited.

 

Related Parties Transactions

 

A related party is generally defined as (i) any person that holds 10% or more of the Company’s securities and their immediate families, (ii) the Company’s management, (iii) someone that directly or indirectly controls, is controlled by or is under common control with the Company, or (iv) anyone who can significantly influence the financial and operating decisions of the Company. A transaction is considered to be a related party transaction when there is a transfer of resources or obligations between related parties. Related parties may be individuals or corporate entities.

 

Transactions involving related parties cannot be presumed to be carried out on an arm’s-length basis, as the requisite conditions of competitive, free market dealings may not exist. Representations about transactions with related parties, if made, shall not imply that the related party transactions were consummated on terms equivalent to those that prevail in arm’s-length transactions unless such representations can be substantiated. It is not, however, practical to determine the fair value of amounts due from/to related parties due to their related party nature.

 

F-13

 

Segment Reporting

 

The Company uses the “management approach” in determining reportable operating segments. The management approach considers the internal organization and reporting used by the Company’s chief operating decision maker for making operating decisions and assessing performance as the source for determining the Company’s reportable segments. The Company’s chief operating decision maker has been identified as the chief executive officer of the Company who reviews financial information based on U.S. GAAP. The chief operating decision maker now reviews results analyzed by marketing channel. This analysis is only presented at the revenue level with no allocation of direct or indirect costs. Consequently, the Company has determined that it has only one operating segment.

 

Recently Issued Accounting Pronouncements

 

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)” and issued subsequent amendments to the initial guidance or implementation guidance including ASU 2018-01, 2018-10, 2018-11, 2018-20 and 2019-01 (collectively, including ASU 2016-02, “ASC 842”). Under ASC 842, lessees will be required to recognize all leases at the commencement date including a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.

 

The standard will be effective for the Company beginning January 1, 2019, with early adoption permitted. The Company plans to adopt the standard on January 1, 2019 on a modified retrospective basis and will not restate comparable periods. The Company will elect the package of practical expedients permitted under the transition guidance, which allows the Company to carry forward the historical lease classification, the assessment whether a contract is or contains a lease and initial direct costs for any leases that exist prior to adoption of the new standard. The Company will also elect the short-term lease exemption for contracts with lease terms of 12 months or less. In addition, the Company will elect the land easement transition practical expedient and will not reassess whether an existing or expired land easement is a lease or contains a lease if it has not historically been accounted for as a lease. The Company estimates that approximately $0.67 million would be recognized as total right-of-use assets and total lease liabilities on the consolidated balance sheet as of January 1, 2019. However, the Company does not expect the adoption to have a material impact to its consolidated statements of operations and comprehensive income (loss) and cash flows.  

 

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820), – Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement,” which makes a number of changes meant to add, modify or remove certain disclosure requirements associated with the movement amongst or hierarchy associated with Level 1, Level 2 and Level 3 fair value measurements. The amendments in this Update modify the disclosure requirements on fair value measurements based on the concepts in FASB Concepts Statement, Conceptual Framework for Financial Reporting—Chapter 8: Notes to Financial Statements, including the consideration of costs and benefits. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The amendments are effective for all entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the potential impacts of ASU 2018-13 on its consolidated financial statements.

 

Recently Adopted Accounting Pronouncements

 

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (ASC 606)”. Under ASU 2014-09, revenue is recognized when a customer obtains control of promised goods or services and is recognized in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. ASU 2014-09 is effective for fiscal years and interim periods within those years beginning after December 15, 2017, and early adoption is permitted for periods beginning after December 15, 2016. The Company elected adopting the standard using the modified retrospective method on January 1, 2018. The Company recognized the cumulative effect of applying the new revenue standard as an adjustment to the opening balance of retained earnings at the date of adoption. The comparative information has not been restated and continues to be reported under the accounting standards in effect for the periods presented. See Note 2 - Revenue recognition, for additional accounting policy and transition disclosures.

 

F-14

 

In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities,” which improves the recognition and measurement of financial instruments. The new guidance requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income and separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements. The ASU allows a measurement alternative for equity investments without readily determinable fair value and do not qualify for the existing practical expedient in ASC 820, Fair Value Measurements and Disclosures, at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transaction for identical or similar investments of the same issuer, if any.

 

ASU 2016-01 was further amended in February 2018 by ASU 2018-03, “Technical Corrections and Improvements to Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” This update was issued to clarify certain narrow aspects of guidance concerning the recognition of financial assets and liabilities established in ASU 2016-01. This includes an amendment to clarify that an entity measuring an equity security using the measurement alternative may change its measurement approach to a fair valuation method in accordance with Topic 820, Fair Value Measurement, through an irrevocable election that would apply to that security and all identical or similar investments of the same issued.

 

ASU 2016-01 and 2018-03 are effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company adopted the ASU effective January 1, 2018. The adoption did not have a material impact on our consolidated financial statements.

 

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash”. These amendments require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. As a result, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments do not provide a definition of restricted cash or restricted cash equivalents. The amendments in this ASU are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. The Company has adopted the standard retrospectively effective January 1, 2018. As a result, balance of net cash used in investing activities in the year ended December 31, 2017 and the balance of net cash provided by investing activities in the year ended December 31, 2016 were adjusted to exclude the change in restricted cash, resulting in a decrease in such balance of $541,426 and $96,337, respectively.

 

F-15

 

Note 3 – RESTRICTED CASH

 

Restricted cash, current

 

Restricted cash, current represents the bank deposits used to pledge the bank acceptance notes and letters of credit issued by the Company.

 

The cash is restricted for use over the terms of the bank acceptance notes and was used directly to settle the liabilities when the bank acceptance notes or letters of credit became due.

 

As of December 31, 2018 and 2017, the Company had notes payable of $2,462,044 and $1,377,106, respectively.

 

The notes payable issued during the year ended December 31, 2018 were secured by the land use right and real property of Qingdao Saike Environmental Technology Co., Ltd., a related party, real property of Rongfeng Cui, Principal shareholder, Chairman of the Board and CEO of the Company, and Yanjuan Wang, CEO’s wife, restricted cash of RMB300,000 (approximately $43,600) from Qingdao Gaochuang Technology Finance Guarantee Co., Ltd. (“Gaochuang”), a third party guarantee company, and guaranteed by Rongfeng Cui and Qingdao Gaochuang Technology Finance Guarantee Co., Ltd.

 

The notes payable issued during the year ended December 31, 2017 were secured by the land use right and real property of Qingdao Saike Environmental Technology Co., Ltd., a related party, and real property of Rongfeng Cui, Principal shareholder, Chairman of the Board and CEO of the Company, and Yanjuan Wang, CEO’s wife, and guaranteed by Rongfeng Cui.

 

As of December 31, 2018 and 2017, the Company had non-cancellable letters of credit outstanding in the amount of $63,000, and $97,200, respectively.

 

Restricted cash, non-current

 

In connection with its initial public offering, the Company agreed to deposit $500,000 in a non-interest bearing escrow account to satisfy the potential indemnification obligations for two years following September 25, 2017, which is presented as restricted cash, non-current as of December 31, 2017. As of December 31, 2018, the balance was reclassified to restricted cash, current.

 

F-16

 

Note 4 – INVENTORIES

 

As of December 31, 2018 and 2017, inventories consisted of the following:

 

   December 31,
2018		   December 31,
2017		 
Raw materials  $857,462   $2,392,731 
Work in progress   2,313,763    4,106,837 
Finished goods   1,448,854    2,635,764 
Total   4,620,079    9,135,332 
Inventory write-down   (1,668,508)   - 
Inventories, net  $2,951,571   $9,135,332 

 

The work in progress and finished goods held by third parties were $919,390 and $0 as of December 31, 2018, respectively. The work in progress and finished goods held by third parties were $1,356,461 and $212,063 as of December 31, 2017, respectively.

 

The Company recorded write-down of potentially obsolete or slow-moving inventories of $1,501,510 and lower of cost or market adjustment of $166,998 for the year ended December 31, 2018.

  

Note 5 – PROPERTY, PLANT AND EQUIPMENT, NET

 

As of December 31, 2018 and 2017, property, plant and equipment consisted of the following:

 

   December  31,   December 31, 
   2018   2017 
Machinery equipment  $3,257,452   $3,357,637 
Electronic equipment   66,632    70,421 
Office equipment   237,264    229,978 
Vehicles   75,114    79,385 
Buildings   6,234,238    964,504 
Leasehold Improvement   289,186    262,648 
Total property, plant and equipment   10,159,886    4,964,573 
Less: accumulated depreciation   (1,749,361)   (1,444,200)
Property, plant and equipment, net  $8,410,525   $3,520,373 

 

Depreciation expense for the years ended December 31, 2018, 2017 and 2016 was $388,256, $349,887 and $252,957, respectively.

 

As of December 31, 2018 and 2017, certain property, plant and equipment with net book value of $6,652,037 and $555,070 was pledged as collateral under certain loan arrangements, respectively.

 

Note 6 – LAND USE RIGHTS

 

   December 31,
2018		   December 31,
2017		 
Land use rights  $1,041,736   $232,550 
Accumulated depreciation   (27,198)   (21,527)
Land use rights, net  $1,014,538   $211,023 

 

During the years ended December 31, 2018, 2017 and 2016, amortization expense amounted to $7,099, $14,283 and $3,147, respectively. The Company expects to record amortization expense of $21,979, $21,979, $21,979, $21,979, $21,979 and $904,643 for 2019, 2020, 2021, 2022, 2023 and thereafter, respectively.

 

As of December 31, 2018 and 2017, land use right with net book value of $820,343 and $115,056, respectively, was pledged as collateral under certain loan arrangements.

 

F-17

 

Note 7 – SHORT TERM LOANS

 

The Company’s loans consist of the followings:

 

   December 31,   December 31, 
   2018   2017 
Short term loans  $8,263,038   $1,402,514 
Total  $8,263,038   $1,402,514 

 

   December 31,   December 31, 
   2018   2017 
Secured  $8,021,447   $1,352,514 
Unsecured   241,591    50,000 
Total  $8,263,038   $1,402,514 

 

For the years ended December 31, 2018 and 2017, the Company entered into various loans agreements with various Chinese banks, other entity and individuals for an aggregated amount of $8,400,090 and $2,077,219, respectively, to facilitate its business operations. Interest rate for the loans outstanding during the years ended December 31, 2018 and 2017 ranged from 2.46% to 25% and from 5.22% to 6.09% per annum, respectively.

 

As of December 31, 2018, corporate or personal guarantees provided for those loans were as follows:

 

$407,190   Pledged by real property and land use right of Rongfeng Cui; Guaranteed by Rongfeng Cui and Yanjuan Wang
      
$1,586,393   Pledged by real property of the Company, real property of Rongfeng Cui; Guaranteed by Rongfeng Cui and Yanjuan Wang
      
$3,119,365   Pledged by real property and land use right of the Company; Guaranteed by Rongfeng Cui and Yanjuan Wang
      
$2,908,499   Guaranteed by Rongfeng Cui and Yanjuan Wang

 

On December 20, 2018, the Company entered into a loan agreement with China Construction Bank (“CCB”) to borrow RMB21,450,000 (approximately $3,119,000). The loan bears an annual interest rate of 5.39% and is due in 84 months. Pursuant to the loan agreement, the proceeds of the loan can only be used in the purchase of manufacturing facility and the associated land use right located at Lingang Economic Development Zone, Huangdao District, Qingdao, Shandong Province, People’s Republic of China.

 

As of December 31, 2018, the Company’s future principal obligations according to the terms of the loan agreement are as follows:

 

2019  $5,579,948 
2020   436,275 
2021   436,275 
2022   436,275 
2023   436,275 
Thereafter   937,990 
Total  $8,263,038 

 

The loan agreement between the Company and CCB contains a number of covenants and restrictions. Such covenants and restrictions include, but are not limited to, financial ratios. Unless a breach is remediated or a waiver is obtained, a breach of such covenants and restrictions generally permits lender to demand accelerated repayment of principal and interest.

 

The Company did not meet the financial ratios set forth in the debt covenants as of December 31, 2018 nor subsequently. The Company does not expect to meet the current debt covenant requirement within the next 12 months. As a result, the corresponding loan described above was reclassified as current liability and included in short term loans.

 

The interest expenses for the short term loans were $138,010, $82,234 and $102,274 for the years ended December 31, 2018, 2017 and 2016, respectively.

 

F-18

 

Note 8 – RELATED PARTY TRANSACTIONS

 

The related parties had transactions for the years ended December 31, 2018, 2017 and 2016 consist of the following:

 

Name of Related Party   Nature of Relationship
Rongfeng Cui   Principal shareholder, Chairman of the Board and Chief Executive Officer (“CEO”)
     
Rongbing Cui   Chief Financial Officer (“CFO”), Rongfeng Cui’s brother
     
Rongjie Cui   Rongfeng Cui’s brother
     
Yanjuan Wang   Principal shareholder, Rongfeng Cui’s wife
     
Runrang Cui   Father of Rongfeng Cui, and owner of Huangdao Dinggezhuang Kangkang Family Farm
     
Xiaomei Wang   Rongbing Cui’s wife
     
A group of individuals   A group of shareholders hold more than 10% of the voting interest of the Company
     
Wenbin Pang   Financial Director of the Company
     
Yan Fu   Former Sales Vice President
     
Jichang Zhang   General manager
     
Fucheng Sun   Chief R&D Officer
     
Phillip Zou   Noncontrolling shareholder of Petfood LLC
     
Qingdao Kangkang Pet Supplies Co., Ltd. (“Kangkang”)   Controlled by Rongfeng Cui, through owning 85% of its equity interest
     
Tide (Shanghai) Industrial Co. Ltd. (“Tide”)   Owned by Rongfeng Cui and Yanjuan Wang
     
Qingdao Like Pet Supplies Co., Ltd. (“Like”)   Rongfeng Cui served as CEO, and Shuhua Cui, the sister of Rongfeng Cui, served as the legal person. On May 26, 2016, both Rongfeng Cui and Shuhua Cui resigned from their positions, but still have significant influence on Like.
     
Qingdao Like Electronic Commerce Co., Ltd. (“Like E-commerce”)   Rongfeng Cui was the former supervisor and shareholder, still has significant influence on Like.
     
Qingdao Saike Environmental Technology Co., Ltd. (“Saike”)   Owned by Rongfeng Cui and Yanjuan Wang
     
Huangdao Ding Ge Zhuang Kangkang Family Farm (“Kangkang Family Farm”)   Controlled by Rongfeng Cui’s father
     
TDH Group BVBA   A European company solely owned by Rongfeng Cui prior to November 30, 2018; a wholly-owned subsidiary of the Company since November 30, 2018
     
TDH JAPAN   A Japanese company solely owned by Rongfeng Cui prior to November 30, 2018; a wholly-owned subsidiary of the Company since November 30, 2018
     

Qingdao Yinhe Jiutian Information Technology Co., Ltd.

(“Yinhe Jiutian”)

   Solely owned by Rongbing Cui
     
Huangdao Hanyinhe Software Development Center Co., Ltd. (“Hanyinhe”)   Solely owned by Xiaomei Wang
     
Zhenyu Trading (Qingdao) Co., Ltd. (“Zhenyu”)   Noncontrolling shareholder of Yichong
     
Beijing Quanmin Chongai Information Technology Co., Ltd. (“Quanmin Chongai”)   Controlled by Anqi Zhou, a close relative of Rongfeng Cui

 

F-19

 

Due from related parties

 

Due from related parties consisted of the following:

 

   December 31,   December 31, 
   2018   2017 
Tide  $44   $46 
TDH Group BVBA   -    329,237 
Rongfeng Cui   43,510    32,678 
Total  $43,554   $361,961 

 

The balance of due from Tide represents operating expenses paid by the Company on behalf of Tide. The balances of due from TDH Group BVBA and Rongfeng Cui represent overseas trade receivables collected by the two parties on behalf of the Company.

 

Due to related parties

 

Due to related parties consisted of the following:

 

   December 31,   December 31, 
   2018   2017 
Saike   $16,470   $6,148 
Phillip Zou   1,000    1,000 
Yanjuan Wang   -    29,878 
Rongfeng Cui   27,676    308,847 
Total  $45,146   $345,873 

 

F-20

 

The balance of due to related parties represents expenses paid by related parties on behalf of the Company as well as advances the Company obtained from related parties for working capital purposes. The amounts owed to the related parties are unsecured, non-interest bearing and payable on demand.

 

Short term loans from related parties

 

   December 31,   December 31, 
   2018   2017 
Rongfeng Cui  $84,831   $              - 
A group of individuals who hold more than 10% voting interest of the Company   876,913    - 
Rongbing Cui   31,993    - 
Wenbin Pang   29,085    - 
Yan Fu   29,085    - 
Rongjie Cui   4,363    - 
Jichang Zhang   2,909    - 
Fucheng Sun   2,181    - 
Total  $1,061,360   $- 

 

The Company borrowed unsecured short term loans from related parties in the amount of $1,176,690 and $0, during the years ended December 31, 2018 and 2017, respectively. Interest rate for the loans outstanding during the year ended December 31, 2018 ranged from 3% to 25% per annum. The Company made repayment in the amount of $60,490 and $0, during the years ended December 31, 2018 and 2017, respectively.

 

Modification of loans from related party

 

In January 2018, the Company entered into a loan agreement with an individual. In May 2018, the agreement was amended to, among other things, increase the principal amount from RMB3,000,000 (approximately $466,000) to RMB3,030,000 (approximately $471,000) and increase the interest rate from 3% to 15%. Interest rate will be 24% for the period past due. In March 2019, the agreement was further amended to, among other things, increase the principal amount to RMB3,484,500 (approximately $539,000) and extend the maturity date from January 2019 to May 2019.

 

In June 2018, the Company entered into a loan agreement with another individual. Interest rate was 15% during the loan period and 24% for the period past due. In March 2019, the agreement was amended to, among other things, increase the principal amount from RMB3,000,000 (approximately $462,000) to RMB3,405,000 (approximately $522,000) and extend the maturity date from December 2018 to May 2019.

 

The Company analyzed the amendments under ASC 470-50 and concluded that these amendments did not qualify for debt modification.

 

Long term loans from related party

 

   December 31,   December 31, 
   2018   2017 
Rongfeng Cui  $286,139   $         - 
Less: Rongfeng Cui - current portion   68,673    - 
Non-current portion  $217,466   $- 

 

Long term loans from related party represent loans assumed by the Company in connection with acquisition of TDH Group BVBA. In March 2018, TDH Group BVBA borrowed non-interest bearing, unsecured long term loans from Rongfeng Cui in the aggregate amount of €250,000 (approximately $288,000), of which €60,000 (approximately $69,000), €60,000 (approximately $69,000), €60,000 (approximately $69,000), €60,000 (approximately $69,000), €10,000 (approximately $11,500) and $0 is due in the years ended December 31, 2019, 2020, 2021, 2022, 2023 and thereafter, respectively.

 

F-21

 

Sales to related parties, purchases from related parties and services provided by related parties

 

   For the Years Ended December 31, 
   2018   2017   2016 
SALES TO:               
Like  $1,167,933   $506,495   $- 
Liujiayi   25,832    -    - 
TDH Group BVBA   325,766    -    - 
Total Sales  $1,519,531   $506,495   $- 
PURCHASES FROM:               
Like  $-   $-   $490,388 
Yinhe Jiutian   -    5,059    138,943 
Kangkang Family Farm   -    30,191    13,818 
Zhenyu   28,872    163,127    - 
TDH Group BVBA   2,689    -    - 
Total Purchases  $31,561   $198,377   $643,149 
SERVICE PROVIDED BY:               
Hanyinhe  $9,373   $-   $- 
TDH Group BVBA   278,396    -    - 
TDH JAPAN   134,181    -    - 
Total Services Consumed  $421,950   $-   $- 

 

For the years ended December 31, 2018, 2017 and 2016, the cost of revenue in connection with sales to related parties were $1,448,533, $399,177 and $0, respectively, which were included in cost of revenue-related parties in the accompanying consolidated statement of operations and comprehensive income (loss).

 

During the years ended December 31, 2018, 2017 and 2016, inventories purchased from related parties in the amount of $26,698, $44,502 and $6,616, respectively, were used and sold and included in cost of revenue in the accompanying consolidated statement of operations and comprehensive income (loss).

 

The Company purchased financial application software from Yinhe Jiutian in the amount of $0, $5,059 and $138,943 during the years ended December 31, 2018, 2017 and 2016, respectively.

 

Accounts receivables from related party

 

   December 31,   December 31, 
   2018   2017 
Like  $435,513   $        - 
Total  $435,513   $- 

 

Advances from related party customer

 

   December 31,   December 31, 
   2018   2017 
Like  $          -   $7,520 
Total  $-   $7,520 

 

Accounts payable to related parties

 

   December 31,   December 31, 
   2018   2017 
Yinhe Jiutian  $113,562   $120,020 
Kangkang Family Farm   4,768    31,354 
Zhenyu Trading   6,796    924 
Total  $125,126   $152,298 

 

Operating lease with related parties

 

The Company leases several office spaces from Rongfeng Cui, Rongbing Cui, Runrang Cui, and Saike under non-cancelable operating lease agreements with lease terms range from one to ten years. The rental expenses were $160,143, $82,927 and $56,652 for the years ended December 31, 2018, 2017 and 2016, respectively.

 

The Company recognizes rental expenses under such arrangements on the straight-line basis over the initial term of the lease. The difference between the straight-line expenses and cash paid for rent was recorded as accrued expense, which was included in the balance of due to related parties on the consolidated balance sheets.

F-22

 

Note 9 – INCOME TAXES

 

British Virgin Islands (“BVI”)

 

Under the current laws of BVI, TDH Holdings is not subject to tax on income or capital gain. In addition, payments of dividends by the Company to their shareholders are not subject to withholding tax in the BVI.

 

Hong Kong

 

The Company’s subsidiary, TDH HK, is incorporated in Hong Kong and has no operating profit or tax liabilities during the period. TDH HK is subject to tax at 16.5% on the assessable profits arising in or derived from Hong Kong.

 

United State

 

The Company’s subsidiary, TDH Petfood LLC, is incorporated in the State of Nevada and is subject to the United States Federal and state income tax at a statutory rate of 21%. No provision for the U.S. Federal income tax has been made as TDH Petfood LLC had no taxable income in this jurisdiction for the reporting periods.

 

Japan

 

The Company’s newly acquired subsidiary, TDH JAPAN, is incorporated in Japan and has no operating profit or tax liabilities during the reporting period. TDH JAPAN is subject to tax at 21.421% on the assessable profits arising in or derived from Japan.

 

Belgium

 

The Company’s newly acquired subsidiary, TDH Group BVBA, is incorporated in Belgium and has no operating profit or tax liabilities during the reporting period. TDH Group BVBA is subject to tax at 29.58% on the assessable profits arising in or derived from Belgium.

 

PRC

 

The Company’s subsidiaries incorporated in the PRC are subject to PRC Enterprise Income Tax (“EIT”) on the taxable income in accordance with the relevant PRC income tax laws. On March 16, 2007, the National People’s Congress enacted a new enterprise income tax law, which took effect as of January 1, 2008. The law applies a uniform 25% enterprise income tax rate to both foreign invested enterprises and domestic enterprises. According to the tax law, entities that qualify as high and new technology enterprises (“HNTE”) supported by the PRC government are allowed a 15% preferential tax rate instead of the uniform tax rate of 25%.

 

On December 2, 2016, Tiandihui was granted the HNTE designation jointly by Qingdao science and Technology Bureau, Qingdao Municipal Finance Bureau, Qingdao Municipal State Taxation Bureau, Qingdao Local Taxation Bureau, and is qualified for a preferential tax rate of 15% for the years ended December 31, 2016, 2017 and 2018.

 

The provision for income taxes consists of the following:

 

   For the Years Ended 
   December 31, 
   2018   2017   2016 
Current  $       -   $(46,521)  $89,928 
Deferred   -    (8,581)   (127)
Total  $-   $(55,102)  $89,801 

 

The reconciliations of the statutory income tax rate and the Company’s effective income tax rate are as follows:

 

   For the Years Ended 
   December 31, 
   2018   2017   2016 
HK statutory income tax rate   16.50%   16.50%   16.50%
PRC statutory income tax rate difference   -1.50%   -1.50%   -1.50%
Effect of additional deduction on R&D expense and salary for disabled workers   0.87%   -127.75%   -7.69%
Effect of expenses not deductible for tax purposes   -0.05%   1.10%   0.40%
Effect of change of tax rate for temporary difference   -    -    - 
Valuation allowance recognized with respect to the loss in subsidiaries   -15.82%   19.83%   -0.03%
Others   -    -    0.49%
Total   -%   -91.82%   8.17%

 

F-23

 

Accounting for Uncertainty in Income Taxes

 

The tax authority of the PRC Government conducts periodic and ad hoc tax filing reviews on business enterprises operating in the PRC after those enterprises complete their relevant tax filings. Therefore, the Company’s PRC entities’ tax filings results are subject to change. It is therefore uncertain as to whether the PRC tax authority may take different views about the Company’s PRC entities’ tax filings, which may lead to additional tax liabilities.

 

ASC 740 requires recognition and measurement of uncertain income tax positions using a “more-likely-than-not” approach. The management evaluated the Company’s tax positions and concluded that no provision for uncertainty in income taxes was necessary as of December 31, 2018 and 2017.

 

Deferred tax assets and liabilities as of December 31, 2018 and 2017 are composed of the following:

 

   As of December 31, 
   2018   2017 
Deferred tax assets, non-current        
Net operating loss carrying forward  $2,115,514   $274,073 
Total deferred tax assets          
Valuation allowance   (2,115,514)   (274,073)
Total  $-   $- 

 

   As of December 31, 
   2018   2017 
Deferred tax liabilities, non-current        
Property, plant and equipment  $4,929   $5,810 
Total  $4,929   $5,810 

   

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible or are utilized.

 

Note 10 – STOCKHOLDERS’ EQUITY

 

On December 31, 2016, a total of 371,092 common shares were issued at $2.5 per share to Fulcan Capital Partners, LLC, Xiumei Lan and Zhonghua Liu with cash proceeds of $827,730 received during the year ended December 31, 2017, and the remaining proceeds of $100,000 received during the year ended December 31, 2018.

 

On September 25, 2017, the Company completed its initial public offering on the NASDAQ Capital Market under the symbol of “PETZ”. The Company offered 1,523,750 common shares at $4.25 per share. Net proceeds raised by the Company from the initial public offering amounted to $5,542,047 after deducting underwriting discounts and commissions and other offering expenses. Out of the $5.5 million net proceeds, $500,000 was deposited into an escrow account to satisfy the initial $500,000 in potential indemnification obligations arising during an escrow period of two years following the closing date of September 25, 2017 and was presented as restricted cash.

 

In November 2018, the Company issued 156,130 and 936,782 common shares to acquire 100% equity interest in TDH Japan and TDH Group BVBA, respectively.

 

As of December 31, 2018 and 2017, the Company had statutory reserve in the amount of $160,014. In accordance with the relevant laws and regulations of the PRC, the Company’s PRC subsidiaries are required to set aside at least 10% of their respective after-tax net profits each year determined in accordance with PRC GAAP and if any, to fund the statutory reserve until the balance of the reserve reaches 50% of their respective registered capital. The statutory reserve is not distributable in the form of cash dividends and can be used to make up cumulative prior year losses.

 

F-24

 

Note 11 – CONCENTRATIONS OF CREDIT RISK AND MAJOR CUSTOMERS

 

Customers

 

For the years ended December 31, 2018, 2017 and 2016, customers accounting for 10% or more of the Company’s net revenue were as follows:

 

    For the Years Ended  
    December 31,  
Customer   2018     2017     2016  
                   
Customer A     * %     * %     12.00 %
Customer B     * %     10.89 %     12.67 %

 

* Less than 10%

 

As of December 31, 2018, Customer E, and Customer F accounted for 21.69% and 33.92% of the Company’s total current outstanding accounts receivable, respectively.

 

As of December 31, 2017, Customer B, and Customer E accounted for 14.77% and 15.76% of the Company’s total current outstanding accounts receivable, respectively.

 

Suppliers

 

For the years ended December 31, 2018, 2017 and 2016, suppliers accounting for 10% or more of the Company’s purchase were as follows:

 

   For the Years Ended
December 31,		 
Supplier  2018   2017   2016 
Supplier A   *%   10.65%   14.12%
Supplier B   *%   13.23%   13.39%

 

* Less than 10%

 

As of December 31, 2018 and 2017, no supplier’s balance accounted for over 10% of the Company’s total accounts payable and notes payable.

 

F-25

 

Note 12 – SEGMENTAL AND REVENUE ANALYSIS

 

The Company is solely engaged in the business of manufacturing and selling of pet food. Since the nature, the production processes and the marketing channel of the products are substantially similar, the Company is considered as operating in a single reportable segment with revenues derived from multiple product lines, marketing channels and countries. Certain entity-wide disclosures relating to revenues for the years ended December 31, 2018, 2017 and 2016 are as follows:

 

The net revenue generated from different marketing channels consists of the following:

 

   For the Years Ended 
   December 31, 
   2018   2017   2016 
Overseas sales  $15,832,362   $21,190,063   $18,882,589 
Domestic sales   4,102,457    2,086,462    1,129,133 
Electronic commerce   3,800,668    5,734,121    4,461,504 
Less: Sale tax and addition   (61,450)   (31,135)   (29,490)
Total net revenue  $23,674,037   $28,979,511   $24,443,736 

 

The net revenue generated from different product lines is set forth as following:

 

   For the Years Ended 
   December 31, 
   2018   2017   2016 
Pet chews  $6,271,777   $9,614,426   $10,316,841 
Dried pet snacks   13,611,010    14,851,868    11,204,517 
Wet canned pet food   2,782,382    3,035,196    1,926,455 
Dental health snacks   495,581    856,875    606,648 
Baked pet biscuits   95,169    8,226    123,898 
Others   479,568    644,055    294,867 
Less: Sales tax and addition   (61,450)   (31,135)   (29,490)
Total net revenue  $23,674,037   $28,979,511   $24,443,736 

 

The net revenue generated from different countries is set forth as following:

 

   For the Years Ended 
   December 31, 
   2018   2017   2016 
South Korea  $2,870,998   $5,397,982   $5,299,721 
China   6,569,382    6,553,715    5,073,272 
United Kingdom   2,415,043    3,213,303    3,227,619 
Germany   2,522,149    3,585,535    3,204,314 
Other countries   9,357,915    10,260,111    7,668,300 
Less: Sales tax and addition   (61,450)   (31,135)   (29,490)
Total net revenue  $23,674,037   $28,979,511   $24,443,736 

 

“Other countries” are comprised of all countries whose revenue, individually, was less than 10% of the Company’s total revenue.

 

Substantially all of the Company’s long-lived assets are located in the PRC.

 

F-26

 

Note 13 – COMMITMENTS AND CONTINGENCIES

 

The Company has entered into multiple lease agreements for the lease of premises for factory buildings, office spaces and warehouses. Also see Note 8 for operating leases with related parties.

 

Rental expense, including expenses incurred from operating leases with related parties, for the years ended December 2018, 2017 and 2016 was $218,414, $163,497, and $161,136, respectively. The Company has future minimum lease obligations, including lease obligations with related parties, as of December 31, 2018 as follows:

 

2019  $207,943 
2020   187,876 
2021   58,723 
2022   61,423 
2023   64,285 
Thereafter   231,790 
Total  $812,040 

 

The Company provides counter guarantee to Gaochuang including a cash deposit of RMB300,000 (approximately $43,600) and asset pledge of four invention patents and certain property, plant and equipment with net book value of $850,541 as of December 31, 2018 in consideration of the guarantees provided by Gaochuang for certain notes payables financed by the Company during the year ended December 31, 2018 (the “Counter Guarantee”). The Counter Guarantee arrangement further includes an unlimited joint liability guarantee provided by Rongfeng Cui and Yanjuan Wang, and a third party guarantee provided by Saike.

 

Note 14 – BUSINESS COMBINATIONS

 

In September 2018, the Company’s board of directors approved the acquisitions by the Company of TDH Group BVBA and TDH JAPAN by issuance of 936,782 and 156,130 of the Company’s common shares, respectively, to Rongfeng Cui, the sole owner of the two entities. The Company completed the acquisitions in November 2018. The fair value of the total consideration transferred was measured based on the stock price and the acquired net assets were recorded at their fair values on the acquisition date.

 

The purchase price was allocated as follows:

 

Purchase consideration  $1,053,020 
Net assets acquired, excluding property, plant and equipment and long-term loans from related party   (333,464)
Property, plant and equipment   2,704 
Long-term loans-related party   (215,811)
Goodwill   1,599,591 
      
Total  $1,053,020 

 

The acquisitions had been accounted for as business acquisitions and the results of operations of TDH Group BVBA and TDH Japan from the acquisition date have been included in the Company’s consolidated financial statements.

 

Neither the results of operations since the acquisition date nor the pro forma results of operations of the acquirees were presented because the effects of these business combinations, individually and in the aggregate, were not significant to the Company’s consolidated results of operations.

 

The Company performed an impairment test for goodwill on December 31, 2018 and identified an impairment loss of $1,599,591 as the fair value of the reporting unit is less than its carrying value based on the management’s specific analysis of future production plan and sales forecasts.

 

F-27

 

Note 15 – LONG-TERM INVESTMENTS

 

In February 2018, the Company acquired 5% equity interests in Liujiayi Pet Technology (Beijing) Co., Ltd. (“Liujiayi”) for a cash consideration of RMB500,000 (approximately $79,400). The investment was accounted for at cost, less impairment, plus or minus changes resulting from observable price changes in orderly transaction for identical or similar investments of the same issuer, if any, using the measurement alternative due to lack of readily determinable fair values, pursuant to ASC 321.

 

In March 2018, the Company invested RMB1,000,000 (approximately $156,200) in Shandong Tide Food Co., Ltd. (“Shandong Tide”), a pet food production company that was newly established in 2018, representing 37% equity interest in Shandong Tide. The investment was accounted for as equity method in accordance with ASC 323. The Company recognized its proportionate share of Shandong Tide’s net loss in the amount of $17,524 into the consolidation statements of operations and comprehensive income (loss).

 

Note 16 – SUBSEQUENT EVENTS

 

Subsequent borrowings from and repayments to related parties

 

During the subsequent period, the Company obtained a three-month short term loan in the amount of $3,300,000 from a principal shareholder. The interest rate is 15% for the loan period and 24% for the period past due.

 

In February 2019, the Company obtained a five-year, non-interest bearing long term loan in the amount of RMB3,712,500 (approximately $554,000) from Rongfeng Cui. The Company needs to make monthly repayment to Rongfeng Cui in the amount of RMB61,875 (approximately $9,200) from March 2019 to February 2024. In March, April and May 2019, the Company made repayment of RMB61,875 (approximately $9,200), RMB61,875 (approximately $9,200) and RMB61,875 (approximately $9,200), respectively, to Rongfeng Cui.

 

Subsequent issuance of common shares

 

In January 2019, the Company issued 2,000,000 common shares at $0.5 per share to an investor with cash proceeds of $1,000,000 received in February 2019.

 

 

F-28