Item 1. Business
Our Company
Our Company is in the business of breeding, raising, and selling hogs in the People’s Republic of China. We operate our business through contractual arrangements between our wholly-owned subsidiary, WFOE, and our variable interest entity, Fengze and its wholly owned subsidiary, Tianzhili. Our efforts are focused on growing healthy, hearty hogs for sale for breeding and meat purposes. We believe our location in Hubei and our investment in breeding and farming technology position us well to reach these goals.
Fengze entered the hog breeding and production business in 2005 when it built its first hog farm. Fengze now currently owns and operates eleven commercial farms in Wuhan. Our farms, in the aggregate, will have an annual production capacity of approximately 170,000 hogs when the most recently acquired tenth and eleventh farms reach full capacity. We conduct genetic, breeding and nutrition research to improve our hog production capabilities. Our animal nutrition research consists of the development of a premix we feed our hogs. In coordination with a local institute, we developed this product to improve our feed to meat conversion ratio, thus reducing our feed costs, and to improve the health of our hogs.
We currently derive our revenues from hog farming. We believe we have developed a reputation for quality in our market by investing in high quality breeding stock and in technology to improve the health of our hogs by, for example, using temperature controls to increase comfort and to speed piglet rearing, and by creating a biofeed premix that has improved our success in growing hogs while reducing costs. We believe we have a reputation for low pollution by virtue of receiving a certificate of pollution-free agricultural product from Hubei province. We believe we have a reputation for low-additive pork products as a result of the use of our biofeed premix, which allows us to reduce our reliance on antibiotics, and by efforts we have undertaken to reduce disease risks among our hogs that do not require chemicals, such as maintaining geographic separation between our farms to prevent cross-contamination.
On December 29, 2010, we completed the acquisition of the assets of the Hengdian Farm, located in Wuhan City, which represents our tenth farm and which produces up to 20,000 hogs annually at full production. This farm had reached full production capacity but is now below full capacity due to food contamination which occured at a number of our farms in late 2011.
On May 12, 2011, we completed the acquisition of our eleventh farm from An Puluo Food Processing Co., Ltd. (“An Puluo”), located in Enshi Tujia and Miao Autonomous Prefecture of Hubei Province. This farm will produce up to 20,000 hogs annually once it reaches full production. We paid a total of approximately $2.2 million for the rights to the land, structures and equipment.
On June 22, 2011, Fengze established its wholly owned subsidiary, Tianzhili. Tianzhili is engaged in the business of raising black hogs in conjunction with local farmers near Enshi City, Hubei Province. Tianzhili will sell black hogs to An Puluo or other slaughter houses.
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Corporate Information
Our principal executive office is located at Suite F, 23rd Floor, Building B, Jiangjing Mansion, 228 Yanjiang Ave., Jiangan District, Wuhan City, Hubei Province, China 430010. Our telephone number is (+86) 27 8274 0726 and Fax number is (+86) 27 8274 0906. Our website address is www.tianli-china.com.
Our Corporate Structure
Tianli is a holding company incorporated in the British Virgin Islands in November 2009. Tianli owns all of the outstanding capital stock of HCS, which was incorporated in Hong Kong in November 2009 as a limited liability company. HCS, in turn, owns all of the outstanding capital stock of WFOE, which was incorporated in 2005 as a domestic Chinese company. In January 2010, the Wuhan Administrator for Industry and Commerce, and the Wuhan Municipal Commission of Commerce approved the transfer of all of the equity of WFOE to HCS, at which time WFOE became a wholly foreign-owned enterprise. Fengze was organized in 2005 as a domestic limited liability company in China. Tianzhili was incorporated in 2011 as a domestic limited liability company in China and is wholly owned by Fengze. WFOE has entered into a series of control agreements with Fengze and all of the owners of Fengze, which agreements allow WFOE to control Fengze. Through our ownership of HCS, HCS’ ownership of WFOE and WFOE’s agreements with Fengze, we believe that Tianli controls Fengze and therefore, we consolidate the results of operations of Fengze’s with ours as a variable interest entity.
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Our current corporate structure is as follows:
Equity interest
Contractual arrangements including Entrusted Management Agreement and Exclusive Option Agreement.
Contractual arrangements including Exclusive Option Agreement, Shareholders’ Voting Proxy Agreement and Pledge of Equity Interest Agreement.
Although Chinese laws and regulations prevent direct foreign investment in certain industries, they currently do not prohibit or restrict foreign ownership in hog breeding businesses. To protect our shareholders from adverse consequences resulting from possible future ownership restrictions, rather than acquire an equity interest in Fengze, we caused WFOE to enter into certain control agreements with Fengze and its shareholders, pursuant to which we control Fengze and are entitled to the benefit of the results of its operations. The control agreements include an Entrusted Management Agreement, an Exclusive Option Agreement, a Shareholders’ Voting Proxy Agreement and a Pledge of Equity Agreement, each of which is described below. As a result of these agreements, WFOE is entitled to receive 100% of the profits of Fengze and is obligated for 100% of the losses of Fengze. Thus, although WFOE and Fengze are independent legal entities and neither is liable for the obligations of the other, as a consequence of the control agreements, though not responsible for Fengze’s obligations, WFOE is obligated for its losses.
Entrusted Management Agreement. Fengze and WFOE entered into an Entrusted Management Agreement, which provides that WFOE will be fully and exclusively responsible for the management of Fengze. As consideration for such services and WFOE’s agreement to bear all losses of Fengze, Fengze has agreed to pay WFOE an annual fee equal to Fengze’s earnings. This agreement will terminate upon the earliest of: (1) the winding up of Fengze; (2) the termination date of the Entrusted Management Agreement, as agreed by the parties thereto; or (3) the date on which WFOE completes the acquisition of Fengze.
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Exclusive Option Agreement. Fengze and each of Fengze’s shareholders entered into an Exclusive Option Agreement with WFOE, which provides that WFOE will be entitled to acquire all of the outstanding shares of Fengze from the current shareholders upon certain terms and conditions. In addition, WFOE was granted an irrevocable option to purchase all or part of the assets and business of Fengze at a price based on the circumstances at the time of the exercise of the option. Such option may be exercised at any time we determine to do so, provided it is then allowable under PRC laws and regulation. The Exclusive Option Agreement prohibits Fengze and its shareholders from transferring any portion of the equity interests, business or assets of Fengze to anyone other than WFOE. WFOE has not yet taken any action to exercise these rights of purchase, and there is no guarantee that it will do so, that it will be permitted to do so by applicable law at such times as it may wish to do so or that Fengze or one or more of its shareholders will not default under its obligations under such agreement.
Shareholders’ Voting Proxy Agreement. All shareholders of Fengze executed a Shareholders’ Voting Proxy Agreement to irrevocably appoint persons designated by WFOE with the exclusive right to exercise, on their behalf, all of their Voting Rights in accordance with applicable law and Fengze’s Articles of Association, including but not limited to the rights to sell or transfer all or any of their equity interests in Fengze and to appoint and elect the directors and Chair as the authorized legal representative of Fengze. This agreement will be only terminated upon the acquisition of all of the equity interests in, or all assets and business of Fengze by WFOE.
Pledge of Equity Agreement. WFOE and all shareholders of Fengze entered into a Pledge of Equity Agreement, pursuant to which each shareholder pledged all (100%) of its shares in Fengze to WFOE. If Fengze or any of its respective shareholders breaches its respective contractual obligations in the “Entrusted Management Agreement”, “Exclusive Option Agreement” and “Shareholders’ Voting Proxy Agreement”, WFOE, as Pledgee, will be entitled to foreclose on the pledged equity interests. The Fengze shareholders cannot dispose of the pledged equity interests or take any actions that would prejudice WFOE’s interest. This pledge has been recorded with applicable authorities in China to perfect WFOE’s security interest.
Industry and Market Background
China is the world’s largest hog producing and pork consuming country. China has accounted for nearly half of the world’s pork production and consumption for more than five years. Not only does China consume more pork than any other country, Chinese per-capita pork consumption is among the highest in the world, as pork is China’s most popular meat. In terms of meat consumption in China, during the past 10 years, the annual per-capita pork consumption increased 20.5%. It is expected that in 2020, pork consumption will account for approximately 55% of total Chinese meat consumption, while poultry will represent approximately 23%, according to the China Animal Agriculture Association. According to the National Statistics Bureau of China, in 2011 China consumed over 50.5 million tons of pork, a reduction of 0.4% from the amount consumed in 2010. In 2011; the retail price of pork has increased 37% from its price in 2010.
Consumption of pork per person in China has grown from 31.2 kilograms in 2000 to an estimated 38.7 kilograms per person in 2011. The USDA said it expects China's pork consumption in 2012 to rise 4% from 2010's level of consumption.
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Because pork represents such a large portion of the meat consumed by Chinese, both national and local governments have adopted policies and taken actions in an effort to balance the desire of consumers for low prices against the farmers’ need to operate profitably while seeking to increase the efficiencies of the industry. The Chinese government has established a national pork reserve program to balance the market demand and supplies of pork and to keep the price of pork stable. For example, in 2009, ministries of the PRC entered the market and purchased pork to increase its price to what they perceived to be an appropriate level. Alternatively the government could decide to take steps to reduce the price of pork. We cannot predict what policies the government may choose to adopt in the future. Nevertheless, as food makes up a large portion of the budget for many Chinese families, we anticipate the government is likely to remain involved in the development of the pork industry. Even though the central government periodically supports an artificial floor price with its strategic pork reserves, there is no guarantee that this support will continue in the future. If such support is terminated, our industry could see fluctuations in the price of pork, which could dramatically affect our operations.
China’s Hog Industry
China’s hog industry is in the midst of a transition from a large number of relatively small farms, to larger, more commercial farms. Meat hog production in the PRC is currently dominated by backyard farms (those that sell 5-10 hogs annually) and small farms (those that sell less than 100 hogs annually). We believe that farms that sell less than 100 hogs per year comprise approximately 75% of the hog farms in China and account for approximately one-third of the hogs sold annually in China. Farms that sell between 100 and 500 head a year account for approximately 21% of China’s hog farms and approximately one-third of the hogs sold annually in China. Farms that sell between 500 and 3,000 hogs annually represent less than 3% of China’s hog farms but account for approximately 19% of the hogs sold in China. Those that sell more than 3,000 hogs annually account for less than one-half of one percent of all hog farms but sell more than 15% of China’s hogs annually.
According to the USDA, China’s hog industry is transitioning toward larger commercial farms partly as a result of government policies and incentives. We believe that the Company is well positioned to benefit from this trend.
Our Geographic Market
Our farms are located in Wuhan City, which is the capital of and largest city in Hubei Province. With a population of nearly 10 million, Wuhan City is one of China’s ten largest cities, and is considered an important center for economy, trade, finance, transportation, information technology and education in Central China. Wuhan City is located less than 800 miles from Shanghai, Beijing, Guangzhou, Tianjin, Chongqing and Xi’an, some of China’s largest cities. Hubei Province includes thirteen cities that range in population from approximately 300,000 to nearly 10 million residents.
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Due to its central location, Hubei is well-known in China for the adaptability of its breeder hogs. Breeder hogs from the southern part of China tend to not tolerate the cold weather in northern China; similarly, breeder hogs from the northern part of China tend not to tolerate the heat of southern China. We have found that breeder hogs raised in Hubei tend to adapt well to variations in both the north and south of China.
Wuhan City’s government was one of the first local governments to provide economic incentives to hog farms that reached certain production levels. Farms located within Wuhan prefecture that reach an annual production capacity of 10,000 hogs are eligible for a one-time grant of RMB 1.5 million (approximately $230,000). When a farm reaches 20,000 hog capacity, it is eligible for a grant of RMB 3 million (approximately $460,000), less any grant it received when its capacity reached 10,000 hogs.
Breeder Hogs and Market Hogs
We utilize a variety of purebred hogs at our farms. The primary purebred varieties that we utilize are the Yorkshire, Landrace and Duroc. We breed both purebred and cross-bred hogs in order to attain what we feel are the most desirable traits in the hogs produced in our farms.
In 2011, we sold approximately 29.82% of our hogs as breeder hogs, which are predominately females, approximately 61.28% as market hogs, and approximately 8.90% as retail pork products. Breeder hogs are sold to other hog farms throughout China for use in their reproductive programs, and used in our own farms as breeder sows. We prefer to sell hogs as breeders, as they command a higher price and are sold when they are younger and have consumed less feed and other resources, leading to a higher profit margin than market hogs. Breeder hogs weigh approximately 110 - 120 pounds at the time of sale while market hogs weight about 220 - 240 pounds.
Male hogs are nearly always sold as market hogs as substantially fewer boars are required than sows for breeding purposes. Female hogs that do not meet breeder hog standards are also sold as market hogs.
Our Breeding Efforts
A key element of breeding hogs is to utilize sows which are most likely to give birth frequently to large, healthy litters that display the attributes that customers prefer. As a result, we genetically catalogue our sows, so that we can identify purebred and first-cross hogs to maintain our purebred nucleus herd for fidelity to breed standards and to develop the most favorable parent line sows and boars for commercial market hog production.
We screen all potential breeders for favorable qualities. We rely on a combination of performance data and visual appraisals of breeder hogs for selection purposes. We index purebred sows monthly and select the top 20% to maintain our nucleus herd. Having established the baseline herd level, we experiment with combinations of boars and sows to continue to improve the characteristics of our hogs.
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In addition to selecting the most favorable breeding stock, we constantly monitor our breeding sows and replace any that have disease related problems or that display other unfavorable breeding characteristics. A quality sow can give birth for 3 to 4 years, and can give birth 6 to 8.5 times during her life typically to a litter of 10-12 piglets each time. If a sow consistently gives birth to small litters, we remove it from the breeding stock. Likewise, if a sow repeatedly fails to get pregnant during fertile periods or displays false pregnancy (a condition that can last for up to two months) we will remove it from the breeding herd and replace it with a more productive sow.
Our Premix
We believe one of the most challenging issues in the hog production industry is the growing variety and variability of swine diseases. Many hog farms manage diseases through the use of antibiotic drugs. In addition to administering antibiotics directly, many commercial hog farms also use antibiotics in premix feed, without regard to whether particular hogs require treatment. Heavy use of these drugs in China has resulted in pork with drug residues and excess levels of heavy metals and other contaminants.
We seek to avoid the use of what we view as excessive amounts of antibiotics in our hogs. After years of research and development in cooperation with our consultant, Professor Ming Li of China Central Teachers University, we have developed our own premix, which we use instead of commercially available biofeed premixes. Our premix contains no antibiotics and, according to testing by Hubei Province Import and Export Commodity Inspection and Quarantine Bureau, our pork products test negative for drug residues and meet the industry limits for heavy metals.
By developing our own premix, we reduced our feed costs. Our premix adds live microbes to swine feed, which we believe result in better absorption of feed and a generally healthier intestinal system. Better absorption of feed results in lower waste and we believe that we have realized a 10% to 12% reduction in feed costs as a result. In addition, because these bacteria improve the hogs’ health, we have seen savings on drug costs of approximately RMB 10 (approximately $1.50) per hog.
Our Hog Farms
Fengze built its first hog farm in 2005. In 2006, Fengze purchased the land rights, farm structures and related equipment and inventory of five additional hog farms from separate sellers. In 2008, Fengze built one hog farm and acquired land rights, long-lived assets and inventory of another. In 2009 Fengze constructed its ninth hog farm. This farm will have an annual capacity of 20,000 hogs once it attains full production level. In December 2010, Fengze completed the acquisition of the assets of a tenth farm, the Hengdian Farm, which produces up to 20,000 hogs annually when at full production. In May 2011, we completed the acquisition of our eleventh farm. This farm will produce up to 20,000 hogs annually once it reaches full production. Our tenth farm reached full production during 2011. During the fourth quarter of 2011, several of our farms, including the tenth farm, were not operating at full capacity due to the receipt of contaminated food stock that resulted in diseased hogs that required disposal, causing these farms to fall below full capacity as of December 31, 2011.
At present, we, through Fengze, operate six hog farms with an annual capacity of 20,000 hogs each and five hog farms with an annual capacity of 10,000 hogs each.
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Each of our hog farms is designed to raise hogs from breeding through preparation for sale as breeder or market hogs. While there are differences among our farms, they follow the same basic organizational model, with separate buildings dedicated to sow operations, nursery operations and finishing operations. In addition to these specific functional buildings, our farms also feature housing for some of our farmers for the benefit of our farm operations. To minimize the risk of contamination, access to our farms is very limited to outsiders, including Company staff. To limit the number of personnel that enter our farms, and thus the risk of contamination, we provide on-site housing to a large portion of our farm employees.
Each farm has a farm manager who is responsible for monitoring animal care, animal health and equipment. Specialized crews trained in moving hogs assist with the loading, unloading, health care and sanitation for each unit.
Our Strategies
We plan to enhance our position as one of Wuhan’s largest hog farming companies. We intend to achieve this goal by implementing the following strategies:
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We plan to increase hog production quality and capacity by continuing to
upgrade our genetic breeding base. We plan to purchase and import purebred hogs to improve the genetic strength and diversity of our breeding pool, increasing our ability to maintain quality purebred stock within our breeding operations. This will enable us to breed superior breeding hogs that can be used in our operations or sold to other breeder farms, resulting in improved margins.
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We expect to continue to acquire or construct hog farms. We expect to focus on constructing new black hog rearing facilities in accordance with our joint development agreements with several cooperatives in Enshi Autonomous Prefecture in Hubei Province.
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We intend to develop our sow replacement program to continually replace
less-productive sows with more productive ones. It requires significant effort to identify, track and measure the attributes of our breeder hogs. We have found that the more data we capture, the greater the rewards of our breeding program and the more successful we are in implementing sow replacement strategies, with resulting improvement in operations.
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We will position our brand image in order to command a premium for branded meat products at retail if we decide to supply pork products to selected existing third party retail outlets. We have registered the trademark “Tianli An Puluo” for pork products. As a result of the recognition we have received for our products in Wuhan, we believe this trademark will be valuable and may allow us to charge a premium price for Fengze’s products if and when we distribute pork to retail operators. If we elect to supply pork products to retailers, we expect to utilize third party processing plants rather than acquire and operate one ourselves.
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Principal Suppliers
The following are the principal suppliers we rely upon to obtain raw materials for hog feed and veterinary supplies. We believe the materials provided by these suppliers are widely available and do not anticipate that we would be unable to obtain these materials from other suppliers in the event they are unable or unwilling to supply our needs.
Supplier
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Wuhan Zhu Brothers Feed Technology Co., Ltd.
Feed supplies (corn, beans, bran and other commodities)
Wuhan Maozhu Agritech Research Co., Ltd.
Feed supplies
Purchases from Wuhan Zhu Brothers Feed Technology Co., Ltd. (“Wuhan Zhu Brothers”) accounted for approximately 51% and 64% of our purchase of inventories in 2011 and 2010, respectively. We are not subject to any long-term agreement with Wuhan Zhu Brothers. All purchases are on a “spot” basis and are not subject to long terms agreements.
Purchases from Wuhan Maozhu Agritech Research Co., Ltd. accounted for approximately 13% of our purchases of inventories during 2011.
Research and Development
We focus our research and development efforts on improving the genetic composition of our hogs and the quality of the feed provided to the hogs. As of December 31, 2011, our research and development team consisted of 49 employees. These research and development employees do not work exclusively on research and development and participate in other general administrative functions of the Company. In addition, some of our operating employees regularly participate in our research and development programs.
In the fiscal years ended December 31, 2011 and 2010, we spent $98,053 and $66,286, respectively, on research and development activities.
Sales and Marketing
Purchasers come to our farms to purchase breeder and market hogs. The purchasers of breeder hogs consist of farmers who purchase for their own accounts and brokers who sell the hogs to other hog farms. The purchasers of market hogs include slaughterhouses and brokers who sell the hogs to slaughterhouses. Purchases are paid for at the time of the sale. Purchasers are responsible for transporting hogs from our farms. In this way, we have been able to reduce our transportation costs and risks associated with delivering hogs. Return of product is not permitted.
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Because we have primarily relied upon having purchasers come to our farms, to date our expenditures on marketing and advertising have not been significant. If our capacity should grow or we should otherwise determine it is in our interests to do so, we may rely more upon advertising and marketing in the future and our expenditures for such efforts will increase.
Competition
We compete based on the quality of our product, especially as it pertains to breeder hogs, and on price. Our products are to some degree commodities and there is extensive competition from other hog farms in the region.
We believe that Wuhan has 75 farms with annual production capacities of at least 10,000 hogs and, of these, 21 farms have annual production capacities of at least 20,000 hogs. Inclusive of the farms in Wuhan, we believe that Hubei province has approximately 439 hog farms with annual production capacities of 10,000 or more hogs. We believe our annual capacity of approximately 170,000 hogs as of December 31, 2011 makes us one of Hubei province’s largest hog farming companies.
Customers
Our five largest customers collectively represented approximately 25% and 35% of our sales for the years ended December 31, 2011 and 2010, respectively. There were no customers who represented more than 10% of our sales in 2010.
In 2011, the customers that accounted for more than 10% of our revenues were:
Regulation
Restriction on Foreign Ownership
The principal regulation governing foreign ownership of agricultural businesses in the PRC is the Foreign Investment Industrial Guidance Catalogue, effective December 11, 2007 (the “Catalogue”). The Catalogue classifies various industries into four categories: encouraged, permitted, restricted and prohibited. We are engaged in an encouraged industry. Such a designation offers businesses distinct advantages. For example, businesses engaged in encouraged industries:
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are not subject to restrictions on foreign investment, and, as such, foreigners can own a majority in Sino-foreign joint ventures or establish wholly-owned foreign enterprises in the PRC;
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with total investment of less than $100 million, are subject to regional (not central) government examination and approval which are generally more efficient and less time-consuming; and
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may import certain equipment while enjoying a tariff and import-stage value-added tax exemption.
The National Development and Reform Commission and the Ministry of Commerce periodically jointly revise the Catalogue. As such, there is a possibility that our company’s business may fall outside the scope of the definition of an encouraged industry in the future. Should this occur, we would no longer benefit from such designation.
Taxation and Subsidies
The PRC government has provided tax incentives and subsidies to domestic companies in our industry to encourage the development of agricultural businesses in China. We have received business tax exemptions or reductions, subsidies, and government incentives in connection with Fengze’s ownership of hog farms and WFOE’s management of those operations. An example is that both Fengze and WFOE were exempted from income taxes for 2010 and prior years.
The PRC government authorities may reduce or eliminate these incentives through new legislation or other regulatory actions at any time in the future. In the event that we are no longer exempt from income taxation, our applicable tax rate would increase from 0% to up to 25%, the standard business income tax rate in the PRC.
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, and the Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996). 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 SAFE or its local counterpart 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 valid. 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 loans to our subsidiary or VIE..
Dividend Distribution. The principal regulations governing the distribution of dividends by foreign holding companies include the Foreign Investment Enterprise Law (1986), as amended, and the Administrative Rules under the Foreign Investment Enterprise Law (2001).
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Under these regulations, foreign 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, foreign 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 enterprise. These reserves are not distributable as cash dividends.
Notice 75. On October 21, 2005, SAFE issued Notice 75, which became effective as of November 1, 2005. According to Notice 75, prior registration with the local SAFE branch is required for PRC residents to establish or to control an offshore company for the purposes of financing that offshore company with assets or equity interests in an enterprise located in the PRC. An amendment to registration or filing with the local SAFE branch by such PRC resident is also required for the injection of equity interests or assets of an onshore enterprise in the offshore company or overseas funds raised by such offshore company, or any other material change involving a change in the capital of the offshore company.
Under the relevant rules, failure to comply with the registration procedures set forth in Notice 75 may result in restrictions being imposed on the foreign exchange activities of the relevant onshore company, including the increase of its registered capital, the payment of dividends and other distributions to its offshore parent or affiliate and capital inflow from the offshore entity, and may also subject relevant PRC residents to penalties under PRC foreign exchange administration regulations.
PRC residents who control our company are required to register with SAFE in connection with their investments in us. Such individuals began this registration process on March 8, 2010. If we use our stock or other 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 Notice 75.
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, CSRC and SAFE, jointly issued Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the New M&A Rule, which became effective on September 8, 2006. 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 or the applicability of the CSRC approval requirement.
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Based on our understanding of the current PRC laws and regulations, we believe that because we currently control our Chinese affiliate, Fengze, by virtue of WFOE’s VIE agreements with Fengze and not through an equity interest acquisition nor an asset acquisition as described in the New M&A Rule, and CSRC currently has not issued any definitive rule or interpretation concerning whether structures like ours are subject to this new procedure, we are in compliance with the new M&A Rule.
Intellectual Property Rights
Trademarks. 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:
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Convention establishing the World Intellectual Property Organization (WIPO Convention) (June 4, 1980);
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Paris Convention for the Protection of Industrial Property (March 19, 1985);
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Patent Cooperation Treaty (January 1, 1994); and
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The Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPs) (November 11, 2001).
The PRC Trademark Law, adopted in 1982 and revised in 2001, and implementation rules adopted in 2002, protect registered trademarks. The Trademark Office of the State Administration of Industry and Commerce (“SAIC”) handles trademark registrations and grants trademark registrations for a term of ten years.
We, through Fengze, have used “Hanxi” for years on swine products. In 2009, Fengze applied for and registered “Hanxi” as a trademark with China’s SAIC Trademark Office, in Class No. 31, which relates to live animals, live poultry, live fish, trees, cereals, plants, fresh fruits, fresh vegetables, fodder and crustaceans. The registration is valid from April 21, 2009 to April 20, 2019. As a registered trademark “Hanxi” is exclusively owned by Fengze for products within the range limited by Class No. 31; any identical or similar trademark may not be used on commodities involved in Class No. 31. Fengze does not currently own any trademark on “Hanxi” outside of Class No. 31. In the event of trademark infringement, the SAIC has the authority to fine the infringer and to confiscate or destroy the infringing products. In addition to actions taken by SAIC, Fengze would be entitled to sue an infringer for compensation.
On August 1 and August 30, 2011, we entered into a collaborative agreement and a supplemental agreement (the “Agreements”) with An Puluo Food Processing Co., Ltd. (“An Puluo”) to pursue retail business. Pursuant to the Agreements we are allowed to apply to register “Tianli An Puluo” as a exclusive trademark with China’s SAIC Trademark Office. We began to use “Tianli An Puluo” at our retail sales departments in local major supermarkets in greater Wuhan City.
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In accordance with our collaborative agreement with An Puluo, we were able to establish retail operations within existing retail facilities with whom An Puluo had ongoing business arrangements. In these retail facilities, we are permitted to retail their pork products. The owners of these retail facilities are responsible for collection of all retail sales made by us. These retail facilities are responsible for remitting to us the sales that they collect on behalf of us, less any fees for operating a retail operation in their facility.
Business Trade Secrets, We have not applied for any patent protection for our premix; however, we rely on Chinese business secret laws to protect our interest in this premix.
Our premix was developed in conjunction with Professor Ming Li of China Central Teachers University. In return for providing financial and other support to Professor Li’s research, Professor Li assigned the rights to the results of his research and development (specifically, the premix) to us. In connection with this assignment, Professor Li agreed to protect the secrecy of our premix formula and to indemnify us against any damages caused if he discloses that information to third parties.
In addition to the terms under which we obtained rights to the premix, we have taken a number of measures to maintain the premix as a business secret under Chinese law.
Notwithstanding these measures, if we are required to sue to protect our rights in the premix, the ultimate determination of whether the premix constitutes a business secret protected under Chinese law will be made on the facts of the case itself. We cannot guarantee that we will be found to have a business secret or that any court will protect our rights in the premix formula.
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 Tentative Provisions on the Foreign Exchange Registration Administration of Foreign-Invested Enterprise; and the Notice on Certain Matters Relating to the Change of Registered Capital of Foreign-Invested Enterprises.
Under the aforesaid laws and regulations, the increase of the registered capital of a foreign-invested enterprise is subject to the prior approval of the authority which approved the initial investment. In addition, the increase in registered capital and the total investment amount must both be registered with SAIC and SAFE.
Shareholder loans made by offshore parent holding companies to their PRC subsidiaries are regarded as foreign debts in China for regulatory purposes which are 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 the Administration Rules on the Settlement, Sale and Payment of Foreign Exchange.
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Under these regulations, shareholder loans made by offshore parent holding companies to their PRC subsidiaries are to be registered with SAFE. Furthermore, the total amount of foreign debts that can be incurred 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 governmental approval.
A failure to comply with increasingly stringent environmental regulations and related litigation could result in penalties, damages and adverse publicity for our business. Our operations and properties are subject to extensive and increasingly stringent laws and regulations pertaining to, among other things, the discharge of materials into the environment and the handling and disposition of wastes (including solid and hazardous wastes) or otherwise relating to protection of the environment.
Fengze has incurred, and we will continue to incur, capital and operating expenditures to comply with these laws and regulations. We typically expend approximately $150,000 or more to construct hog waste systems at each hog farm we build and there are also ongoing expenses to comply with environmental regulations. If we were to build a farm, or purchase a farm without the necessary waste equipment, we would expect to spend $150,000 or more in connection with such farm for environmental compliance purposes in addition to ongoing maintenance.
The hog farming industry in the PRC is subject to extensive government regulation, which is still evolving and could adversely affect our ability to sell products in the PRC or could increase our production costs. The hog farming industry in the PRC is regulated by a number of governmental agencies, including the Ministry of Agriculture, the Ministry of Commerce, the Ministry of Health, the General Administration of Quality Supervision, Inspection and Quarantine, and the State Environmental Protection Administration. These regulatory bodies have broad discretion and authority to regulate many aspects of the hog farming industry in the PRC, including, without limitation, setting hygiene and quality standards. In addition, the regulatory framework in the PRC is evolving. If the relevant regulatory authorities set standards with which we are unable to comply or which increase our costs so as to render our products non-competitive, our profitability and our ability to sell products in the PRC may be impacted.
Each province in the PRC requires hog farmers to obtain and maintain a license for each hog farm owned and operated in that province. Currently, all of our hog farms are located in the city of Wuhan in Hubei province, and we have obtained a license to own and operate each of our hog farms. We need to maintain our licenses to operate our current hog farms. If we pursue acquisitions of other hog farms, we will need to obtain additional licenses to operate those farms.
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Employees
As of December 31, 2011, we had approximately 466 employees, of whom 411 were full-time employees. All of our employees are based in China. Of the total, 8 were in management and administration, 11 were farm managers, 11 served as deputy farm managers, 49 were in technical support (including the research and development staff, and veterinarians located on the farms), 30 were engaged in administration, and 302 were in farming. We believe that our relations with our employees are good. We have never had a work stoppage, and our employees are not subject to a collective bargaining agreement.
ITEM 1A.
ITEM 1A. Risk Factors
The purchase of our common shares involves a high degree of risk. Before you invest you should carefully consider the risks and uncertainties described below and other information and our consolidated financial statements and related notes included elsewhere in this report. If any of the following events actually occurs, our financial condition or operating results may be materially and adversely affected, our business may be severely impaired, and the price of our common stock may decline, perhaps significantly. This means you could lose all or a part of your investment.
Risks Related to Our Industry
If there are any interruptions to or a decline in the amount or quality of our breeding stock or feed components, our production or sales could be materially and adversely affected.
Swine feed components and breeding stock are the principal raw materials used in our business. We purchase all of our swine feed components from a number of third-party suppliers. We generally breed and raise our own hogs and periodically purchase new breeding stock from third parties, including stock sourced from Europe and the United States. These third-party suppliers may not continue to be able or willing to satisfy our need for breeding stock and swine feed components. The supply of breeding stock may be affected by outbreaks of diseases or epidemics. Suppliers may not be able to provide live hogs or swine feed components of sufficient quantity or quality to meet our requirements. Any interruptions to or decline in the amount or quality of live hogs or swine feed components could materially disrupt our production and adversely affect our business. We are vulnerable to increases in the price of raw materials (particularly of swine feed components and occasionally live hogs) and other operating costs, and we may not be able to entirely offset increasing costs by increasing prices. If we are unable to entirely offset cost increases by raising prices, our profit margins and financial condition could be adversely affected.
If the pork market in the PRC does not grow as we expect, our results of operations and financial condition may be adversely affected.
We believe pork products have strong growth potential in the PRC and, accordingly, we have acquired farms. If the pork market in the PRC does not grow as we expect, our business may be harmed, we may need to adjust our growth strategy, and our results of operation may be adversely affected.
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We may be unable to maintain our profitability in the face of a consolidating retail environment in the PRC.
We sell substantial amounts of our hogs to slaughterhouses, which sell to smaller retailers and supermarkets and large retailers. The supermarket and food retail industry in the PRC has been and is expected to continue consolidating.
As the supermarket and food retail industry continue to consolidate and retail customers grow larger and become more sophisticated, they may demand lower prices and increased promotional programs from our slaughterhouse customers, which may demand lower prices from us. If we are forced to lower prices in response to pressure from customers, our profitability could decline.
The hog farming industry in the PRC may face increased competition, as well as increased industry consolidation, which may affect our market share and profit margin.
The hog farming industry in the PRC is highly competitive. We believe that our ability to maintain our market share and grow our operations within this landscape of intense competition depends largely upon our ability to distinguish our hogs from our competitors’ hogs, especially as to our breeders.
We cannot assure you that our current or potential competitors will not develop hog breeding and farming technology of a quality comparable or superior to ours, or adapt more quickly than we do to evolving consumer preferences or market trends. In addition, our competitors may merge or form alliances among farms to achieve a scale of operations which would make it difficult for us to compete. Competition may also lead to price wars, which may adversely affect our market share and profit margin. We cannot assure you that we will be able to compete effectively with our current or potential competitors.
The outbreak of animal diseases could adversely affect our operations.
An occurrence of serious animal diseases or any outbreak of other animal epidemics in the PRC might result in material disruptions to our operations, to the operations of our customers or suppliers or a decline in our industry or a slowdown in economic growth in the PRC and surrounding regions, any of which could have a material adverse effect on our operations. In 2007, tens of millions of pigs were killed in China as a result of Blue Ear disease, which resulted in inflation in pork prices and affected 25 of China’s 33 provinces. While we take measures at each of our farms to prevent the outbreak of disease, there can be no assurance that our facilities or products will not be affected by an outbreak of disease in the future, or that the market for pork products in the PRC will not decline as a result of fear of disease. In either case, our business, results of operations and financial condition would be adversely and materially affected.
Outbreaks of swine flu could adversely affect our business, results of operations and financial condition.
An occurrence of a serious animal disease, such as swine influenza or H1N1 virus, a respiratory disease of pigs caused by influenza viruses, or any outbreak of other epidemics in the PRC affecting animals or humans might result in material disruptions to our operations, to the operations of our customers or suppliers or a decline in the supermarket or food retail industry or a slowdown in economic growth in the PRC and surrounding regions, any of which could have a material adverse effect on our operations and turnover.
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Consumer concerns regarding the safety and quality of food products or health concerns could adversely affect sales of our products.
Our sales performance could be adversely affected if consumers lose confidence in the safety and quality of our products. Consumers in the PRC are increasingly conscious of food safety and nutrition. Consumer concerns about, for example, the safety of pork products could discourage them from buying pork products and cause our results of operations to suffer.
We may be subject to substantial liability should the consumption of pork products made from our hogs cause personal injury or illness and, unlike most food companies in the United States, we do not maintain product liability insurance to cover potential liabilities.
The sale of food products for human consumption involves an inherent risk of injury to consumers. Such injuries may result from tampering by unauthorized third parties or product contamination or degeneration, including the presence of foreign contaminants, chemical substances or other agents or residues during the various stages of the production process. While we are subject to governmental inspections and regulations, we cannot assure you that consumption of our products will not cause a health-related illness, or that we will not be subject to claims or lawsuits relating to such matters.
Even if a product liability claim is unsuccessful or is not fully pursued, the negative publicity surrounding any assertions that our products caused personal injury or illness could adversely affect our reputation with customers and our corporate and brand image. Furthermore, our products could potentially suffer from product tampering, contamination or degeneration or be mislabeled or otherwise damaged. Under certain circumstances, our products may be recalled. Even if a situation does not necessitate a recall, we cannot assure you that product liability claims will not be asserted against us. A product liability judgment against us or a product recall could have a material adverse effect on our revenues, profitability and business reputation.
We purchase many commodities for raw materials and packaging, and price changes for the commodities we depend on may adversely affect our profitability.
We have not entered into long term contracts for the purchase of raw materials at fixed prices. The raw materials used in our feed are largely commodities that can experience significant price fluctuations caused by external conditions and changes in governmental agricultural programs over which we exercise no influence. We attempt to recover commodity cost increases by increasing hog prices and creating additional operating efficiencies, but cannot assure that we will always be successful in offsetting these cost increases.
Our hog farming business could be adversely affected by fluctuations in pork commodity prices.
The price at which hogs are sold is directly affected by the supply and demand for pork products and other meat products in the PRC, all of which are determined by market forces and other factors over which we have little or no control. A downward fluctuation in the demand for pork may adversely impact our results of operations.
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Risks Related to Our Business
Our limited operating history makes it difficult to evaluate our future prospects and results of operations.
We have a limited operating history. Fengze and WFOE were established in 2005, and HCS and Tianli were established in 2009. Additionally we have been a US public company only since July 2010. Accordingly, you should consider our future prospects in light of the risks and uncertainties experienced by new companies in evolving markets such as the growing market for pork products in the PRC. Some of these risks and uncertainties relate to our ability to:
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produce breeder hogs that will be responsive to the needs of other hog farmers;
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attract additional customers and increased spending per customer;
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increase awareness of the quality of our hogs and to continue to develop customer loyalty;
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respond to competitive actions of other hog farmers;
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respond to changes in our regulatory environment;
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manage risks associated with intellectual property rights;
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maintain effective control of our costs and expenses;
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raise sufficient capital to sustain and expand our business;
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attract, retain and motivate qualified personnel;
If we are unsuccessful in addressing any of these risks and uncertainties, our business may be materially and adversely affected.
We may require additional financing in the future and our operations could be curtailed if we are unable to obtain required additional financing when needed.
We may need to obtain additional debt or equity financing to fund future capital expenditures. Any additional equity may result in dilution to the holders of our shares of capital stock. Additional debt financing may include conditions that would restrict our freedom to operate our business, such as conditions that:
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limit our ability to pay dividends or require us to seek consent for the payment of dividends;
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increase our vulnerability to general adverse economic and industry conditions;
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require us to dedicate a portion of our cash flow from operations to payments on our debt, thereby reducing the availability of our cash flow for capital expenditures, working capital and other general corporate purposes; and
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may limit our flexibility in planning for, or reacting to, changes in our business and our industry.
We cannot guarantee that we will be able to obtain any additional financing on terms that are acceptable to us, or at all.
Potential disruptions in the capital and credit markets may adversely affect our business, including the availability and cost of short-term funds for liquidity requirements, which could adversely affect our results of operations, cash flows and financial condition.
We may need to rely on the credit markets, particularly for short-term borrowings from banks within the PRC, as well as the capital markets, to meet our financial commitments and short-term liquidity needs if internal funds are not available from operations. Disruptions in the credit and capital markets could adversely affect our ability to draw on short-term bank facilities. Further, our access to funds under any such credit facilities is dependent on the ability of banks that are parties to those facilities to meet their funding commitments, which is dependent on governmental economic policies in the PRC. Banks that choose to enter into agreements with us may not be able to meet their funding commitments if they experience shortages of capital and liquidity or if they experience excessive volumes of borrowing requests from us and other borrowers within a short period of time.
Our operating results may fluctuate from period to period.
Our operating results have fluctuated from period to period and are likely to continue to fluctuate as a result of a wide range of factors. For example, the pricing for hogs has experienced significant fluctuations. Additionally demand for pork in general is relatively high before the Chinese New Year in January or February and lower thereafter. Our production and sales are generally lower in the summer due to a slight drop in meat consumption during the warmer summer months.
If WFOE is required to make a payment under its agreement to bear the losses of Fengze, our liquidity may be adversely affected, which could harm our financial condition and results of operations.
Under the terms of the Entrusted Management Agreement with Fengze, WFOE agreed to bear the losses of Fengze. WFOE may be required to absorb the losses at a time when WFOE does not have sufficient cash to make such payment and at a time when we or WFOE may be unable to borrow such funds on terms that are acceptable, if at all. As a result, any losses of Fengze that must be absorbed, under the Entrusted Management Agreement may have an adverse effect on our liquidity, financial condition and results of operations.
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The loss of any key customer could reduce our revenues and our profitability.
Our key customers are principally hog brokers, hog farmers and slaughterhouses in the PRC. There can be no assurance that we will maintain or improve the relationships with these customers or other customers, or that we will be able to continue to supply these customers at current levels or at all.
If we cannot maintain long-term relationships with our larger customers, the loss of our sales to them could have an adverse effect on our business, financial condition and results of operations.
Our bank accounts are not insured or protected against loss.
We maintain cash with various banks and trust companies located in the PRC and in Hong Kong. These cash accounts are not insured or otherwise protected. Should any bank or trust company holding our cash deposits become insolvent, or if we are otherwise unable to withdraw funds, we would lose the cash on deposit with that particular bank or trust company.
We are substantially dependent upon our senior management and key research and development personnel.
We are highly dependent on our senior management to manage our business and operations. In particular, we rely substantially on our chief executive officer, Ms. Hanying Li, and our chief financial officer, Mr. Bihong Zhang, to manage our operations.
We also depend on our key research and development personnel for the development of new breeding, nutrition and farming technologies and the enhancement of our existing products and technologies personnel. We do not maintain key man life insurance on any of our senior management or key personnel. The loss of the services of one of them would have a material adverse effect on our business and operations. Competition for senior management and our other key personnel is intense and the pool of suitable candidates is limited. We may be unable to locate a suitable replacement for any senior management or key personnel that we lose. In addition, if any member of our senior management or key personnel joins a competitor or forms a competing company, they may compete with us for customers, business partners and other key professionals and staff members of our company. Although each of our senior management and key personnel has signed a confidentiality and non-competition agreement in connection with his employment with us, we cannot assure you that we will be able to successfully enforce these provisions in the event of a dispute between us and any member of our senior management or key personnel.
We compete for qualified personnel with other agricultural companies and research institutions. Competition for these personnel could cause our compensation costs to increase, which could have a material adverse effect on our results of operations. Our future success and ability to grow our business will depend in part on our ability to identify, hire and retain additional qualified personnel. If we are unable to attract and retain qualified employees, we may be unable to meet our business and financial goals.
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We may not be able to adequately protect and maintain our intellectual property, trade secrets, and brand names.
We rely on a combination of trademark, trade secret, nondisclosure agreement and patent laws to protect our trade secrets and other valuable intellectual property and in particular, our premix formula. We have not applied for patents for our products or formulas, as our management believes an application for such patents would result in public knowledge of our proprietary technology and formulas. Our management has concluded that the risk of infringement of our proprietary technology in China in such a case outweighs the risk of being unable to protect our rights legally in China. Since we do not have patent protection for our technology or formulas, we may not be able to protect our rights to this intellectual property if our competitors discover or illegally obtain our technology or formulas. Our inability to protect our rights to this intellectual property may adversely affect our ability to prevent competitors from using our products and developments.
Our senior management lacks experience managing a public company and complying with laws applicable to operating as a U.S. public company domiciled in the British Virgin Islands.
Prior to the completion of our initial public offering in July 2010, Fengze operated as a private company located in China. In connection with our initial public offering, the senior management of Fengze formed Tianli in the British Virgin Islands, HCS in Hong Kong and caused WFOE to become Tianli’s subsidiary in the PRC. They also caused Fengze and WFOE to enter into agreements that gave Tianli effective control over the operations of Fengze by virtue of its ownership of HCS and HCS’ ownership of WFOE. In the process of taking these steps to prepare our company for our initial public offering, Fengze’s senior management became the senior management of Tianli. None of Tianli’s senior management has experience managing a public company or managing a British Virgin Islands company.
Our Company is subject to laws, regulations and obligations that prior to our initial public offering did not apply to it, and our senior management has no experience in complying with such laws, regulations and obligations. For example, Tianli must comply with British Virgin Islands laws applicable to companies that are domiciled in that country. By contrast, prior to our initial public offering, senior management was experienced in operating the business of Fengze in compliance with Chinese law. Similarly, by virtue of our initial public offering, Tianli is required to file quarterly and annual reports and to comply with U.S. securities and other laws, which were not applicable to Tianli prior to our initial public offering. These obligations can be burdensome and complicated, and failure to comply with such obligations could have a material adverse effect on Tianli. In addition, the process of learning about such new obligations as a public company in the United States will require senior management to devote time and resources to such efforts that might otherwise be spent on the operation of the business of hog farming.
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We may not pay dividends.
We have not previously paid any cash dividends, and we do not anticipate paying any dividends on our common shares. Although we achieved net profitability in 2006, we cannot assure you that our operations will continue to result in sufficient revenues to enable us to operate profitably or to generate positive cash flows. Furthermore, there is no assurance our Board of Directors will declare dividends even if we are profitable. Dividend policy is subject to the discretion of our Board of Directors and will depend on, among other things, our earnings, financial condition, capital requirements and other factors. If we determine to pay dividends on any of our common shares in the future, we will be dependent, in large part, on receipt of funds from our operations.
Our growth strategy may prove to be disruptive and divert management resources, which could adversely affect our existing businesses.
Over the last six years, we constructed or acquired eleven farms in Wuhan City. Our growth strategy includes the continued expansion of our annual hog production, largely by constructing black hog rearing facilities with local cooperatives in the Enshi Autonomous Prefecture in Hubei Province. The implementation of such strategy may involve large transactions and present financial, managerial and operational challenges, including diversion of management attention from existing businesses, difficulty with integrating personnel and financial and other systems, increased expenses, including compensation expenses resulting from newly-hired employees, assumption of unknown liabilities and potential disputes. We also could experience financial or other setbacks if any of our growth strategies incur problems of which we are not presently aware.
As part of our growth strategy, we have acquired assets within the PRC. If any of our acquisitions are found not to comply with applicable laws or regulations, we might be required to make filings or submissions to PRC regulators or amend the terms of such acquisitions to meet PRC regulatory requirements.
We expect to continue to expand our operations in the PRC and have in recent years completed several farm acquisitions. While we believe that each of these acquisitions complied with all PRC laws and regulations, the regulatory environment that governs transactions in the PRC has continued to evolve in recent years and remains subject to interpretation by the agencies that have responsibility for reviewing or approving such transactions. If any of the acquisitions we completed were reviewed by a PRC regulator, it is possible that we may be required to demonstrate how the transaction complied with applicable PRC laws. This could require us to expend resources that would otherwise be used to manage our company. Further, if regulators determine that any of our transactions did not comply with applicable regulations, we may be required to renegotiate or revise the terms of the acquisition with the counterparties to the affected transaction. If such a scenario were to occur, we cannot be sure that our efforts to meet the regulator’s requirements would be successful, or that such efforts would not have an adverse effect on our operations.
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Foreign Operational Risks
We are dependent on the state of the PRC’s economy as all of our business is conducted in the PRC.
All of our business operations are conducted in the PRC, and all of our customers are also located in the PRC. Accordingly, our results of operations, financial condition and prospects are subject to economic, political and legal developments in China. 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, control of foreign exchange and allocation of resources. Any material slowdown in the PRC’s economy may cause a reduction in the prices, a slowdown in the rate of growth of pork consumption or a reduction in consumption, which may in turn lead to a decline in the demand for our products. Any to these could have a material adverse effect on our business, financial condition and results of operations.
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 affect service of process in the U.S., or to enforce a judgment obtained in the U.S. against us or any of these persons.
Fluctuation of the Renminbi (RMB) may indirectly affect our financial condition by affecting the economy of the PRC and by affecting our reported US dollar results.
Although we use the United States dollar for financial reporting purposes, nearly all of the transactions affected by WFOE and Fengze are denominated in the PRC’s currency, the RMB. The value of the RMB fluctuates and is subject to changes in the PRC’s political and economic conditions. Such fluctuations could adversely impact our US dollar denominated financial reports. We do not currently engage in hedging activities to protect against foreign currency risks. Future movements in the exchange rate of the RMB could adversely affect the economy of the PRC and thus the consumption of our products.
If any dividend is declared in the future, you may be taxed on a larger amount in U.S. dollars than the U.S. dollar amount that you actually receive.
If you are a United States holder, you will be subjected to taxation on the U.S. dollar value of your dividends, if any, at the time you receive them. Specifically, if a dividend is declared and paid in a currency other than US dollars, 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.
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We may become a passive foreign investment company, which could result in adverse U.S. tax consequences to U.S. investors.
Based upon 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:
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75% or more of our gross income in a taxable year is passive income; or
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the average percentage of our assets by value in a taxable year which produce or are held for the production of passive income (which includes cash) is at least 50%.
We cannot assure you 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 like 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 free 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 the interpretation of the same may be subject to further changes.
We do not have business interruption, litigation or natural disaster insurance.
The insurance industry in China is still at an early stage of development. In particular PRC insurance companies offer limited business products. As a result, we do not have any business liability or disruption insurance coverage for our operations in China. Any business interruption, litigation or natural disaster may result in our business incurring substantial costs not covered by insurance.
WFOE’s contractual arrangements with Fengze may result in adverse tax consequences to us.
We could face material and adverse tax consequences if the PRC tax authorities determine that WFOE’s contractual arrangements with Fengze were not made on an arm’s length basis and adjust our income and expenses for PRC tax purposes in the form of a transfer pricing adjustment, or if they determine that the Company has not complied with the arrangements. A transfer pricing adjustment could result in a reduction, for PRC tax purposes, of expenses recorded by Fengze, which could adversely affect us by increasing Fengze’s tax liability if Fengze was no longer exempt from Chinese income taxes at some future date without reducing WFOE’s tax liability, which could further result in late payment fees and other penalties to Fengze for underpaid taxes.
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WFOE’s contractual arrangements with Fengze may not be as effective in providing control over Fengze as direct ownership.
We conduct substantially all of our operations, and generate substantially all of our revenues, through contractual arrangements with Fengze that provide us with effective control over Fengze. We depend on Fengze to hold and maintain contracts with our customers. Fengze owns substantially all of our intellectual property, facilities and other assets relating to the operation of our business, and employs the personnel for substantially all of our business. Neither Tianli, nor HCS nor WFOE has any ownership interest in Fengze. Although we have been advised by our PRC legal counsel that WFOE’s contractual arrangements with Fengze are valid, binding and enforceable under current PRC laws and regulations, these contractual arrangements may not be as effective in providing us with control over Fengze as direct ownership of Fengze would. In addition, Fengze or its shareholders may breach the contractual arrangements. For example, Fengze may decide not to make contractual payments to WFOE, and consequently to our company, in accordance with the existing contractual arrangements. In the event of any such breach, we would have to rely on legal remedies under PRC law. These remedies may not always be effective.
PRC laws and regulations governing our businesses and the validity of certain of our contractual arrangements are uncertain. If we are found to be in violation of such PRC laws and regulations, we could be subject to sanctions. In addition, changes in such PRC laws and regulations may materially and adversely affect our business.
There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including, but not limited to, the laws and regulations governing our business, or the enforcement and performance of WFOE’s contractual arrangements with Fengze. Tianli and WFOE are considered foreign persons or foreign invested enterprises under PRC law. As a result, Tianli and WFOE are subject to limitations on foreign ownership of Chinese companies. These laws and regulations are relatively new and may be subject to change, and their interpretation and enforcement may involve substantial uncertainty. The effectiveness of newly enacted laws, regulations or amendments may be delayed, resulting in detrimental reliance by foreign investors. New laws and regulations that affect existing and proposed future businesses may be applied retroactively.
The PRC government has broad discretion in dealing with violations of laws and regulations, including levying fines, revoking business and other licenses, and requiring actions necessary for compliance. In particular, licenses and permits issued or granted to us by relevant governmental bodies may be revoked at a later time by higher regulatory bodies. We cannot assure you that our current ownership and operating structure would not be found in violation of any current or future PRC laws or regulations. As a result, we may be subject to sanctions, including fines, and could be required to restructure our operations or cease to provide certain services. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. Any of these or similar actions could disrupt our business operations or restrict us from conducting a substantial portion of our business operations, which could materially and adversely affect our business, financial condition and results of operations.
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The shareholders of Fengze have conflicts of interest with us, which may adversely affect our business.
We rely on WFOE’s contractual obligations to enforce our interest in receiving payments from Fengze. Conflicts of interests may exist between Fengze’s shareholders and our Company. As a result, we have required Fengze and each of its shareholders to execute irrevocable powers of attorney to appoint an individual designated by us to be his attorney-in-fact to vote on his behalf on all matters requiring shareholder approval by Fengze and to require Fengze’s compliance with the terms of its contractual obligations. We cannot assure you, however, that Fengze’s shareholders will act in our interests or that conflicts of interests will be resolved in our favor. In addition, these shareholders could violate their agreements with us by diverting business opportunities from us to others. If we cannot resolve any conflicts of interest between us and Fengze’s shareholders, we would have to rely on legal proceedings, which could result in the disruption of our business.
Recent PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident shareholders to personal liability and limit our ability to inject capital into WFOE, limit WFOE’s ability to increase its registered capital, distribute profits to us, or otherwise adversely affect us.
On October 21, 2005, the SAFE issued the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Reverse Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or Notice 75, which became effective as of November 1, 2005. This Notice and other regulations, which require our shareholders who are PRC residents to make various filings, may have various adverse impacts upon our company and its operations. The failure or inability of our PRC resident shareholders to make any required registrations or comply with other requirements may subject such shareholders to fines and legal sanctions and may also limit our ability to contribute additional capital into or provide loans to WFOE or Fengze, limit their ability to pay dividends or otherwise distribute profits to us, or otherwise adversely affect us.
We rely on dividends paid by WFOE for our cash needs.
In the future we would rely primarily on dividends paid by WFOE for our cash needs, including the funds necessary to pay our operating expenses, dividends and other cash distributions, if any, to our shareholders, and to service any debt we may incur. WFOE is dependent upon remittances of the management fee from Fengze for its cash needs. Regulations in the PRC currently permit payment of dividends only out of accumulated profits as determined in accordance with accounting standards and regulations in China. British Virgin Islands law also places restrictions on the payment of dividends.
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Pursuant to the new PRC enterprise income tax law effective on January 1, 2008, dividends payable by a foreign investment entity to its foreign investors are subject to a withholding tax of up to 20%. In practice, the tax authorities typically impose a withholding tax rate of 10% rate, as prescribed in the implementation regulations; however, there can be no guarantee that this practice will continue as more guidance is provided by relevant government authorities. As a result, we are unable to predict whether any such payments from HCS to Tianli, the BVI parent company, will be subject to withholding tax because it is unclear whether Tianli will be deemed to be a resident enterprise for Chinese tax purposes. If so, Tianli may be subject to an enterprise income tax rate of 25% on all of its income on a worldwide basis. However, if Tianli is deemed to be a non-resident enterprise, then it will be subject to a withholding tax on any dividends paid by its Chinese subsidiaries to Tianli.
Our business benefits from certain government incentives. Expiration, reduction or discontinuation of, or changes to, these incentives will increase our tax burden and reduce our net income.
The PRC government has provided tax incentives and subsidies to domestic companies in our industry to encourage the development of agricultural businesses in China. We have received business tax exemptions or reductions, subsidies and government incentives in connection with Fengze’s ownership of hog farms and WFOE’s management of these operations. An example is that both Fengze and WOFE were exempted from income taxes for 2011 and prior years.
The PRC government authorities may reduce or eliminate these incentives through new legislation at any time in the future. In the event that we are no longer exempt from income taxation, our applicable tax rate would increase from 0% to up to 25%, the standard business income tax rate in the PRC. Similarly, the termination of the government practice of partially subsidizing the cost of hog insurance could reduce our profits or cause such insurance to become more expensive as fewer farmers elected to purchase such insurance. The reduction or discontinuation of any of these economic incentives could negatively affect our company.
The 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.
Current law provides for specific standards and procedures for the termination of an employment contract and places the burden of proof on the employer. In addition, the law requires 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, downsizing of more than 20 people or more than 10% of the workforce may occur only under specified circumstances. To date, there has been very little guidance and precedents 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 law and thus our ability to adjust the size of our operations when necessary may be curtailed. Accordingly, if we face periods of decline in business activity or adverse economic periods specific to our business, this new law could exacerbate the adverse effect of the economic environment on our results of operations and financial condition.
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If relations between the United States and China become an issue, 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, economic and other issues. Controversies may arise in the future between these two countries. Any political or trade controversies 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 China.
Our business may be adversely affected by political, economic and social developments in China. For many years, the Chinese government has pursued economic reform policies including the encouragement of private economic activity and greater economic decentralization. However in the future the Chinese government may decide not to pursue these policies or may alter them to our detriment with little, if any, prior notice. Nationalization or expropriation could even result in the total loss of our investment in China and in the total loss of your investment in us.
Because our operations are located in China, information about our operations are not readily available from independent third-party sources.
Because Fengze and WFOE are based in China, our shareholders may have greater difficulty in obtaining information about them on a timely basis than would shareholders of a U.S.-based company. 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.
Our failure to obtain prior approval of the China Securities Regulatory Commission (“CSRC”) of the listing and trading of our common shares on a foreign stock exchange could have a material adverse effect upon our business, operating results, reputation and trading price of our common shares.
On August 8, 2006, six PRC regulatory agencies, including the Ministry of Commerce, the State Assets Supervision and Administration Commission, the State Administration of Taxation, the State Administration for Industry and Commerce, the CSRC and SAFE, jointly issued the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (the “New M&A Rule”). The New M&A Rule became effective on September 8, 2006. This regulation contains provisions that purport to require that an offshore special purpose vehicle (“SPV”) formed for listing purposes and controlled directly or indirectly by PRC companies or individuals shall obtain the approval of the CSRC prior to the listing and trading of such SPV’s securities on an overseas stock exchange. On September 21, 2006, the CSRC published procedures specifying documents and materials required to be submitted to it by SPVs seeking CSRC approval of overseas listings.
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However, the application of the New M&A Rule remains unclear with no consensus currently existing among leading PRC law firms regarding the scope and applicability of the CSRC approval requirement. We believe, based upon our understanding of current PRC laws and regulations that we are in compliance with the new M&A Rule because:
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We currently control our Chinese affiliate, Fengze, by virtue of WFOE’s VIE agreements with Fengze, and not through equity interest or asset acquisition which may be contrary to the New M&A Rule; and
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In spite of the lack of clarity on this issue, the CSRC has not issued any definitive rule or interpretation regarding whether offerings like our initial public offering are subject to the New M&A Rule.
If prior CSRC approval for our structure and initial public offering was required, we may face regulatory actions or other sanctions from the CSRC or other PRC regulatory authorities. These authorities may impose fines and penalties upon our operations in the PRC, limit our operating privileges in the PRC, or take other actions that could have a material adverse effect upon our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our common shares.
Risks Relating to our Common Stock and our Status as a Public Company
The market price for our common shares may be volatile, which could result in substantial losses to investors.
The market price for our common shares may be volatile and subject to wide fluctuations in response to factors including the following:
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actual or anticipated fluctuations in our quarterly operating results;
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changes in the Chinese economy;
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announcements by our competitors of acquisitions, strategic partnerships, joint ventures or capital commitments;
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additions or departures of key personnel;
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uncertainties about PRC companies generally; or
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potential litigation.
In addition, the securities markets have from time to time experienced price and volume fluctuations that are not related to the operating performance of particular companies. As a result, to the extent shareholders sell our shares, they may not receive a price per share that is based solely upon our business performance. We cannot guarantee that shareholders will not lose some of their entire investment in our common shares.
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If our financial condition deteriorates, we may not meet continued listing standards of the NASDAQ Global Market and our shareholders could find it difficult to sell our shares.
Our common shares are listed on the NASDAQ Global Market. The NASDAQ Global Market requires companies to fulfill specific requirements in order for their shares to continue to be listed. If we fail to continue to meet NASDAQ’s continued listing requirements and of our shares are delisted from the NASDAQ Global Market at some later date, our shareholders could find it difficult to sell our shares.
Our management is generally not familiar with the United States securities laws.
Our management is generally unfamiliar with the requirements of the United States securities laws and may not appreciate the need to devote the resources necessary to comply with such laws. A failure to adequately respond to the requirements of the applicable securities laws could lead to investigations by the Securities and Exchange Commission and other regulatory authorities that could be costly, divert management's attention and disrupt our business.
We will incur significant costs as a result of operating as a public company, and our management will be required to devote substantial time to new compliance requirements.
As a public company we will incur significant legal, accounting and other expenses under the Sarbanes-Oxley Act of 2002, together with rules implemented by the Securities and Exchange Commission and applicable market regulators. These rules impose various requirements on public companies, including requiring certain corporate governance practices. Our management and other personnel will need to devote a substantial amount of time to these compliance requirements. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly.
Our classified board structure may prevent a change in our control.
Our board of directors is divided into three classes of directors. Directors of each class are to be chosen for three-year terms upon the expiration of their current terms, and each year one class of directors is elected by the shareholders. The staggered terms of our directors may reduce the possibility of a tender offer or an attempt at a change in control, even though a tender offer or change in control might be in the best interest of our shareholders.
Shares eligible for future sale may adversely affect the market price of our common shares, as the future sale of a substantial amount of outstanding common shares in the public marketplace could reduce the price of our common shares.
The market price of our shares could decline as a result of sales of substantial amounts of our shares in the public market, or the perception that these sales could occur. In addition, these factors could make it more difficult for us to raise funds if required through future offerings of our common shares. As of March 13, 2012, we had outstanding an aggregate of 10,135,000 common shares. Of those shares, all but those owned by our affiliates, are freely transferable without restriction or further registration under the Securities Act. The shares held by our affiliates may be sold in the future without registration under the Securities Act to the extent permitted by Rule 144 or other exemptions under the Securities Act. The shares held by our affiliates could also be sold in private transactions or transactions outside of the United States without the being reported in the United States.
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Our chief executive officer owns a significant percentage of our common shares, decreasing your influence on shareholder decisions.
Hanying Li, our chairwoman and chief executive officer, beneficially owns approximately 26% of our outstanding common shares. In addition our employees, officers and/or directors, directly or indirectly, in the aggregate, beneficially own approximately 31 % of our outstanding shares. As a result, these individuals and, in particular Ms. Li, possess substantial ability to impact our management and affairs and the outcome of matters submitted to shareholders for approval. These shareholders, acting individually or as a group, could exert control and substantial influence over matters such as electing directors and approving mergers or other business combination transactions. This concentration of ownership and voting power may discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our common shares.
We may suffer a change in control and our business could be significantly harmed if our chief executive officer or other significant employees pledge their common shares to secure loans and default in the payment of those loans.
If our chief executive officer, who owns approximately 26% of our outstanding common shares, or another significant employee owning a significant number of common shares were to pledge her or his shares to secure the payment of a loan, and then default in the payment of that loan, the default could result in a sale of a substantial number of our common shares resulting in a decrease in the price of our shares and a change in control of our company.
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 amended and restated memorandum and articles of association, the British Virgin Islands Business Companies Act, 2004 (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 to a large extent governed by the common law of the British Virgin Islands and by the BVI Act. The rights of our shareholders and the fiduciary responsibilities of our directors under British Virgin Islands law are 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.
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.
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British Virgin Islands companies may not be able to initiate shareholder derivative actions, thereby depriving shareholders of the ability to protect their interests.
British Virgin Islands companies may not have standing to initiate a shareholder derivative action in a federal court of the United States. 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 provide little protection for minority shareholders, so minority shareholders will have little or no recourse if the shareholders are dissatisfied with the conduct of our affairs.
Under the law of the British Virgin Islands, there is little statutory law for the protection of minority shareholders other than the provisions of the BVI Act dealing with shareholder remedies. The principal protection under statutory law is that shareholders may bring an action to enforce the constituent documents of the corporation, our amended and restated memorandum and articles of association. Shareholders are entitled to have the affairs of the company conducted in accordance with the general law and the articles and memorandum.
Item 2.
Item 2. Properties
We currently operate eleven hog farms within the Wuhan City area. We also maintain a separate headquarters office in Wuhan City. We have two farms that are less than 10 acres each. The largest hog farm currently operating contains approximately 80 acres and has an annual capacity of 20,000 hogs.
These farms are generally located on lands that we lease from farming associations. Under Chinese law, the traditional farmers, represented by local farming authorities, are able to lease this land to us to develop for agricultural purposes. The commercial leases are held for periods of between 20 and 50 years, depending on the local farming authority.
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At the conclusion of the current leases, we expect to have the ability to renew the leases.
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Item 3.
Item 3. Legal Proceedings.
There are no pending legal proceedings to which we are a party or in which any of our directors, officers or affiliates, any owner of record or beneficially of more than 5% of any class of our voting securities, or security holder is a party adverse to us or has a material interest adverse to us. Our property is not the subject of any pending legal proceedings.
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PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market for Our Common Shares
Our common stock has been listed on the Nasdaq Global Market since July 20, 2010, under the symbol “OINK.” The prices set forth below reflect the quarterly high and low closing prices of a share of our common shares for the periods indicated as reported by finance.yahoo.com.
Holders
On March 1, 2012, there were approximately 1,200 stockholders of record of our common shares. The number of record holders does not include persons who held our common stock in nominee or “street name” accounts through brokers.
Dividends
We have never declared or paid any cash dividends on our common shares. We anticipate that we will retain any earnings to support operations and to finance the growth and development of our business. Therefore, we do not expect to pay cash dividends in the foreseeable future. Any future determination relating to our dividend policy will be made at the discretion of our Board of Directors and will depend on a number of factors, including future earnings, capital requirements, financial conditions and future prospects and other factors the Board of Directors may deem relevant.
If we determine to pay dividends on any of our common shares in the future, as a holding company, we will be dependent on receipt of funds from WFOE, which in turn would be dependent on the receipt of funds from our variable interest entity, Fengze. Payments of dividends by WFOE to our Company are subject to laws and regulations in the PRC including the requirement that foreign invested enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business. Further, such remittances would require WFOE to provide an application for remittance that includes, in addition to the application form, a foreign registration certificate, board resolution, capital verification report, audit report on profit and stock bonuses, and a tax certificate. There are no such similar foreign exchange restrictions in the British Virgin Islands.
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Recent Sales of Unregistered Securities
There have not been any sales of unregistered securities which have not previously been reported.
Purchases of Equity Securities by the Company and Affiliated Purchasers
During the fourth quarter of our fiscal year ended December 31, 2011, neither we nor any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act) purchased any shares of our common stock, the only class of our equity securities registered pursuant to section 12 of the Exchange Act.
Item 6.
Item 6. Selected Financial Data
This item does not apply to smaller reporting companies.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)
The following discussion and analysis of our Company’s financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements.
Overview
Our Company is in the business of breeding, raising, and selling hogs in the Wuhan City area of the PRC, and has recently entered into an agreement that provides it with the ability to sell finished pork products through selected retail channels. We control Fengze, pursuant to a series of control agreements between Fengze and our wholly owned subsidiary, WFOE. Fengze mainly produces and sells hogs for breeding stock and slaughter. As of December 31, 2011, Fengze owned and operated eleven commercial farms in the Wuhan City area. Fengze’s tenth farm was acquired in December 2010 and its eleventh farm was acquired in May 2011. Once they achieve full production, each of these farms will have an annual operating capacity of 20,000 hogs. In addition, Fengzi owns Tianzhili which operates in the Enshi City area. Tianzhili mainly raises and sell black hogs in conjunction with local hog farmers in Enshi. In addition, it will distribute black pork products through our retail business unit which we operate in conjunction with An Puluo based on a collaborative agreement entered into in August 2011 which allows us to sell pork products in supermarkets around Wuhan City. Pursuant to such Agreement, we retain 60% of the retail net income and h An Puluo receives 40% of the net income. Currently, we are selling our pork products under the brand name “Tianli An Puluo” in over 50 supermarkets in greater Wuhan City, including, Wal-Mart, Zon 100, and RT Mart.
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In the last two years, our business has grown rapidly as a result of the expansion of our annual capacity levels as discussed above, and China’s strengthening economy, and the resulting strong demand for our hogs, particularly for our breeder hogs.
In an effort to significantly increase the scale of our operations, we recently concluded a series of agreements (the “Exclusivity Agreements”) with the Animal Husbandry and Veterinary Bureau of Enshi Tujia and Miao Autonomous Prefecture of Hubei Province, the Animal Husbandry and Veterinary Bureau of Xianfeng County of Hubei Province, the Xuwang Hog Farming Professional Cooperatives of Xianfeng County, and the Qiming Hog Farming Professional Cooperatives of Xianfeng County, whereby we were granted the exclusive right to breed and sell Enshi black hogs in Enshi Autonomous Prefecture in Hubei Province. Enshi black hog is one of the oldest hog species with a lineage that can be traced back to the year 1611. Enshi black hog originated in the Enshi Tujia and Miao Autonomous Prefecture in Hubei Province and the meat of the Enshi Black Hog is considered by many Chinese to be superior to that of many other breeds and for that reason, black hog meat generally sells for more than standard hog meat. The Company estimates that the price of Enshi black hog meat is currently approximately 35% above the price of typical lean pork meat. The agreements also call for the joint development, funding and operation of local cooperatives in the Enshi Autonomous Prefecture in Hubei Province whereby the Company, the relevant governmental agencies and the cooperatives will assist participating farmers to breed and raise Enshi black hogs which will be purchased by the Company for resale as meat hogs or retained or sold as breeders at the Company’s discretion. By entering into this arrangement, we hope to be able to develop a widely recognized brand of black hog meat and to profit from the sale of black hogs grown by independent farmers as well as those grown by us. If successfully implemented, this program should allow us to profit from the black hogs grown by the participating farmers who will be obligated to purchase feed, vaccines and other supplies from us and then sell us their hogs at a price which is comparable to the costs at which we currently grow our own hogs.
The Exclusivity Agreements envision that we will work with the Animal Husbandry and Veterinary Bureaus of Xianfeng County and Enshi Tujia and Miao Autonomous Prefecture, respectively, to develop a regional breeding and distribution program whereby local farmers will be trained and supervised by us, the relevant governmental agencies and their cooperatives in raising a breed of black hogs genetically developed and monitored by us with the approval of the local government agency. We will work with all of the farmers participating in the program to ensure that the quality of the breed is maintained and to develop standardized programs for the feed and care of the hogs. As part of this effort, we will develop an appropriate feed mix, which the farmers will purchase from us. To be eligible to participate in the program farmers will need to be able to maintain no less than 6 sows or produce at least 100 black hogs per year. By the end of 2011 we had funded and completed the construction of 125 farms for local farmers and we envision that we will fund and construct up to an additional 183 farms by the end of this year. The goal is to achieve a production capacity of 100,000 hogs during 2012 with a long run target of an annual capacity of 1 million hogs. Achievement of any of the program’s goals and the need for financing are dependent upon the participation, cooperation and skills of local farmers which are currently being evaluated. The agreements are generally for a period of ten years.
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As noted above, we should benefit from this program in a number of ways, principally by reselling the black hogs purchased from the participating farmers and by providing the farmers with necessary supplies. The price at which black hog meat sells is currently 35% above the price of white hog meat. We believe this will provide sufficient margin to us even if the relative prices change.
We believe that because this program offers many advantages to the participating farmers and the local governments, the number of farmers wanting to join the program will be significant ensuring the success of the program and will result in a significant increase in the volume of pork we sell. Enshi Autonomous prefecture is a relatively poor area of China. By joining this program participating farmers will benefit from our expertise in breeding and caring for hogs, and will be producing a breed which is generally considered superior to the meat of standard hogs. To develop our strain of black hog we will apply internationally recognized advanced molecular breeding strategies. The project will be supported by the Animal Husbandry Research Institution of Hubei, which has significant experience in hog breeding research. Moreover, the Enshi Autonomous Prefecture government has determined to emphasize hog farming in China’s current five-year development plan (2011-2015), which should cause it to cooperate with us to make the project a success. Significantly, the local governments have agreed that we are the only company with which it will undertake a project such as this.
In addition to the advantages of this program, we believe that some of the risks typical to hog farming will be minimized. For example, because individual farms will be relatively small and decentralized, and under strict supervision to employ disease control methods we determine appropriate, the risk of disease should be lower than on traditional farms, Further, if a farm were to develop a problem, it should not spread since the farms are decentralized in the Prefecture’s mountainous region. In addition, because of the emphasis being placed on this project by the local government, we anticipate a high level of cooperation from the farmers who are being given the opportunity to profit from what is otherwise communal land.
We have agreed to contribute to the financial needs of the project in various ways and the local governments have agreed to provide us and the participating farmers with various subsidies, incentives and insurance. The precise demands upon us will depend upon the rate at which the project grows which, in turn, will be impacted by the availability of financing that may be necessary to modernize and support the participating farmers. Given the long term of this project, it is likely that there will be continued negotiation of various issues that arise during the life of the project.
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Principal Factors Affecting our Results of Operations
Revenues and Incomes
We derive our revenues from the sale of hogs to other hog farms for breeding purposes, to brokers who sell the product both to other hog farms for breeding purposes and to slaughterhouses, and directly to slaughterhouses. We breed and raise hogs that are eventually sold as either breeder or market hogs which will be sold to slaughter houses for conversion into pork products. Some of the hogs are bred and raised for the purpose of sale as market hogs, while others become market hogs because customers do not select them as breeder hogs. Also very few boars are required for breeding purposes, as compared with sows. As approximately half of a litter will be males, most of these males will be sold as market hogs. The average sales price for a breeder is significantly higher than that of a market hog, and since breeder hogs are sold at a younger age than market hogs and usually weigh about 110 pounds at the date it is sold, as compared to the average weight of about 220 pounds for a market hog, the direct cost of feeding and otherwise raising a breeder hog is less than a market hog. Thus the gross margin for breeder hogs is substantially higher than that of a market hog. Consequently, the Company has focused its operations so that a significant portion of its sales are represented by breeder hogs, and its success in so doing has been a major contribution to its operating profit.
We also receive some subsidies from the government for operating our farms. Some of these subsidies are non-recurring, such as the payment we receive when we reach specified annual production capacities, or for the acquisition of certain operating equipment. Others, such as subsidies for breeder hog insurance, are ongoing so long as we qualify. Of course, there is no assurance the government will continue any of its policies for granting subsidies.
Commencing in the third quarter of 2011, we also began to derive revenue from retail sales of pork products through our collaborative arrangement with An Puluo. In August 2011, Fengze and An Puluo signed a collaborative agreement whereby we received the right to sell processed pork products at retail under the brand name “Tianli An Puluo” in greater Wuhan City. We are the principal participant in this collaborative arrangement and accordingly costs incurred and revenue generated is recorded on a gross basis in our financial statements. According to the collaborative agreement, Fengzi and An Puluo share the net profit (after tax) from this business on a ratio of 60% vs 40%.
Factors Affecting Revenues
The following factors, among others, affect the revenues and profitability that we derive from our operations. For other factors affecting our revenues, see “Risk Factors-Risks Related to Our Business,” included elsewhere in this Form 10-K
Consumer demand for pork products. Consumer demand for pork products is closely linked to the performance of the general Chinese economy and is sensitive to business and personal discretionary spending levels.
Declines in consumer demand may occur as a result of adverse general economic conditions. Lower consumer confidence and changes in consumer preferences for pork as compared with other meats can lower the revenues and profitability of our operations. As a result, changes in consumer demand and general business cycles can subject our revenues to volatility.
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Revenues resulting from the sale of breeder hogs. A significant amount of our revenues and operating margin result from the sales of young breeder hogs to other hog farmers. Because these breeder hogs command a price significantly higher than market hogs, and are sold at a younger age, thus incurring less feed and related finishing expenses, the profitability of the sale of a breeder hog is higher than that for the sale of a market hog. A significant reduction in the proportion of our sales that are breeder hogs would very likely significantly reduce our overall profit margin.
Government action in our industry. Because pork occupies such a central role in the Chinese diet, the government has occasionally taken action to prevent the price of pork from dropping below specified levels and has provided subsidies to companies engaged in hog farming. We benefit from this protection, and we could be harmed if the government terminated such practices. In addition, the government has taken actions to prevent the spread of diseases among livestock, including mandatory culls of affected animals. These actions have occasionally resulted in relative shortages, which tend to lead to higher prices for healthy animals, and could result in a reduction of our stock, thus reducing revenues and profit. Likewise it is possible that the government could implement some form of price controls that could adversely impact our ability to price our products as to recover increases in costs such as feed.
Competition and subsidies. While the hog farming industry in Hubei province and the Wuhan City area includes a large number of farms, many of those farms are smaller farms that sell relatively few hogs per year. We believe the incentives being given to farms that reach specified annual production capacities are likely to result in a consolidation of the industry. Our ability to increase our production capacity and thus to qualify for these incentives for our operations allows us to receive non-recurrent benefits from these subsidies, as well as to benefit from increased economies of scale in our operations.
Expansion. We believe we must continue to expand our production capacity to attain additional market share. Since 2006, we have acquired or built eleven hog farms. If we fail to make acquisitions or expand our production capacity, our revenue growth could slow.
Epidemic outbreaks. The outbreak of animal diseases could adversely affect our revenues. An occurrence of serious animal diseases, such as foot-and-mouth disease, or any outbreak of other epidemics in the PRC affecting animals or humans might result in material disruptions to our sales.
Taxes. Currently the Company believes that the provisions of the PRC’s Enterprise Income Tax law provide it with an exemption from PRC income taxes, VAT taxes and business service taxes. If this understanding is incorrect or if the law or interpretations of the law change, this could significantly impact the Company’s net operating results.
Contractual arrangements with Fengze. We conduct substantially all of its operations, and generate substantially all of our revenues, through contractual arrangements with Fengze that provide us with effective control over Fengze. We depend on Fengze to hold and maintain contracts with our customers. Fengze owns substantially all of our intellectual property, facilities and other assets relating to the operation of our business, and employs the personnel for substantially all of our business. Neither Tianli, nor HCS nor WFOE has any ownership interest in Fengze. Although WFOE’s contractual arrangements with Fengze are valid, binding and enforceable under current PRC laws and regulations, these contractual arrangements may not be as effective in providing the Company with control over Fengze as direct ownership of Fengze would.
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Costs and Expenses
We primarily incur the following costs and expenses:
Costs of goods sold. In raising hogs for sale, we incur a number of costs that represent the costs of goods sold. We must purchase hog feed, premix components, medicines and other supplies to grow our hogs and keep them healthy. In addition to these items, cost of goods sold includes expenses such as the amortization of the sows (referred to as biological assets), farm employee wages, water, electricity, equipment depreciation expense, maintenance expense, quarantine expense, equipment costs, insurance expense, and sewage charges.
General and administrative expenses. General and administrative expenses consist primarily of compensation expense for our corporate staff, professional fees (including consulting, audit and legal fees), communication costs, research and development costs, gasoline, welfare expenses, education expenses, travel and business hospitality expenses, land rent, and other office administrative and related expenses.
Sales and marketing costs. Sales and marketing costs include salaries, wages, and promotion expenses.
Factors Affecting Expenses
Supplies and commodity prices. The largest component of our expenses relates to the price of materials required to breed and raise hogs for sale. Specifically, while we ordinarily breed our own hogs, we periodically purchase breeding stock to continue to improve our genetic breeding pool. Similarly, the prices of corn and soybean husks in China are important to our operations, because corn and soybean husks are the primary component of the hogs’ diet. To the extent the prices of these materials vary, our cost of goods will fluctuate, and we may not be able to recover these higher costs by higher prices for our products. For this reason, we may be affected by droughts, floods, crop diseases and the like, which tend to make feed scarcer and thus more expensive.
Transition to public company. As we are now a public company, our administrative costs have increased materially, including audit, legal, travel to the United States, investor relations and advisor costs as well as the need to comply with detailed reporting requirements.
Number of customers. The more customers we have, the related selling expenses, travel expenses and other similar costs will likely increase. At present, we sell substantially all of our hogs to a relatively small number of customers. We believe this concentration of customers has allowed us to focus our marketing and selling efforts.
Number of farms we operate. We have acquired or constructed a number of hog farms in the last several years. As we operate more farms, our administrative expenses tend to increase in dollars terms.
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Retail expenses. As we pursue a strategy of providing our branded product to retail outlets, we expect that we will face additional costs such as promotion and advertising expenses to establish our brand image and retail recognition.
In connection with the Enshi Black Hog program described above, we have agreed to incur various costs and contribute various amounts to cover the costs of different aspects of the program. During the year ended December 31, 2011, we signed 7 joint development agreements, generally for periods of 10 years, with 7 local cooperatives in the Enshi Autonomous Prefecture in Hubei Province whereby the Company, the relevant governmental agencies and the cooperatives will assist participating farmers to breed and raise Enshi black hogs which will be purchased by us for resale as meat hogs or retained or sold as breeders at our discretion. Under these agreements, we provide funding to local independent farmers to construct small-scale hog rearing facilities on which the farmers will grow the black hogs for sale to us. Pursuant to these joint development agreements, title to these small-scale hog rearing facilities belongs to us and the local cooperatives (and the individual farmers) have the right to use them. With respect to three of the cooperatives, we have purchased $1.82 million of hog rearing facilities and equipment that has been completed and is operational and included in plant and equipment as of December 31, 2011. With regard to four of the cooperatives, we have purchased $2.45 million of hog rearing facilities and equipment that has not been completed and is not operational and is included in construction in progress as of December 31, 2011.
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Comparison of the Results of Operations for the Years Ended December 31, 2011 and 2010
All amounts, other than percentages, in U.S. dollars
Revenues. Our revenues increased by $10,158,631 or approximately 47.74% in the year ended December 31, 2011 as compared to the year ended December 31, 2010. This growth was primarily the result of a 55% increase in sales of our market hogs and sales of $2.8 million derived from our retail operations which only began in 2011 yet comprised nearly 9% of our revenues for the year. We sold approximately 10% more market hogs in 2011 than in 2010, at an average price per hog that was approximately 41% higher than that in 2010. As a result, sales revenue attributable to market hogs increased by approximately 55%. Market hogs realized strong growth in sales in 2011, thus accounting for approximately 61% of sales revenue in 2011, up from 58% of sales revenue in 2010. This increase was offset by the weaker demand for our breeder hogs. We sold approximately 10% less breeder hogs in 2011 than we sold in 2010, at an average price per hog 18% above the price per hog in 2010. As a result, sales revenue attributable to breeder hogs slightly increased by approximately 6%. Our sales volume of breeder hogs decreased in part because the pork retail price in China soared sharply during 2011 which caused hog farmers to put purchases of breeder hogs on hold fearing a reduction in the pork retail price.
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The tables below illustrate the sales of breeder hogs, market hogs, and processed pork products for the years ended December 31, 2011 and 2010.
Sales by Products
Profit Margins. Our gross profit margin decreased to 36% in the year 2011 from 43% in 2010. This decrease in our profit margin reflected the impact of the increased cost of feed and the start-up of our retail operations which operate at a lower margin than our hog production business. Also, in the fourth quarter of 2011, food contamination at several hog farms cost the Company approximately $1,246,000 from lost diseased hogs.
The gross margins for breeder hogs were 47% and 59% in the years 2011 and 2010, respectively, and the gross margins for market hogs were 32% in the years 2011 and 2010, respectively. The gross margin from our processed pork products sold through retail channels was 33%. The decrease of the gross margins for breeder hogs is mainly due to a greater mix of crossbred breeders sold in 2011 as compared to purebreds, which have a higher margin than crossbreds. The increase of the gross margins for market hogs was mainly due to the increase of pork retail prices which have been pushed up as a result of a shortage in the supply of hogs in China.
Expenses. Selling, general and administrative expenses increased by $1,962,506 in 2011 as compared to 2010. The increase was primarily the result of $255,454 of stock-based compensation expenses for shares issued to our investment relationship consultants and our directors, $812,500 of general and administrative expenses incurred as a public company, and $606,000 of selling, general and administrative expenses from our retail segment that commenced operations in the third quarter of 2011.
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Net Other Income (Expense). Net other income (expense) decreased from $171,583 of net other income for 2010 to ($136,156) of net other expense for 2011, a net decrease of $307,739. This decrease was primarily due to an increase of $149,833 in interest expense and an increase of $163,002 from a one-time financing service fee to obtain loans from banks which is included in other expense.
Income taxes. As an agricultural business, the Company is exempt from the Chinese income tax and our hog farming operations are exempt from VAT. Revenues generated from our retail business cooperative with An Puluo are subject to a 13% VAT rate.
Net Income. Our net income for the years ended December 31, 2011 and 2010 was $8,096,134 and $8,158,672, respectively. The slight 0.77% decrease in net income was primarily the result of inflated feed costs offset by increased sales price for breeder and market hogs. The increased price received for breeder and market hogs was sufficient to offset the cost associated with food contamination which occurred in the fourth quarter of 2011 which cost us approximately $1,246,000 in lost hogs.
Liquidity and Capital Resources
The following discussion regarding liquidity and capital resources reflects our position as of December 31, 2011.
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, 2011 our working capital was $11,865,004 as compared to $12,999,228 at December 31, 2010, reflecting a decrease in cash and cash equivalents balances to $6,518,533 at the end of 2011 as compared to $7,983,793 at the end of 2010. The December 31, 2010 balance included the benefit of proceeds from our July 19, 2010 IPO. The components of cash flows are discussed below.
Consolidated Statement of Cash Flows
Cash Provided by Operating Activities
Net cash provided by operating activities in the year ended December 31, 2011 totaled $6,692,815. Cash from operating activities mainly consisted of our net income for the year of $8,096,134, supplemented by non-cash expenses of depreciation and amortization of $2,248,593, amortization of prepaid rental expense of $201,339 and stock-based compensation of $255,454, and a decrease in advances to suppliers of $1,001,973, and an increase in accounts payable and other payables of $763,331, and partially offset by an increase in accounts receivable of $978,788 and an increase in inventories of $4,848,421. Our increase in accounts receivable reflects the opening of our retail business which started in the third quarter of 2011. Sales to local supermarkets were made on terms of 30 to 45 days. The increase in inventories was in part due to the increase in the number of hogs resident in the farms and a decision to increase our supplies of feed to insure availability and to purchase before further increases in cost.
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For the year ended December 31, 2010, cash provided by operations totaled $7,153,139. Cash from operating activities mainly consisted of our net income for 2010 of $8,158,672, supplemented by depreciation and amortization of $1,124,874, partially offset by an increase in inventory of $1,345,473 and a decrease in accounts payable of $222,172. This increase in inventory was in part due to the increase in the number of hogs resident in the farms and a decision to increase our supplies of feed to insure availability and to purchase supplies before further increases in cost.
Cash Used in Investing Activities
Net cash used in investing activities for 2011 totaled $14,399,554. This included an advance of $1,084,363 to An Puluo, additions to construction in progress of $3,152,428 for establishing and upgrading hog farms, including hog farms for small farmers in the black hog program, $4,606,733 of plant and equipment investments, $1,923,470 for additions to our breeder stock, $785,223 for the purchase of intangible assets, and long-term prepaid rents of $1,906,343, mainly from the purchase of assets of our eleventh hog farm.
During 2010, we used $9,943,109 in investing activities. This included $5,399,050 of plant and equipment investments, which included disbursements of $1,793,921 to the previous owners of farms that the Company had acquired in prior years, $2,011,890 for the construction of and related equipment for farm #9, $550,000 as a partial payment for farm #10, and upgrades of the facilities of other farms. In addition, there were $3,195,574 of additions to our breeder stock, $530,303 as a deposit for the potential acquisition of a new farm, and $818,182 of advances made for upgrading the recently acquired 10th farm and the acquisition of some water waste system equipment.
Cash Provided by Financing Activities
During 2011, the Company obtained $4,647,272 in proceeds from new short-term bank loans which are due by May 31, 2012 and November 22, 2012.
During 2010, net cash provided by financing activities was $8,540,180, which reflects the net proceeds, less related expenses, of $9,158,260 from our IPO, and the repayment of the $662,460 advance previously provided by our Chairwoman.
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Commitments for Capital Expenditures
We have been actively pursuing upgrading our existing farms and expansion of our joint development agreement and collaborative agreement. As of December 31, 2011, the Company had deposited $750,992 for building a new feed processing facility, a new refrigerator, and improvements to several of our existing hog farms. The remaining amount, approximately $533,000 will be paid upon completion of the improvements. The construction is expected to be completed before the end of 2012.
Our participation in the Enshi Black Hog program will require us to incur various costs and contribute various amounts to cover the costs of different aspects of the program as more fully described above. As of December 31, 2011, we had provided funding totaling $4.27 million to local independent farmers to construct small-scale hog farms in which the farmers will raise black hogs for sale to the Company. We expect further funding for this program may be required later this year, and we believe that such funds will be available out of the cash flow generated by operations.
Off Balance Sheet Items
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,
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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,
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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
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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, purchase commitments and other contractual obligations. These transactions are recognized in our financial statements in accordance with generally accepted accounting principles in the United States.
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Critical Accounting Policies
See “Note 2. Basis of Presentation and Summary of Significant Accounting Policies” in the Notes to our Financial Statements included herein for a discussion of the critical accounting policies and estimates adopted in preparing our financial statements
Item 7A.
Item 7A. Qualitative and Quantitative Disclosures about Market Risk.
This item does not apply to smaller reporting companies.
Item 8.
Item 8. Financial Statements
The consolidated financial statements of Tianli Agritech, Inc. are presented following Item 15.
Item 9.
Item 9. Chances in and Disagreements with Accountants on Accounting and Financial Disclosure
By letter dated June 2, 2011, the Company dismissed Sherb & Co., LLP as independent registered public accounting firm for the Company. The dismissal of Sherb & Co., LLP was approved by the Audit Committee of the Board of Directors of the Company.
Sherb & Co., LLP issued an audit report on the consolidated financial statements of the Company as at and for the years ended December 31, 2010 and 2009, which did not contain an adverse opinion or a disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope or accounting principles. In connection with the audit of the consolidated financial statements of the Company as at and for the years ended December 31, 2010 and 2009 and through date of dismissal, (i) there were no disagreements between the Company and Sherb & Co., LLP on any matters of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements, if not resolved to the satisfaction of Sherb & Co., LLP, would have caused Sherb & Co., LLP to make reference to the subject matter of the disagreement in its report on the Company's financial statements for such year or during the interim period through the date of this Report, and (ii) there were no reportable events within the meaning set forth in Item 304(a)(1)(v) of Regulation S-K.
Prior to filing a Form 8-K reporting such dismissal, the Company provided Sherb & Co., LLP with a copy of the disclosures in the Form 8-K and Sherb & Co., LLP furnished the Company with a letter addressed to the Securities and Exchange Commission stating that it agreed with the Company's statements in the Form 8-K. A copy of the letter furnished by Sherb & Co., LLP was filed as an exhibit to that Form 8-K.
On June 7, 2011, the Company signed a letter to engage Crowe Horwath (HK) CPA Limited as its registered independent public accountants for the fiscal year ending December 31, 2011. The decision to engage Crowe Horwath (HK) CPA Limited was approved by the Audit Committee of the Board of Directors of the Company.
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During the Company's two most recent fiscal years ended December 31, 2010 and 2009 and through the date of engagement, the Company did not consult with Crowe Horwath (HK) CPA Limited (HK) CPA Limited on (i) the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that may be rendered on the Company's financial statements, and Crowe Horwath (HK) CPA Limited did not provide either a written report or oral advice to the Company that Crowe Horwath (HK) CPA Limited concluded was an important factor considered by the Company in reaching a decision as to any accounting, auditing, or financial reporting issue; or (ii) the subject of any disagreement, as defined in Item 304 (a)(1)(iv) of Regulation S-K and the related instructions, or a reportable event within the meaning set forth in Item 304(a)(1)(v) of Regulation S-K.
By letter dated December 27, 2011, the Company dismissed Crowe Horwath (HK) CPA Limited as independent registered public accounting firm for the Company. The dismissal of Crowe Horwath (HK) CPA Limited was approved by the Audit Committee of the Board of Directors of the Company.
Crowe Horwath (HK) CPA Limited did not conduct an audit of the consolidated financial statements of the Company as at and for the year ending December 31, 2011 prior to its dismissal.
Since its engagement as the Company’s independent registered public accounting firm on June 7, 2011 and through the date of its dismissal: (i) there were no disagreements between the Company and Crowe Horwath (HK) CPA Limited on any matters of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements, if not resolved to the satisfaction of Crowe Horwath (HK) CPA Limited, would have caused Crowe Horwath (HK) CPA Limited to make reference to the subject matter of the disagreement in its report on the Company's financial statements for such year or during the interim period through the date of dismissal, and (ii) there were no reportable events within the meaning set forth in Item 304(a)(1)(v) of Regulation S-K.
Prior to filing a Form 8-K reporting such dismissal, the Company provided Crowe Horwath (HK) CPA Limited with a copy of the disclosures in the Form 8-K and Crowe Horwath (HK) CPA Limited furnished the Company with a letter addressed to the Securities and Exchange Commission stating that it agreed with the Company's statements in the Form 8-K. A copy of the letter furnished by Crowe Horwath (HK) CPA Limited was filed as an exhibit to that Form 8-K.
On December 27, 2011, the Company signed a letter to engage Sherb & Co., LLP as its registered independent public accountants for the fiscal year ending December 31, 2011. The decision to engage Sherb & Co., LLP was approved by the Audit Committee of the Board of Directors of the Company.
Sherb & Co., LLP was the Company’s registered independent public accountants during the Company's two most recent fiscal years ended December 31, 2010 and 2009 and issued an audit report on the consolidated financial statements of the Company as at and for the years ended December 31, 2010 and 2009.
Except with respect to the audit of the consolidated financial statements of the Company as at and for the years ended December 31, 2010 and 2009, and their review of the Company’s interim financial statements for the fiscal year ended December 31, 2011 prior to June 2, 2011, during the Company's two most recent fiscal years ended December 31, 2010 and 2009, and through the date of its engagement, the Company did not consult with Sherb & Co., LLP on (i) the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that may be rendered on the Company's financial statements, and Sherb & Co., LLP did not provide either a written report or oral advice to the Company that Sherb & Co., LLP concluded was an important factor considered by the Company in reaching a decision as to any accounting, auditing, or financial reporting issue; or (ii) the subject of any disagreement, as defined in Item 304 (a)(1)(iv) of Regulation S-K and the related instructions, or a reportable event within the meaning set forth in Item 304(a)(1)(v) of Regulation S-K.
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Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures [to be confirmed or revised]
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) under the Exchange Act) that are designed to ensure that information that would be required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including to the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
As required by Rule 13a-15 under the Exchange Act, under the supervision and with the participation of our management, including Hanying Li, our Chief Executive Officer, and Bihong Zhang, our Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2011 and have concluded that the disclosure controls and procedures are effective to ensure that material information relating to our company is recorded, processed, summarized, and reported in a timely manner.
Management’s Report on Internal Control over Financial Reporting
Section 404 of the Sarbanes-Oxley Act of 2002 requires that management document and test the Company’s internal control over financial reporting and include in this Annual Report on Form 10-K a report on management’s assessment of the effectiveness of our internal control over financial reporting.
Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting refers to the process designed by, or under the supervision of Hanying Li, our Chief Executive Officer, and Bihong Zhang, our Chief Financial Officer, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP, and includes those policies and procedures that:
(1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;
(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that our receipts and expenditures are being made only in accordance with the authorization of our management and directors; and
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(3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2011. In making this assessment, management used the framework set forth in the report entitled Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. The COSO framework summarizes each of the components of a company’s internal control system, including (i) the control environment, (ii) risk assessment, (iii) control activities, (iv) information and communication, and (v) monitoring. Based on that evaluation, Hanying Li, our Chief Executive Officer, and Bihong Zhang, our Chief Financial Officer, concluded that as of December 31, 2011, and as of the date that the evaluation of the effectiveness of our disclosure controls and procedures was completed, our disclosure controls and procedures were effective to satisfy the objectives for which they were intended.
Changes in Internal Controls over Financial Reporting.
During the fiscal year ended December 31, 2011, there were no changes in our internal control over financial reporting identified in connection with the evaluation performed during the fiscal year covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information.
Not applicable.
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PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant.
Our executive officers and directors are:
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Ms. Hanying Li. Ms. Li has served as our Chair since January 2010. Ms. Li founded Fengze in 2005. From 1979 through 2004, Ms. Li was deputy director of the Wuhan City Prosecutor’s Office. Ms. Li received her bachelor degree in law from Hubei Finance & Economic University. Ms. Li was nominated as a director for her experience operating hog farms and leadership of our company before it went public.
Mr. Bihong Zhang. Mr. Zhang has served as CFO and a director since January 2010. From 2008 through 2009, Mr. Zhang was partner in the accounting firm Zhong Cheng Xin (Beijing). From 2005 through 2008, Mr. Zhang was a senior manager in the accounting firm Li An Da. From 1995 through 2005, Mr. Zhang was a senior project manager of Zhong Tian Hua Zheng (Inner Mongolia), an accounting firm. Mr. Zhang is a licensed Certified Public Accountant in China. Mr. Zhang received his diploma from Inner Mongolia Forestry College of Economics and Management. Mr. Zhang was nominated as a director because of his familiarity and experience with the accounting issues that affect commercial hog farms in China.
Mr. Jishan Hu. Mr. Hu has served as an independent Director since January 2010. Mr. Hu has been senior economic advisor to China National Petroleum Corporation (CNPC) since 2006, and president of CNPC from 1993 to 2006. Mr. Hu was nominated as a director because of his management and corporate governance experience.
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Mr. Benyan Li. Mr. Li has served as an independent Director since January 2010. Mr. Li was the head Congressman of Qiaokou District People’s Congress between 2006 and 2009, chief prosecutor of Qiaokou District between 2001 and 2006, and chief prosecutor of Huangpi District between 1999 and 2001. Mr. Li received his diploma from the College of Central South Politics and Law. Mr. Li was nominated as a director because of his familiarity with applicable laws and agencies in Wuhan.
Mr. Youhang Peng. Mr. Peng has served as an independent Director since January 2010. Since 2004, Mr. Peng has been the Senior Managing Director of Caybridge International. Mr. Peng holds a bachelor degree from Tsinghua University and a master’s degree from the University of California at Davis. Mr. Peng serves as our Audit Committee financial expert. Mr. Peng was nominated as a director because of his experience in capital markets and accounting.
Peter E. Gadkowski. Mr. Gadkowski has been a director of the Company since December, 2010. He has been an attorney in private practice in Colorado Springs, Colorado since February 2000 and from September 1992 to December 1994. He also has experience in the pork industry. He founded, managed and served as CEO and a director of WPP Holding Corp., a hog farm in Yuma, Colorado, from March 1995 through August 1999, which was sold to Smithfield Foods, Inc. He also served as General Counsel and CFO of Premium Standards Farms, Inc., Kansas City, Missouri, from July 1990 to August 1992, which was sold to Continental Grain and then subsequently to Smithfield Foods, Inc. Mr. Gadkowski graduated magna cum laude from the California Western School of Law, and received an MBA in Finance and a BS in Business and Economics from Lehigh University.
Dr. Huanchun Chen. Dr. Chen is a professor at the Chinese Academy of Engineering and an expert in infectious diseases of domesticated animals. He graduated with a degree in Veterinarian Medicine from the University of Munich, Germany. Since 2000, Dr. Chen has served as a Vice President and Professor in the Laboratory of Preventive Veterinary Science at Huazhong University of Agriculture. Dr. Chen’s major achievements include confirming the outbreak of Hog Pseudorabies in China, separating and identifying the Hog Pseudorabies Virus, developing various diagnostic methods, systematically illustrating five forms of clinical manifestation of Hog Pseudorabies of China, and coming up a plan to eliminate the Hog Pseudorabies. In 2001, he has won the 2nd Prize of National Advance of Science and Technology. By developing all kinds of new-type inactivated vaccine and attenuated vaccine and diagnosis reagent kit, he has won 3 kinds of identified achievement and 14 kinds of expert acceptance achievement.
Mr. Jianguo Hu. Mr. Hu has been a director of the Company since December 6, 2010 and Vice General Manager and Technical Director of the Company since 2008. He leads the Company’s research and directs its breeding production. From January 2005 to January 2008, Mr. Hu was previously the Executive Director of Hubei Provincial Association for Hog Raising. From January 2003 to December 2004Mr. Hu served as a Director of the Wuhan Nanhu Modern Pig Raising Technology Research Center, which conducts research and promotion of modern hog raising techniques.
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Board of Directors and Board Committees
Our board of directors currently consists of eight directors. There are no family relationships between any of our executive officers and directors. A director is not required to hold shares in our Company. There are currently no arrangements or understandings pursuant to which our directors are selected or nominated.
The directors are divided into three classes, as nearly equal in number as the then total number of directors permits. Class I directors shall face re-election at our annual general meeting of shareholders in 2014 and every three years thereafter. Class II directors shall face re-election at our annual general meeting of shareholders in 2012 and every three years thereafter. Class III directors shall face re-election at our annual general meeting of shareholders in 2013 and every three years thereafter.
If the number of directors changes, any increase or decrease will be apportioned among the classes so as to maintain the number of directors in each class as nearly as possible. Any additional directors of a class elected to fill a vacancy resulting from an increase in such class will hold office for a term that coincides with the remaining term of that class. Decreases in the number of directors will not shorten the term of any incumbent director. These board provisions could make it more difficult for third parties to gain control of our company by making it difficult to replace members of the Board of Directors.
A director may vote in respect of any contract or transaction in which he is interested, provided, however that the nature of the interest of any director in any such contract or transaction shall be disclosed by him at or prior to its consideration and any vote on that matter. A general notice or disclosure to the directors or otherwise contained in the minutes of a meeting or a written resolution of the directors or any committee thereof of the nature of a director’s interest shall be sufficient disclosure and after such general notice it shall not be necessary to give special notice relating to any particular transaction. A director may be counted for a quorum upon a motion in respect of any contract or arrangement which he shall make with our company, or in which he is so interested and may vote on such motion.
The Board of Directors maintains a majority of independent directors who are deemed to be independent under the definition of independence provided by NASDAQ Listing Rule 5605(a)(15). Peter E. Gadkowski, Jishan Hu, Benyan Li, Youhang Peng and Dr. Huanchun Chen are our independent directors.
Ms. Hanying Li currently holds both the positions of Chief Executive Officer and Chairwoman of the Board. These two positions have not been consolidated into one position; Ms. Li simply holds both positions at this time. We do not have a lead independent director because we believe our independent directors are encouraged to freely voice their opinions on a relatively small company board. We believe this leadership structure is appropriate because we are a smaller reporting company and deem it appropriate to be able to benefit from the guidance of Ms. Li as both our principal executive officer and Chairwoman of the Board.
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Our Board of Directors plays a key role in our risk oversight. As such, it is important for us to have both our Chief Executive Officer and Chief Financial Officer serve on the Board as they play 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.
Board Committees
The Board has established three committees: 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 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 of Directors is responsible for the assessment of the performance of the board, considering and making recommendations to the board with respect to the nominations for election of directors and other governance issues. The nominating committee considers diversity of opinion and experience when nominating directors.
The nominating committee identifies and evaluates nominees for our Board of Directors, including nominees recommended by stockholders, based on numerous factors it considers appropriate. The nominating committee is responsible for making recommendations to the Board of Directors of nominees to stand for election as directors. The nominating committee currently consists of Mr. Peter Gadkowski, Mr. Jishan Hu, Benyan Li and Mr. Youhang Peng, with Mr. Gadkowski serving as Chairman. The members of the Nominating Committee are independent, as that term is defined by NASDAQ.
The Board of Directors periodically reviews the diversity of specific skills and characteristics necessary as a member of our Board. The nominating committee will assess the skill areas currently represented on the Board against the target skill areas, as well as recommendations of directors regarding skills that could improve the overall quality and ability of the Board to carry out its function.
The nominating committee will consider persons recommended by stockholders for inclusion as nominees for election to our Board of Directors if the names, biographical data, and qualifications of such persons are submitted and delivered in writing in a timely manner. The criteria that the committee and the full board will use to assess the qualifications of candidates for election to the board will include matters such as experience in the hog or agricultural industry, financial or technical expertise, strength of character, quality of judgment, concern for the interests of the Company’s shareholders, and how these skills might be best utilized by the Company. The committee will also consider the extent to which the nominee would fill a present need on our Board of Directors.
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Interested Transactions
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.
Director Compensation
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 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 our directors.
All directors hold office until the next annual meeting of shareholders at which their respective class of directors is re-elected and until their successors have been duly elected and qualified. Officers are elected by and serve at the discretion of the Board of Directors. Employee directors do not receive any compensation for their services as directors. Non-employee directors are entitled to receive compensation per year for serving as directors and may receive option grants from our company. In addition, non-employee directors are entitled to be reimbursed for their actual travel expenses for each Board of Directors meeting attended.
The following table sets forth certain information regarding the compensation paid to our directors during the fiscal year ended December 31, 2011.
___________
(1)
Ms. Li and Mr. Zhang received payment in their capacities as officers of our company and/or subsidiaries/affiliates but did not receive any compensation for serving as directors of our company
(2)
Peter E. Gadkowski, Dr. Huanchun Chen, and Jianguo Hu were appointed as directors in December, 2010.
(3)
Represents options to purchase 8,667 common shares at an exercise price of $6.00 per shares which are exercisable until January 31, 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.
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 (or anyone serving at our request as a director of another entity), 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.
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The decision of our Board of Directors as to whether an individual eligible for indemnification acted honestly and in good faith with a view to our best interests and as to whether the individual 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 an individual did not act honestly and in good faith and with a view to our best interests or that the individual had reasonable cause to believe that his or her conduct was unlawful. If an individual eligible for indemnification has been successful in defense of any proceedings referred to above, that individual 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.
We may purchase and maintain insurance in relation to any of our directors or officers against any liability asserted against the directors or officers and incurred by the directors or officers in that capacity, whether or not we have or would have had the power to indemnify the directors or officers against the liability as provided in our amended and restated memorandum and articles of association.
Insofar as indemnification for liabilities arising under the Securities Act may be permitted for our directors, officers or persons controlling our company 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.
Compliance with Section 16(a) of the Exchange Act
Section 16 of the Securities Exchange Act requires our directors and executive officers and persons who own more than 10% of a registered class of our equity securities to file various reports with the Securities and Exchange Commission concerning their holdings of, and transactions in, our securities. Copies of these filings must be furnished to us.
Based on a review of the copies of such forms furnished to us and representations from our executive officers and directors, although all our officers, directors and greater than 10% stockholders (other than Changxin Wu and Guoping Wang, who have resigned as directors) filed all reports required to be filed in accordance with the filing requirements of Section 16(a) of the Exchange Act, except that the Form 3’s of Dr. Huanchun Chen and, Jianguo Hu were not filed timely.
Code of Business Conduct and Ethics
Our code of business conduct and ethics provides that our directors and officers are expected to avoid any action, position or interest that conflicts with the interests of our company or gives the appearance of a conflict. Directors and officers have an obligation under our code of business conduct and ethics to advance our company’s interests when the opportunity to do so arises.
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Item 11.
Item 11. Executive Compensation.
The following table sets forth information with respect to the amounts awarded to, earned by, or paid to, Hanying Li, our principal executive officer, during the year ended December 31, 2011 and 2010 for services provided in all capacities to us and our subsidiaries. No executive officer (or former executive officer) received more than $100,000 in compensation for the fiscal year ended December 31, 2011 and 2010.
Summary Compensation Table
Employment Agreements
Hanying Li
We entered into an employment agreement with our president and chief executive officer, Ms. Hanying Li effective December 1, 2009 which is scheduled to expire on November 30, 2012. Ms. Li’s employment agreement is subject to automatic renewal through November 30, 2014 unless terminated prior to renewal. Under the terms of her employment agreement, Ms. Li is entitled to:
•
Base compensation of $50,000, payable in 12 equal monthly installments of $4,167.
•
Year-end bonus of $96,000, payable in the event our annual audited profits increase by at least 150% of the previous year’s audited profits.
•
Reimbursement of reasonable expenses incurred by Ms. Li.
Bihong Zhang
We entered into an employment agreement with our chief financial officer, Mr. Bihong Zhang effective December 1, 2009 which is scheduled to expire on November 30, 2012. Mr. Zhang’s employment agreement is subject to automatic renewal through November 30, 2014 unless terminated prior to renewal.
Under the terms of his employment agreement, Mr. Zhang is entitled to:
•
Base compensation of $40,800, payable in 12 equal monthly installments of $3,400.
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•
Year-end bonus of $47,000, payable in the event our annual audited profits increase by at least 150% of the previous year’s audited profits.
•
Reimbursement of reasonable expenses incurred by Mr. Zhang.
Each of Ms. Li and Mr. Zhang has agreed during that the term of his or her employment agreement and for 36 months afterwards to:
•
keep confidential and not disclose the our confidential information;
•
take and implement all appropriate measures to protect the confidentiality of our confidential information;
•
not disclose, transmit, exploit or otherwise use for her or his own account or for others, elements of our confidential information;
Each of Ms. Li and Mr. Zhang has also agreed not to compete with our company directly or indirectly while employed by us and for a period of 24 months afterwards.
The employment agreement of Ms. Li or Mr. Zhang may be terminated at any time by either party upon presentation of 60 days’ prior notice.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The following table sets forth, as of March 13, 2012, the number of our common shares beneficially owned by (i) each person or entity known to us to be the beneficial owner of more than 5% of the outstanding common shares, (ii) each of our directors and each of our executive officers named in the Summary Compensation Table in Item 11, and (iii) all of our officers and directors as a group. Information relating to the beneficial ownership of our common shares by principal stockholders and management is based upon information furnished by each person using "beneficial ownership" concepts under the rules of the Securities and Exchange Commission. Under these rules, a person is deemed to be a beneficial owner of a security if that person has or shares voting power, which includes the power to sell or direct the sale of the security, or investment power, which includes the power to vote or direct the voting of the security. The person is also deemed to be a beneficial owner of any security of which that person has a right to acquire beneficial ownership within 60 days. Under the Securities and Exchange Commission’s rules, more than one person may be deemed to be a beneficial owner of the same securities, and a person may be deemed to be a beneficial owner of securities as to which he or she may not have any pecuniary beneficial interest. Each beneficial owner's percentage ownership is determined by assuming that options or warrants that are held by such person (but not those held by any other person) and which are exercisable within 60 days after March 13, 2012 have been exercised. Except as noted below, or as required by applicable community property laws, each person has sole voting and investment power for all common shares shown as beneficially owned by them. As of March 13, 2012, we had outstanding 10,135,000 common shares. Unless otherwise indicated in the footnotes, the address for each officer and director listed below is in the care of Tianli Agritech, Inc., Suite F, 23rd Floor, Building B, Jiangjing Mansion, 228 Yanjiang Ave., Jiangan District, Wuhan City, Hubei Province, China 430010.
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_______________
*
Less than 1%.
(1)
Includes 450,000 shares owned by Ms. Li’s spouse, Hua Zhang.
(2)
Represents shares which Mr. Gadkowski may acquire upon exercise of options.
(3)
Includes 2,600,000 shares owned by Mr. Zhang’s spouse, Hanying Li.
Item 13.
Item 13. Certain Relationships and Related Transactions
Payables to Related Party
At December 31, 2011, Fengze had aggregate payables to Ms. Li of approximately $120,326. Such amount was due to Ms. Li for advances to Fengze for its business expenses related to the operations of our hog farms. These amounts were due upon demand and without interest and will be repaid in 2012.
Contractual Arrangements with Domestic Companies and their Shareholders
We operate our business in China through a series of contractual arrangements with Fengze and its shareholders, who are related parties. For a description of these contractual arrangements, see “Item 1 - Business- Our Corporate.
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Related Party Transactions
We recognize that transactions between us and any of our directors or executives with a related party can present potential or actual conflicts of interest and create the appearance that our decisions are based on considerations other than the best interests of our Company and stockholders. Therefore in accordance with our Code of Ethics, it is our preference to avoid such transactions. All potential related party transactions involving the Company and/or its employees are to be presented in advance to the Company's Audit Committee to be reviewed for a potential conflict of interest. Such transactions must be approved by the Audit Committee before they can commence.
Director Independence
The Board of Directors maintains a majority of directors who are deemed to be independent under the definition of independence provided by NASDAQ Listing Rule 5605(a)(15). Peter E. Gadkowski, Jishan Hu, Benyan Li, Youhang Peng and Dr. Huanchun Chen are our independent directors.
Item 14.
Item 14. Principal Accounting Fees and Services
The following is a summary of the fees billed to us by Sherb & Co., LLP and Crowe Horwath International for professional services rendered for the fiscal years ended December 31, 2011 and 2010:
Audit Fees. Consists of fees billed for professional services rendered for the audit of our consolidated financial statements and review of interim consolidated financial statements included in quarterly reports and services that are normally provided in connection with statutory and regulatory filings or engagements.
Audit Related Fees. Consists of fees billed for assurance and related services that are reasonably related to the performance of the audit or review of our consolidated financial statements and are not reported under "Audit Fees".
Tax Fees. Consists of fees billed for professional services for tax compliance, tax advice and tax planning. These services include preparation of federal and state income tax returns.
All Other Fees. Consists of fees for product and services other than the services reported above.
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Board of Directors' Pre-Approval Policies
Our Board of Directors' policy is to pre-approve all audit and permissible non-audit services provided by the independent auditors. These services may include audit services, audit related services, tax services, and other services. Pre-approval is generally provided for up to one year, and any pre-approval is detailed as to the particular service or category of services and is generally subject to a specific budget. The independent auditors and management are required to periodically report to the Board of Directors regarding the extent of services provided by the independent auditors in accordance with this pre-approval and the fees for the services performed to date. The Board of Directors may also pre-approve particular services on a case-by-case basis.
Our Board of Directors has reviewed and discussed with Sherb & Co., LLP., our audited financial statements contained in this Annual Report on Form 10-K for the 2011 fiscal year. The Board of Directors also has discussed with Sherb & Co., LLP , the matters required to be discussed pursuant to SAS No. 61 (Codification of Statements on Auditing Standards, AU Section 380), which includes, among other items, matters related to the conduct of the audit of our financial statements.
Our Board of Directors has received and reviewed the written disclosures and the letter from Sherb & Co., LLP. required by Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees), and has discussed with Sherb & Co., LLP its independence from our company.
Our Board of Directors has considered whether the provision of services other than audit services is compatible with maintaining auditor independence. Based on the review and discussions referred to above, the Board of Directors determined that the audited financial statements be included in our Annual Report on Form 10-K for our 2011 fiscal year for filing with the SEC.
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PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules.
Exhibits.
No.
Description
1.1
Form of Placement Agreement dated June 30, 2010 with Anderson & Strudwick, Incorporated (1)
3(i).1
Amended and Restated Articles of Association of the Registrant (1)
3(ii).1
Amended and Restated Memorandum of Association of the Registrant (1)
4.1
Specimen Share Certificate (2)
4.2
Form of Placement Agent Warrant (included in Exhibit. 10.1) (1)
10.1
Form of Placement Agent Warrant Agreement (1)
10.2
Translation of Entrusted Management Agreement for Fengze (1)
10.3
Translation of Shareholder Voting Proxy Agreement for Fengze (1)
10.4
Translation of Pledge of Equity Interest Agreement for Fengze (1)
10.5
Translation of Exclusive Option Agreement for Fengze (1)
10.6
Form of Share Incentive Plan (1)
10.7
Form of Lock-Up Agreement (1)
10.8
Translation of Employment Agreement between Registrant and Ms. Hanying Li, Chief Executive Officer of the Registrant (1)
10.9
Translation of Employment Agreement between Registrant and Mr. Bihong Zhang, Chief Financial Officer of the Registrant (1)
10.10
Form of Make-Good Escrow Agreement (1)
10.11
Translation of Land Lease Contract - Zhulin (1)
10.12
Translation of Land Lease Contract - Fengze (1)
10.13
Translation of Land Lease Contract - Jinmu (1)
10.14
Translation of Side Agreement Related to Land Lease Contract - Jinmu (1)
10.15
Translation of Land Lease Contract - Tianjian (1)
10.16
Translation of Side Agreement Related to Land Lease Contract - Tianjin (1)
10.17
Translation of Land Lease Contract - Nanyan (1)
10.18
Translation of Side Agreement Related to Land Lease Contract - Nanyan (1)
10.19
Translation of Land Lease Contract - Mingxiang (1)
10.20
Translation of Side Agreement Related to Land Lease Contract - Mingxiang (1)
10.21
Translation of Land Lease Contract - Huajian A & B (1)
10.22
Translation of Side Agreement Related to Land Lease Contract - Huajian A & B (1)
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10.23
Translation of Feed Sale Agreements (1)
10.24
Translation of Land Use Rights Transfer Agreement - Qingsonggang (1)
10.25
Summary of Terms of Demand Note with Hanying Li (3)
14.1
Code of Business Conduct and Ethics (1)
16.1
Letter of Sherb & Co., LLP to the Commission (4)
16.2
Letter of Crowe Horwath (HK) CPA Limited to the Commission (5)
21.1
Subsidiaries and Affiliate of the Registrant (1)
31.1
Certification of Principal Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) under the Exchange Act
31.2
Certification of Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) under the Exchange Act
32.1
Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
___________
(1)
Incorporated by reference to the Company’s registration statement on Form S-1 (Registration No. 333- 165522) filed on March 17, 2010 (the “Registration Statement’), and declared effective as amended, on June 30, 2010.
(2)
Incorporated by reference to Amendment No. 4 to the Registration Statement filed on June 30, 2010.
(3)
Incorporated by reference to Amendment No. 2 to the Registration Statement filed on June 1, 2010.
(4)
Incorporated by reference to exhibit 16.1 to the Company’s Current report on Form 8-K filed on June 8, 2011.
(5)
Incorporated by reference to exhibit 16.1 to the Company’s Current report on Form 8-K filed on December 30, 2011.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Principal Executive Officer)
By:
/s/ Bihong Zhang
Bihong Zhang
Chief Financial Officer
(Principal Financial and Accounting Officer)
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 13, 2012.
Signature
Title
/s/ Hanying Li
Chief Executive Officer (Principal Executive
Hanying Li
Officer) and Chair of the Board
/s/ Bihong Zhang
Chief Financial Officer (Principal Financial and Accounting
Bihong Zhang
Officer) and a Director
/s/ Jishan Hu
Director
Jishan Hu
/s/ Benyan Li
Director
Benyan Li
/s/ Youhang Peng
Director
Youhang Peng
Director
Peter E. Gadkowski
/s/ Dr. Huanchun Chen
Director
Dr. Huanchun Chen
/s/ Jianguo Hu
Director
Jianguo Hu
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Tianli Agritech, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Tianli Agritech, Inc. and Subsidiaries (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of operations and comprehensive income, stockholders’ equity and cash flows for the years then ended. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, 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. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2011 and 2010, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
/s/Sherb & Co., LLP
Sherb & Co., LLP
March 9, 2012
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TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 1-ORGANIZATION AND DESCRIPTION OF BUSINESS
The consolidated financial statements include the financial statements of Tianli Agritech, Inc. (referred to herein as “Tianli”); its wholly-owned subsidiary, HC Shengyuan Limited, a Hong Kong limited liability company (“HCS”); HCS’s wholly-owned subsidiary, Wuhan Fengxing Agricultural Science and Technology Development Co., Ltd., a Chinese limited liability company and a wholly foreign owned entity (“WFOE”); WFOE’s variable interest entity, Wuhan Fengze Agricultural Science and Technology Development Co., Ltd., a Chinese limited liability company (“Fengze” or the “VIE”), where WFOE is deemed the primary beneficiary; Fengze’s wholly-owned subsidiary, Hubei Tianzhili Breeder Hog Co., Ltd., a Chinese limited liability company (“Tianzhili”). All of the Tianli’s operations are conducted by Fengze and Tianzhili whose results of operations are consolidated into those of Tianli. HCS and WFOE are sometimes referred to as the “subsidiaries”. Tianli, its consolidated subsidiaries and Fengze and Tianzhili are collectively referred to herein as the “Company”, “we” and “us”, unless specific reference is made to an entity.
Tianli was incorporated in the British Virgin Islands on November 9, 2009 as a limited liability company. The Company is engaged in the business of breeding, raising, and selling hogs for use in China’s pork meat production and hog breeding by other hog producers. The Company also sells pork products through its retail operation. The Company operates eleven production farms in areas around Wuhan City, within Hubei Province, People’s Republic of China (“PRC”). Its wholly owned subsidiary, HCS, was incorporated in Hong Kong on November 24, 2009 as a limited liability company. Other than its equity interest in HCS, Tianli does not own any assets or conduct any operations.
WFOE was incorporated in Wuhan City on June 2, 2005. On November 26, 2009, HCS entered into a stock purchase agreement with WFOE where HCS would acquire a 100% equity interest of WFOE. On January 19, 2010, the Wuhan Municipal Commission of Commerce approved the ownership change. On January 27, 2010, the ownership change was declared effective by Wuhan Administrator for Industry & Commerce. HCS acquired WFOE and became the holder of 100% of the equity interest of WFOE, and WFOE effectively became the wholly-owned subsidiary of the Company. Other than the equity interest in WFOE, HCS does not own any assets or conduct any operations.
WFOE conducts its business through Fengze, which is consolidated as a variable interest entity, as discussed below.
Chinese laws and regulations currently do not prohibit or restrict foreign ownership in hog breeding businesses. However, Chinese laws and regulations do prevent direct foreign investment in certain industries. On December 1, 2009, to protect the Company’s stockholders from possible future foreign ownership restrictions, Fengze and all of the stockholders of Fengze (“Principal Stockholders”) entered into an Entrusted Management Agreement (the “EMA”) with WFOE, which provides that WFOE will be fully and exclusively responsible for the management of Fengze. WFOE is also entitled to receive the residual return of Fengze. As a result of the agreement, WFOE will absorb 100% of the expected losses and gains of Fengze, which results in WFOE being the primary beneficiary of Fengze.
WFOE also entered into a Pledge of Equity Agreement (the “PEA”) with the Principal Stockholders, who pledged all their equity interest in these entities to WFOE. The PEA, which was entered into by each Principal Shareholder, pledged each of the Principal Stockholders’ equity interest in WFOE as a guarantee for the entrustment payment under the EMA.
In addition, WFOE entered into an Option Agreement (the “OA”) to acquire the Principal Stockholders’ equity interest in these entities if or when permitted by the PRC laws.
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TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 1-ORGANIZATION AND DESCRIPTION OF BUSINESS - CONTINUED
Collectively, the EMA, PEA and OA are referred to as the Exclusive Agreements, based upon which the Company consolidates the variable interest entity, Fengze, as required by generally accepted accounting principles in the United States (“US GAAP”), because the Company is the primary beneficiary of the VIE. The profits and losses of Fengze are allocated to WFOE and thus to the Company based upon the EMA.
As discussed in Note 19, the Company completed its Initial Public Offering (“IPO”) on July 19, 2010, whereby it issued 2,000,000 shares of its common stock at a price of $6.00 per share.
On May 12, 2011, the Company acquired its eleventh farm from An Puluo Development Co. (“An Puluo”), which is located in Enshi Tujia and Miao Autonomous Prefecture of Hubei Province, for a purchase price of $2.2 million.
On June 22, 2011, Fengze established a wholly owned subsidiary, Hubei Tianzhili Breeder Hog Co., Ltd. (“Tianzhili”), in Enshi City, Hubei Province as a limited liability company. Tianzhili engages in the business of raising and selling black hogs through several major Chinese retail channels in cooperation with An Puluo that commenced in the third quarter of 2011.
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TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements have been prepared in conformity with US GAAP. The basis of accounting differs from that used in the statutory accounts of the Company, which are prepared in accordance with the accounting principles of the PRC (“PRC GAAP”). The Company’s functional currency is the Chinese Renminbi (“RMB”); however the accompanying consolidated financial statements have been translated and presented in United States Dollars (“USD”). All significant intercompany transactions and balances have been eliminated.
Use of Estimates
The preparation of these financial statements in conformity with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and the related disclosure of contingent assets and liabilities at the date of these financial statements and the reported amounts of revenues and expenses during the reporting period. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Accordingly, actual results may differ from these estimates. Significant estimates include the useful lives of property and equipment, land use rights and biological assets, and assumptions used in assessing impairment for long-term assets.
Principles of Consolidation
Pursuant to US GAAP, Fengze is the VIE of the Company and the Company is the primary beneficiary of the VIE. Accordingly, the VIE has been consolidated in the Company’s financial statements.
Based on various VIE agreements, the Company is able to exercise control over the VIE, and obtain the financial interests such as the periodic income of the VIE through the EMA, PEA, and OA and to acquire the net assets of VIE through purchase of their equities at essentially no cost. The Company therefore concluded that its interest in the VIE is not a non-controlling interest and therefore is not classified as such. Based on the Exclusive Agreements the amount of controlling interest of the Fengze shareholders, who are holding shares of the VIE for the Company, is zero. They exercise no controls over the VIE and no financial interests of ownership are due to them either for periodic income or the net assets.
Cash and Cash Equivalents
Cash and cash equivalents consist of all cash balances and highly liquid investments with an original maturity of three months or less. Because of the short maturity of these investments, the carrying amounts approximate their fair value. Restricted cash is excluded from cash and cash equivalents.
Accounts Receivable
Accounts receivable is stated at cost, net of an allowance for doubtful accounts. The Company maintains allowances for doubtful accounts for estimated losses resulting from the failure of customers to make required payments. The Company reviews the accounts receivable on a periodic basis and makes allowances where 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, the customer’s payment history, its current credit-worthiness and current economic trends. Management believes that the accounts receivable is fully collectable.
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TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Therefore, no allowance for doubtful accounts is deemed to be required at December 31, 2011 and 2010.
Inventories
Inventories are stated at the lower of cost, as determined by the weighted-average method, or market. Management compares the cost of inventories with the market value, and allowance is made for writing down the inventories to their market value if that is lower. Costs of raised animals include proportionate costs of breeding, including amortization of the breeding herd or biological assets, plus the costs of feed and other maintenance costs through the balance sheet date. Management inspects and monitors inventory on a continual basis.
Prepaid Expenses
Prepaid expenses at December 31, 2011 and 2010 totaled $174,893 and $83,832, respectively, and includes prepayments to suppliers for merchandise that had not yet been shipped to us, as well as services that had not yet been provided to us. We recognize prepayments as inventory or expense as suppliers make delivery of goods or provide services, in compliance with our accounting policy.
Plant and Equipment
The Company states plant and equipment at cost less accumulated depreciation. Expenditures for maintenance and repairs are charged to operations as incurred; additions, renewals and betterments are capitalized. When plant and equipment assets are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any resulting gain or loss is recorded as an operating expense. In accordance with US GAAP, the Company examines the possibility of decreases in the value of plant and equipment when events or changes in circumstances reflect the fact that their recorded value may not be recoverable. The Company computes depreciation using the straight-line method over the estimated useful lives of the assets with a residual value of 5% of plant and equipment.
Estimated useful lives of the Company’s assets are as follows:
Construction in Progress
Construction in progress consists of amounts expended for building construction of new breeding and animal rearing facilities. Once the building construction is completed and the facilities are approved for adequate breeding and animal rearing activity, the construction in progress assets are categorized as buildings and production equipment and are then accounted for in plant and equipment. Assets accounted for as plant and equipment are used in the Company’s production process, whereupon they are depreciated over their estimated useful lives.
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TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Biological Assets
Biological assets consist primarily of hogs purchased or selected from the Company’s own production for breeding and farrowing, which management believes will produce piglets that grow faster and have better quality breeding capabilities and carcasses with a high percentage of meat and a small quantity of fat. The costs to purchase and cultivate these breeding hogs and the expenditures related to labor and materials to feed the breeding hogs until they become commercially productive and breedable are capitalized. When these breeding hogs are entered into breeding and farrowing production, amortization of the costs of these breeding hogs commences. The estimated production life for breeding hogs is three years, and the costs are amortized to a residual value of $76 (RMB 500). After the breeding hogs have completed their production life of breeding, these breeding hogs are then transferred into inventory as the vast majority of these breeding hogs will then be sold for meat processing. Expenses incurred maintaining breeding hogs during gestation until piglets are weaned are capitalized into inventory and included in Work in process-biological assets, a component of inventories. If these breeding hogs produce piglets which are deemed appropriate for internal breeding purposes, the gestation and raising costs until weaned for these piglets are then allocated into biological assets.
Amortized expenses pertaining to biological assets are included in inventory costs for those piglets to be sold and ultimately become a component of cost of goods sold.
Land Use Rights
According to the laws of the 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. Land use rights are being amortized using the straight-line method over their lease terms.
The Company carries land use rights at cost less accumulated amortization. In accordance with US GAAP, the Company examines the possibility of decreases in the value of land use rights when events or changes in circumstances reflect the fact that their recorded value may not be recoverable. The Company computes amortization using the straight-line method over the 50 year life of the land use rights.
Impairment of Long-lived Assets
In accordance with US GAAP, the Company periodically reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. 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 did not consider it necessary to record any impairment charges during the years ended December 31, 2011 and 2010.
Index
TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Fair Value of Financial Instruments
Effective January 1, 2008, the Company adopted ASC 820, Fair Value Measurements and Disclosure (“ASC 820”) for assets and liabilities measured at fair value on a recurring basis. ASC 820 establishes a common definition for fair value to be applied to existing generally accepted accounting principles that require the use of fair value measurements, establishes a framework for measuring fair value and expands disclosure about such fair value measurements. The adoption of ASC 820 did not have an impact on the Company’s financial position or operating results, but did expand certain disclosures.
ASC 820 defines fair value as the price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Additionally, ASC 820 requires the use of valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. These inputs are prioritized below:
Level 1: Observable inputs such as quoted market prices in active markets for identical assets or liabilities
Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data
Level 3: Unobservable inputs for which there is little or no market data, which require the use of the reporting entity’s own assumptions.
The Company did not identify any assets and liabilities that are required to be presented on the condensed consolidated balance sheets at fair value in accordance with the relevant accounting standards.
The carrying values of cash and cash equivalents, trade receivables and payables, and short-term bank loans and debts approximate their fair values due to the short maturities of these instruments.
Revenue Recognition
The Company generates revenues from the business of breeding, raising, and selling hogs for use in Chinese pork meat production and the sale of hogs for breeding by other hog producers. Starting from the quarter ended September 30, 2011, the Company also generates revenue from selling processed pork products to retailers.
Revenues generated from the sales of breeding and meat hogs and processed pork are recognized when these products are delivered to customers in accordance with previously agreed upon pricing and delivery arrangements, and the collectability of these sales is reasonably assured. Cash payment, which sometimes is in the form of wired cash transfers to the Company’s bank account, is usually received by the Company at the time the hogs are sold. Sold hogs and processed pork are not returnable and accordingly, no provision has been made for returnable goods. The customers are responsible for the shipping of the hogs that they have purchased.
Index
TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Collaborative Arrangements
The Company evaluates whether an arrangement is a collaborative arrangement under FASB ASC Topic 808, Collaborative Arrangements, at its inception based on the facts and circumstances specific to the arrangement. The Company also reevaluates whether an arrangement qualifies or continues to qualify as a collaborative arrangement whenever there is a change in either the roles of the participants or the participants’ exposure to significant risks and rewards dependent on the ultimate commercial success of the endeavor. For those collaborative arrangements where it is determined that the Company is the principal participant, costs incurred and revenue generated from third parties are recorded on a gross basis in the financial statements.
The Company’s collaboration agreements with third parties are performed on a ‘‘best efforts’’ basis with no guarantee of either technological or commercial success.
Payments to and from the Company’s collaboration partners are presented in the statements of income based on the nature of the arrangement (including its contractual terms), the nature of the payments and applicable accounting guidance. Under the collaborative agreements with An Puluo, the Company is the principal in the transaction and the Company records revenues when An Puluo sells the product and title passes to its customer. The Company and An Puluo share the profit from this collaborative business and all profit sharing to An Puluo are recorded as part of Cost of sales in the Company’s consolidated statements of income.
In accordance with the Company’s collaborative agreement with An Puluo, the Company was able to establish retail operations within existing retail facilities with whom An Puluo had ongoing business arrangements. In these retail facilities, the Company is permitted to retail their pork products. The owners of these retail facilities are responsible for collection of all retail sales made by the Company. These retail facilities are responsible for remitting to the Company the sales that they collect on behalf of the Company, less any fees for operating a retail operation in their facility. As of December 31, 2011 and 2010, the retailers owed the Company $994,329 and $0, respectively, accounted for as accounts receivable of the Company. (see Note 3 and Note 15)
According to the agreement, the Company and An Puluo share the net income of the collaborative retail business on a ratio of 60% to the Company and 40% to An Puluo. Profit sharing to An Puluo during the year of 2011 was $134,071, and was recorded as part of cost of goods sold in the Company’s consolidated statements of income. Profit sharing payable was $136,200 as of December 31, 2011 and was recorded as part of due to An Puluo.
Index
TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Income Taxes
The Company accounts 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 its financial statements or tax returns. The Company did not have any deferred tax assets or liabilities as of December 31, 2011 and 2010.
The Company is subject to the Enterprise Income Tax law (“EIT”) of the People’s Republic of China. However, according to the EIT, companies that are engaged in the agricultural business and primary processing of agricultural products are exempt from the 25% enterprise income tax. The Company is engaged in breeding, raising, and selling hogs for use in Chinese pork meat production and hog breeding, which is exempt from the Chinese income tax. Tianli is incorporated in the British Virgin Islands. Under the current tax laws of the British Virgin Islands, the Company is not subject to income taxes. In addition, the Company is not subject to the PRC’s 17% VAT tax for hog sales or the 5% business tax levied on incomes from services rendered. According to the PRC tax regulations, companies engaging in the agricultural business are exempt from these taxes. With respect to the Company’s agreement with An Puluo, the Company has commenced engagement in retail sales activities to which they are not exempt from VAT taxes. With respect to this operation, the Company is required to collect VAT taxes of 13% from their customers. As of December 31, 2011, the Company has no VAT payable with respect to their retail operations.
Index
TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Basic and Diluted Earnings per Share
The Company reports earnings per share in accordance with FASB ASC 260 “Earnings per share”. The Company’s basic earnings per share are computed using the weighted average number of shares outstanding for the periods presented. Diluted earnings per share are computed based on the assumption that any dilutive options or warrants were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, the Company’s outstanding stock warrants are assumed to be exercised, and funds thus obtained were assumed to be used to purchase common stock at the average market price during the period. There were no dilutive instruments outstanding during the years ended December 31, 2011 and 2010.
Foreign Currency Translation
As of December 31, 2011, the accounts of Tianli were maintained and its financial statements were expressed in Chinese Renminbi (RMB). Such financial statements were translated into United States Dollars (USD) in accordance with US GAAP, with the RMB as the functional currency. All assets and liabilities are translated at the current exchange rates as of the balance sheet dates. These rates were RMB 6.35 per US dollar and RMB 6.60 per US dollar as of December 31, 2011 and 2010, respectively. Stockholders’ equity is translated at the historical rates and items in the statements of operations and cash flows are translated at the average exchange rate for the period. The resulting translation adjustments are reported under other comprehensive income in accordance with US GAAP as a component of stockholders’ equity.
During the years ended December 31, 2011 and 2010, the transactions of Tianli were denominated and recorded in RMB and are translated at the average rates of exchange for the period. There rates were RMB 6.46 and RMB 6.76 per US dollar for the years ended December 31, 2011 and 2010, respectively. Exchange gains and losses are recognized for the different foreign exchange rates applied when the foreign currency assets and liabilities are settled. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.
Stock Based Compensation
In December 2004, the Financial Accounting Standards Board, or FASB, issued FASB ASC 718-10-55 - Compensation-Stock Compensation, or ASC 718-10-55. Under ASC 718-10-55, companies are required to measure the compensation costs of share-based compensation arrangements based on the grant-date fair value and recognize the costs in the financial statements over the period during which employees are required to provide services. Share-based compensation arrangements include stock options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans. In addition, FASB ASC 825-10-50-10 - Financial Instruments - Overall - Disclosures, or ASC 825-10-50-10, expresses views of the Securities and Exchange Commission, or the SEC, staff regarding the interaction between ASC 718-10-55 and certain SEC rules and regulations and provides the staff's views regarding the valuation of share-based payment arrangements for public companies. The Company’s compensation cost is measured on the date of grant at its fair value. Such compensation amounts, if any, are amortized over the respective vesting periods or period of service of the option grant.
Index
TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Contingencies
Certain conditions may exist as of the date the financial statements are issued, which may result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur. The Company’s management and legal counsel assess such contingent liabilities, and such assessments inherently involve an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company’s legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought.
If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in the Company’s financial statements. If the assessment indicates that a potential material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material would be disclosed.
Loss contingencies considered to be remote by management are generally not disclosed unless they involve guarantees, in which case the guarantee would be disclosed.
Accrual of Environmental Obligations
ASC Section 410-30-25 “Recognition” of environmental obligations requires the accrual of a liability if both of the following conditions are met:
a) Information available before the financial statements are issued or are available to be issued indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements.
b) The amount of the loss can be reasonably estimated.
As of December 31, 2011, the Company did not have any environmental remediation obligations, nor did it have any asset retirement obligations under ASC 410. Furthermore, the Company did not have any environmental remediation loss contingencies requiring recognition or disclosure in its financial statements.
Recently Issued Accounting Pronouncements
In January 2011, the FASB issued ASU No. 2011-01- Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. The amendments in this update temporarily delay the effective date of the disclosures about troubled debt restructurings in ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, for public entities. The delay is intended to allow the FASB time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring will then be coordinated. This deferral is expected not to have a material impact on the Company’s consolidated financial statements.
Index
TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 2-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Recently Issued Accounting Pronouncements
In January 2011, the FASB issued ASU No. 2011-02- Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The amendments in this update provide additional guidance to assist creditors in determining whether a restructuring of a receivable meets the criteria to be considered a troubled debt restructuring. For public companies, the new guidance is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption within those annual periods. Early application is permitted. The adoption of the provisions in ASU 2011-02 did not have a material impact on the Company’s consolidated financial statements.
In May 2011, the FASB issued ASU No. 2011-04 - Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S.GAAP and IFRSs. The amendments in this update intend to converge requirements for how to measure fair value and for disclosing information about fair value measurements in US GAAP with International Financial Reporting Standards. For public entities, this ASU is effective for interim and annual periods beginning after December 15, 2011. The adoption of the provisions in ASU 2011-04 is expected not to have a material impact on the Company’s condensed consolidated financial statements.
In June 2011, the FASB issued ASU No. 2011-05 - Comprehensive Income (Topic 220): Presentation of Comprehensive Income. The amendments in this update require (i) that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements (the current option to present components of other comprehensive income (“OCI”) as part of the statement of changes in stockholders’ equity is eliminated); and (ii) presentation of reclassification adjustments from OCI to net income on the face of the financial statements. For public entities, the amendments in this ASU are effective for years, and interim periods within those years, beginning after December 15, 2011. The amendments in this update should be applied retrospectively. Early adoption is permitted. The adoption of the provisions in ASU 2011-05 will have no material impact on the Company’s condensed consolidated financial statements.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company’s consolidated financial statements upon adoption.
Index
TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 3-ACCOUNTS RECEIVABLE
Accounts receivable consisted of the following:
Accounts receivable as of December 31, 2011 arose from sales of processed pork products in retail sales establishments in accordance with the Company’s collaborative agreement with An Puluo. (see Note 2 and Note 15).
NOTE 4-INVENTORIES
Inventories consisted of the following:
Management compares the cost of inventories with the market value, and allowance is made for writing down the inventories to their market value, if lower. As of December 31, 2011 and 2010, the Company determined that no such write downs were necessary. The term “Work in process-biological assets” has the meaning set forth above in Note 2-Biological Assets.
Finished goods included in the Company’s inventories were the processed pork products available to sell through the Company’s retail operation (see Note 15).
Index
TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 5-ADVANCES TO SUPPLIERS
The Company makes advances for materials or services the Company uses in its operations. As of December 31, 2011 and 2010, advances to suppliers amounted to $7,868 and $1,036,765, respectively.
The balance as of December 31, 2010 included deposits of $404,811 and $545,455 for the purchase of imported breeding hogs and water waste treatment equipment, respectively. The remaining balance consisted largely of advances for feed and medical supplies.
NOTE 6-ACQUISITION DEPOSITS
On December 27, 2010, the Company entered into an agreement with An Puluo Food Corporation, Ltd. (“An Puluo”) regarding a hog farm in Hubei Province. Under the terms of this agreement, the Company made a deposit totaling $530,303 (RMB 3,500,000) to An Puluo as of December 31, 2010. The sale was completed on May 12, 2011 (see note 8).
NOTE 7-LOAN TO AN PULUO
As of December 31, 2011 and 2010, the Company had a loan to An Puluo of $1,101,582 and $0, respectively. The loan receivable was non-interest bearing, unsecured and due on demand. Management expects that the loan will be collected within 12 months.
NOTE 8-PLANT AND EQUIPMENT
Plant and equipment consist of the following:
On May 12, 2011, the Company acquired its eleventh farm from Au Puluo, which is located in Enshi Tujia and Miao Autonomous Prefecture of Hubei Province, for a purchase price of approximately $2.2 million. The consideration was allocated to long-term rental prepayments for parcels of land of $1,765,130 (RMB 11,216,518, also see Note 11) and plant and equipment of $469,507.
Depreciation expense was $1,142,964 and $713,699 for the years ended December 31, 2011 and 2010, respectively. $1,080,536 and $603,760 of depreciation expense was capitalized into inventories during the years ended December 31, 2011 and 2010.
Index
TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 9-CONSTRUCTION IN PROGRESS
Construction in progress consists of amounts expended for the construction of new breeding and animal rearing facilities. Once construction is completed and the facilities are approved to be used for breeding and animal rearing activity, the construction in progress assets are placed into production and transferred into plant and equipment, whereupon they are depreciated over their estimated useful lives. As of December 31, 2011 and 2010, the construction in progress was $3,202,483 and $272,727, respectively. Included in this amount were:
-
$750,992 for building up a new feed processing facility, a new refrigerator and the improvements of several of the Company’s hog farms; and
-
$2,451,491 funding to local independent farmers to construct small-scale hog farms. During the year ended December 31, 2011, the Company signed 7 joint development agreements, for periods of approximately 10 years, with 7 local cooperatives in the Enshi Autonomous Prefecture in Hubei Province whereby the Company, the relevant governmental agencies and the cooperatives will assist participating farmers to breed and raise Enshi black hogs which will be purchased by the Company for resale as meat hogs or retained or sold as breeders at the Company’s discretion. Under these agreements, the Company provides funds to local independent farmers to construct small-scale hog rearing facilities, within the cooperatives, which are sufficient for the Company’s requirements to grow black hogs for sale to the Company. Pursuant to these joint development agreements, title to the physical plants and equipment included in these small-scale hog rearing facilities belongs to the Company whereby the local cooperatives (and the individual farmers) have the right to use them. As of December 31, 2011, the Company has expended a total of $4.27 million to build these hog rearing facilities. With respect to three of the cooperatives, the Company has purchased $1.82 million of hog rearing facilities and equipment that has been completed and is operational and included in plant and equipment as of December 31, 2011. With regard to four of the cooperatives, the Company has purchased $2.45 million of hog rearing facilities and equipment that has not been completed and is not operational and is included in construction in progress as of December 31, 2011.
According to the joint development agreements, each participating farmer paid a deposit of approximately one-third of the construction cost of the hog farm to the Company upon completion of the respective hog farm. The deposit is amortized against the depreciation expense over a period of 10 years. Should the farmer withdraw from the program within this period, the deposit will be refunded proportionately. As of December 31, 2011 and 2010, deposits from farmers (see Note 17) were $600,156 and $0, respectively.
Index
TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 10-BIOLOGICAL ASSETS
Biological assets consist of the following:
Amortization of the biological assets, included as a component of inventory, for the years ended December 31, 2011 and 2010 was $1,060,754 and $395,500, respectively. $1,006,456 and $394,228 of amortization of the biological assets was capitalized into inventories during the years ended December 31, 2011 and 2010.
NOTE 11-LONG-TERM PREPAID EXPENSES
Long-term prepaid expenses primarily consist of prepaid rental expenses for three parcels of land comprising the Company’s eleventh farm (see Notes 6 and 8). The prepaid rental expenses are being amortized using the straight-line method over the lease term of 21.33 years.
Long-term prepaid expenses at December 31, 2011 and 2010 are as follows:
Amortization expense for the years ended December 31, 2011 and 2010 was $90,971 and $0, respectively.
The estimated amortization expense of long-term prepaid expenses over each of the next five years and thereafter will be $93,769 per annum.
Index
TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 12-INTANGIBLE ASSETS
According to the laws of PRC, the government owns all the land in PRC. Companies or individuals are authorized to possess and use the land only through land use rights granted by the Chinese government. Land use rights are being amortized using the straight-line method over the lease term of 50 years.
Land use rights at December 31, 2011 and 2010 are as follows:
Amortization expense for the years ended December 31, 2011 and 2010 was $44,875 and $15,675, respectively.
The estimated amortization expense of land use rights over each of the next five years and thereafter will be $44,875 per annum.
NOTE 13-SHORT-TERM LOANS
As of December 31, 2011 and 2010, the short-term loans are as follows:
The Company paid $68,333 and $86,749 to guarantee service providers for providing the guarantee of the loans from Shanghai Pudong Development Bank and Communication Bank of China. Amount of $155,082 and nil was recorded as other expense for the years ended December 31, 2011 and 2010, respectively.
Index
TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 14-ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
As of December 31, 2011 and 2010, accounts payable and accrued liabilities are as follows:
NOTE 15-DUE TO AN PULUO
As of December 31, 2011 and 2010, amounts due to An Puluo are as follows:
On August 1 and August 30, 2011, the Company entered into a collaborative agreement and a supplemental agreement (the “Agreements”) with an unrelated processed pork producer, An Puluo, to pursue retail business opportunities, under an exclusive right, of An Puluo processed pork products. This cooperation will allow the Company to begin to brand their name, “Tianli An Puluo”, with upscale consumers in greater Wuhan City.
At the inception of the collaborative retail business, the Company evaluated the facts and circumstances specific to the arrangement and has determined that it is the principal participant, and accordingly costs incurred and revenue generated from third parties are recorded on a gross basis in the financial statements.
(a)
According to the Agreements, the Company purchases processed pork products from An Puluo for retail sales in Wuhan City. During the year ended December 31, 2011, purchases of processed pork products from An Puluo were $2,219,035, and the payable to An Puluo for purchases of processed pork products was $954,363 as of December 31, 2011.
(b)
Also according to the Agreements, the Company and An Puluo share the net income of the cooperative retail business on a ratio of 60% to the Company and 40% to An Puluo. Profit sharing payable to An Puluo was $136,200 as of December 31, 2011.
The amounts disclosed above do not include transactions with third parties other than An Puluo, or other costs associated with the products under the collaborative arrangements.
Index
TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 16-ACQUISITION PAYABLES
Acquisition payables consist of the payables due as the result of the Company’s acquisitions of farm assets such as buildings, equipment, land use rights and prepaid expenses. Such purchases require initial payments to the seller of the assets upon the closing of the purchase, with subsequent payments due in the short term for the remaining balances.
Acquisition payables of $921,212 at December 31, 2010 were in relation to the acquisition of the Company’s tenth hog farm, which has been fully paid during the quarter ended March 31, 2011. Total consideration for the tenth hog farm was $1,471,212.
NOTE 17-OTHER PAYABLES
Other payables in the years ended December 31, 2011 and 2010 were $781,037 and $0, respectively. Included in other payables were deposit payables of $600,158 and payable to an investment relationship consultant of $180,880.
During the year ended December 31, 2011, the Company signed 7 joint development agreements with 7 local cooperatives in the Enshi Autonomous Prefecture in Hubei Province. Under these agreements, the Company provides funding to local independent farmers to construct small-scale hog farms in which the farmers will grow the black hogs for sale to the Company (see Note 9).
According to the joint development agreements, each participating farmer paid a deposit of approximately one-third of the construction cost of the hog farm to the Company upon completion of the respective hog farm. The deposit is amortized against the depreciation expense over a period of 10 years. Should the farmer withdraw from the program within this period, the deposit will be refunded proportionately. As of December 31, 2011 and 2010, deposits from farmers were $600,158 and $0, respectively.
The amortization of deposit payables for the year ended December 31, 2011 was $5,824. The following table sets forth the aggregate future amortization expected for the next five years:
NOTE 18-RELATED PARTY TRANSACTIONS
Parties are considered to be related if one party has the ability, directly or indirectly, to control the other party or exercise significant influence over the other party in making financial and operational decisions. Parties are also considered to be related if they are subject to common control or common significant influence. The amount due to related party was $120,326 and nil as of December 31, 2011 and 2010, respectively. The amount represented the advances from the Company’s shareholder and chief executive officer, Hanying Li, for operating purposes. Such advances are non-interest bearing and due upon demand.
Index
TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 19-CAPITAL STOCK
The Company is authorized to issue 50,000,000 shares of common stock, $0.001 par value, and as of December 31, 2011 and 2010, it had 10,135,000 shares and 10,125,000 shares issued and outstanding, respectively.
On July 19, 2010, the Company closed its initial public offering (“IPO”) of its common stock. The Company sold 2,000,000 common shares at a price of $6.00 per share and the shares commenced trading on the NASDAQ Global Market on July 20, 2010. As part of this initial public offering, the placement agent received 200,000 warrants to purchase the Company’s stock at a price of $7.20 per share. These warrants are exercisable over a five year period from the date of issuance of July 2010.
On October 1, 2010, the Company granted 10,000 warrants to its investor relations consultant with an exercise price of $7.50 that will expire in October 2015.
On December 6, 2010 the Company granted 26,000 options with exercise price of $6.00 to a director with vesting of one-third as of the date of grant, one-third vesting in December 2011, and the final one-third vesting in December 2012, contingent on the director continuing to serve as a board member. The option can be exercised through January, 2017. The Company recognizes the compensation cost over the award’s service period and for the year ended December 31, 2011 and 2010, the amortization of these options amounted to $21,374 and $21,372, respectively, based on a Black Scholes valuation of the options as of the date of the grant.
The Company granted to its investor relation firm 44,000 shares of the Company’s common stock for services to be rendered up through October 2011 pursuant to an agreement made in October 2010. The shares were valued at $234,080 and amortized over the service term. The amortization of this grant was $234,080 for the year ended December 31, 2011. As of July 2011, the Company issued 10,000 shares of the 44,000 shares to the investor relation firm.
The fair value of the director options and the placement agent warrants were estimated as of the grant date using the Black Scholes options pricing model. The determination of the fair value is affected by the price of the Company’s common stock at the date of the grant as well as assumptions made regarding the expected price volatility of the common stock over the terms of the grant, the risk-free interest rate and any expected dividends.
The table below provides the estimated fair value of the director options, and the significant assumptions used to determine their values.
Index
TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 19-CAPITAL STOCK (CONTINUED)
The following table summarizes the stock options and warrants outstanding as of December 31, 2011 and the activity during the year ended December 31, 2011.
The weighted average remaining contractual life for the options and the warrants is 3.93 years and 3.55 years, respectively. The market value of the Company’s common stock was $1.26 and $6.25 as of December 31, 2011 and 2010, respectively. The intrinsic value of the outstanding options and the warrants as of December 31, 2011 was $0. The intrinsic values of the outstanding options and the warrants as of December 31, 2010 were $6,500 and $0, respectively.
NOTE 20-STATUTORY RESERVES
As stipulated by the Company Law of the PRC, net income after taxation can only be distributed as dividends after appropriation has been made for the following:
•
Making up cumulative prior years’ losses, if any;
•
Allocations to the “Statutory surplus reserve” of at least 10% of income after tax, as determined under PRC accounting rules and regulations, until the fund amounts to 50% of the Company’s registered capital;
•
Allocations to the discretionary surplus reserve, if approved by the stockholders;
•
The transfer to this reserve must be made before distribution of any dividend to shareholders. The surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholding or by increasing the par value of the shares currently held by them, provided that the remaining reserve balance after such issue is not less than 25% of the registered capital.
In accordance with the Chinese Company Law, the Company has allocated 10% of its net income as the statutory reserve contributions. The reserves amounted to $2,416,647 and $1,510,423 as of December 31, 2011 and 2010, respectively.
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TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 21-CERTAIN RISKS AND CONCENTRATION
Credit risk and major customers
As of December 31, 2011 and 2010, 87% and 78% of the Company’s cash including cash on hand and deposits in accounts were maintained within the PRC where there is currently no rule or regulation in place for obligatory insurance to cover bank deposits in the event of a bank’s failure. However, the Company has not experienced any such losses and believes it is not exposed to any significant risks on its cash in bank accounts
The Company’s key customers are principally hog brokers, hog farmers and slaughterhouses, all of which are located in the PRC. The Company has not entered into long-term supply contracts with any of these major customers.
There were no other customers who accounted for more than 10% of the Company’s revenues for the years ended December 31, 2011 or 2010.
Risk arising from operations in foreign countries
Substantially all of the Company’s operations are conducted in China. The Company’s operations are subject to various political, economic, and other risks and uncertainties inherent in China. Among other risks, the Company’s operations are subject to the risks of restrictions on transfer of funds; changing taxation policies; foreign exchange restrictions; and political conditions and governmental regulations.
Risk arising from contractual arrangements with Fengze
The Company conducts substantially all of its operations, and generates substantially all of its revenues, through contractual arrangements with Fengze that provide the Company with effective control over Fengze. The Company depends on Fengze to hold and maintain contracts with its customers. Fengze owns substantially all of the Company’s intellectual property, facilities and other assets relating to the operation of the Company’s business, and employs the personnel for substantially all of its business. Neither Tianli, nor HCS nor WFOE has any ownership interest in Fengze. Although WFOE’s contractual arrangements with Fengze are valid, binding and enforceable under current PRC laws and regulations, these contractual arrangements may not be as effective in providing the Company with control over Fengze as direct ownership of Fengze would.
NOTE 22-GOVERNMENT SUBSIDIES
The Company received subsidies of $233,928 and $221,897 in the years ended December 31, 2011 and 2010, respectively for recurring breeder hog subsidies and an award from the provincial government for the Company becoming a public company in the United States. All such subsidies are recorded as “subsidy income” in the financial statements.
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TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 23-SEGMENT INFORMATION
The Company follows FASB ASC 280-Segment Reporting, which requires that companies disclose segment data based on how management makes decision about allocating resources to segments and evaluating their performance. The Company has two operating segments identified by products, “Hog Farming” and “Retail”. The hog farming segment consists of sales of our raised breeder hogs and raised market hogs that were sold to meat processors. Our retail segment consists of the selling of processed pork products through several major retailers.
The Company primarily evaluates performance based on income before income taxes and excluding non-recurring items.
The segment data presented below were prepared on the same basis as the Company’s consolidated financial statements.
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TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 23-SEGMENT INFORMATION (CONTINUED)
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TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 24-COMMITMENTS AND CONTINGENCIES
General
The Company follows ASC 450, Accounting for Contingencies, in determining its accruals and disclosures with respect to loss contingencies. Accordingly, estimated losses from loss contingencies are accrued by a charge to income when information available prior to issuance of the financial statements indicates that it is probable that a liability could be been incurred and the amount of the loss can be reasonably estimated. Legal expenses associated with the contingency are expensed as incurred. If a loss contingency is not probable or reasonably estimable, disclosure of the loss contingency is made in the financial statements when it is at least reasonably possible that a material loss could be incurred. The Company has not accounted for any loss contingencies as of December 31, 2011 and 2010.
Lease obligations
The Company leases office space that has a remaining term of nine years. Also as a condition of being the holder of the land use rights for its hog farms, the Company makes rental payments to the government over the term of the land use rights, which range from 19 years to 50 years. The Company does not have capital leases. In most cases, management expects that, in the normal course of business, leases will be renewed or replaced. Net rental expense relating to the Company’s operating leases for the years ended December 31, 2011 and 2010 was $86,721 and $66,459, respectively.
The following table sets forth the aggregate minimum future annual rental commitments at December 31, 2011 under all non-cancelable leases for years ending December 31:
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TIANLI AGRITECH, INC. AND SUBSIDIARIES
NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
NOTE 24-COMMITMENTS AND CONTINGENCIES (CONTINUED)
Capital commitments
Capital expenditures
The Company has been actively pursuing the acquisition of additional hog farms and upgrading its existing farms. As of December 31, 2011, the Company had deposited $750,992, included in construction in progress, for building a new feed processing facility, new refrigerator, and the improvements of several of the Company’s hog farms. The remaining amount due will be paid upon completion.
The Company’s execution of the Enshi Black Hog program (see note 9) will require the Company to incur various costs and contribute various amounts to cover the costs of different aspects of the program as more fully described above. As of December 31, 2011, the Company provided funds totaling $4.27 million to local independent farmers to construct small-scale hog farms in which the farmers will grow the black hogs for sale to the Company. Upon satisfactory completion of these farms, these farms would become fixed assets of the Company. The Company expects that further funding for this program will be required later this year, and management believes that such funds will be available out of the cash flow generated by operations.
Environmental matters
Environmental laws and regulations to which the Company is subject mandate additional concerns and requirements of the Company. Failure to comply with applicable laws, regulations and permits can result in injunctive actions, damages and civil and criminal penalties. The laws and regulations applicable to the Company's activities change frequently and it is not possible to predict the potential impact on the Company from any such future changes.
Although management believes that the Company is in material compliance with the statutes, laws, rules and regulations of every jurisdiction in which it operates, no assurance can be given that the Company’s compliance with the applicable statutes, laws, rules and regulations will not be challenged by governing authorities or private parties, or that such challenges will not lead to material adverse effects on the Company’s financial position, results of operations, or cash flows.
The Company is not involved in any legal matters. While incapable of estimation, in the opinion of the management, the individual regulatory and legal matters in which it might be involved in the future are not expected to have a material adverse effect on the Company’s financial position, results of operations, or cash flows.