ITEM 1. BUSINESS.
Business Overview
We are a leading China based producer and supplier of premium branded Traditional Chinese Medicine consumer products including commercially cultivated Cordyceps Militaris (aka Chinese Golden Grass), organic and specialty food products and functional health beverages.
Our primary product is Cordyceps Militaris, also known as Chinese Golden Grass. Cordyceps Militaris is a species of parasitic fungus that is typically found in north-eastern China. It is a precious ingredient in traditional Chinese medicine and widely believed in China to offer high medical and health benefits by nourishing the yin, boosting the yang, and invigorating the meridians of the lungs and kidneys. According to Georges Halpern’s Healing Mushrooms, certain research has shown that Cordyceps Militaris may boost the immune system, and can be used as a supplement for combating certain effects of fatigue and aging, the occurrences of certain tumors, and combating arteriosclerosis and certain gastrointestinal disorders, as well as reducing blood pressure. In addition, Cordyceps Militaris has significantly high economic values. According to Halpern, wild Cordyceps Militaris can cost as much as $10,000 per kilogram. Due to the extremely sensitive growing conditions of Cordyceps Militaris, it is very difficult to grow the plant in a man-made environment. After several years of laboratory tests, we developed a technology to commercially grow and produce Cordyceps Militaris in 2006. We generated 74.1% and 90.9% of our revenues from Cordyceps Militaris for fiscal years 2011 and 2010, respectively. We believe that we own approximately 19% of the worldwide market share in the cultivated Cordyceps Militaris industry. We plan to continue to focus on Cordyceps Militaris based consumer products in the near future, which is our fastest growing product line with the greatest market demand and a significantly higher profit margin.
We also sell organic and specialty food products through our VIE Entity, Harbin Shuaiyi Green & Specialty Food Trading LLC, or Harbin Shuaiyi, which was formed in 2001. After years of development, we believe that we have become one of the largest wholesale distributors of organic and specialty food in Heilongjiang Province, China. We plan to increase our focus in our organic and specialty food products business, including efforts to become a producer and increase our distribution capabilities.
We introduced the Cordyceps based functional health beverages in the fourth quarter of 2010. The non-carbonized beverage products were developed internally and contain the Cordyceps Militaris as a key ingredient. The products are currently being marketed directly to consumers in select cities in Jiangsu and Anhui Province through various distribution channels.
Corporate History and Structure
General
We were originally incorporated in the State of Nevada on December 22, 2002. On October 15, 2003, we acquired all the outstanding common stock of YzApp Solutions Inc. We sold our ownership in YzApp Solutions Inc. on December 3, 2008. Following incorporation, we engaged in the business of developing software which allowed us to act as an application service provider acting as a conduit between retailers and financial institutions. Because this business was not successful, we were focused on the identification of suitable businesses with which to enter into a business opportunity or business combination until December 23, 2008, when we completed our reverse acquisition of New Zealand WAYNE’s New Resources Development Co., Ltd., or New Resources. As a result of our reverse acquisition of New Resources, we are no longer a shell company and maintain active business operations.
On May 19, 2009, we filed amended and restated articles of incorporation with the Nevada Secretary of State to amend our articles of incorporation to, among other things, (1) change our name from “YzApp International Inc.” to “Shuaiyi International New Resources Development Inc.,” (2) increase the total number of shares of common stock that we have the authority to issue from 50,000,000 to 190,000,000 shares and (3) effect a 1-for-114.59 reverse split of our outstanding common stock.
On January 11, 2010, we changed our name to Nutrastar International Inc. to more accurately reflect our marketing and branding strategy and our products. Our common stock has been quoted on the OTC Bulletin Board under the new symbol NUIN.OB since January 20, 2010.
Background and History of New Resources and Heilongjiang Shuaiyi
New Resources is a holding company, which was incorporated in the BVI under the BVI Business Company Act on March 13, 2008. New Resources was wholly-owned by New Zealand WAYNE’s Investment Holdings Co., Ltd., or Investment Holdings, a BVI company, before we acquired New Resources on December 23, 2008.
Heilongjiang Shuaiyi New Energy Development Co., Ltd., or Heilongjiang Shuaiyi, was established on July 11, 2006 under the laws of the PRC. Heilongjiang Shuaiyi has two wholly-owned subsidiaries, Daqing Shuaiyi Biotech Co., Ltd., or Daqing Shuaiyi, and Harbin Shuaiyi. On July 28, 2008, pursuant to a restructuring plan intended to ensure compliance with regulatory requirements of the PRC, the nine original shareholders of Heilongjiang Shuaiyi, or the Founders, including our chairperson and chief executive officer, Lianyun Han, entered into an equity transfer agreement, or the Equity Transfer Agreement, with New Resources, pursuant to which the Founders transferred all of their equity interests in Heilongjiang Shuaiyi to New Resources for a purchase price of RMB 60 million (approximately $8.8 million). As a result, New Resources became the 100% owner of Heilongjiang Shuaiyi and, indirectly, Daqing Shuaiyi and Harbin Shuaiyi.
On December 8, 2008, Heilongjiang Shuaiyi entered into a separate loan agreement and promissory notes, or the Notes, with each of the Founders, pursuant to which Heilongjiang Shuaiyi borrowed an aggregate of RMB 60 million (approximately $8.8 million) from the Founders, which amount is exactly equal to the proceeds that they were entitled to receive for the transfer of their ownership of Heilongjiang Shuaiyi under the Equity Transfer Agreement. The Notes bear no interest and are payable in successive equal yearly payments beginning on the tenth anniversary of the Notes, December 8, 2018, and within the first month of each year thereafter. The final payment is due on January 1, 2028. On February 12, 2009, Heilongjiang Shuaiyi and the Founders amended the Notes, pursuant to which the Founders subordinated any right to receive any payment with respect to this loan to the payment or provision for payment in full of all claims of all present and future creditors of Heilongjiang Shuaiyi.
On December 23, 2008, pursuant to a share exchange agreement, we completed a reverse acquisition transaction of New Resources whereby we issued to Investment Holdings 689,390 shares of our series A preferred stock, constituting approximately 94% of our issued and outstanding capital stock on a fully-diluted basis, in exchange for all of the issued and outstanding capital stock of New Resources. New Resources thereby became our wholly owned subsidiary and Investment Holdings became our controlling stockholder.
VIE Restructuring
According to relevant Chinese laws, the equity interest transfer price should be paid by New Resources to the Founders in full within a certain period of time after Heilongjiang Shuaiyi obtained the new business license. Because New Resources would not be able to pay off the equity interest transfer price within such required time period, New Resources and the Founders decided to transfer all of the equity interests in Heilongjiang Shuaiyi owned by New Resources back to the Founders. On October 22, 2010, our subsidiary, New Resources, entered into an equity transfer agreement with the Founders, pursuant to which New Resources transferred all of its equity interests in Heilongjiang Shuaiyi back to the Founders. As a result, the equity transfer agreement between New Resources and the Founders, dated July 28, 2008, was terminated and New Resources’ obligations to pay off the transfer price for the equity interest in Heilongjiang Shuaiyi to the Founders were discharged.
In connection with the equity transfer, the Founders, our indirectly wholly-owned Chinese subsidiary, Harbin Baixin Biotech Development Co., Ltd., or Harbin Baixin, and Heilongjiang Shuaiyi entered into the following commercial arrangements, or collectively, VIE Agreements, pursuant to which we have contractual rights to control and operate the businesses of Heilongjiang Shuaiyi and Heilongjiang’s two Chinese subsidiaries, Daqing Shuaiyi and Harbin Shuaiyi:
Pursuant to a technical service agreement, or the Service Agreement, entered into by and between Harbin Baixin and Heilongjiang Shuaiyi, Harbin Baixin will provide certain exclusive technical services to Heilongjiang Shuaiyi in exchange for the payment by Heilongjiang Shuaiyi of a service fee that is calculated based on the market price in light of the particulars of the service and the time of such service provided by Harbin Baixin;
Pursuant to an exclusive purchase option agreement, or the Option Agreement, entered into by and among Harbin Baixin, the Founders and Heilongjiang Shuaiyi, the Founders granted to Harbin Baixin an option to purchase at any time during the term of this agreement, all or part of the equity interests in Heilongjiang Shuaiyi, or the Equity Interests, at the exercise price equal to the lowest possible price permitted by Chinese laws;
Pursuant to a voting rights proxy agreement, or the Voting Rights Agreement, entered into by and among Harbin Baixin, the Founders and Heilongjiang Shuaiyi, each of the Founders irrevocably entrusted Harbin Baixin and any entities or individuals designated by Harbin Baixin to, among others, exercise its voting rights and other rights as a shareholder of Heilongjiang Shuaiyi; and
Pursuant to an equity pledge agreement, the Pledge Agreement, entered into by and among Harbin Baixin, the Founders and Heilongjiang Shuaiyi, the Founders pledged all of the Equity Interests to Harbin Baixin to secure the full and complete performance of the obligations and liabilities on the part of the Founders and Heilongjiang Shuaiyi under this and above contractual arrangements
As a result of the above contractual arrangements, or the Contractual Arrangements, we transferred all of our indirect equity interests in Heilongjiang Shuaiyi back to the Founders, among whom, Ms. Lianyun Han became a majority shareholder of Heilongjiang Shuaiyi by owning 68.3% equity interest in Heilongjiang Shuaiyi. At the same time, we maintain substantial control over the VIE Entities’ daily operations and financial affairs, election of their senior executives and all matters requiring shareholder approval. Furthermore, as the primary beneficiary of the VIE Entities, we are entitled to consolidate the financial results of the VIE Entities in our own consolidated financial statements under Financial Accounting Standards Board Accounting Standard Codification (ASC) Topic 810 and related subtopics related to the consolidation of variable interest entities, or ASC Topic 810.
On October 22, 2010, Heilongjiang Shuaiyi also entered into a termination agreement with each of the Founders, pursuant to which, the Notes were terminated and none of the parties will have any further obligations and rights thereunder.
Private Placement Transactions
On December 17, 2009, we completed a private placement transaction and sold 1,000,000 shares of our common stock to certain accredited investors at $2.50 per share for a total of $2.5 million pursuant to a securities purchase agreement. In addition, we issued to each of the investors two warrants to purchase in aggregate 500,000 shares of our common stock, including a Series A warrant having a term of three years with an exercise price of $3.25 per share and a Series B warrant having a term of three years with an exercise price of $4.00 per share, both of which are subject to the usual adjustments for certain corporate events.
In addition, pursuant to the securities purchase agreement, the Shareholder agreed to place a total of 1,000,000 shares of the Company’s common stock held by it into escrow to secure the make good obligations described below on behalf of the investors. Under the securities purchase agreement, the Shareholder agreed that: (i) in the event that our consolidated financial statements reflect less than $9,000,000 of after-tax income for the fiscal year ending December 31, 2010, it will transfer to the investors, on a pro rata basis, for no additional consideration, 500,000 shares of our common stock owned by it; and (ii) in the event that our consolidated financial statements reflect less than $11,000,000 of after-tax net income for the fiscal year ending December 31, 2011, it will transfer to the investors, on a pro rata basis, for no additional consideration, 500,000 shares of common stock owned by it. We achieved the 2011 and 2010 performance thresholds and no escrow shares have been transferred to the investors.
On May 27, 2010, we entered into a securities purchase agreement, or the 2010 Securities Purchase Agreement, with certain investors, pursuant to which, we agreed to issue and sell up to an aggregate of 250,000 Units at a purchase price of $28.56 per Unit, for an aggregate purchase price of up to $7,140,000, or the Aggregate Purchase Price. Each Unit consists of (i) one share of a newly designated series A preferred stock, par value $0.001 per share, or the Series A Preferred Stock, with an initial one-to-ten conversion ratio into shares of the Company’s common stock, par value $0.001 per share, and (ii) warrants to purchase five shares of common stock at an exercise price of $3.40 per share, or the Series C Warrants. In addition, Gilford Securities Incorporated, as the placement agent of this transaction, received from the investors a fee equal to 2% of the Aggregate Purchase Price and Series C Warrants to purchase 2% of the aggregate number of shares of common stock that shares of Series A Preferred Stock to be issued under the 2010 Securities Purchase Agreement are convertible into.
In connection with the 2010 Securities Purchase Agreement, we filed a Certificate of Designation of Series A Preferred Stock with the Secretary of State of the State of Nevada, or the 2010 Certificate, on May 27, 2010, which became effective upon filing. Pursuant to the 2010 Certificate, there are 300,000 shares of Series A Preferred Stock authorized.
On June 7, 2010 and June 28, 2010, we consummated the first and the second closing of the private placement transaction contemplated by the 2010 Securities Purchase Agreement, respectively, in which we issued in aggregate 197,706 Units to certain investors at a purchase price of $28.56 per unit for gross proceeds of approximately $5.65 million.
The following chart reflects our organizational structure as of the date of this report:
Business Segment Information
Our business operations can be categorized into three segments based on the type of products we manufacture and sell, specifically (i) Cordyceps Militaris, (ii) organic and specialty food products and (iii) functional health beverage.
We grow and sell our Cordyceps Militaris as well as manufacture and distribute our functional health beverages through Daqing Shuaiyi. Harbin Shuaiyi is mainly engaged in the business of selling our organic and specialty food products.
For financial information relating to our business segments, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 20 to our consolidated financial statements appearing elsewhere in this annual report.
Our Industry
The nutraceutical industry is currently made up of many small and medium-sized companies that manufacture and distribute products generally intended to, or marketed for the purpose of maintaining, and sometimes improving, health and general well being. According to the China Enterprises Association, there are currently over 3,000 manufacturers of nutraceutical products in China, with an annual production value of over $6.25 billion. Of these manufacturers, large enterprises with registered capital of over $12.5 million only account for 1.45%; medium-sized enterprises with registered capital under $12.5 million, but over $6.25 million, make up 38%; and workshop-style enterprises with registered capital below $12,500 make up 12.5% of the total number of manufacturers.
Widespread economic development in China has not only increased the disposable income of Chinese consumers, it has also lead to an increase in consumer awareness of the risks of dietary imbalances and the importance of maintaining appropriate levels of vitamins and minerals in the human body. Along with a growing middle class, all of these facts have rapidly increased China’s 480 million urban consumers’ demand for nutraceutical products. Today the Chinese health supplements industry is estimated to be worth approximately $6 billion in annual sales, according to the China Health Care Association, which is an association attached to China’s Ministry of Health. We believe that the next era of nutrition will focus on naturally occurring properties provided from plants, fruits, and vegetables, which support good health.
Because of the rarity and high prices of the wild collected variety, attempts have long been made to cultivate Cordyceps Militaris. By the mid-1980s, the majority of Cordyceps Militaris available in the worldwide marketplace were cultivated. Because of the development of modern biotechnology-based cultivation methods, the availability of this previously rare health supplement has greatly increased in the last 20 years. The demand for Cordyceps Militaris has also compounded exponentially, in this same time frame, partly because of the opening of China to trade with the West in the 1970s, exposing many more people around the world to the concepts and practices of traditional Chinese medicine. As Cordyceps Militaris has always been highly revered in traditional Chinese medicine, we believe that with increased exposure to traditional Chinese medicine, the demand for this plant has also increased. Such an increase has lead to overharvesting of the wild stocks and a subsequent shortage of wild collected varieties of Cordyceps Militaris.
International markets for Cordyceps Militaris are mainly in the United States, Canada, Japan, Korea, Hong Kong and Southeast Asia. The European and Australian markets are also emerging. According to Market Survey of Cordyceps Militaris 2010, published by China Market Monitoring Center in 2010, the current international market demand for Cordyceps Militaris is about 1,000 tons a year, while the Chinese domestic market demand is about 500 tons a year with an annual growth rate of over 13%. With about 50 Cordyceps Militaris manufacturers in China having an aggregate production capacity of only 290 tons a year, there is a big gap between supply and demand and therefore a great potential for our Cordyceps Militaris market.
Our Competitive Strengths
We believe that our success to date and potential for future growth can be attributed to a combination of our strengths, including the following:
High-end niche products. We sell organic and specialty food products, functional health beverages and Cordyceps Militaris products that the followers of traditional Chinese medicine believe have high nutrient concentration, potential health benefits and high value. Our products are positioned in the high-end market as premium healthy food and are distinguished from the common nutraceutical products in the market.
Leading market position and significantly high margin. We believe we have established ourselves as a leading player in China’s Cordyceps Militaris industry. We believe that we currently own approximately 19% of the production in the world market of Cordyceps Militaris. By successfully commercializing our Cordyceps Militaris planting technology, we believe that we have achieved economies of scale and a significantly high margin that affords a competitive advantage.
Leading-edge R&D team. Our research and development team has a strong and extensive technology background and has been an early participant in the Cordyceps Militaris market. Currently we have 21 technicians in our R&D department. The head of our research and development team, Mr. Lichen Wang, is a lead expert in the field of edible fungus in China. Mr. Wang graduated with a Bachelor’s degree in edible fungus and has served as the deputy director of several research institutes of edible fungus in Northeast China.
Experienced management team with a strong track record. Our management team has extensive operating experience and industry knowledge. Ms. Lianyun Han, our founder and chief executive officer, has more than 10 years of experience in operational management and business development. We believe that our management team’s experience and capabilities have contributed greatly to our significant growth in the past three years.
Our Growth Strategy
As a leading Cordyceps Militaris consumer products producer in China, we believe we are well positioned to capitalize on future industry growth in China. We are dedicated to providing healthy and high nutritional products to our consumers. We will implement the following strategic plans to take advantage of industry opportunities and our competitive strengths:
Focus on brand development. With intense price competition among many similar or identical products in the industry, we believe that building brand awareness is the primary means to generate and sustain profitable growth in the future. We believe that developing close cooperative relationships with research centers of well-known universities in China and globally is key to building brand equity. We also market our products through an integrated marketing program that includes advertising in relevant media outlets, attending trade shows and offering seminars and lectures to local communities regarding the products and their health benefits.
Introducing new products. We constantly evaluate our products and seek to adapt to changing market conditions by updating our products to reflect new trends in consumer preferences. We endeavor to expand our market presence by introducing additional competitive nutraceutical products to our product offerings. Our new products under development include Cordyceps Militaris based alcoholic products and instant soluble powder oral liquids.
Increase production capacity. Our existing production lines of Cordyceps Militaris have been running at close to full capacity while the market demand for our existing products continues to increase. In order to meet the raw material needs of our products, expand sales of small packages and beverages of our Cordyceps Militaris products, we undertook to add 10 plants to our production line, of which three were completed in 2010 and three plants have been substantially completed as of December 2011 and expected to begin operating during the first half of 2012. We anticipate that the entire project will be completed in 2012. Annual production capacity of Cordyceps Militaris is expected to increase to 87 tons in 2012, up from 72 tons in 2011 and 55 tons in 2010. We will convert more buildings into biotechnologically controlled cultivation plants to grow and process Cordyceps Militaris in the future.
Further expand our distribution network to increase the prevalence of our products nationwide. Our current sales depend heavily on the sales of our large-pack products to pharmaceutical companies. To support our rapid growth in sales, we plan to further expand our distribution network by selling our small-pack products through direct sales channel, specialty stores and franchise stores. We have one-year contracts with our major distributors which normally extend for one more year by the end of the contracts. We maintain constant communications with these distributors to keep us informed regarding consumer preferences and market trends in order to develop new products. We also organize monthly product promotion meetings with the distributors to increase the sales of small package products. We are at the initial rollout phase of our functional health beverage through distribution channels in Jiangsu Province and Anhui Province. We have contracts with local distributors which we expect to be renewed upon expiration. We plan to further expand our distribution networks by selling the functional health beverage through additional distribution channels, specialty stores, supermarkets and franchise stores.
Technology innovation. We believe that the development of new technology is critical to our success. We will continuously improve the quality of our existing and future products through new technologies. We expect to maintain our long-term partnership with Chinese universities and research institutes in order to develop new technologies.
Our Products and Production Process
Cordyceps Militaris
Our primary product is Cordyceps Militaris. Cordyceps Militaris is a species of parasitic fungus that is typically found in the north eastern mountainous regions of China. As a precious ingredient in traditional Chinese medicine, Cordyceps Militaris is widely believed in China to offer high medical and health benefits by nourishing the yin, boosting the yang, and invigorating the meridians of the lungs and kidneys. Due to the extremely sensitive growing conditions of Cordyceps Militaris, it is very difficult to grow the plants in man-made environments. Through several years laboratory tests, we developed the technology to commercially grow and produce Cordyceps Militaris in 2006. Our production process primarily includes planting, purifying and packaging.
Our present production capacity of Cordyceps Militaris is approximately 72 tons annually. We generated 74.1% and 90.9% of our revenues from Cordyceps Militaris for the years ended December 31, 2011 and 2010, respectively. We believe that we own approximately 19% worldwide market share in the entire cultivated Cordyceps Militaris industry. We plan to continue to focus on Cordyceps Militaris, which is our fastest growing product with the greatest market demand and a significantly high profit margin. To achieve this end, we added three additional production facilities to produce Cordyceps Militaris in 2011 and are expanding our designed annual production capacity to 87 tons for year 2012. .
Organic and Specialty Food
Growth in domestic demand for organic products has been driven by rising incomes in China. Through Harbin Shuaiyi, we act as either a sales agent or a distributor to market and sell organic and specialty food products supplied by third-party producers. These products mainly include Northeast Peculiar Rice. Northeast Peculiar Rice is grown in accordance with organic product standards established by the Chinese Ministry of Agriculture. To qualify as “organic,” food must be produced in an environment which relies upon natural resources, without the use of conventional pesticides, artificial fertilizers, in an appropriate ecological environment, and must undergo a series of scientific and technological quality control processes. Our Northeast Peculiar Rice is rich in protein, fiber fats, amino acids and calcium, iron, zinc, selenium and other elements and vitamins. After years of development, we believe we have become the largest wholesale distributor of organic and specialty food in Heilongjiang Province, China. We plan to increase our focus in our organic and specialty food products business, including efforts to become a producer and increasing our distribution capabilities.
Functional Health Beverages
Through development by our Research and Development team, we introduced the functional beverages featuring the Cordyceps Militaris as a core ingredient in 2010. The beverage products were developed with the health benefits of enhancing immunity, reducing fatigue, enhancing circulations, among other benefits derived from our Cordyceps Militaris. The products are currently available in select areas in Jiangsu and Anhui Province and in our specialty stores located at Daqing and Harbin City. We generated 20.0% and 1.8% of our revenues from our functional health beverages for the years ended December 31, 2011 and 2010, respectively. In 2012, we plan to target mass consumer markets by increasing our distribution channels.
New products under development
We plan to further diversify our Cordyceps Militaris based product mix to cater to different customer tastes and preferences. Currently, we have the following two products under development.
Cordycepin. Cordycepin is the major bioactive compound of Cordyceps Militaris. Cordycepin has been used as a raw material in various nutraceutical products, cosmetics and drugs worldwide. According to Georges Halpern’s Healing Mushrooms, Cordycepin is medicinally used to treat bacterial infections such as tuberculosis and leprosy as well as possibly inhibiting HIV replication.
Oral liquids and alcoholic products. As an extension of our different functional beverage products, we endeavor to expand our market presence by introducing additional competitive nutraceutical products to our product offerings. Our new products under development include Cordyceps Militaris based alcoholic products and instant soluble powder oral liquids.
Marketing and Sales
Currently, we have 149 experienced sales and marketing personnel who are responsible for direct sales activities, market research, promotion and advertisement. We strengthen our market presence by employing various types of marketing strategies. We participate in trade shows such as China Sugary and Wine Trade Fair, Harbin International Fair for Trade and Economic Cooperation and Beijing Agriculture Exposition and offer seminars and lectures to local communities regarding the health benefits of our products. These activities help to promote our reputation and name recognition in the industry.
Our sales depend heavily on the sales of our large-pack products to pharmaceutical companies. To support our rapid growth in sales, we plan to further expand our distribution network by selling our small-pack products through direct sales channels, specialty stores and franchise stores.
Raw Materials and Suppliers
Our raw materials primarily consist of carbamide, wheat, glucose, citric acid, bitter salt, peptone, and pupa powder. The price for such material fluctuates depending upon market conditions, as such, any short-term price fluctuations may have a material effect on the Company.
We have established long-term relationships with our key suppliers. However, we do not have fixed price long-term supply contracts. We try to adopt a dual supplier system for raw materials to reduce the exclusive reliance on our key suppliers when possible. In such a case, if our primary suppliers cannot supply us with our raw material for any reason, we may be able to acquire raw material from another supplier to minimize the impact. All of our suppliers must meet our quality standards and delivery requirements consistently in order to remain on our approved supplier list.
The flexible sourcing arrangements are designed to ensure the stable supply of raw materials and promote healthy competition among our suppliers. We believe our supplier arrangements encourage our suppliers to provide high quality raw materials timely and efficiently.
The following table lists major suppliers of our raw materials in 2011:
(All amounts in thousands of US dollars):
Our Major Customers
The following table provides information on our major clients in fiscal year 2011:
(All amounts in thousands of US dollars):
Our Competition
Most of our competitors for sales of Cordyceps Militaris products are small-sized local producers and generally have a much lower production capacity. Compared to these competitors, we believe we have a much higher production capacity and more advanced growing and production technology. Our major competitors in China include Dalian Kangrongboer Biotech Co. Ltd., Liaoning Limin Cordyceps Co. Ltd., Hebei Cangzhou Cordyceps Co. Ltd., Henan Huazhong Biotech Co. Ltd., Anshan Huayu Biotech Co. Ltd., Dalian Lanshi Cordyceps Biotech Co. Ltd., Beijing Jingdu Cordyceps Biotech Co. Ltd. , Ningqiang Likangfuxi Biotech Co.Ltd., and Shenyang Juxin Cordyceps Co. Ltd.
Research and Development
Our research and development activities focus on developing new products and new technologies. We currently have 21 employees dedicated to research and development. Since 2003, we have also maintained a close cooperation relationship with China Institute of Science, one of the most prestigious academic institutions of scientific and technological research in China, to improve commercially grown Cordyceps Militaris.
As described below, on April 10, 2006, we spent RMB 30 million (approximately $4.4 million) in acquiring the technologies of Cordyceps Militaris cultivation from Mr. Runjiao Wang. In 2011 and 2010, our research and development expenses were $186,958 and $114,145, respectively.
Intellectual Property
We currently have the following patents pending approval:
On April 10, 2006, Daqing Shuaiyi entered into an exclusive licensing agreement with Mr. Runjiao Wang, pursuant to which Mr. Wang agreed to grant Daqing Shuaiyi an exclusive right to use the cultivation technology of Cordyceps Militaries that Mr. Wang developed. According to this licensing agreement, Daqing Shuaiyi is allowed to use this technology exclusively in China for ten years beginning on April 10, 2006. In consideration of the rights granted to Daqing Shuaiyi under this licensing agreement, Daqing Shuaiyi agreed to pay Mr. Wang a licensing fee in an amount of RMB 30 million (approximately $4.4 million). In addition, Daqing Shuaiyi has the right of first refusal with respect to the cultivation technology when the licensing agreement expires.
We have applied for the trademark of “帅亿东方神” with the Trademark Office of the State Administration for Industry and Commerce of China. Under Chinese laws, we are allowed to use “帅亿东方神” for the sales and marketing of our products even if our trademark application is still pending. Once our application is approved, the trademark will have a term of ten years and may be continually renewed thereafter.
We rely on trade secret protection and confidentiality agreements to protect our proprietary information and knowhow. Our management and each of our research and development personnel have entered into a standard confidentiality agreement, which includes a clause acknowledging that all inventions, designs, trade secrets, works of authorship, developments and other processes generated by them on our behalf are our property, and assigning to us any ownership rights that they may claim in those works. Despite our precautions, it may be possible for third parties to obtain and use, without our consent, intellectual property that we own or are licensed to use. Unauthorized use of our intellectual property by third parties, and the expenses incurred in protecting our intellectual property rights, may adversely affect our business. See Item 1A, “Risk factors-Risks Related to Our Business-Failure to adequately protect our intellectual property rights may undermine our competitive position, and litigation to protect our intellectual property rights may be costly.”
Regulation
Because our operating entities are located in the PRC, we are regulated by the national and local laws of the PRC. Currently only the general rules of commerce in China are applicable to us.
We are also subject to the PRC’s foreign currency regulations. The PRC government has controlled RMB reserves primarily through direct regulation of the conversion of RMB into other foreign currencies. Although foreign currencies, which are required for “current account” transactions, can be bought freely at authorized PRC banks, the proper procedural requirements prescribed by PRC law must be met. At the same time, PRC companies are also required to sell their foreign exchange earnings to authorized PRC banks and the purchase of foreign currencies for capital account transactions still requires prior approval of the PRC government.
Our Employees
As of December 31, 2011, we employed a total of 332 full-time employees. The following table sets forth the number of our employees by function.
Our employees are not represented by a labor organization or covered by a collective bargaining agreement. We have not experienced any work stoppages. We believe we maintain good relations with our employees.
Seasonality
The production and sale of our primary product, Cordyceps Militaris, historically have not been subject to seasonal variations. However since a majority of our sales are in China, the timing of the various Chinese holidays such as Lunar Chinese New Year, May and October holidays may have some impact to our revenue cycle.
Insurance
We do not have any business liability, interruption or litigation insurance coverage for our operations in China. Insurance companies in China offer limited business insurance products. While business interruption insurance is available to a limited extent in China, we have determined that the risks of interruption, cost of such insurance and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. Therefore, we are subject to business and product liability exposure. See Item 1A, “Risk Factors - We do not carry any business interruption insurance, third-party liability insurance for our production facilities or insurance that covers the risk of loss of our products in shipment.”
ITEM 1A.
ITEM 1A. RISK FACTORS.
The shares of our stock are highly speculative in nature, involve a high degree of risk and should be purchased only by persons who can afford to lose the entire amount invested in the. Before purchasing any of the shares of stock, you should carefully consider the following factors relating to our business and prospects. You should pay particular attention to the fact that we conduct all of our operations in China and are governed by a legal and regulatory environment that in some respects differs significantly from the environment that may prevail in the U.S. and other countries. If any of the following risks actually occurs, our business, financial condition or operating results will suffer, the trading price of our
stock could decline, and you may lose all or part of your investment.
RISKS RELATED TO OUR BUSINESS
Our current business is significantly based on a single product, Cordyceps Militaris, which currently accounts for approximately 74 percent of our revenues, and we may not be able to generate significant revenue if this product fails.
Approximately 74% of our sales for the year ended December 31, 2011 come from a single product, Cordyceps Militaris, and our business may suffer a material adverse impact if this product fails. If we experience difficulties or obstacles in the manufacture and sale of Cordyceps Militaris, we may not be able to generate significant revenues, our business may fail and you would lose all or part of your investment in our company.
We may not be able to grow and harvest sufficient Cordyceps Militaris to satisfy our production requirements and any decline in the amount or quality of Cordyceps Militaris could reduce our sales and negatively affect our results of operations, financial condition and business prospects.
Our Cordyceps Militaris related business and financial results significantly depend on maintaining a consistent and cost-effective supply of wild strains of Cordyceps Militaris. The availability, size and quality of Cordyceps Militaris for the production of our products are subject to risks inherent to growing, such as size, quality, and yield fluctuation caused by technical problems of growing, pest and disease problems, and other factors beyond our control. Because all Cordyceps Militaris used to produce our Cordyceps products are grown by us, we may not be able to locate in a timely manner any third party suppliers who could provide us with sufficient materials to meet our production needs when our self-supply faces significant fluctuations in the availability of Cordyceps Militaris. Therefore, any interruptions to or decline in the amount or quality of our Cordyceps Militaris supply could materially disrupt our production and adversely affect our business and financial condition and financial prospects.
We rely on contractual arrangements with our VIE Entities for our operations, which may not be as effective in providing control over these entities as direct ownership.
Our operations are dependent on our VIE Entities in which we have no equity ownership interest and must rely on the Contractual Arrangements to control and operate the businesses of the VIE Entities. The Contractual Arrangements may not be as effective in providing control over these entities as direct ownership. For example, if the VIE Entities are unwilling or unable to perform their obligations under the VIE Agreements, including payment of service fees under the Service Agreement as they become due, we will not be able to conduct our operations in the manner currently planned. In addition, the VIE Entities may seek to renew their agreements on terms that are disadvantageous to us. Although we have entered into the VIE Agreements that provide us with substantial ability to control the VIE Entities, we may not succeed in enforcing our rights under them by relying on legal remedies under Chinese law, which may not be adequate. In addition, if we are unable to renew these agreements on favorable terms when these agreements expire, or to enter into similar agreements with other parties, our business may not be able to operate or expand, and our operating expenses may significantly increase.
The principal shareholder of Heilongjiang Shuaiyi has potential conflicts of interest with us, which may adversely affect our business.
Ms. Lianyun Han, our chairman and chief executive officer, is also the principal shareholder of Heilongjiang Shuaiyi. Conflicts of interests between her duties to our company and Heilongjiang Shuaiyi may arise. As Ms. Han is a director and executive officer of our company, she has a duty of loyalty and care to us when there are any potential conflicts of interests between our company and Heilongjiang Shuaiyi. Additionally, Ms. Han has entered into the Voting Rights Agreement with us and executed an irrevocable power of attorney to appoint the person designated by us to be her attorney-in-fact to vote on her behalf on all Heilongjiang Shuaiyi matters requiring shareholder approval. We cannot assure, however, that when conflicts of interest arise, Ms. Han will act completely in our interests or that conflicts of interests will be resolved in our favor. In addition, Ms. Han could violate her employment agreement with us or her legal duties by diverting business opportunities from us to others. In addition, Ms. Han may be able to cause the VIE Agreements to be performed, amended or terminated in a manner adverse to us by, among other things, failing to remit payments to us on a timely basis or operating Heilongjiang Shuaiyi so as to cause harm to our business. If we cannot resolve any conflicts of interest between us and Ms. Han, we would have to rely on legal proceedings, which could result in the disruption of our business.
Our arrangements with the VIE Entities and its shareholders may be subject to a transfer pricing adjustment by the PRC tax authorities which could have an adverse effect on our income and expenses.
We could face material and adverse tax consequences if the PRC tax authorities determine that our agreements with the VIE Entities and its shareholders were not entered into based on arm’s length negotiations. As a result, they may adjust our income and expenses for PRC tax purposes in the form of a transfer pricing adjustment. Such an adjustment may require that we pay additional PRC taxes plus applicable penalties and interest, if any.
The exercise of our option to purchase part or all of the equity interests in the VIE Entities under the Option Agreement might be subject to approval by the PRC government and foreign ownership restrictions on the VIE Entities’ current businesses under PRC laws. Our failure to purchase the equity of the VIE Entities may impair our ability to substantially control the VIE Entities and could result in actions by VIE Entities that conflict with our interests.
Our Option Agreement with the VIE Entities gives our Chinese subsidiary, Harbin Baixin, the option to purchase all or part of the equity interests in the VIE Entities. However, the option may not be exercised by Harbin Baixin if the exercise would violate any applicable laws and regulations in China or cause any license or permit held by, and necessary for the operation of the VIE Entities, to be cancelled or invalidated. Under the laws of China, if a foreign entity, through a foreign investment company that it invests in, acquires a domestic related company, China’s regulations regarding mergers and acquisitions would technically apply to the transaction. Application of these regulations requires an examination and approval of the transaction by China’s Ministry of Commerce, or MOFCOM, or its local counterparts. Also, an appraisal of the equity or assets to be acquired is mandatory. However, our local PRC counsel has advised us that local counterparts of MOFCOM hold the view that such a transaction would not require their approval.
Therefore, we do not believe at this time that an approval and an appraisal are required for Harbin Baixin to exercise its option to acquire the VIE Entities. In light of the different views on this issue, however, it is possible that the central MOFCOM office in Beijing will issue a standardized opinion imposing the approval and appraisal requirement. If we are not able to purchase the equity of the VIE Entities, then we will lose a substantial portion of our ability to control the VIE Entities and our ability to ensure that the VIE Entities will act in our interests.
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, our business may be negatively affected.
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 the Contractual Arrangements with the VIE Entities.
Nutrastar, New Resources, Oriental Global Holdings Limited and Harbin Baixin are considered foreign investors or foreign invested enterprises under PRC law. As a result, Nutrastar, New Resources, Oriental Global Holdings Limited and Harbin Baixin are subject to limitations under PRC law on foreign ownership of Chinese companies. These laws and regulations are relatively new and may be subject to change, and their official 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 also 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 predict the effect of the interpretation of existing or new PRC laws or regulations on our businesses. 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 significantly 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.
Our sales and reputation may be affected by product liability claims, litigation, product recalls, or adverse publicity in relation to our products.
The sale of products for human consumption involves an inherent risk of injury to consumers. We face risks associated with product liability claims, litigation, or product recalls, if our products cause injury, or become adulterated or misbranded. Our products are subject to product tampering, and to contamination risks, such as mold, bacteria, insects, and other pests, and off-flavor contamination during the various stages of the procurement, production, transportation and storage processes. If any of our products were to be tampered with, or become tainted in any of these respects and we were unable to detect this, our products could be subject to product liability claims or product recalls. We cannot predict what impact such product liability claims or resulting negative publicity would have on our business or on our brand image. The successful assertion of product liability claims against us could result in potentially significant monetary damages, diversion of management resources and require us to make significant payments and incur substantial legal expenses. We do not have product liability insurance and have not made provisions for potential product liability claims. Therefore, we may not have adequate resources to satisfy a judgment if a successful claim is brought against us. Even if a product liability claim is not successfully pursued to judgment by a claimant, we may still incur substantial legal expenses defending against such a claim. Finally, serious product quality concerns could result in governmental action against us, which, among other things, could result in the suspension of production or distribution of our products, loss of certain licenses, or other governmental penalties. A widespread product recall could result in significant loss due to the cost of conducting a product recall including destruction of inventory and the loss of sales resulting from the unavailability of the product for a period of time.
In addition product liability claims and product recalls could have a material adverse effect on the demand for our products and on our business goodwill and reputation. Adverse publicity could result in a loss of consumer confidence in our products.
We compete in an industry that is brand-conscious, and unless we are able to establish and maintain brand name recognition our sales may be negatively impacted.
Our business is substantially dependent upon awareness and market acceptance of our products and brand by our targeted consumers. In addition, our business depends on acceptance by our suppliers and consumers of our brand. Although we believe that we have made progress towards establishing market recognition for our brand “帅亿东方神” in the Chinese Golden Grass products industry, it is too early in the product life cycle of the brand to determine whether our products and brand will achieve and maintain satisfactory levels of acceptance by our customers.
We compete in an industry characterized by rapid changes in consumer preferences, so our inability to continue developing new products to satisfy our consumers’ changing preferences would have a material adverse effect on our sales volumes.
Our success depends on our ability to anticipate, gauge and react in a timely and effective manner to changes in consumer spending patterns and product preferences. We must continually work to develop, produce and market new products, maintain and enhance the recognition of our brands, achieve a favorable mix of products, and refine our approach as to how and where we market and sell our products. Through development by our Research and Development team, we introduced the functional beverages featuring the Chinese Golden Grass as a core ingredient in 2010. The beverage products are currently available in select areas in Jiangsu Providence and Anhui Province and in our specialty stores located at Daqing City. We generated 20.0% of our revenues from our functional health beverages in 2011. In 2012, we will be targeting mass consumer markets by introducing additional varieties of specialty beverage products with the health benefits of enhancing immunity, reducing fatigue, enhancing circulations, among other benefits derived from our Cordyceps Militaris. While we have devoted and will continue to devote considerable effort and resources to shape, analyze and respond to consumer preferences by developing new products, consumer spending patterns and preferences cannot be predicted with certainty and can change rapidly. Our failure to adapt our product offering to respond to such changes may result in reduced demand and lower prices for our products, resulting in a material adverse effect on our sales volumes, sales and profits.
Our current market distribution and penetration is limited as compared with the potential market and so our initial views as to customer acceptance of a particular product can be erroneous, and there can be no assurance that true market acceptance will ultimately be achieved. In addition, customer preferences are also affected by factors other than taste. If we do not adjust to respond to these and other changes in customer preferences, our sales may be adversely affected.
Expansion of our business may put added pressure on our management and operational infrastructure impeding our ability to meet any potential increased demand for the products that we sell and possibly hurting our future operating results.
Our business plan is to significantly grow our operations to meet anticipated growth in demand for the products that we sell, and by the introduction of new product offerings. Growth in our business may place a significant strain on our personnel, management, financial systems and other resources. The evolution of our business also presents numerous risks and challenges, including:
our ability to successfully and rapidly expand sales to potential new distributors in response to potentially increasing demand;
the costs associated with such growth, which are difficult to quantify, but could be significant; and
rapid technological change.
To accommodate any such growth and compete effectively, we may need to obtain additional funding to improve information systems, procedures and controls and expand, train, motivate and manage our employees, and such funding may not be available in sufficient quantities, if at all. If we are not able to manage these activities and implement these strategies successfully to expand to meet any increased demand, our operating results could suffer.
Due to our rapid growth in recent years, our past results may not be indicative of our future performance and evaluating our business and prospects may be difficult.
Our business has grown and evolved rapidly in recent years as demonstrated by our growth in net income for the fiscal year ended December 31, 2011 to $17.0 million, from $13.4 million for the fiscal year ended December 31, 2010. We may not be able to achieve similar growth in future periods, and our historical operating results may not provide a meaningful basis for evaluating our business, financial performance and prospects. Moreover, our ability to achieve satisfactory production results at higher volumes is unproven. Therefore, you should not rely on our past results or our historical rate of growth as an indication of our future performance.
We depend heavily on key personnel, and turnover of key employees and senior management could harm our business.
Our future business and results of operations depend in significant part upon the continued contributions of our key technical and senior management personnel, including Lianyun Han, our chief executive officer and chairperson, and Robert Tick, our chief financial officer. The expertise of management and technical innovation of the company give it a strong competitive advantage. We do not maintain key person insurance on these individuals. The loss of any of these key employees’ services or any of our other management poses a risk to our business. We may not be able to attract or retain qualified management on acceptable terms in the future due to the intense competition for qualified personnel in our industry and as a result, our business could be adversely affected.
Our inability to protect our trademarks, patent and trade secrets may prevent us from successfully marketing our products and competing effectively.
Failure to protect our intellectual property could harm our brands and our reputation, and adversely affect our ability to compete effectively. Further, enforcing or defending our intellectual property rights, including our trademarks, patents, copyrights, know how and trade secrets, could result in the expenditure of significant financial and managerial resources. We produce, market and sell our products using the brand “帅亿东方神” We regard our intellectual property, particularly our trademark, know how and trade secrets to be of considerable value and importance to our business and our success. We rely on a combination of patent, trademark, trade secrecy laws, and contractual provisions to protect our intellectual property rights. There can be no assurance that the steps taken by us to protect these proprietary rights will be adequate or that third parties will not infringe or misappropriate our patent, trademark, trade secrets or similar proprietary rights. In addition, there can be no assurance that other parties will not assert infringement claims against us, and we may have to pursue litigation against other parties to assert our rights. Any such claim or litigation could be costly and we may lack the resources required to defend against such claims. In addition, any event that would jeopardize our proprietary rights or any claims of infringement by third parties could have a material adverse affect on our ability to market or sell our brands, and profitably exploit our products.
We may be exposed to potential risks relating to our internal controls over financial reporting.
As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the SEC adopted rules requiring public companies to include a report of management on the company’s internal controls over financial reporting in their annual reports, including Form 10-K. Under current law, we are subject to this requirement beginning with our annual report for the fiscal year ended December 31, 2007. A report of our management is included under Item 9A of this report, in which our management concluded that our internal controls over our financial reporting were effective for the year ended December 31, 2011. However, in the future, our management may conclude that our internal controls over our financial reporting are not effective due to the identification of one or more material weaknesses. In the event we identify significant deficiencies or material weaknesses in our internal controls that we cannot remediate in a timely manner, investors and others may lose confidence in the reliability of our financial statements.
We do not carry any business interruption insurance, third-party liability insurance for our production facilities or insurance that covers the risk of loss of our products in shipment.
Operation of our facilities involves many risks, including equipment failures, natural disasters, industrial accidents, power outages, labor disturbances and other business interruptions. Furthermore, if any of our products are faulty, then we may become subject to product liability claims or we may have to engage in a product recall. We do not carry any business interruption insurance, product recall or third-party liability insurance for our production facilities or with respect to our products to cover claims pertaining to personal injury or property or environmental damage arising from defects in our products, product recalls, accidents on our property or damage relating to our operations. As a result, we may be required to pay for financial and other losses, damages and liabilities, including those caused by natural disasters and other events beyond our control, out of our own funds, which could have a material adverse effect on our business, financial condition and results of operations.
We may be exposed to liabilities under the Foreign Corrupt Practices Act, and any determination that we violated the Foreign Corrupt Practices Act could have a material adverse effect on our business.
We are subject to the Foreign Corrupt Practice Act, or the FCPA, and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the statute for the purpose of obtaining or retaining business. We have operations, agreements with third parties and make sales in China, which may experience corruption. Our activities in China create the risk of unauthorized payments or offers of payments by one of the employees, consultants, sales agents or distributors of our company, because these parties are not always subject to our control. It is our policy to implement safeguards to discourage these practices by our employees. However, our existing safeguards and any future improvements may prove to be less than effective, and the employees, consultants, sales agents or distributors of our Company may engage in conduct for which we might be held responsible. Violations of the FCPA may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition. In addition, the government may seek to hold our Company liable for successor liability FCPA violations committed by companies in which we invest or that we acquire.
If we become directly subject to the recent scrutiny, criticism and negative publicity involving U.S.-listed Chinese companies, we may have to expend significant resources to investigate and resolve the matter which could harm our business operations, stock price and reputation and could result in a loss of your investment in our stock, especially if such matter cannot be addressed and resolved favorably.
Recently, U.S. public companies that have substantially all of their operations in China, particularly companies like us which have completed so-called reverse merger transactions, have been the subject of intense scrutiny, criticism and negative publicity by investors, financial commentators and regulatory agencies, such as the SEC. Much of the scrutiny, criticism and negative publicity has centered around financial and accounting irregularities and mistakes, a lack of effective internal controls over financial accounting, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result of the scrutiny, criticism and negative publicity, the publicly traded stock of many U.S. listed Chinese companies has sharply decreased in value and, in some cases, has become virtually worthless. Many of these companies are now subject to shareholder lawsuits and SEC enforcement actions, and are conducting internal and external investigations into the allegations. It is not clear what effect this sector-wide scrutiny, criticism and negative publicity will have on our Company, our business and our stock price. If we become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we will have to expend significant resources to investigate such allegations and/or defend our company. This situation will be costly and time consuming and distract our management from growing our company. If such allegations are not proven to be groundless, our company and business operations will be severely and your investment in our stock could be rendered worthless.
The disclosures in our reports and other filings with the SEC and our other public pronouncements are not subject to the scrutiny of any regulatory bodies in the PRC. Accordingly, our public disclosure should be reviewed in light of the fact that no governmental agency that is located in China where substantially all of our operations and business are located have conducted any due diligence on our operations or reviewed or cleared any of our disclosure.
We are regulated by the SEC and our reports and other filings with the SEC are subject to SEC review in accordance with the rules and regulations promulgated by the SEC under the Securities Act and the Exchange Act. Unlike public reporting companies whose operations are located primarily in the United States, however, substantially all of our operations are located in China. Since substantially all of our operations and business take place in China, it may be more difficult for the Staff of the SEC to overcome the geographic and cultural obstacles that are present when reviewing our disclosure. These same obstacles are not present for similar companies whose operations or business take place entirely or primarily in the United States. Furthermore, our SEC reports and other disclosure and public pronouncements are not subject to the review or scrutiny of any PRC regulatory authority. For example, the disclosure in our SEC reports and other filings are not subject to the review of China Securities Regulatory Commission, a PRC regulator that is tasked with oversight of the capital markets in China. Accordingly, you should review our SEC reports, filings and our other public pronouncements with the understanding that no local regulator has done any due diligence on our company and with the understanding that none of our SEC reports, other filings or any of our other public pronouncements has been reviewed or otherwise been scrutinized by any local regulator.
There are limitations on the liability of our directors, and we may have to indemnify our officers and directors in certain instances.
Our bylaws provide that we will indemnify our officers and directors and may indemnify our employees and other agents. We may also have contractual indemnification obligations under our agreements with our executive officers and directors. The foregoing indemnification obligations could result in us incurring substantial expenditures to cover the cost of settlement or damage awards against directors and officers, which we may be unable to recoup. These provisions and resultant costs may also discourage us from bringing a lawsuit against directors and officers for breaches of their fiduciary duties and may similarly discourage the filing of derivative litigation by our stockholders against our directors and officers even though such actions, if successful, might otherwise benefit us and our stockholders.
RISKS RELATED TO DOING BUSINESS IN CHINA
Adverse changes in political and economic policies of the PRC government could impede the overall economic growth of China, which could reduce the demand for our products and damage our business.
We conduct substantially all of our operations and generate all of our revenue in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The PRC economy differs from the economies of most developed countries in many respects, including:
a higher level of government involvement;
a early stage of development of the market-oriented sector of the economy;
a rapid growth rate;
a higher level of control over foreign exchange; and
the allocation of resources.
As the PRC economy has been transitioning from a planned economy to a more market-oriented economy, the PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. While these measures may benefit the overall PRC economy, they may also have a negative effect on us.
Although the PRC government has in recent years implemented measures emphasizing the utilization of market forces for economic reform, the PRC government continues to exercise significant control over economic growth in China through the allocation of resources, controlling the payment of foreign currency-denominated obligations, setting monetary policy and imposing policies that impact particular industries or companies in different ways.
Any adverse change in economic conditions or government policies in China could have a material adverse effect on the overall economic growth in China, which in turn could lead to a reduction in demand for our services and consequently have a material adverse effect on our business and prospects.
Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.
We conduct substantially all of our business through our subsidiaries and VIE Entities in the PRC, which are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to foreign-invested enterprises. The PRC legal system is based on written statutes, and prior court decisions may be cited for reference but have limited precedential value. Since 1979, a series of new PRC laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit legal protections available to you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. In addition, most of our executive officers and directors are residents of China and not of the United States, and most of the assets of these persons are located outside the United States. As a result, it could be difficult for investors to affect service of process in the United States or to enforce a judgment obtained in the United States against our Chinese operations and PRC entities.
If we are found to have failed to comply with applicable laws, we may incur additional expenditures or be subject to significant fines and penalties.
Our operations are subject to PRC laws and regulations applicable to us. However, many PRC laws and regulations are uncertain in their scope, and the implementation of such laws and regulations in different localities could have significant differences. In certain instances, local implementation rules and/or the actual implementation are not necessarily consistent with the regulations at the national level. Although we strive to comply with all the applicable PRC laws and regulations, we cannot assure you that the relevant PRC government authorities will not later determine that we have not been in compliance with certain laws or regulations. Our failure to comply with applicable PRC laws and regulations could subject us to administrative penalties and injunctive relief, as well as civil remedies, including fines, injunctions and recalls of our products. It is possible that changes to such laws or more rigorous enforcement of such laws or with respect to our current or past practices could have a material adverse effect on our business, operating results and financial condition.
The PRC government exerts substantial influence over the manner in which we must conduct our business activities.
The PRC government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of the jurisdictions in which we operate may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.
Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.
Restrictions on currency exchange may limit our ability to receive and use our sales revenue effectively.
All our sales revenue and expenses are denominated in RMB. Under PRC law, the RMB is currently convertible under the “current account,” which includes dividends and trade and service-related foreign exchange transactions, but not under the “capital account,” which includes foreign direct investment and loans. Currently, our PRC subsidiaries and VIE Entities may purchase foreign currencies for settlement of current account transactions, including payments of dividends to us, without the approval of the State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. However, the relevant PRC government authorities may limit or eliminate our ability to purchase foreign currencies in the future. Since a significant amount of our future revenue will be denominated in RMB, any existing and future restrictions on currency exchange may limit our ability to utilize revenue generated in RMB to fund our business activities outside China that are denominated in foreign currencies.
Foreign exchange transactions by our PRC subsidiaries and VIE Entities under the capital account continue to be subject to significant foreign exchange controls and require the approval of or need to register with PRC government authorities, including SAFE. In particular, if our PRC entities borrow foreign currency through loans from us or other foreign lenders, these loans must be registered with SAFE, and if we finance our PRC entities by means of additional capital contributions, these capital contributions must be approved by certain government authorities, including the MOFCOM, or their respective local counterparts. These limitations could affect their ability to obtain foreign exchange through debt or equity financing.
Fluctuations in exchange rates could adversely affect our business and the value of our securities.
The value of our common stock will be indirectly affected by the foreign exchange rate between U.S. dollars and RMB and between those currencies and other currencies in which our sales may be denominated. Appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue in the future as well as earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.
Since July 2005, the RMB has no longer been pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.
Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.
We rely principally on dividends paid by our operating subsidiary to fund cash and financing requirements, and limitations on the ability of our operating subsidiary to make payments to us could have a material adverse effect on our ability to conduct our business and fund our operations.
We are a holding company and conduct substantially all of our business through our operating subsidiary and affiliated VIE Entities, which are limited liability companies established in China. We rely principally on dividends paid by our subsidiary for our cash needs, including the funds necessary to pay dividends and other cash distributions to our shareholders, to service any debt we may incur and to pay our operating expenses. The payment of dividends by entities organized in China is subject to limitations. In particular, regulations in China currently permit payment of dividends only out of accumulated profits as determined in accordance with PRC accounting standards and regulations. Our PRC subsidiary, Harbin Baixin, is also required to set aside at least 10% of its after-tax profit based on PRC accounting standards each year to its general reserves until the accumulative amount of such reserves reaches 50% of its registered capital. These reserves are not distributable as cash dividends. In addition, it is required to allocate a portion of its after-tax profit to its staff welfare and bonus fund at the discretion of its board of directors. Moreover, if Harbin Baixin incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us. Any limitation on the ability of Harbin Baixin to distribute dividends and other distributions to us could materially and adversely limit our ability to make investments or acquisitions that could be beneficial to our businesses, pay dividends or otherwise fund and conduct our business.
Under the New EIT Law, we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.
China passed a new Enterprise Income Tax Law, or the New EIT Law, and its implementation regulations, both of which became effective on January 1, 2008. Under the New EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese domestic enterprise for enterprise income tax purposes. The implementing rules of the New EIT Law define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise. On April 22, 2009, the State Administration of Taxation issued the Notice Concerning Relevant Issues Regarding Cognizance of Chinese Investment Controlled Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria of de facto Management Bodies, or the Notice, further interpreting the application of the New EIT Law and its implementation with respect to non-Chinese enterprises or group controlled offshore entities. Pursuant to the Notice, an enterprise incorporated in an offshore jurisdiction and controlled by a Chinese enterprise or group will be classified as a “non-domestically incorporated resident enterprise” if (i) its senior management in charge of daily operations reside or perform their duties mainly in China; (ii) its financial or personnel decisions are made or approved by bodies or persons in China; (iii) substantial assets and properties, accounting books, corporate chops, board and shareholder minutes are kept in China; and (iv) at least half of its directors with voting rights or senior management often reside in China. A resident enterprise would be generally subject to the uniform 25% enterprise income tax rate as to its worldwide income. Substantially all of our management is currently based in China. Therefore, we may be treated as a Chinese resident enterprise for enterprise income tax purposes. The tax consequences of such treatment are currently unclear, as they will depend on how local tax authorities apply or enforce the New EIT Law or the implementation regulations.
In addition, under the New EIT Law and implementation regulations, the PRC income tax at the rate of 10% is applicable to dividends payable to investors that are “non-resident enterprises” (and that do not have an establishment or place of business in the PRC, or that have such establishment or place of business but the relevant income is not effectively connected with the establishment or place of business) to the extent that such dividends have their source within the PRC unless there is an applicable tax treaty between the PRC and the jurisdiction in which an overseas holder resides which reduces or exempts the relevant tax. Similarly, any gain realized on the transfer of shares by such investors is also subject to the 10% PRC income tax if such gain is regarded as income derived from sources within the PRC. If we are considered a PRC “resident enterprise”, it is unclear whether the dividends we pay with respect to our shares, or the gain you may realize from the transfer of our shares, would be treated as income derived from sources within the PRC and be subject to PRC tax. If we are required under the New EIT Law to withhold PRC income tax on our dividends payable to our foreign shareholders, or if you are required to pay PRC income tax on the transfer of your shares, the value of your investment in our shares may be materially and adversely affected.
We face uncertainty from China’s Circular on Strengthening the Administration of Enterprise Income Tax on Non-Resident Enterprises’ Share Transfer, or Circular 698, that was released in December 2009 with retroactive effect from January 1, 2008.
The Chinese State Administration of Taxation (SAT) released a circular (Guoshuihan No. 698 - Circular 698) on December 15, 2009 that addresses the transfer of shares by nonresident companies. Circular 698, which is effective retroactively to January 1, 2008, may have a significant impact on many companies that use offshore holding companies to invest in China. Circular 698, which provides parties with a short period of time to comply with its requirements, indirectly taxes foreign companies on gains derived from the indirect sale of a Chinese company. Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise by selling the shares in an offshore holding company, and the latter is located in a country or jurisdiction where the effective tax burden is less than 12.5% or where the offshore income of his, her, or its residents is not taxable, the foreign investor is required to provide the tax authority in charge of that Chinese resident enterprise with the relevant information within 30 days of the transfers. Moreover, where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise through an abuse of form of organization and there are no reasonable commercial purposes such that the corporate income tax liability is avoided, the PRC tax authority will have the power to re-assess the nature of the equity transfer in accordance with PRC’s “substance-over-form” principle and deny the existence of the offshore holding company that is used for tax planning purposes. There is uncertainty as to the application of Circular 698. For example, while the term "indirectly transfer" is not defined, it is understood that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. Moreover, the relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax in the country or jurisdiction and to what extent and the process of the disclosure to the tax authority in charge of that Chinese resident enterprise. In addition, there are not any formal declarations with regard to how to decide “abuse of form of organization” and “reasonable commercial purpose,” which can be utilized by us to balance if our Company complies with the Circular 698. As a result, we may become at risk of being taxed under Circular 698 and we may be required to expend valuable resources to comply with Circular 698 or to establish that we should not be taxed under Circular 698, which could have a material adverse effect on our financial condition and results of operations.
If the China Securities Regulatory Commission, or CSRC, or another PRC regulatory agency determines that CSRC approval is required in connection with the reverse acquisition of New Resources, the reverse acquisition may be unwound, or we may become subject to penalties.
On August 8, 2006, six PRC regulatory agencies, including the CSRC, promulgated the Provisions Regarding Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rule, which became effective on September 8, 2006. The M&A Rule, among other things, requires that an offshore company controlled by PRC companies or individuals that have acquired a PRC domestic company for the purpose of listing the PRC domestic company’s equity interest on an overseas stock exchange must obtain the approval of the CSRC prior to the listing and trading of such offshore company’s securities on an overseas stock exchange. On September 21, 2006, the CSRC, pursuant to the M&A Rule, published on its official web site procedures specifying documents and materials required to be submitted to it by offshore companies seeking CSRC approval of their overseas listings.
We do not believe that the M&A Rule concerning the CSRC approval for acquisition of a PRC domestic company by an offshore company controlled by PRC companies or individuals applies to our reverse acquisition of New Resources because neither Nutrastar International Inc. nor New Resources was a “Special Purpose Vehicle” or an “offshore company controlled by PRC companies or individuals” as defined in the M&A Rule. If the CSRC or another PRC governmental agency subsequently determines that we must obtain CSRC approval prior to the completion of the reverse acquisition, the reverse acquisition may be unwound and we may face regulatory actions or other sanctions from the CSRC or other PRC regulatory agencies. These regulatory agencies may impose fines and penalties on our operations in China and limit our operating privileges in China, or take other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our shares.
The M&A Rule establishes more complex procedures for some acquisitions of Chinese companies by foreign investors, which could make it more difficult for us to pursue growth through acquisitions in China.
The M&A Rule establishes additional procedures and requirements that could make some acquisitions of Chinese companies by foreign investors more time-consuming and complex, including requirements in some instances that the PRC Ministry of Commerce be notified in advance of any change-of-control transaction and in some situations, require approval of the PRC Ministry of Commerce when a foreign investor takes control of a Chinese domestic enterprise. In the future, we may grow our business in part by acquiring complementary businesses, although we do not have any plans to do so at this time. The M&A Rule also requires PRC Ministry of Commerce anti-trust review of any change-of-control transactions involving certain types of foreign acquirers. Complying with the requirements of the M&A Rule to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval from the PRC Ministry of Commerce, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.
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 our PRC entities, limit our PRC entities’ ability to increase their 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. 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 onshore 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. Moreover, Notice 75 applies retroactively. As a result, PRC residents who have established or acquired control of offshore companies that have made onshore investments in the PRC in the past were required to complete the relevant registration procedures with the local SAFE branch by March 31, 2006.
We have requested our shareholders who are PRC residents to make the necessary applications, filings and amendments as required under Notice 75 and other related rules. We attempt to comply, and attempt to ensure that our shareholders who are subject to these rules comply, with the relevant requirements. However, we cannot provide any assurances that all of our shareholders who are PRC residents will comply with our request to make or obtain any applicable registrations or comply with other requirements required by Notice 75 or other related rules. 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 the subsidiaries and VIE Entities, limit their ability to pay dividends or otherwise distribute profits to us, or otherwise adversely affect us.
Failure to comply with PRC regulations in respect of the registration of our PRC citizen employees’ shares or share options may subject such employees or us to fines and legal or administrative sanctions.
Pursuant to the Implementation Rules of the Administration Measure for Individual Foreign Exchange issued by SAFE on January 5, 2007 and Operation Rules on the Foreign Exchange Administration of the Participation of Domestic Individuals in Overseas Listed Companies’ Employee Stock Ownership Plans and Share Option Schemes issued by SAFE on March 28, 2007, PRC citizens who are granted shares or share options by an overseas listed company under its employee share option or share incentive plan are required, through the PRC subsidiary of such overseas listed company or other qualified PRC agents, to register with SAFE and complete certain other procedures related to the share option or other share incentive plan. Foreign exchange income from the sale of shares or dividends distributed by the overseas listed company may be remitted into a foreign currency account of such PRC citizen or be exchanged into RMB. In addition, the overseas listed company or its PRC subsidiary or other qualified PRC agent is required to appoint an asset manager or administrator, appoint a custodian bank and open dedicated foreign currency accounts to handle transactions relating to the share option scheme or other share incentive plan. We and our PRC employees who have been granted stock options are subject to this rule. We cannot assure you that we and our PRC optionees will complete such registration procedures in a timely manner, or at all. If we or our PRC optionees fail to comply with these regulations, we or our PRC optionees may be subject to fines and legal sanctions, which could have a material adverse effect on our business and results.
The implementation of the new PRC employment contract law and increases in the labor costs in China may hurt our business and profitability.
A new employment contract law became effective on January 1, 2008 in China. It imposes more stringent requirements on employers in relation to entry into fixed-term employment contracts, recruitment of temporary employees and dismissal of employees. In addition, under the newly promulgated Regulations on Paid Annual Leave for Employees, which also became effective on January 1, 2008, employees who have worked continuously for more than one year are entitled to paid vacation ranging from 5 to 15 days, depending on the length of the employee’s service. Employees who waive such vacation entitlements at the request of the employer will be compensated for three times their normal daily salaries for each vacation day so waived. As a result of the new law and regulations, our labor costs may increase. There is no assurance that disputes, work stoppages or strikes will not arise in the future. Increases in the labor costs or future disputes with our employees could damage our business, financial condition or operating results.
Our failure to pay social insurance and housing accumulation fund for all of our employees may expose us to relevant administrative penalties.
The PRC laws and regulations require all employers in China to fully contribute their own portion of the social insurance premium and housing accumulation fund for their employees within a certain period of time. Failure to do so may expose the employers to make rectification for the accrued premium and fund by the relevant labor authority. We have failed to fully contribute the social insurance premium and housing accumulation fund. As a result, we may be in violation of applicable PRC labor laws and we cannot assure you that PRC governmental authorities will not impose penalties on us for failure to comply. In addition, in the event that any current or former employee files a complaint with the PRC government, we may be subject to making up the social insurance and housing accumulation fund payment obligations as well as paying administrative fines.
Any recurrence of the Swine Flu (H1N1), severe acute respiratory syndrome, or SARS, the Avian Flu, or another widespread public health problem in the PRC could adversely affect our operations.
At times throughout the past decade, there have been recent outbreaks of the highly pathogenic Swine Flu, caused by the H1N1 virus, in certain regions of the world, including parts of China, where all of our manufacturing facilities are located and where all of our sales occur. Our business is dependent upon our ability to continue to manufacture and distribute our products, and an outbreak of the Swine Flu, or a renewed outbreak of SARS, the Avian Flu, or another widespread public health problem in China, could have a negative effect on our operations. Any such outbreak could have an impact on our operations as a result of:
quarantines or closures of our manufacturing or distribution facilities or the retail outlets, which would severely disrupt our operations,
the sickness or death of our key officers and employees, and
a general slowdown in the Chinese economy.
You may have difficulty enforcing judgments against us.
We are a Nevada holding company and most of our assets are located outside of the United States. Most of our current operations are conducted in the PRC. In addition, most of our directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons is located outside the United States. As a result, it may be difficult for you to effect service of process within the United States upon these persons. It may also be difficult for you to enforce in U.S. courts judgments on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors, most of whom are not residents in the United States and the substantial majority of whose assets are located outside of the United States. In addition, there is uncertainty as to whether the courts of the PRC would recognize or enforce judgments of U.S. courts. Courts in China may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions. China does not have any treaties or other arrangements that provide for the reciprocal recognition and enforcement of foreign judgments within the United States. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates basic principles of PRC law or national sovereignty, security or the public interest. So it is uncertain whether a PRC court would enforce a judgment rendered by a court in the United States.
RISKS RELATED TO THE MARKET FOR OUR STOCK GENERALLY
Our common stock is quoted on the OTC Bulletin Board which may have an unfavorable impact on our stock price and liquidity.
Our common stock is quoted on the OTC Bulletin Board. The OTC Bulletin Board is a significantly more limited market than the New York Stock Exchange or Nasdaq system. The quotation of our shares on the OTC Bulletin Board may result in a less liquid market available for existing and potential stockholders to trade shares of our common stock, could depress the trading price of our common stock and could have a long-term adverse impact on our ability to raise capital in the future.
The market price of our common stock is volatile, leading to the possibility of its value being depressed at a time when you may want to sell your holdings.
The market price of our common stock is volatile, and this volatility may continue. Numerous factors, many of which are beyond our control, may cause the market price of our common stock to fluctuate significantly. In addition to market and industry factors, the price and trading volume for our common stock may be highly volatile for specific business reasons. Factors such as variations in our revenues, earnings and cash flow, announcements of new investments, cooperation arrangements or acquisitions, and fluctuations in market prices for our products could cause the market price for our shares to change substantially.
Securities class action litigation is often instituted against companies following periods of volatility in their stock price. This type of litigation could result in substantial costs to us and divert our management’s attention and resources.
Moreover, the trading market for our common stock will be influenced by research or reports that industry or securities analysts publish about us or our business. If one or more analysts who cover us downgrade our common stock, the market price for our common stock would likely decline. If one or more of these analysts cease coverage of us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which, in turn, could cause the market price for our common stock or trading volume to decline.
Furthermore, securities markets may from time to time experience significant price and volume fluctuations for reasons unrelated to operating performance of particular companies. These market fluctuations may adversely affect the price of our common stock and other interests in our company at a time when you want to sell your interest in us.
We are subject to penny stock regulations and restrictions and you may have difficulty selling shares of our common stock.
The SEC has adopted regulations which generally define so-called “penny stocks” to be an equity security that has a market price less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exemptions. Our common stock is considered as a “penny stock” and we are subject to Rule 15g-9 under the Exchange Act, or the Penny Stock Rule. This rule imposes additional sales practice requirements on broker-dealers that sell such securities to persons other than established customers and “accredited investors” (generally, individuals with a net worth in excess of $1,000,000 or annual incomes exceeding $200,000, or $300,000 together with their spouses). For transactions covered by Rule 15g-9, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to sale. As a result, this rule may affect the ability of broker-dealers to sell our securities and may affect the ability of purchasers to sell any of our securities in the secondary market.
For any transaction involving a penny stock, unless exempt, the rules require delivery, prior to any transaction in penny stock, of a disclosure schedule prepared by the SEC relating to the penny stock market. Disclosure is also required to be made about sales commissions payable to both the broker-dealer and the registered representative and current quotations for the securities. Finally, monthly statements are required to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stock.
There can be no assurance that our common stock will qualify for exemption from the Penny Stock Rule. In any event, even if our common stock were exempt from the Penny Stock Rule, we would remain subject to Section 15(b)(6) of the Exchange Act, which gives the SEC the authority to restrict any person from participating in a distribution of penny stock, if the SEC finds that such a restriction would be in the public interest.
Certain provisions of our Articles of Incorporation may make it more difficult for a third party to effect a change-of-control.
Our Articles of Incorporation authorizes our board of directors to issue up to 1,000,000 shares of preferred stock. The preferred stock may be issued in one or more series, the terms of which may be determined at the time of issuance by the board of directors without further action by the stockholders. These terms may include preferences as to dividends and liquidation, conversion rights, redemption rights and sinking fund provisions. The issuance of any preferred stock could diminish the rights of holders of our common stock, and therefore could reduce the value of such common stock. In addition, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with, or sell assets to, a third party. The ability of our board of directors to issue preferred stock could make it more difficult, delay, discourage, prevent or make it more costly to acquire or effect a change-in-control, which in turn could prevent our stockholders from recognizing a gain in the event that a favorable offer is extended and could materially and negatively affect the market price of our common stock. In connection with our private placement transaction in June 2010, we filed the 2010 Certificate with the State of Nevada, pursuant to which we authorized 300,000 shares of Series A Preferred Stock and issued 197,706 shares of Series A Preferred Stock to the investors.
The conversion of preferred stock or exercise of warrants we issued in our previous private placements may result in dilution to the holders of our common stock and cause the price of our common stock to decline.
Dilution of the per share value of our common stock could result from the conversion of our outstanding Series A Preferred Stock issued to the investors in the recent private placement and the exercise of outstanding warrants that we issued in connection with our previous private placement transactions. As of March 26, 2012, there were 147,820 shares of our Series A Preferred Stock outstanding, which may be converted into our common stock at the option of the holders of the Series A Preferred Stock in whole or in part at any time at an initial conversion ratio of 1-for-10. In addition, as of March 26, 2012, there were outstanding warrants to purchase 1,628,041 shares of our common stock. When the conversion price of the Series A Preferred Stock or the exercise price of the warrants is less than the trading price of our common stock, the conversion of Series A Preferred Stock or the exercise of the warrants would have a dilutive effect on our shareholders. The possibility of the issuance of shares of our common stock upon the conversion of Series A Preferred Stock or exercise of the warrants could cause the trading price of our common stock to decline as well.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not Applicable.
ITEM 2.
ITEM 2. PROPERTIES.
All land in China is owned by the State or collectives. Individuals and companies are permitted to acquire land use rights for general or specific purposes. In the case when land is used for industrial purposes, the land use rights are granted for a period of 50 years. The rights may be renewed at the expiration of the initial and any subsequent terms according to the relevant Chinese laws. Granted land use rights are transferable and may be used as security for borrowings and other obligations.
Our primary production facility is located in Daqing, Heilongjiang Province, which started production in 2006. The facility consists of nine factory buildings and is located on a 410,000 square meter tract where we have leased the land use rights for twenty years from Heilongjiang Shuaiyi Technology Development Co., Ltd (“Shuaiyi Technology”). Shuaiyi Technology and our company are under common control and management.
We currently have one main operating production line and thirteen supplemental production lines of Cordyceps Militaris with an aggregate processing capacity of 72 tons annually.
To meet the expected growth of our business and to broaden our product portfolio, we are in the process of expanding our designed annual production capacity to 87 tons by adding three additional production facilities to produce Cordyceps Militaris. By the end of 2011, the constructions of these new production facilities have been completed and we expect that these new facilities will start operating in 2012.
Harbin Shuaiyi entered into a premise lease agreement with a PRC individual, Liye Qian, on December 28, 2005, pursuant to which Harbin Shuaiyi leased the premise located at 2nd Floor, 2nd Building, No. 41 Xiangdian Street, Xiangfang District, Harbin with an area of 2,400 square meters. The lease term was from January 1, 2006 to December 31, 2010. Harbin Shuaiyi used the facility as an exhibit center for our more than 800 green foods. We paid a monthly rent of RMB 13,000 approximately $1,625) for using this facility. On October 1, 2010, as Harbin Shuaiyi’s legal representative, Xinjun Li entered into a lease agreement with Qingling Zhang, pursuant to which, Harbin Shuaiyi leased the premise located at No. 8, F Suite, Yueshan International Building, Harbin Development Zone with an area of 262.11 square meters. The lease term is from October 1, 2010 to October 1, 2013. We use the facility as an exhibit center for our organic and specialty food products. We paid an annual rent of RMB 240,000 (approximately $38,100) for the first year and such rent increases by 10% annually thereafter. As a result of this new lease agreement, we terminated our lease agreement with Liye Qian.
On April 15, 2011, Heilongjiang Shuaiyi entered into an asset transfer agreement or the Transfer Agreement with Ms. Han. Pursuant to the Transfer Agreement, Heilongjiang Shuiayi acquired an office building located at 54-1 Ganshui Road, Xiangfang District, Harbin, with a construction area of 1,854.1 square meters, from Ms. Han at a cash consideration of RMB 12.75 million (approximately $1.95 million including other incidental costs), which was fully paid in April 2011. The purchase price was determined based on a real property valuation report issued by an independent appraisal firm, Harbin Guoxin Real Estate Appraisal and Consulting Co., Limited on November 11, 2010. Management believes the terms of the purchase transactions and the consideration that the Company paid in connection with this transaction were comparable to the terms available and the amounts that would be paid in an arm’s-length transaction. Management intends to move the corporate headquarters in China to this new office building in 2012.
We believe that all our properties have been adequately maintained, are generally in good condition, and are suitable and adequate for our business.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business. We are currently not aware of any such legal proceedings or claims that we believe will have a material adverse affect on our business, financial condition or operating results.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
Our common stock is quoted under the symbol “NUIN.OB” on the OTC Bulletin Board but has not been traded on the OTC Bulletin Board except on a limited and sporadic basis. The CUSIP number is 67060M 107.
The following table sets forth, for the periods indicated, the high and low closing prices of our common stock. These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions. These prices have been adjusted to give retroactive effect to the 1-for-114.59 reverse split of our common stock that occurred on May 19, 2009.
(1) The above table sets forth the range of high and low closing bid prices per share of our common stock as reported by www.quotemedia.com for the periods indicated.
Approximate Number of Holders of Our Common Stock
As of March 26, 2012, there were approximately 345 holders of record of our common stock. This number excludes the shares of our common stock owned by stockholders holding stock under nominee security position listings.
Dividends
We have never declared or paid a cash dividend. Any future decisions regarding dividends will be made by our board of directors. We currently intend to retain and use any future earnings for the development and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. Our board of directors has complete discretion on whether to pay dividends, subject to the approval of our stockholders. Even if our board of directors decides to pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant.
Securities Authorized for Issuance Under Equity Compensation Plans
See Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters - Securities Authorized for Issuance Under Equity Compensation Plans.”
Recent Sales of Unregistered Securities
We have not sold any equity securities during the fiscal year ended December 31, 2011 that were not previously disclosed in a quarterly report on Form 10-Q or a current report on Form 8-K that was filed during the 2011 fiscal year.
Purchases of Equity Securities
On August 24, 2011, the Board of Directors of the Company authorized a repurchase of up to $5 million of the Company’s common stock over twelve (12) months pursuant to a stock repurchase program, or the Repurchase Program. Under the terms of the Repurchase Program, the Company may repurchase shares through open market, negotiated private or block transactions. The Repurchase Program does not obligate the Company to repurchase any dollar amount or number of shares of its common stock, and the program may be extended, modified, suspended or discontinued at any time. The following table provides information relating to the Company’s repurchases of common stock during the fourth quarter of the fiscal year ended December 31, 2011.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
Not Applicable.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following management’s discussion and analysis should be read in conjunction with our financial statements and the notes thereto and the other financial information appearing elsewhere in this report. In addition to historical information, the following discussion contains certain forward-looking information. See “Special Note Regarding Forward Looking Statements” above for certain information concerning those forward looking statements.
Overview
We are a leading China based producer and supplier of premium branded Traditional Chinese Medicine consumer products including commercially cultivated Cordyceps Militaris, organic and specialty food products and functional health beverages.
Our primary product is commercially cultivated Cordyceps Militaris, which is developed from wild strains of Cordyceps Militaris. We sell our products through an extensive nationwide sales and distribution network covering six provinces and ten cities in China. Our Cordyceps Militaris products are grown and processed by Daqing Shuiayi, and are mainly sold to pharmaceutical companies which are further processed into drugs and nutraceutical products or sold directly to consumers in the form of raw material or incorporated into our beverage products. We generated 74.1% and 90.9% of our revenues from Cordyceps Militaris for fiscal years 2011 and 2010, respectively. We believe that we own approximately 19% of the market share in the entire cultivated Cordyceps Militaris industry in China.
We also sell organic and specialty food products through our VIE Entity, Harbin Shuaiyi, which was formed in 2001. After years of development, we believe that we have become the largest wholesale distributor of organic and specialty food in Heilongjiang Province, China.
We introduced the Cordyceps functional health beverages in the fourth quarter of 2010. The non-carbonized beverage products were developed internally and contain the Cordyceps Militaris as a key ingredient. The products are currently being marketed directly to consumers in select cities in Jiangsu and Anhui Province through various distribution channels. We generated 20.0% and 1.8% of our revenues from Cordyceps functional health beverages for fiscal years 2011 and 2010, respectively. The functional health beverages are in the initial commercialization cycle in the Chinese consumer market.
Our sales revenue grew by 41.1% in the fiscal year ended December 31, 2011 to approximately $34.21 million, from approximately $24.24 million for 2010. Our gross margin for 2011 was 75.9%, as compared to 80.9% for 2010.
Industry Wide Factors that are Relevant to Our Business
We expect several key demographic, healthcare, and lifestyle trends to drive the growth of our business in the coming future:
Increased Focus on Healthy Living: Our management believes that as China becomes more affluent, its citizens are becoming more health conscious. They are leading more active lifestyles and becoming increasingly focused on healthy living, nutrition, and supplementation. According to the Nutrition Business Journal, a higher percentage of today’s global population is involved to some degree in health and wellness than a few years ago. We believe that growth in the health supplements industry will continue to be driven by consumers who increasingly embrace health and wellness as a critical part of their lifestyles.
Aging Population: The average age of the Chinese population is increasing. According to World Population Prospects: The 2004 Revision (2005), the percentage of elderly persons in China is projected to triple between 2006 and 2050, from 8 percent to 24 percent, a total of 322 million people. We believe that these consumers are significantly more likely to use health supplements than younger persons and have higher levels of disposable income to pursue healthy lifestyles.
Rising Healthcare Costs and Use of Preventive Measures: Healthcare related costs have increased substantially in China. A research released by Chinese Academy of Social Sciences in 2007 indicated that the out-of-pocket health expenditures in China increased by 1,900% from 1990 to 2004. To reduce medical costs and avoid the complexities of dealing with the healthcare system, and given increasing incidence of medical problems and concern over the use and effects of prescription drugs, many consumers take preventive measures, including alternative medicines and nutritional supplements.
Taxation
United States
Nutrastar International Inc. is subject to United States tax at a tax rate of 34%. No provision for income taxes in the United States has been made as Nutrastar International Inc. had no income taxable in the United States.
British Virgin Islands
New Resources was incorporated in the BVI. Under the current law of the BVI, New Resources is not subject to income or capital gains tax. In addition, dividend payments are not subject to withholding tax in the BVI.
PRC
In 2007, the PRC government promulgated the New EIT Law, and the relevant implementation rules, which became effective on January 1, 2008. Under the New EIT Law and its implementation rules, all domestic and foreign investment companies will be subject to a uniform enterprise income tax at the rate of 25%. As a result, our PRC subsidiaries and VIE Entities are subject to enterprise income tax at the rates of 25% in 2009, 2010 and 2011 except for Daqing Shuaiyi which continued to be entitled to a preferential tax treatment and was subject to a reduced EIT rate of 12.5% in 2009 and 2010.
Under the New EIT Law, dividends from PRC subsidiaries to their non-PRC shareholders will be subject to a withholding tax at a rate of 20%, which is further reduced to 10% by the implementation rules, if the non-PRC shareholder is considered to be a non-PRC tax resident enterprise without any establishment or place within China or if the dividends payable has no connection with the non-PRC shareholder’s establishment or place within China, unless any such non-PRC shareholder’s jurisdiction of incorporation has a tax treaty with China that provides for a different withholding arrangement.
In addition, pursuant to the New EIT Law, enterprises established under the laws of non-PRC jurisdictions, but whose “de facto management body” is located in the PRC, should be treated as resident enterprises for PRC tax purposes. However, it is currently uncertain whether we may be deemed a resident enterprise, or how to interpret whether any income or gain is derived from sources within China. See Item 1A, “Risk Factors - Under the New EIT Law, we may be classified as a ‘resident enterprise’ of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.” If we, as a Nevada company with substantially all of our management located in China, were treated as a resident enterprise for PRC tax purposes, we will be subject to PRC tax on our worldwide income at the 25% uniform tax rate, which would have an impact on our effective tax rate.
Business Segment Information
Our business operations can be categorized into three segments based on the type of products we manufacture and sell, specifically (i) Cordyceps Militaris, (ii) organic and specialty food products and (iii) functional health beverages.
We grow and sell our Cordyceps products as well as manufacture and distribute our functional health beverages through Daqing Shuaiyi. Harbin Shuaiyi is mainly engaged in the business of selling our organic and specialty food products.
In 2011, our sales revenue from our Cordyceps Militaris was approximately $25.34 million, sales revenue from our organic and specialty food products was approximately $2.02 million and sales revenue from our functional health beverages was $6.85 million.
We expect that majority of our revenue for 2012 will still come from our Cordyceps Militaris products, with an increase in percentage of revenue coming from the functional health beverages as we expand our distribution channels. We also expect that sales and marketing related costs associated with branding and advertising of the functional health beverages will increase as a percentage of revenue.
Additional information regarding our products can be found at Note 20 in our audited consolidated financial statements contained elsewhere in this annual report.
Results of Operations
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010
The following table sets forth key components of our results of operations for the periods indicated, in dollars and as a percentage of revenue.
(All amounts, other than percentage, in thousands of US dollars)
Net Revenue. Our revenues are generated from the sale of our Cordyceps Militaris products, functional health beverages and organic and specialty food products. Revenues increased by $9.96 million, or 41.1%, to $34.21 million in 2011, from $24.24 million in 2010. This increase was mainly attributable to the increase in sales of our core product, Cordyceps Militaris by $3.30 million and the increase in sales of our beverage products by $6.42 million. The increase in sales of our products is driven by the continued increase in market demand for our Cordyceps Militaris beverage products, combined with an increase in average selling price of Cordyceps Militaris products.
Our business operations can be categorized into three segments based on the type of products we manufacture and sell, specifically (i) Cordyceps Militaris, (ii) organic and specialty food products and (iii) functional health beverages. The following table shows the different segments comprising our total sales revenue for the Cordyceps Militaris, beverages and other agricultural products:
Sales Revenue by Product Segments
(all amounts, other than percentages, in thousands of U.S. dollars)
Cost of Goods Sold. Our cost of goods sold is primarily comprised of the costs of our raw materials, labor and overhead. Our cost of goods sold increased by $3.61 million, or 77.8%, to approximately $8.25 million in 2011 from $4.64 million in 2010. This increase was commensurate with increased sales of our core products and increased production costs associated with the launch of functional health beverage products. As a percentage of revenues, the cost of goods sold increased to 24.1% for the year ended December 31, 2011 from 19.1% for year 2010. This increase in cost of goods sold as a percentage of revenue was mainly attributable to costs associated with the launch of our functional health beverages, partially offset by our product mix shift towards smaller packages of Cordyceps Militaris products which have higher gross margins. Our functional health beverages generally have a lower margin than our Cordyceps Militaris products as we outsource the production of the beverages to a third party bottler.
Gross Profit. Our gross profit increased approximately $6.36 million, or 32.4%, to approximately $25.96 million in 2011 from $19.60 million in 2010. Gross profit as a percentage of revenues was 75.9% in 2011, a decrease of 5.0% from 80.9% in 2010. Such percentage decrease was mainly due to a higher volume of sales of functional health beverages which have a lower gross margin than Cordyceps Militaris products. Such decrease was partially offset by the product mix shift towards smaller packages of Cordyceps Militaris products which have higher gross margins.
Selling Expenses. Our selling expenses include sales commissions, cost of advertising and promotional materials, salaries and fringe benefits of sales personnel, and other sales related costs. Selling expenses increased $0.55 million, or 50.5% to $1.64 million in 2011 from $1.09 million in 2010. As a percentage of revenues, selling expenses increased to 4.8% for 2011 from 4.5% in 2010. The increase in the amount and percentage of selling expenses was mainly attributable to the increase in sales commission due to our higher revenues and sales related cost attributable to the rollout of our functional health beverages product line to new distribution channels as well as costs associated with the opening of specialty stores to sell our products, which outpaced the increase in our revenue.
General and Administrative Expenses. General and administrative expenses include the costs associated with staff and support personnel who manage our business activities, depreciation charge for fixed assets, and professional fees paid to third parties. General and administrative expenses were $2.84 million in year 2011, compared with $2.72 million in 2010. As a percentage of revenues, general and administrative expenses decreased to 8.3% in 2011 from 11.2% in 2010. The decrease in general and administrative expenses as a percentage of revenue was mainly due to the increase in the revenue which outpaced the increase in general and administrative expenses.
Income Before Income Taxes. Income before income taxes increased approximately $7.12 million, or 45.5%, to approximately $22.80 million in 2011 from $15.66 million in 2010. As a percentage of revenues, income before income taxes increased to 66.6% in 2011 from 64.6% in 2010. The increase in income before income taxes is mainly attributable to the increase in the amount of our gross profit resulting in an increase in income from operations of $5.69 million and increase in other income of $1.43 million mainly as a result of change in fair value of outstanding warrants.
Income Taxes. Nutrastar International Inc. is subject to United States federal income tax at a tax rate of 34%. No provision for income taxes in the United States has been made as Nutrastar International Inc. had no income taxable in the United States for the year ended December 31, 2011. New Resources was incorporated in the BVI and under the current laws of the BVI, is not subject to income taxes. Oriental Global was formed in Hong Kong and under the current laws of Hong Kong, is not subject to income taxes. Our PRC subsidiary and the VIEs are subject to national and local income taxes within China at the applicable tax rate on the taxable income as reported in their PRC statutory financial statements in accordance with relevant income tax laws. China passed a new Enterprise Income Tax Law, or the New EIT Law, and its implementing regulations, both of which became effective on January 1, 2008.
The New EIT Law provides for a grandfathering on tax holidays which were granted under the then effective tax laws and regulations. Therefore, Daqing Shuaiyi had continued to be entitled to a three-year 50% income tax reduction until December 31, 2010. Therefore, Daqing Shuaiyi was subject to a 12.5% income tax rate in 2010 and Harbin Shuaiyi was subject to a tax rate of 25% in 2010. Both entities were subject to an income tax rate of 25% in 2011.
Income taxes increased approximately $3.58 million to $5.80 million in 2011 from $2.22 million in 2010. We paid more taxes in 2011 because of the increase in sales, taxable income and income tax rate as a result of the expiration of the income tax holidays on December 31, 2010 described above.
Net Income. Net income increased approximately $3.54 million, or 26.3%, to $17.00 million in 2011 from $13.44 million in 2010, as a result of the factors described above.
Liquidity and Capital Resources
As of December 31, 2011, we had cash and cash equivalents (excluding restricted cash) of approximately $54.56 million. The following table provides detailed information about our net cash flow for all financial statement periods presented in this report.
Cash Flow
(All amounts in thousands of U.S. dollars)
Operating Activities
Net cash provided by operating activities was $18.80 million in year ended December 31, 2011, an increase of $3.45 million from $15.35 million in year ended December 31, 2010. The increase in the cash provided by operating activities was mainly attributable to the increase in net income of $3.54 million.
Investing Activities
Our primary uses of cash for investing activities are payments for the acquisition of property, plant and equipment.
Net cash used in investing activities was $7.40 million in fiscal year 2011, an increase of approximately $7.18 million from approximately $0.22 million used in investing activities in fiscal year 2010. The significant increase of the cash used in investing activities was mainly due to the $5.14 million expenditures associated with the construction and purchase of property, plant and equipment for the organic and specialty food business and the RMB12.75 million ($1.97 million) expenditures including other incidental costs in connection with the purchase of a new corporate headquarter facility in Harbin during the year 2011.
Financing Activities
Net cash provided by financing activities for the fiscal year ended December 31, 2011 was $0.21 million as compared to $4.40 million provided by financing activities in fiscal year 2010. The decrease of the net cash provided by financing activities was mainly attributable to the net proceeds of approximately $5.48 million from the capital raising in June 2010 whereas no capital raising occurred in 2011.
On June 7 and June 28, 2010, we consummated two closings of a private placement transaction and issued in aggregate approximately 197,706 Units consisting of shares of series A preferred stock and warrants to purchase our common stock, to certain investors at a purchase price of $28.56 per unit for gross proceeds of approximately $5.65 million.
We believe that our cash on hand and cash flow from operations will meet our expected capital expenditure and working capital requirements for the next 12 months. We are in the process of significantly expanding our organic and specialty food consumer products business. We expect that the expansion will require capital expenditures of approximately $8.06 million over the next 12 to 18 months, which will be funded from our cash on hand and cash generated from operations. However, we may in the future require additional cash resources due to changed business conditions, implementation of our strategy to expand our production capacity or other investments or acquisitions we may decide to pursue. If our own financial resources are insufficient to satisfy our capital requirements, we may seek to sell additional equity or debt securities or obtain additional credit facilities. The sale of additional equity securities could result in dilution to our stockholders. The incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and financial covenants that would restrict our operations. Financing may not be available in amounts or on terms acceptable to us, if at all. Any failure by us to raise additional funds on terms favorable to us, or at all, could limit our ability to expand our business operations and could harm our overall business prospects.
Effects of Inflation
Inflation and changing prices have not had a material effect on our business and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future. However, our management will closely monitor the price change and continually maintain effective cost control in operations.
Off Balance Sheet Arrangements
We do not have any off balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity or capital expenditures or capital resources that is material to an investor in our securities.
Seasonality
Our operating results and operating cash flows historically have not been subject to seasonal variations. However, extended holidays in China such as the Lunar Chinese New Year, May and October holidays will impact the Company’s operations due to holiday shut downs. This pattern may change, however, as a result of new market opportunities or new product introductions.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires our management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements, including the notes thereto, and related disclosures of commitments and contingencies, if any. We consider our critical accounting policies to be those that require the more significant judgments and estimates in the preparation of financial statements, including the following:
Basis of preparation
These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.
Principle of consolidation
The accompanying consolidated financial statements include the financial statements of Nutrastar and its wholly owned subsidiaries, New Resources, Oriental Global and Harbin Baixin, and its VIEs Heilongjiang Shuaiyi, Daqing Shuaiyi and Harbin Shuaiyi. All significant inter-company balances or transactions have been eliminated on consolidation.
The Company has evaluated the relationship with Heilongjiang Shuaiyi, Daqing Shuaiyi and Harbin Shuaiyi and based on the result of the evaluation, believes that these entities are variable interest entities and that it is the primary beneficiary of these entities. Consequently, the Company has included the results of operations of these variable interest entities in the consolidated financial statements. The Company’s relationships with Heilongjiang Shuaiyi, Daqing Shuaiyi and Harbin Shuaiyi are governed by a series of contractual arrangements. Under PRC laws, Heilongjiang Shuaiyi, Daqing Shuaiyi and Harbin Shuaiyi are independent legal persons and none of them is exposed to liabilities incurred by the other parties.
The accounts of Heilongjiang Shuaiyi, Daqing Shuaiyi and Harbin Shuaiyi are consolidated in the accompanying financial statements pursuant to the Financial Accounting Standards Board Accounting Standard Codification (ASC) Topic 810 and related subtopics related to the consolidation of variable interest entities. The Company does not have any non-controlling interests in net income and accordingly, did not subtract any net income in calculating the net income attributable to the Company. Because of the contractual arrangements, the Company had a pecuniary interest in the VIEs that require consolidation of the Company’s and the VIEs’ financial statements.
Use of estimates
The preparation of these consolidated 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 consolidated 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 under different assumptions or conditions. Significant estimates for the years ended December 31, 2011 and 2010 include the useful lives of property and equipment and intangible assets, assumptions used in assessing impairment for long-term assets and the fair values of share-based payments and warrants granted.
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 provides 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.
Inventories
Inventories are stated at the lower of cost, determined on a weighted average basis, or market. Costs of inventories include purchase and related costs incurred in bringing the products to their present location and condition. Market value is determined by reference to selling prices after the balance sheet date or to management’s estimates based on prevailing market conditions. Management will write down the inventories to market value if it is below cost. Management also regularly evaluates the composition of its inventories to identify slow-moving and obsolete inventories to determine if a valuation allowance is required.
Derivative financial instruments
The Company evaluates all its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then revalued at each reporting date, with changes in the fair value reported in the consolidated statements of income. For stock-based derivative financial instruments, the Company uses Monte-Carlo simulation methods to value the derivative instruments at inception and on subsequent valuation dates.
Property, plant and equipment
Property, plant and equipment are stated at cost less accumulated depreciation and accumulated impairment losses, if any. Gains or losses on disposals are reflected as gain or loss in the year of disposal. The cost of improvements that extend the life of property, plant and equipment are capitalized. These capitalized costs may include structural improvements, equipment and fixtures. All ordinary repair and maintenance costs are expensed as incurred.
Depreciation for financial reporting purposes is provided using the straight-line method over the estimated useful lives of the assets as follows:
Construction in progress
Construction in progress includes direct costs of construction of buildings, equipment and other assets. Interest incurred during the period of construction, if material, is capitalized. Construction in progress is not depreciated until such time as the assets are completed and put into service.
Intangible assets
The Company’s intangible assets include a ten-year exclusive right to use a proprietary process and computer software. The Company’s amortization policy on intangible assets is as follows:
The Company accounts for its intangible assets pursuant to FASB ASC Subtopic 350-30, “General Intangibles Other Than Goodwill”. Under ASC 350-30-35, intangibles with definite lives continue to be amortized on a straight-line basis over the lesser of their estimated useful lives or contractual terms. Intangibles with indefinite lives are evaluated at least annually for impairment by comparing the asset’s estimated fair value with its carrying value, based on cash flow methodology.
Impairment of long-lived assets
The Company reviews and evaluates its long-lived assets for impairment when events or changes in circumstances indicate that the related carrying amounts may not be recoverable. An impairment is considered to exist if the total estimated future cash flows on an undiscounted basis are less than the carrying amount of the assets, including goodwill, if any. An impairment loss is measured and recorded based on discounted estimated future cash flows. In estimating future cash flows, assets are grouped at the lowest level for which there is identifiable cash flows that are largely independent of future cash flows from other asset groups.
Revenue recognition
Revenue is recognized when the following four revenue criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured.
Sales revenue is recognized net of value added and sales related taxes, sales discounts and returns at the time when the merchandise is delivered to the customer. Based on historical experience, management estimates that sales returns are immaterial and has not recorded an allowance for estimated sales returns.
Share-based payments
The Company accounts for share-based compensation awards to employees in accordance with FASB ASC Topic 718, “Compensation - Stock Compensation”, which requires that share-based payment transactions with employees be measured based on the grant-date fair value of the equity instrument issued and recognized as compensation expense over the requisite service period.
The Company accounts for share-based compensation awards to non-employees in accordance with FASB ASC Topic 718 and FASB ASC Subtopic 505-50, “Equity-Based Payments to Non-employees”. Under FASB ASC Topic 718 and FASB ASC Subtopic 505-50, stock compensation granted to non-employees has been determined as the fair value of the consideration received or the fair value of equity instrument issued, whichever is more reliably measured and is recognized as expenses as the goods or services are received.
Income taxes
The Company is subject to income taxes in the United States and other foreign jurisdictions where it operates. The Company accounts for income taxes in accordance with FASB ASC Topic 740, “Income Taxes”. FASB ASC Topic 740 requires an asset and liability approach for financial accounting and reporting for income taxes and allows recognition and measurement of deferred tax assets based upon the likelihood of realization of tax benefits in future years. Under the asset and liability approach, deferred taxes are provided for the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is provided for deferred tax assets if it is more likely than not these items will either expire before the Company is able to realize their benefits, or that future deductibility is uncertain.
The Company’s income tax returns are subject to examination by the Internal Revenue Service (“IRS”) and other tax authorities in the locations where it operates. The Company assesses potentially unfavorable outcomes of such examinations based on the criteria of FASB ASC 740-10-25-5 through 740-10-25-7 and 740-10-25-13 (formerly FASB Interpretation No. 48 (“FIN 48”) “Accounting for Uncertainty in Income Taxes”). The interpretation prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken (or expected to be taken) in a tax return. This Interpretation also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods and income tax disclosures.
Research and development costs
Research and development costs are expensed as incurred, and are charged to general and administrative expenses. Research and development costs were $186,958 and $114,145 for the years ended December 31, 2011 and 2010, respectively.
Advertising costs
The Company expenses all advertising costs as incurred. Advertising costs charged to selling expenses were $129,030 and $117,635 for the years ended December 31, 2011 and 2010, respectively.
Shipping and handling costs
Substantially all costs of shipping and handling of products to customers are included in selling expense. Shipping and handling costs for the years ended December 31, 2011 and 2010 were insignificant.
Comprehensive income
FASB ASC Topic 220, “Comprehensive Income”, establishes standards for reporting and displaying comprehensive income and its components in the consolidated financial statements. Accumulated other comprehensive income includes foreign currency translation adjustments.
Foreign currency
The Company uses the United States dollar (“US Dollar” or “US$” or “$”) for financial reporting purposes. The PRC subsidiaries and VIEs within the Company maintain their books and records in their functional currency, Chinese Renminbi (“RMB”), being the lawful currency in the PRC. Assets and liabilities of the PRC subsidiaries and VIEs are translated from RMB into US Dollars using the applicable exchange rates prevailing at the balance sheet date. Items on the statements of income and cash flows are translated at average exchange rates during the reporting period. Equity accounts are translated at historical rates. Adjustments resulting from the translation of the Company’s financial statements are recorded as accumulated other comprehensive income.
The exchange rates used to translate amounts in RMB into US Dollars for the purposes of preparing the consolidated financial statements are based on the rates as published on the website of People’s Bank of China and are as follows:
No representation is made that the RMB amounts could have been, or could be, converted into US Dollars at the above rates. The value of RMB against US dollars and other currencies may fluctuate and is affected by, among other things, changes in China’s political and economic conditions. Any significant revaluation of RMB may materially affect the Company’s financial condition in terms of US Dollar reporting.
Segment reporting
The Company follows FASB ASC Topic 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 believes that during the years ended December 31, 2011 and 2010, it operated in three business segments - growing and sales of Chinese Golden Grass, which is widely used for Chinese medicine, manufacturing and sale of functional health beverages featuring the Chinese Golden Grass as a core ingredient, and sales of organic and specialty products. The manufacturing and sale of Chinese Gold Grass functional health beverages was launched in the fourth quarter of 2010.
Throughout the years ended December 31, 2011 and 2010, all of the Company’s operations were carried out in one geographical segment - China.
Earnings per share
The Company reports earnings per share in accordance with the provisions of FASB ASC Topic 260, "Earnings per Share". FASB ASC Topic 260 requires presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution (using the treasury stock method) that could occur if securities or other contracts to issue common stock were exercised and converted into common stock.
Commitments and contingencies
The Company follows FASB ASC Subtopic 450-20, “Loss 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 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.
Recent 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 will have no material impact on our consolidated financial statements.
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. Early application is permitted. The adoption of the provisions in ASU 2011-02 will have no material impact on our 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 will have no material impact on our 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 our consolidated financial statements.
In September 2011, the FASB issued ASU No. 2011-08 -Intangibles -Goodwill and Other (Topic 350). The amendments in this update will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under these amendments, an entity would not be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The amendments include a number of events and circumstances for an entity to consider in conducting the qualitative assessment. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. We do not expect the adoption of the provisions in this update will have a significant impact on our consolidated financial statements.
In December 2011, the FASB issued ASU No. 2011-11 -Balance Sheet (Topic 210). The objective of this update is to provide enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this update. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. We do not expect the adoption of the provisions in this update will have a significant impact on our consolidated financial statements.
In December 2011, the FASB issued ASU No. 2011-12 -Comprehensive Income (Topic 220). The amendments in this update supersede certain pending paragraphs in ASU No. 2011-05, to effectively defer only those changes in ASU No. 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. The amendments will be temporary to allow the Board time to redeliberate the presentation requirements for reclassifications out of accumulated other comprehensive income for annual and interim financial statements for public, private, and non-profit entities. The amendments in this update are effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2011. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. We do not expect the adoption of the provisions in this update will have a significant impact on our 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 our consolidated financial statements upon adoption.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not Applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The full text of our audited consolidated financial statements as of December 31, 2011 and 2010 begins on page of this annual report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rule 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 our 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, our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2011. Based on that evaluation, our Chief Executive Officer and 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 are intended.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Exchange Act defines internal control over financial reporting as a process designed by, or under the supervision of, our principal executive and principal financial officers and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America and includes those policies and procedures that:
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. 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 our assessment we determined that, as of December 31, 2011, our internal control over financial reporting is effective based on those criteria.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting during the fourth quarter of fiscal year 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION.
We have no information to disclose that was required to be disclosed in a report on Form 8-K during fourth quarter of fiscal year 2011, but was not reported.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
Directors and Executive Officers
The following sets forth information about our directors and executive officers as of the date of this report:
Lianyun Han. Ms. Han has extensive experience in operational management and business development. Ms. Han is the founder of our company and has been our Chief Executive Officer, President and the chairperson of our board of directors since the completion of the reverse acquisition of New Resources on December 23, 2008. Ms. Han has been the chairman and chief executive officer of our subsidiary Heilongjiang Shuaiyi since its formation in 2006. From 1998 to 2006, Ms. Han was the president of Heilongjiang Shuaiyi Technology Development Co., Ltd., a company that is engaged in the business of developing, manufacturing, marketing and selling high-tech agricultural products. Ms. Han holds a Bachelor’s degree in Chinese Language and Literature from Harbin Normal University.
Robert Tick. Mr. Tick has over 16 years experience in accounting and finance. Mr. Tick was the Chief Financial Officer of ANDA Networks, Inc., a telecom equipment provider, from July 2007 to August 2010, Vice President of Finance from October 2005 to July 2007 and Corporate Controller from April 2003 to November 2004. From November 2004 to October 2005, Mr. Tick served as the Controller for T-RAM Semiconductors Inc., a fabless semiconductor company. Mr. Tick is a Certified Public Accountant and holds a B.S. in Accounting and Finance from San Francisco State University and an M.B.A. from Washington State University.
Hongbing Hua. Mr. Hua has over 15 years experience in sales and marketing management. Prior to joining the Company, from 2003 to 2004, Mr. Hua was the Project General Planning Principle of Wanglaoji Herbal Tea, JDB Group, one of the largest herbal tea manufacturers in China. From 1998 to 2001, he was the VP Sales & Marketing of Beijing Huiyuan Beverage and Food Group Co., Ltd., a leading company engaged in the manufacture and sales of juice and other beverage products in China. Mr. Hua holds a Bachelor’s degree in international finance from Tianjin University.
Chunming Zhang. Mr. Zhang has decades of working experience in production management. Mr. Zhang became our director on January 12, 2009. Mr. Zhang joined Heilongjiang Shuaiyi in 2006 as the production manager. From 1998 to 2006, Mr. Zhang was the vice president of Heilongjiang Shuangyasha Boiler Factory. Mr. Zhang holds a Bachelor’s degree in economics from Northeast Agricultural University.
Henry Ngan. Mr. Ngan has been the Chief Financial Officer of ZST Digital Networks, Inc. (NASDAQ: ZSTN) since March 2011, a company that is a developer, manufacturer and supplier of digital and optical network equipment to cable system operators and provider of GPS tracking devices and support services for transport-related enterprises in China. From February 2009 to January 2011, Mr. Ngan has served as the Chief Financial Officer of Hong Kong Highpower Technology, Inc. (NASDAQ HPJ), a developer, manufacturer and marketer of nickel-metal hydride (Ni-MH) and lithium-ion (Li-ion) batteries and related products. Prior to joining the company, Mr. Ngan had served as Vice President and Senior Equity Analyst at Brean Murray, Carret & Co., a full service investment bank, in New York City from July 2008, an Equity Research Analyst at Buckingham Research Group in New York, an equity research firm, from June 2004 to January 2008 and at Robotti & Company, a diversified financial services boutique, from October 2002 until June 2004. During his tenure, Mr. Ngan accumulated a significant amount of experience in accounting, auditing, consulting and valuation analysis. Mr. Ngan received a Bachelor’s degree in Accounting from the University at Albany, State University of New York, and an MBA in finance, and information and communication systems from Fordham University. Mr. Ngan is also a Certified Public Accountant licensed in the state of New York.
Virginia P’an. Ms. P’an is currently the CEO of the TransCapital Group LLC, a business consulting service provider, and Yumi EcoSolutions, Inc., an importer and distributor of eco-friendly materials. She is a seasoned global executive, successful entrepreneur and financier and a recognized international business expert. As an innovator and authority on China and the Pacific Rim, Ms. P’an advises senior executives and board of directors on strategic investments, business strategy, operations and funding. Prior to founding the current companies, and their predecessor companies, she was the first female Vice President at American Express Bank from 1978 to 1984 and was the architect of the national debit card banking system for Taiwan from 1980 to 1982. Before her current positions, Ms. P’an also served as Managing Partner for KCSA Worldwide and Managing Director of Adam Friedman Associates from 1994 to 2006, two prominent financial communications and investor relations firms based in New York City. She is currently an active member of the Board of AIESEC US, a non-profit organization promoting cultural understanding and international co-operation and the Advisory Board of the Babson Graduate School of Business which is internationally ranked #1 for entrepreneurship. Ms. P’an is the recipient of the prestigious "Leading Women Entrepreneur of the World", "Business Innovator" and "International Women of Influence" Awards and is fluent in Mandarin and other Chinese dialects.
Jianbing Zhong. Mr. Zhong has been with Leichi Investment Limited Company, or Leichi, a financial consulting company, since July 2007 and is principally responsible for managing the company’s legal affairs including the performance of business due diligence and market research, joint project arrangement, private equity financing, corporate strategy planning and business consulting. Over the years, he has participated in many joint projects covering various industries from environmental protection, new materials, new energy and modern agriculture provided to consumer and wholesales franchises. Prior to working with Leichi, Mr. Zhong was at the Fujian Yinsen Group, a company engaged in the business of collection, treatment, disposal and recycling of industrial wastes, from 2005 to 2007 and was responsible for undertaking the company’s legal affairs. Mr. Zhong graduated from The South-Central University for Nationalities with a bachelor’s degree in law.
Joshua Kurtzig. Mr. Kurtzig currently is a partner at a Tangram Capital Partners, an investment management firm focused on Asia. From October 2010 to April 2011, Mr. Kurtzig was a Managing Director at ARC China Holdings Ltd., a Shanghai-based investment manager focused on investments in China, where he is responsible for portfolio management, deal sourcing, and overseeing the establishment of regional RMB funds. Before joining ARC China Holdings Ltd., Mr. Kurtzig was a director at DAC Management LLC from April 2008 to September 2010, an Asia-focused alternative investment manager. From March 2007 to April 2008, Mr. Kurtzig worked as Director and China Representative for Kreab AB, a company provides communication services to corporations, organizations, and government authorities. From February 2006 to March 2007, Mr. Kurtzig was Director of Financial Advisory Services for Stonebridge International LLC, an international advisory firm that helps U.S. and other multinational companies shape and execute strategies to solve problems and seize business opportunities worldwide. He holds a Bachelor’s degree from University of Virginia, a Master of Science degree from the London School of Economics, and an M.B.A. from NYU’s Stern School of Business. Mr. Kurtzig speaks English, French, Mandarin Chinese and Russian.
Pursuant to the Securities Purchase Agreement, dated May 27, 2010, we are obligated to cause one person designated by ARC China Inc. to be duly appointed or elected to the Board of Directors. Mr. Kurtzig was elected as our director on January 24, 2011 according to this requirement.
Directors are elected until their successors are duly elected and qualified.
Family Relationships
There is no family relationship among any of our officers or directors.
Involvement in Certain Legal Proceedings
To the best of our knowledge, none of our directors or executive officers has been convicted in a criminal proceeding, excluding traffic violations or similar misdemeanors, or has been a party to any judicial or administrative proceeding during the past five years that resulted in a judgment, decree or final order enjoining the person from future violations of, or prohibiting activities subject to, federal or state securities laws, or a finding of any violation of federal or state securities laws, except for matters that were dismissed without sanction or settlement. Except as set forth in our discussion below in Item 13, “Certain Relationships and Related Transactions, and Director Independence,” none of our directors, director nominees or executive officers has been involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules and regulations of the SEC.
Board Composition and Committees
Our Board of Directors is currently composed of seven members, Ms. Lianyun Han, Mr. Robert Tick, Mr. Chunming Zhang, Mr. Henry Ngan, Ms. Virginia P’an, Mr. Jianbing Zhong and Mr. Joshua Kurtzig. Since October 2010, the Board of Directors has established three Committees: the Audit Committee, the Compensation Committee, and the Governance and Nominating Committee. Each of the Audit Committee, Compensation Committee and Governance and Nominating Committee are comprised entirely of our independent directors. From time to time, the Board of Directors may establish other committees. The Board of Directors has adopted a written charter for each of the committees which is available on the Company’s website http://www.nutrastarintl.com. Printed copies of each of our committee charters may be obtained, without charge, by contacting the Corporate Secretary, Nutrastar International Inc., 7/F Jinhua Mansion, 41 Hanguang Street, Nangang District, Harbin, China 150080.
Audit Committee
Our Audit Committee consists of three members: Henry Ngan, Virginia P’an and Jianbing Zhong. Each member of the Audit Committee meets the independence criteria prescribed by applicable regulation and the rules of the SEC for audit committee membership and is an ‘‘independent director’’ within the meaning of applicable NASDAQ listing standards. Each Audit Committee member meets NASDAQ’s financial literacy requirements, and the Board of Directors has further determined that Mr. Henry Ngan (i) is ‘‘audit committee financial expert’’ as such term is defined in Item 407(d) of Regulation S-K promulgated by the SEC, and (ii) also meet NASDAQ’s financial sophistication requirements.
The Audit Committee oversees our accounting and financial reporting processes and the audits of the financial statements of our Company. The Audit Committee is responsible for, among other things:
selecting our independent auditors and pre-approving all auditing and non-auditing services permitted to be performed by our independent auditors;
reviewing with our independent auditors any audit problems or difficulties and management’s response;
reviewing and approving all proposed related-party transactions, as defined in Item 404 of Regulation S-K under the Securities Act of 1933, as amended;
discussing the annual audited financial statements with management and our independent auditors;
reviewing major issues as to the adequacy of our internal controls and any special audit steps adopted in light of significant internal control deficiencies;
annually reviewing and reassessing the adequacy of our Audit Committee charter;
meeting separately and periodically with management and our internal and independent auditors;
reporting regularly to the full Board; and
such other matters that are specifically delegated to our Audit Committee by our Board from time to time.
Compensation Committee
Our Compensation Committee consists of three directors, Henry Ngan, Virginia P’an and Jianbing Zhong. The members of the Compensation Committee are all independent directors within the meaning of applicable NASDAQ listing standards.
Our Compensation Committee assists the Board of Directors in reviewing and approving the compensation structure of our executive officers, including all forms of compensation to be provided to our executive officers. Our chief executive officer may not be present at any Compensation Committee meeting during which his compensation is deliberated. The Compensation Committee is permitted to delegate its authority in accordance with Nevada law unless prohibited by the Company’s by-laws or the Compensation Committee charter. The Compensation Committee is responsible for, among other things:
approving and overseeing the compensation package for our executive officers;
reviewing and approving corporate goals and objectives relevant to the compensation of our chief executive officer, evaluating the performance of our chief executive officer in light of those goals and objectives, and setting the compensation level of our chief executive officer based on this evaluation; and
reviewing periodically and making recommendations to the Board of Directors regarding any long-term incentive compensation or equity plans, programs or similar arrangements, annual bonuses, employee pension and welfare benefit plans; and reviewing and making recommendations to the Board of Directors regarding succession plans for the chief executive officer and other senior officers.
Governance and Nominating Committee
Our Governance and Nominating Committee consists of three directors: Henry Ngan, Virginia P’an and Jianbing Zhong. The members of our Governance and Nominating Committee are all independent directors within the meaning of applicable NASDAQ listing standards.
The Governance and Nominating Committee assists the Board of Directors in identifying individuals qualified to become our directors and in determining the composition of the Board of Directors and its committees. The Governance and Nominating Committee is responsible for, among other things:
identifying and recommending to the Board of Directors nominees for election or re-election to the Board of Directors, or for appointment to fill any vacancy;
reviewing annually with the Board of Directors the current composition of the Board of Directors in light of the characteristics of independence, age, skills, experience and availability of service to us;
reviewing periodically the compensation paid to non-employee directors for annual retainers and meeting fees, if any, and making recommendations to the Board of Directors for any adjustments;
identifying and recommending to the Board of Directors the directors to serve as members of the Board’s committees; and
monitoring compliance with our Corporate Governance Guidelines.
Section 16(A) Beneficial Ownership Reporting Compliance
Under U.S. securities laws, directors, certain executive officers and persons holding more than 10% of our common stock must report their initial ownership of the common stock, and any changes in that ownership, to the SEC. The SEC has designated specific due dates for these reports. Based solely on our review of copies of such reports filed with the SEC by and written representations of our directors and executive offers, we believe that our directors and executive offers filed the required reports on time in 2011 fiscal year.
Code of Ethics
Our board of directors has adopted a code of ethics that applies to Chief Executive Officer, President, Chief Financial Officer, Principal Executive Officer, Principal Financial Officer, Principal Accounting Officer, Controller and persons performing similar functions. The code of ethics addresses, among other things, ethical conduct, conflicts of interest, compliance with laws, regulations and policies, including disclosure requirements under the federal securities laws, confidentiality, trading on inside information, and reporting of violations of the code. A copy of the code of ethics has been filed as Exhibit 14.1 to our Current Report on Form 8-K filed on October 8, 2010 and is also available on our website, http://www.nutrastarintl.com. Any amendments or waivers to the code of ethics will be posted on our website within four business days of such amendment or waiver.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
Summary Compensation Table - 2011 and 2010
The following table sets forth information concerning all cash and non-cash compensation awarded to, earned by or paid to the named persons for services rendered in all capacities during the noted periods.
(1)
Robert Tick was appointed as our Chief Financial Officer on July 16, 2010.
(2)
Daniel K. Lee resigned as our Chief Financial Officer on May 5, 2010.
(3)
The amounts in the Stock Awards column reflect the aggregate grant date fair values of Restricted Stock, calculated in accordance with FASB ASC Topic 718. These are not amounts paid to or realized by Mr. Tick or Mr. Lee.
(4)
The amounts in the Option Awards column represent the grant date fair value of stock option awards granted to Mr. Tick, calculated in accordance with FASB ASC Topic 718. These are not amounts paid to or realized by Mr. Tick.
Employment Agreements
Heilongjiang Shuaiyi entered into an employment agreement with our CEO and President, Ms. Lianyun Han. Ms. Han’s employment agreement has a five-year term beginning on December 7, 2008 and ending on December 7, 2013. Ms. Han’s employment agreement provides for a monthly salary of approximately $1,000 and an annual bonus of approximately $3,000. Ms. Han is subject to customary non-competition and confidentiality covenants under the agreement. The employment agreement does not entitle Ms. Han to severance payments or payments following a change in control.
On July 16, 2010, we and Mr. Robert Tick entered into an employment agreement. The term of the employment agreement is for three years commencing on July 16, 2010. The employment agreement provides, among other things, that Mr. Tick’s monthly base salary will be $12,650. During the term of the employment agreement, if either party terminates the employment for any reason, a minimum of sixty (60) days notice must be given in writing to the other party. The employment agreement also contains covenants prohibiting Mr. Tick from competing with us during his employment with us or disclosing any confidential information of us both during his employment and after the termination of employment. On January 24, 2010, we and Mr. Tick entered into an amendment No. 1 to the employment agreement, pursuant to which, effective January 1, 2011, Mr. Tick’s monthly base salary is increased from $12,650 to $16,000.
On July 16, 2010, we and Mr. Tick also entered into a stock option agreement under the Company’s 2009 Equity Incentive Plan. Pursuant to the terms of the stock option agreement, Mr. Tick was granted options to purchase an aggregate 150,000 shares of common stock of the Company, among which, an option to purchase 75,000 shares will be vested on December 31, 2011 with an exercise price of $5.00 per share, an option to purchase 100,000 shares will be vested on December 31, 2012 with an exercise price of $7.00 per share. Each of the options expires three years after its respective vesting date.
According to the stock option agreement, in the event Mr. Tick’s employment with us is terminated for any reason except for death or disability, he may exercise the options only to the extent that the options would have been exercisable on the termination date and no later than three months after the termination date. If Mr. Tick’s employment is terminated because of his death or disability, the options may be exercised only to the extent that such options would have been exercisable by Mr. Tick on the termination date and must be exercised by Mr. Tick no later than twelve months after the termination date. If the employment is terminated for Cause as defined in the stock option agreement, the options will terminate immediately. In no event will the options be exercised later than December 31, 2015. On January 24, 2011, our Compensation Committee of the Board of Directors approved the repricing of the options that we granted to Mr. Tick on July 16, 2010. As a result, each such option outstanding has an exercise price of $3.50 per share which is higher than the closing price of the Company’s common stock on the OTC Bulletin Board on that date (the “Repricing”). In addition, the vesting schedules of the outstanding options granted to Mr. Tick were changed from vesting on an annual basis to vesting on a semi-annual basis.
On July 16, 2010, we also entered into a restricted shares grant agreement under the Company’s 2009 Equity Incentive Plan with Mr. Tick. Pursuant to the terms of the restricted shares grant agreement, we granted to Mr. Tick 150,000 restricted shares of our common stock subject to the vesting schedule therein. If Mr. Tick’s service with us ceases for any reason other than Mr. Tick’s (a) death, (b) disability, (c) retirement, or (d) termination by us without cause, any nonvested restricted shares will be automatically forfeited to us.
Both the options and the restricted shares granted to Mr. Tick are also subject to certain acceleration provisions provided in the stock option agreement and the restricted shares grant agreement, respectively.
We have not provided retirement benefits (other than a state pension scheme in which all of our employees in China participate) or severance or change of control benefits to our named executive officer.
Outstanding Equity Awards at Fiscal Year End
The following table sets forth information concerning the fiscal 2011 year-end value of unvested options and restricted shares for Mr. Robert Tick. No other executive officers received unexercised options or stock that has not vested or equity incentive plan awards that remained outstanding as of the end of the fiscal year 2011.
On January 24, 2011, the Compensation Committee approved the repricing of the options that we granted to Mr. Tick on July 16, 2010. In addition, the vesting schedules of the outstanding options were changed from vesting on an annual basis to vesting on a semi-annual basis.
The terms of the options currently held by Mr. Tick are as follows:
Compensation of Directors
The table below sets forth the compensation of our directors for the fiscal year ended December 31, 2011:
(1)
Ms. Han does not receive additional compensation for her service as our director. The compensation disclosed herein is her compensation for serving as our CEO and President as disclosed in the Summary Compensation Table above.
(2)
Became our director on January 24, 2011. The compensation disclosed herein reflects the compensation Mr. Tick received as the Chief Financial Officer of our company.
(3)
Became our director on January 24, 2011.
(4)
The amounts in the Stock Awards column reflect the aggregate grant date fair values of Restricted Stock, calculated in accordance with FASB ASC Topic 718. These are not amounts paid to or realized by the respective directors.
(5)
The amount reported in the “Option Awards” column reflects the aggregate grant date fair value computed in accordance with FASB ASC Topic 718. These are not amounts paid to or realized by each of the relevant directors.
On October 5, 2010, we entered into separate independent director contracts with each of Mr. Henry Ngan, Ms. Virginia P’an and Mr. Jianbing Zhong. Pursuant to the director contracts, we granted, under our 2009 Equity Incentive Plan, to Mr. Ngan 40,000 restricted shares of our common stock, Ms. P’an 30,000 restricted shares and Mr. Zhong 20,000 restricted shares, as compensation for the services to be provided by them as independent directors. On the same date, we also entered into separate restricted shares grant agreements with each of the above directors to evidence the grant of these restricted shares. The restricted shares will vest in equal installments on a semi-annual basis over a two-year period.
On January 24, 2011, we entered into an independent director contract with Mr. Kurtzig. Under the terms of the independent director contract, we agreed to grant, under the Company’s 2009 Equity Incentive Plan, to Mr. Kurtzig 20,000 restricted shares of our common stock as compensation for the services to be provided by him as a director of the Company. On the same date, we also entered into a restricted shares grant agreement with Mr. Kurtzig to evidence the grant of the restricted shares. The restricted shares will vest in equal installments on a semi-annual basis over a two-year period.
On August 11, 2011, the Company entered into a restricted shares grant agreement with Mr. Kurtzig, whereby the Company agreed to grant, under the Company’s 2009 Equity Incentive Plan, to Mr. Kurtzig 10,000 restricted shares of the Company’s common stock as compensation for the services to be provided by him.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
Security Ownership of Certain Beneficial Owners and Management
The following table sets forth information regarding beneficial ownership of our common stock as of March 26, 2012 (i) by each person who is known by us to beneficially own more than 5% of our voting securities; (ii) by each of our officers and directors; and (iii) by all of our officers and directors as a group. Unless otherwise specified, the address of each of the persons set forth below is in care of Nutrastar International Inc., 7/F Jinhua Mansion, 41 Hanguang Street, Nangang District, Harbin 150080, People’s Republic of China.
* Less than 1%
(1)
Beneficial Ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. For each beneficial owner above, any options exercisable within 60 days have been included in the denominator.
(2)
Based on 15,020,470 shares of common stock issued and outstanding as of March 26, 2012.
(3)
Based on 147,820 shares of Series A Preferred Stock issued and outstanding as of March 26, 2012. Each share of Series A Preferred Stock is convertible initially into ten (10) shares of common stock (subject to customary adjustments for stock splits, combinations, or equity dividends on common stock). Holders of Series A Preferred Stock vote with the holders of common stock on all matters on an “as converted” basis. See “Description of Securities - Preference Shares” below for more information regarding our Series A Preferred Stock.
(4)
Percentage of Total Capital Stock represents total ownership with respect to all shares of our common stock and Series A Preferred Stock, as a single class and on an “as-converted” to common stock basis.
(5)
Includes 8,949,424 shares of common stock owned by New Zealand WAYNE’s Investment Holdings Co., Ltd. Pursuant to the Earn-In Agreement, dated September 12, 2008, as amended, the Founders, including Ms. Han, have the options to acquire a majority interest in New Zealand WAYNE’s Investment Holdings Co., Ltd. upon the satisfaction of certain conditions set forth in the Earn-In Agreement. Upon the passage of six months after the date of Share Exchange Agreement, which was entered into among the Company, New Resources, along with the subsidiaries of New Resources, including Heilongjiang Shuaiyi, Daqing Shuaiyi and Harbin Shuaiyi, and New Zealand WAYNE’s Investment Holdings Co., Ltd., dated December 23, 2008, Ms. Han will own at least a majority ownership of Investment Holdings if she exercises her option pursuant to the Earn-In Agreement. Ms. Han may be deemed to be a beneficial owner of the shares held by Investment Holdings. In addition, pursuant to the Securities Purchase Agreement, dated December 17, 2009, New Zealand WAYNE’s Investment Holdings Co., Ltd., agreed by the Founders, placed a total of 1,000,000 shares held by it into escrow that may be released to the investors in the event we do not meet the performance thresholds for 2010 and 2011. The remaining 7,949,424 shares of common stock owned by New Zealand WAYNE’s Investment Holdings Co., Ltd. are subject to a lock up agreement with ARC China, Inc., dated May 27, 2010 for a 12-month lock up period.
(6)
Includes 487,397 shares underlying a warrant to purchase our common stock. ARC China, Ltd. serves as the investment manager for ARC China Investment Funds. By virtue of the arrangement between ARC China, Ltd. and ARC China Investment Funds, ARC China, Ltd. may be deemed to beneficially own the shares of the Company directly held by ARC China Investment Funds. Investment decisions concerning securities held directly by ARC China Investment Funds are made by ARC China, Ltd. and its investment professionals, subject to review and approval by the board of directors of ARC China Investment Funds. The foregoing information is derived from a Schedule 13D filed with the SEC by ARC China, Ltd. and ARC China Investment Funds on February 17, 2012.
(7)
Includes 63,866 shares underlying a warrant to purchase our common stock.
(8)
Richard Fearon is the managing partner of Accretive Capital Partners, LLC and has sole voting and investment control over the securities held by Accretive Capital Partners, LLC.
Changes in Control
There are no arrangements known to us, including any pledge by any person of our securities, the operation of which may at a subsequent date result in a change in control of the Company.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table includes the information as of the end of fiscal year 2011 for each category of our equity compensation plan:
(1)
On June 3, 2009, our Board of Directors authorized the establishment of the Company’s 2009 Equity Incentive Plan, whereby we are authorized to issue shares of our common stock to certain employees, consultants and directors. The maximum aggregate number of shares of our common stock that may be issued under the 2009 Equity Incentive Plan is 1,000,000 shares. The Plan was approved by our shareholders on June 3, 2009.
(2)
On July 16, 2010, we granted Mr. Robert Tick options to purchase an aggregate 150,000 shares of common stock under the Company’s 2009 Equity Incentive Plan. On January 24, 2011, the Compensation Committee of the Board approved the repricing of the options. As a result, each such option outstanding has an exercise price of $3.50 per share which is higher than the closing price of the Company’s common stock on the OTC Bulletin Board on that date.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
Transactions with Related Persons
The following includes a summary of transactions since the beginning of the 2011 fiscal year, or any currently proposed transaction, in which we were or are to be a participant and the amount involved exceeded or exceeds the lesser of $120,000 or one percent of the average of our total assets at year-end for the last two completed fiscal years, and in which any related person had or will have a direct or indirect material interest (other than compensation described under Item 11, “Executive Compensation”). We believe the terms obtained or consideration that we paid or received, as applicable, in connection with the transactions described below were comparable to terms available or the amounts that would be paid or received, as applicable, in arm’s-length transactions.
On January 10, 2008, Daqing Shuaiyi entered into a land lease agreement with Heilongjiang Shuaiyi Technology Development Co., Ltd., pursuant to which Daqing Shuaiyi leased a land use right for 20 years over a 410,000 square meter tract on which it has nine factory buildings to grow and cultivate Chinese Golden Grass.
On October 15, 2007, Heilongjiang Shuaiyi entered into a loan agreement with its wholly-owned subsidiary, Daqing Shuaiyi, pursuant to which Heilongjiang Shuaiyi agreed to loan RMB 35 million (approximately $5.1 million) to Daqing Shuiayi. The loan is non-interest bearing and unsecured. Daqing Shuaiyi is obligated under the loan agreement to pay off RMB 7 million (approximately $1 million) by October 30 each year starting from 2008. The loan matures on October 15, 2012.
On September 12, 2008, the Shareholder entered into separate Earn-In Agreements with the Founders of Heilongjiang Shuaiyi, including our chairperson and chief executive officer, Lianyun Han. Pursuant to the Earn-In Agreements, each Founder has an option to purchase shares of the Shareholder’s ordinary shares at a purchase price of $0.01 per share (the par value of the Shareholder’s ordinary shares), provided that the aggregate price with respect to the shares eligible to be purchased relating to the satisfaction of condition (4) below is the sum of $0.01 per share, multiplied the number of such shares, plus $1,000, upon the satisfaction of each of the following conditions: (1) six months have expired since the date of the Share Exchange Agreement, provided that on or before that date, the Founder and Heilongjiang Shuaiyi have entered into a binding employment agreement and the Founder is employed by Heilongjiang Shuaiyi pursuant to that agreement on such date; (2) the SEC has declared a registration statement filed by the Company under the Securities Act effective, or investors who purchased common stock from the Company pursuant to a securities purchase agreement being able to sell their common stock under Rule 144; (3) Heilongjiang Shuaiyi and its subsidiaries have achieved not less than $1,560,000 in after-tax net income, as determined under US GAAP for the six months ended June 2009; and (4) Heilongjiang Shuaiyi has achieved not less than $3,900,000 in pre-tax profits, as determined under US GAAP for the fiscal year ending 2009. Notwithstanding the foregoing, for purposes of determining whether or not the financial thresholds described above have been achieved, the purchase of the shares by the Founder or any other person designated by the Founder shall not be deemed to be an expense, charge, or other deduction from revenues of the Company even though GAAP may require contrary treatment. Each Founder may purchase 25% of the total number of shares that he or she is eligible to purchase under his or her Earn-In Agreement upon the satisfaction of each condition described above and the aggregate number of shares eligible for purchase by all of the Founders under the Earn-In Agreements is 100,000. On February 12, 2009, each Founder and the Shareholder entered into the First Amendment to amend the definition of the first condition. As a result, pursuant to the First Amendment, in order to satisfy the first condition for each Founder, only Ms. Lianyun Han needs to enter into a binding employment agreement with Heilongjiang Shuaiyi within six months after the date of the Share Exchange Agreement.
On December 8, 2008, Heilongjiang Shuaiyi entered into separate loan agreement and promissory notes, or the Notes, with the Founders, pursuant to which Heilongjiang Shuaiyi borrowed an aggregate of RMB 60 million (approximately $8.8 million) from the Founders, including from our chairperson and chief executive officer. The Notes bear no interest and are payable in successive equal yearly payments beginning on the tenth anniversary of the Notes, December 8, 2018, and within the first month of each year thereafter. The final payment is due on January 1, 2028. On February 12, 2009, Heilongjiang Shuaiyi and the Founders amended the Notes, pursuant to which the Shuaiyi Founders subordinate any right to receive any payment with respect to this loan to the payment or provision for payment in full of all claims of all present and future creditors of Heilongjiang Shuaiyi. On October 22, 2010, Heilongjiang Shuaiyi entered into a termination agreement with each of the Founders, pursuant to which, the Notes were terminated and none of the parties shall; have any further obligations and rights thereunder.
On April 15, 2011, Heilongjiang Shuaiyi entered into an asset transfer agreement, or the Transfer Agreement, with Ms. Han. Pursuant to the Transfer Agreement, Heilongjiang Shuiayi acquired an office building located at 54-1 Ganshui Road, Xiangfang District, Harbin, with a construction area of 1854.1 square meters, from Ms. Han at a cash consideration of RMB 12.75 million (approximately $1.95 million including other incidental costs), which was fully paid in April 2011. The purchase price was determined based on a real property valuation report issued by an independent appraisal firm, Harbin Guoxin Real Estate Appraisal and Consulting Co., Limited on November 11, 2010. Management believes the terms of the purchase transactions and the consideration that the Company paid in connection with this transaction were comparable to the terms available and the amounts that would be paid in an arm’s-length transaction.
Except as set forth in our discussion above, none of our directors, director nominees or executive officers has been involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules and regulations of the SEC.
Promoters and Certain Control Persons
We did not have any promoters at any time during the past five fiscal years.
Parents of the Company
New Zealand WAYNE’s Investment Holdings Co., Ltd. currently owns 54.24% of Nutrastar International Inc.
Director Independence
Henry Ngan, Virginia P’an, Jianbing Zhong and Joshua Kurtzig each serves on our Board of Directors as an “independent director” as defined by Rule 5605(a)(2) of Listing Rules of The Nasdaq Stock Market, Inc. (the “Nasdaq Listing Rules”). Our Board of Directors currently has three standing committees which perform various duties on behalf of and report to the board of directors: (i) audit committee, (ii) compensation committee and (iii) governance and nominating committee. Each of the three standing committees is comprised entirely of Henry Ngan, Virginia P’an and Jianbing Zhong.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
Independent Auditors’ Fees
The following table represents fees billed and to be billed to the Company for professional audit services rendered by Crowe Horwath (HK) CPA Limited, or Crowe Horwath.
The following table represents fees billed to the Company for professional audit services rendered by AGCA, Inc., or AGCA:
(1)
“Audit fees” consisted of the aggregate fees billed or accrued for professional services rendered for the audit of our annual financial statements and the reviews of the financial statements included in our Forms 10-Q and for any other services that were normally provided in connection with our statutory and regulatory filings or engagements.
(2)
“Audit related fees” consisted of the aggregate fees billed for professional services rendered for assurance and related services that were reasonably related to the performance of the audit or review of our financial statements and were not otherwise included in Audit Fees.
On July 12, 2010 we dismissed AGCA as our independent registered public accounting firm. The decision to change our principal accountants was made by our Board of Directors. On July 12, 2010, we engaged Crowe Horwath as our new independent registered public accounting firm. See more information from the Current Report on Form 8-K filed on July 16, 2010.
Pre-Approval Policies and Procedures
Under the Sarbanes-Oxley Act of 2002, all audit and non-audit services performed by our auditors must be approved in advance by our Board of Directors or the Audit Committee to assure that such services do not impair the auditors’ independence from us. In accordance with its policies and procedures, our Board of Directors pre-approved the audit services performed by Crowe Horwath for our consolidated financial statements as of and for the year ended December 31, 2011. Our Board of Directors delegated its pre-approval authority regarding the non-audited services to its Chair. The Chair of our Board of Directors pre-approved the non-audit services performed by Crowe Horwath for our consolidated financial statements as of and for the year ended December 31, 2011.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
Financial Statements and Schedules
The financial statements are set forth under Item 8 of this annual report on Form 10-K. Financial statement schedules have been omitted since they are either not required, not applicable, or the information is otherwise included.
Exhibit List
The following exhibits are filed as part of this report or incorporated by reference:
*Filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereto duly authorized .
Date: March 28, 2012
NUTRASTAR INTERNATIONAL INC.
By: /s/ Lianyun Han
Lianyun Han
Chief Executive Officer
By: /s/ Robert Tick
Robert Tick
Chief Financial Officer
In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature
Title Date
/s/ Lianyun Han
Chairperson, Chief Executive Officer and President March 28, 2012
Lianyun Han
(Principal Executive Officer)
/s/ Robert Tick
Director, Chief Financial Officer and Treasurer March 28, 2012
Robert Tick
(Principal Financial and Accounting Officer)
/s/ Hongbin Hua
Chief Marketing Officer March 28, 2012
Hongbin Hua
/s/ Chunming Zhang
Director March 28, 2012
Chunming Zhang
/s/ Henry Ngan
Director March 28, 2012
Henry Ngan
/s/ Virginia P’an
Director March 28, 2012
Virginia P’an
/s/ Jianbing Zhong
Director March 28, 2012
Jianbing Zhong
/s/ Joshua Kurtzig
Director March 28, 2012
Joshua Kurtzig
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Nutrastar International Inc.
We have audited the accompanying consolidated balance sheets of Nutrastar International Inc. (“Company”) and subsidiaries as of December 31, 2011 and 2010 and the related consolidated statements of income and comprehensive income, stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2011. These financial statements are the responsibility of the Company’s management. 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 an 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 the Company’s 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 includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company and subsidiaries as of December 31, 2011 and 2010, and the consolidated results of their operations and cash flows for each of the two years in the period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 2, the consolidated financial statements were prepared in accordance with Financial Accounting Standards Board Accounting Standard Codification (ASC) Topic 810 and related subtopics related to the consolidation of variable interest entities.
/s/ Crowe Horwath (HK) CPA Limited
Hong Kong, China
March 28, 2012
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(AMOUNTS EXPRESSED IN US DOLLARS)
See accompanying notes to consolidated financial statements
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(AMOUNTS EXPRESSED IN US DOLLARS)
See accompanying notes to consolidated financial statements
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(AMOUNTS EXPRESSED IN US DOLLARS)
See accompanying notes to consolidated financial statements.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS EXPRESSED IN US DOLLARS)
See accompanying notes to consolidated financial statements
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE DESCRIPTION OF BUSINESS AND ORGANIZATION
Nutrastar International Inc. (“Nutrastar” or the “Company”) was incorporated in the State of Nevada on December 22, 2002. On December 23, 2008, the Company completed a reverse acquisition with New Zealand WAYNE’S New Resources Development Co., Ltd. (“New Resources”). As a result of the reverse acquisition with New Resources, the Company is no longer a shell company and active business operations have been revived. Nutrastar together with its subsidiaries and affiliates as described below are referred to as the “Company”.
On May 19, 2009, the Company filed Amended and Restated Articles of Incorporation with the State of Nevada to amend the Company’s Articles of Incorporation to, among other things, (1) change the name of the Company from “YzApp International Inc.” to “Shuaiyi International New Resources Development Inc.,” (2) increase the total number of shares of common stock that the Company has the authority to issue from 50,000,000 to 190,000,000 shares and (3) effect a one for 114.59 reverse split of the Company’s outstanding common stock. The detailed description of the amendment was provided in the Company’s Form 8-K filed on May 26, 2009.
On January 11, 2010, the Company filed a Certificate of Amendment to its Articles of Incorporation with the State of Nevada, pursuant to which the Company further changed its name from "Shuaiyi International New Resources Development Inc." to "Nutrastar International Inc."
On October 22, 2010, New Resources, a wholly-owned British Virgin Islands subsidiary of the Company, entered into an equity transfer agreement with the original founders of Heilongjiang Shuaiyi (the “Shuaiyi Founders”), pursuant to which New Resources transferred all of its equity interests in Heilongjiang Shuaiyi New Energy Development Co., Ltd. (“Heilongjiang Shuaiyi”), a then wholly-owned Chinese subsidiary of New Resources, to the Shuaiyi Founders (the “Equity Transfer”).
In connection with the Equity Transfer, the Shuaiyi Founders, the Company’s indirectly wholly-owned Chinese subsidiary incorporated on July 13, 2010, Harbin Baixin Biotech Development Co., Ltd. (“Harbin Baixin”) and Heilongjiang Shuaiyi entered into the following commercial arrangements (the “Contractual Arrangement” and together with the Equity Transfer, the “Restructuring”), pursuant to which the Company has contractual rights to control and operate the businesses of Heilongjiang Shuaiyi and Heilongjiang Shuaiyi’s two wholly-owned Chinese subsidiaries, Daqing Shuaiyi Biotech Co., Ltd. (“Daqing Shuaiyi”) and Harbin Shuaiyi Green & Specialty Food Trading LLC (“Harbin Shuaiyi” and together with Heilongjiang Shuaiyi and Daqing Shuaiyi, the “VIEs”):
Service Agreement
Pursuant to a technical service agreement, entered into by and between Harbin Baixin and Heilongjiang Shuaiyi, Harbin Baixin will provide certain exclusive technical services to Heilongjiang Shuaiyi in exchange for the payment by Heilongjiang Shuaiyi of a service fee that is calculated based on the market price in light of the particulars of the service and the time of such service provided by Harbin Baixin (the “Service Agreement”);
Option Agreement
Pursuant to an exclusive purchase option agreement, entered into by and among Harbin Baixin, the Shuaiyi Founders and Heilongjiang Shuaiyi, the Shuaiyi Founders granted to Harbin Baixin an option to purchase at any time during the term of this agreement, all or part of the equity interests in Heilongjiang Shuaiyi (the “Equity Interests”), at the exercise price equal to the lowest possible price permitted by Chinese laws (the “Option Agreement”);
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE DESCRIPTION OF BUSINESS AND ORGANIZATION (CONTINUED)
Voting Rights Agreement
Pursuant to a voting rights proxy agreement, entered into by and among Harbin Baixin, the Shuaiyi Founders and Heilongjiang Shuaiyi, each of the Shuaiyi Founders irrevocably entrusted Harbin Baixin and any entities or individuals designated by Harbin Baixin to, among others, exercise its voting rights and other rights as a shareholder of Heilongjiang Shuaiyi (the “Voting Rights Agreement”); and
Pledge agreement
Pursuant to an equity pledge agreement, entered into by and among Harbin Baixin, the Shuaiyi Founders and Heilongjiang Shuaiyi, the Founders pledged all of the Equity Interests to Harbin Baixin to secure the full and complete performance of the obligations and liabilities on the part of the Shuaiyi Founders and Heilongjiang Shuaiyi under this and above contractual arrangements (the “Pledge Agreement” and together with the Service Agreement, the Option Agreement, the Voting Rights Agreement and the Equity Transfer Agreement, the “Restructuring Documents”).
As a result of the Restructuring, the Company transferred all of its indirect equity interests in Heilongjiang Shuaiyi back to the Shuaiyi Founders, among whom, Ms. Lianyun Han became a majority shareholder of Heilongjiang Shuaiyi by owning a 68.3% equity interest in Heilongjiang Shuaiyi. At the same time, through the above contractual agreement, the Company maintains substantial control over the VIEs’ daily operations and financial affairs, election of their senior executives and all matters requiring shareholder approval. As the primary beneficiary of the VIEs, the Company is entitled to consolidate the financial results of the VIEs in its own consolidated financial statements under Financial Accounting Standards Board Accounting Standard Codification (ASC) Topic 810 and related subtopics related to the consolidation of variable interest entities (collectively, “ASC Topic 810”).
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE DESCRIPTION OF BUSINESS AND ORGANIZATION (CONTINUED)
As of December 31, 2011, details of the subsidiaries and affiliates of the Company are as follows:
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE SUMMARY OF SIGNIFICANT ACCOUNTING POLICES
Basis of preparation
These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.
Principle of consolidation
The accompanying consolidated financial statements include the financial statements of Nutrastar and its wholly owned subsidiaries, New Resources, Oriental Global and Harbin Baixin, and its VIEs Heilongjiang Shuaiyi, Daqing Shuaiyi and Harbin Shuaiyi. All significant inter-company balances or transactions have been eliminated on consolidation.
The Company has evaluated the relationship with Heilongjiang Shuaiyi, Daqing Shuaiyi and Harbin Shuaiyi and based on the result of the evaluation, believes that these entities are variable interest entities and that it is the primary beneficiary of these entities. Consequently, the Company has included the results of operations of these variable interest entities in the consolidated financial statements. The Company’s relationships with Heilongjiang Shuaiyi, Daqing Shuaiyi and Harbin Shuaiyi are governed by a series of contractual arrangements. Under PRC laws, Heilongjiang Shuaiyi, Daqing Shuaiyi and Harbin Shuaiyi are independent legal persons and none of them is exposed to liabilities incurred by the other parties.
The accounts of Heilongjiang Shuaiyi, Daqing Shuaiyi and Harbin Shuaiyi are consolidated in the accompanying financial statements pursuant to the Financial Accounting Standards Board Accounting Standard Codification (ASC) Topic 810 and related subtopics related to the consolidation of variable interest entities. The Company does not have any non-controlling interests in net income and accordingly, did not subtract any net income in calculating the net income attributable to the Company. Because of the contractual arrangements, the Company had a pecuniary interest in the VIEs that require consolidation of the Company’s and the VIEs’ financial statements.
Use of estimates
The preparation of these consolidated 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 consolidated 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 under different assumptions or conditions. Significant estimates for the years ended December 31, 2011 and 2010 include the useful lives of property and equipment and intangible assets, assumptions used in assessing impairment for long-term assets and the fair values of share-based payments and warrants granted.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE SUMMARY OF SIGNIFICANT ACCOUNTING POLICES (CONTINUED)
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 provides 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.
Inventories
Inventories are stated at the lower of cost, determined on a weighted average basis, or market. Costs of inventories include purchase and related costs incurred in bringing the products to their present location and condition. Market value is determined by reference to selling prices after the balance sheet date or to management’s estimates based on prevailing market conditions. Management will write down the inventories to market value if it is below cost. Management also regularly evaluates the composition of its inventories to identify slow-moving and obsolete inventories to determine if a valuation allowance is required.
Derivative financial instruments
The Company evaluates all its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then revalued at each reporting date, with changes in the fair value reported in the consolidated statements of income. For stock-based derivative financial instruments, the Company uses Monte-Carlo simulation methods to value the derivative instruments at inception and on subsequent valuation dates.
Property, plant and equipment
Property, plant and equipment are stated at cost less accumulated depreciation and accumulated impairment losses, if any. Gains or losses on disposals are reflected as gain or loss in the year of disposal. The cost of improvements that extend the life of property, plant and equipment are capitalized. These capitalized costs may include structural improvements, equipment and fixtures. All ordinary repair and maintenance costs are expensed as incurred.
Depreciation for financial reporting purposes is provided using the straight-line method over the estimated useful lives of the assets as follows:
Construction in progress
Construction in progress includes direct costs of construction of buildings, equipment and other assets. Interest incurred during the period of construction, if material, is capitalized. Construction in progress is not depreciated until such time as the assets are completed and put into service.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE SUMMARY OF SIGNIFICANT ACCOUNTING POLICES (CONTINUED)
Intangible assets
The Company’s intangible assets include a ten-year exclusive right to use a proprietary process and computer software. The Company’s amortization policy on intangible assets is as follows:
The Company accounts for its intangible assets pursuant to FASB ASC Subtopic 350-30, “General Intangibles Other Than Goodwill”. Under ASC 350-30-35, intangibles with definite lives continue to be amortized on a straight-line basis over the lesser of their estimated useful lives or contractual terms. Intangibles with indefinite lives are evaluated at least annually for impairment by comparing the asset’s estimated fair value with its carrying value, based on cash flow methodology.
Impairment of long-lived assets
The Company reviews and evaluates its long-lived assets for impairment when events or changes in circumstances indicate that the related carrying amounts may not be recoverable. An impairment is considered to exist if the total estimated future cash flows on an undiscounted basis are less than the carrying amount of the assets, including goodwill, if any. An impairment loss is measured and recorded based on discounted estimated future cash flows. In estimating future cash flows, assets are grouped at the lowest level for which there is identifiable cash flows that are largely independent of future cash flows from other asset groups.
Revenue recognition
Revenue is recognized when the following four revenue criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured.
Sales revenue is recognized net of value added and sales related taxes, sales discounts and returns at the time when the merchandise is delivered to the customer. Based on historical experience, management estimates that sales returns are immaterial and has not recorded an allowance for estimated sales returns.
Share-based payments
The Company accounts for share-based compensation awards to employees in accordance with FASB ASC Topic 718, “Compensation - Stock Compensation”, which requires that share-based payment transactions with employees be measured based on the grant-date fair value of the equity instrument issued and recognized as compensation expense over the requisite service period.
The Company accounts for share-based compensation awards to non-employees in accordance with FASB ASC Topic 718 and FASB ASC Subtopic 505-50, “Equity-Based Payments to Non-employees”. Under FASB ASC Topic 718 and FASB ASC Subtopic 505-50, stock compensation granted to non-employees has been determined as the fair value of the consideration received or the fair value of equity instrument issued, whichever is more reliably measured and is recognized as expenses as the goods or services are received.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE SUMMARY OF SIGNIFICANT ACCOUNTING POLICES (CONTINUED)
Income taxes
The Company is subject to income taxes in the United States and other foreign jurisdictions where it operates. The Company accounts for income taxes in accordance with FASB ASC Topic 740, “Income Taxes”. FASB ASC Topic 740 requires an asset and liability approach for financial accounting and reporting for income taxes and allows recognition and measurement of deferred tax assets based upon the likelihood of realization of tax benefits in future years. Under the asset and liability approach, deferred taxes are provided for the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is provided for deferred tax assets if it is more likely than not these items will either expire before the Company is able to realize their benefits, or that future deductibility is uncertain.
The Company’s income tax returns are subject to examination by the Internal Revenue Service (“IRS”) and other tax authorities in the locations where it operates. The Company assesses potentially unfavorable outcomes of such examinations based on the criteria of FASB ASC 740-10-25-5 through 740-10-25-7 and 740-10-25-13 (formerly FASB Interpretation No. 48 (“FIN 48”) “Accounting for Uncertainty in Income Taxes”). The interpretation prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken (or expected to be taken) in a tax return. This Interpretation also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods and income tax disclosures.
Research and development costs
Research and development costs are expensed as incurred, and are charged to general and administrative expenses. Research and development costs were $186,958 and $114,145 for the years ended December 31, 2011 and 2010, respectively.
Advertising costs
The Company expenses all advertising costs as incurred. Advertising costs charged to selling expenses were $129,030 and $117,635 for the years ended December 31, 2011 and 2010, respectively.
Shipping and handling costs
Substantially all costs of shipping and handling of products to customers are included in selling expense. Shipping and handling costs for the years ended December 31, 2011 and 2010 were insignificant.
Comprehensive income
FASB ASC Topic 220, “Comprehensive Income”, establishes standards for reporting and displaying comprehensive income and its components in the consolidated financial statements. Accumulated other comprehensive income includes foreign currency translation adjustments.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE SUMMARY OF SIGNIFICANT ACCOUNTING POLICES (CONTINUED)
Foreign currency
The Company uses the United States dollar (“US Dollar” or “US$” or “$”) for financial reporting purposes. The PRC subsidiaries and VIEs within the Company maintain their books and records in their functional currency, Chinese Renminbi (“RMB”), being the lawful currency in the PRC. Assets and liabilities of the PRC subsidiaries and VIEs are translated from RMB into US Dollars using the applicable exchange rates prevailing at the balance sheet date. Items on the statements of income and cash flows are translated at average exchange rates during the reporting period. Equity accounts are translated at historical rates. Adjustments resulting from the translation of the Company’s financial statements are recorded as accumulated other comprehensive income.
The exchange rates used to translate amounts in RMB into US Dollars for the purposes of preparing the consolidated financial statements are based on the rates as published on the website of People’s Bank of China and are as follows:
No representation is made that the RMB amounts could have been, or could be, converted into US Dollars at the above rates. The value of RMB against US dollars and other currencies may fluctuate and is affected by, among other things, changes in China’s political and economic conditions. Any significant revaluation of RMB may materially affect the Company’s financial condition in terms of US Dollar reporting.
Segment reporting
The Company follows FASB ASC Topic 280, “Segment Reporting”, which requires that companies disclose segment data based on how management makes decisions about allocating resources to segments and evaluating their performance.
The Company believes that during the years ended December 31, 2011 and 2010, it operated in three business segments - growing and sales of Chinese Golden Grass, which is widely used for Chinese medicine, manufacturing and sale of functional health beverages featuring the Chinese Golden Grass as a core ingredient, and sales of organic and specialty products. The manufacturing and sale of Chinese Gold Grass functional health beverages was launched in the fourth quarter of 2010.
Throughout the years ended December 31, 2011 and 2010, all of the Company’s operations were carried out in one geographical segment - China.
Earnings per share
The Company reports earnings per share in accordance with the provisions of FASB ASC Topic 260, "Earnings per Share". FASB ASC Topic 260 requires presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution (using the treasury stock method) that could occur if securities or other contracts to issue common stock were exercised and converted into common stock.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE SUMMARY OF SIGNIFICANT ACCOUNTING POLICES (CONTINUED)
Commitments and contingencies
The Company follows FASB ASC Subtopic 450-20, “Loss 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 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.
Recent 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 will have no material impact on the Company’s consolidated financial statements.
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. Early application is permitted. The adoption of the provisions in ASU 2011-02 will have no 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 will have no material impact on the Company’s 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 consolidated financial statements.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE SUMMARY OF SIGNIFICANT ACCOUNTING POLICES (CONTINUED)
Recent accounting pronouncements (continued)
In September 2011, the FASB issued ASU No. 2011-08 -Intangibles -Goodwill and Other (Topic 350). The amendments in this update will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under these amendments, an entity would not be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The amendments include a number of events and circumstances for an entity to consider in conducting the qualitative assessment. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. The Company does not expect the adoption of the provisions in this update will have a significant impact on its consolidated financial statements.
In December 2011, the FASB issued ASU No. 2011-11 -Balance Sheet (Topic 210). The objective of this update is to provide enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this update. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The Company does not expect the adoption of the provisions in this update will have a significant impact on its consolidated financial statements.
In December 2011, the FASB issued ASU No. 2011-12 -Comprehensive Income (Topic 220). The amendments in this update supersede certain pending paragraphs in ASU No. 2011-05, to effectively defer only those changes in ASU No. 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. The amendments will be temporary to allow the Board time to redeliberate the presentation requirements for reclassifications out of accumulated other comprehensive income for annual and interim financial statements for public, private, and non-profit entities. The amendments in this update are effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2011. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. The Company does not expect the adoption of the provisions in this update will have a significant impact on its 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.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE FAIR VALUE MEASUREMENTS AND FINANCIAL INSTRUMENTS
The Company values its financial instruments as required by FASB ASC 320-12-65 (formerly SFAS No. 107, “Disclosures about Fair Value of Financial Instruments”). The estimated fair value amounts have been determined by the Company, using available market information or other appropriate valuation methodologies. However, considerable judgment is required in interpreting market data to develop estimates of fair value. Consequently, the estimates are not necessarily indicative of the amounts that could be realized or would be paid in a current market exchange.
ASC Topic 820, Fair Value Measurement and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This topic also establishes a fair value hierarchy which requires classification based on observable and unobservable inputs when measuring fair value. The fair value hierarchy distinguishes between assumptions based on market data (observable inputs) and an entity’s own assumptions (unobservable inputs). The hierarchy consists of three levels:
Level one -
Quoted market prices in active markets for identical assets or liabilities;
Level two -
Inputs other than level one inputs that are either directly or indirectly observable; and
Level three -
Unobservable inputs developed using estimates and assumptions, which are developed by the reporting entity and reflect those assumptions that a market participant would use.
Determining which category an asset or liability falls within the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures each quarter.
Assets and liabilities measured at fair value on a recurring basis are summarized as follows:
The carrying values of cash and cash equivalents, trade and other receivables and payables approximate their fair values due to the short maturities of these instruments.
There was no asset or liability measured at fair value on a non-recurring basis as of December 31, 2011 and 2010.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE FAIR VALUE MEASUREMENTS AND FINANCIAL INSTRUMENTS (CONTINUED)
For stock-based derivative financial instruments, the Company uses Monte-Carlo simulation methods to value the derivative instruments at inception and on subsequent valuation dates using the following assumptions;-
NOTE RESTRICTED CASH
As of December 31, 2011, $4,170 in total was held in escrow according to the agreements in connection with the private placements consummated in June 2010, which is further disclosed in Note 12.
Restricted cash consisted of the following:
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE ACCOUNTS RECEIVABLE, NET
Accounts receivable consisted of the following:
No allowance was deemed necessary as of December 31, 2011 and 2010.
NOTE INVENTORIES
Inventories by major categories are summarized as follows:
NOTE PREPAYMENTS AND OTHER RECEIVABLES
Prepayments and other receivables consisted of the following:
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE INTANGIBLE ASSETS, NET
Intangible assets, net consisted of the following:
In April 2006, the Company purchased from a third party a ten-year exclusive right to use a secret process and method in the cultivation and growing of Chinese Golden Grass, which is widely used for traditional Chinese medicine, for a cash consideration of RMB30,000,000, payable over five years. The exclusive right is amortized over its term of ten years using the straight-line method.
Amortization expense was $464,719 and $443,389 for the years ended December 31, 2011 and 2010, respectively. The estimated expense of the intangible assets over each of the next five years will be:-
NOTE PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment, net consisted of the following:
Depreciation expense for the years ended December 31, 2011 and 2010 was $677,916 and $575,799, respectively.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 10 CONSTRUCTION IN PROGRESS
Construction in progress consisted of the following:
NOTE 11 OTHER PAYABLES, ACCRUALS AND TAXES PAYABLE
Other payables and accruals consisted of the following:
Taxes payable consisted of the following:
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 12 STOCKHOLDERS’ EQUITY
Private Placement in 2010
On May 27, 2010, the Company entered into a securities purchase agreement (the "Securities Purchase Agreement") with certain investors, pursuant to which, the Company agreed to issue and sell up to an aggregate of 250,000 units at a purchase price of $28.56 per unit, for an aggregate purchase price of up to $7,140,000 (the "Aggregate Purchase Price"). Each unit consists of (i) one share of a newly designated series A preferred stock, ("Series A Preferred Stock"), with an initial one-to-ten conversion ratio convertible into shares of the Company’s common stock, ("Common Stock"), and (ii) warrants to purchase five shares of Common Stock at an exercise price of $3.40 per share ("Warrants", together with the shares of Series A Preferred Stock, the "Securities"). In addition, the Company and the investors agreed, that the placement agent of this transaction, will receive from the investors a fee equal to 2% of the Aggregate Purchase Price and Warrants to purchase 2% of the aggregate number of shares of Common Stock that shares of Series A Preferred Stock to be issued under the Securities Purchase Agreement are convertible into.
Pursuant to the Securities Purchase Agreement, the Company also granted registration rights to holders of registrable securities, which include shares of Common Stock issued or issuable upon conversion of shares of the Series A Preferred Stock and shares of Common Stock issuable upon exercise of the Warrants (the "Registrable Securities"). Holders holding a majority of the Securities then outstanding may request the Company to file a registration statement to register the Registrable Securities within a pre-defined period (the "Registration Statement"). The Company may be subject to liquidated damages in the amounts prescribed by the Securities Purchase Agreement if it is unable to file the Registration Statement timely or maintain its effectiveness as required by the Securities Purchase Agreement.
On June 7, 2010, the Company effected the first closing of a private placement transaction and issued approximately 123,403 units at a purchase price of $28.56 per unit for gross proceeds of $3,524,342.
On June 28, 2010, the Company effected the second closing of a private placement transaction and issued approximately 74,303 units at a purchase price of $28.56 per unit for gross proceeds of $2,121,938.
Pursuant to the Securities Purchase Agreement, a written request was received from a holder holding a majority of Series A Preferred Stock on July 14, 2010 and the Company filed the Registration Statement on August 11, 2010. The Registration Statement was declared effective by the Securities and Exchange Commission (“SEC”) on September 15, 2010.
On August 24, 2011, the Board of Directors of the Company authorized a repurchase of up to $5 million of the Company’s common stock over twelve months (the “Repurchase Program”). In connection with the adoption of the Repurchase Program, the Company entered into an amendment agreement (“Amendment No. 1”) with the investors to amend the Securities Purchase Agreement. Specifically, under Amendment No. 1, the Company may use the proceeds for general corporate and working capital purposes and acquisition of assets, businesses or operations or for other purposes that the Board of Directors in good faith deems to be in the best interest of the Company, including the repurchase or redemption of shares of the Company’s capital stock.
Also on August 24, 2011, the Company entered into a lock up agreement with the investors, pursuant to which the investors agreed not to sell, transfer or dispose of, directly or indirectly, any shares of Company common stock or any securities convertible into or exercisable or exchangeable for shares of Company common stock that it beneficially owns without a prior written consent of the Company for a period of six months.
During the year ended December 31, 2011, the Company repurchased 4,661 shares of its common stock under the Repurchase Program at a weighted-average price of $2.05 per share for an aggregate purchase cost of $9,553. As of December 31, 2011, the Company had approximately $4.99 million available under the existing $5 million Repurchase Program.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 12 STOCKHOLDERS’ EQUITY (CONTINUED)
Escrow Agreement
In connection with the Securities Purchase Agreement, the Company entered into an escrow agreement (the "Escrow Agreement") pursuant to which the parties agreed to deposit the investment amount received from the investors into escrow to be released upon the occurrence of the events set forth in the Escrow Agreement. In addition, the Company agreed that $100,000 out of the investment amount will remain in escrow and will be disbursed to an investor relations firm hired by the Company, all of which was released to the investor relations firm during the third quarter of 2010. The Company also agreed that an additional $250,000 will remain in escrow and will be used as compensation for the Chief Financial Officer of the Company, of which $188,905 and $56,925 had been released in 2011 and 2010, respectively, and the remainder will be released from escrow as the compensation is paid (See Note 4).
Allocation of Proceeds in the Private Placement
The guidance provided in ASC 470-20-30-5 has been applied to the amount allocated to the convertible Series A Preferred Stock, and the effective conversion price has been used, to measure the intrinsic value, if any, of the embedded conversion option. The fair value of the embedded conversion features of the Series A Preferred Stock of $1,143,198 and $644,532 were calculated using the intrinsic value model in accordance with the guidance provided in ASC Topic 470-20-30-6 (formerly EITF 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments”) and limited to the amount of the proceeds allocated to the convertible instrument on June 7, 2010 and June 28, 2010, respectively. The intrinsic value of the beneficial conversion feature was calculated by comparing the effective conversion price, which was determined based on the proceeds from the private placement allocated to the convertible Series A Preferred Stock, and the market price of the Company’s common stock of $3.20 and $3.16 on June 7, 2010 and June 28, 2010, respectively. The fair value of $1,143,198 and $644,532 of the beneficial conversion feature has been recognized as a reduction to the carrying amount of the convertible Series A Preferred Stock and an addition to paid-in capital.
The following table sets out the allocation of the proceeds from the Private Placement:
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 12 STOCKHOLDERS’ EQUITY (CONTINUED)
Allocation of Proceeds in the Private Placement (continued)
In accordance with ASC Topic 470-20-30-6, the discount on the Series A Preferred Stock resulting from the accounting for a beneficial conversion feature was amortized and charged to retained earnings, because the Series A Preferred Stock is immediately convertible upon issuance and has no stated redemption date. Amortization of the discount resulting from the accounting for a beneficial conversion feature is considered analogous to a return to holders of perpetual preferred stock and has been accounted for as a reduction to net income available to common stockholders for the purpose of calculation of earnings per share.
Preferred Stock
The Board of the Company is authorized, without further action by the shareholders, to issue, from time to time, up to 1,000,000 shares of preferred stock in one or more classes or series. Similarly, the Board is authorized to fix or alter the designations, powers, preferences and the number of shares which constitute each such class or series of preferred stock. Such designations, powers or preferences may include, without limitation, dividend rights (and whether dividends are cumulative), conversion rights, if any, voting rights (including the number of votes, if any, per share), redemption rights (including sinking fund provisions, if any), and liquidation preferences of any unissued shares or wholly unissued series of preferred stock.
On May 27, 2010, the Company created, from the authorized but unissued shares of its preferred stock, a series of preferred stock consisting of 300,000 shares and has designated this series of preferred stock as the Series A Preferred Stock of which the Company issued 197,706 shares upon the closings of the private placement in 2010.
The following are the principal terms of the Series A Preferred Stock:
Rank: The Series A Preferred Stock ranks senior to the Company’s common stock, but junior to all indebtedness of the Company.
Dividend: Holders of the Series A Preferred Stock are entitled to a cumulative dividend at an annual rate of 6% of the Series A Preferred Stock, payable in additional shares of Series A Preferred Stock, compounded quarterly, and payable upon the occurrence of a Liquidation Event, Conversion, Mandatory Conversion or from time-to-time at the discretion of the Board. When dividends on the Series A Preferred Stock are paid, each such additional share of Series A Preferred Stock shall be valued at the Original Series A Purchase Price, which may be adjusted from time to time pursuant to a split, subdivision, combination or other similar events.
Optional Conversion: Shares of the Series A Preferred Stock are optionally convertible into fully paid and non-assessable shares of Common Stock at a conversion rate calculated by dividing (i) $28.00 per share plus any declared, accrued but unpaid dividends by (ii) the conversion price (the “Conversion Price”), which is initially $2.80 per share, subject to adjustment as provided in the Certificate. Initially, each share of Series A Preferred Stock is convertible into 10 shares of Common Stock.
Mandatory Conversion: All outstanding shares of the Series A Preferred Stock will automatically convert to shares of Common Stock, subject to the conversion restrictions set forth in the Certificate of Designation (the "Mandatory Conversion"), at the earlier to occur of (i) the Company’s shares of Common Stock are listed on the New York Stock Exchange, the NYSE Amex, the NASDAQ Global Market, the NASDAQ Global Select Market or the NASDAQ Capital Market (each, a "National Stock Exchange") and the registration statement on Form S-1 or such other appropriate form promulgated by the SEC registering the Common Stock underlying the Securities pursuant to the Securities Purchase Agreement is declared effective by the Commission, and (ii) 12 months from the date that the Company’s shares of Common Stock are first listed on a National Stock Exchange.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 12 STOCKHOLDERS’ EQUITY (CONTINUED)
Preferred Stock (continued)
Adjustment to Conversion Price: If the Company shall issue any additional stock without consideration or for consideration per share less than the Conversion Price in effect immediately prior to the issuance of such additional stock, then such Conversion Price in effect immediately prior to such issuance shall be adjusted to a price determined by multiplying such Conversion Price by a fraction:
Sum of (x) the number of shares of Common Stock outstanding immediately prior to the issuance of such additional stock plus (y) the number of shares of Common Stock that the aggregate consideration received by the Company for the total number of such additional stock so issued would purchase at Conversion Price (divided by) (x) the number of shares of Common Stock outstanding immediately prior to the issuance of such additional stock plus (y) the number of shares of such additional stock so issued.
Voting: The holders of the Series A Preferred Stock will vote on an "as converted" basis, together with the Common Stock, as a single class, in connection with any proposal submitted to the Company’s stockholders, except as required by Nevada law.
Liquidation Preference: The Series A Preferred Stock has a preference over the Company’s common stock on the Company’s liquidation, dissolution or winding up equal to $28 per share of the Series A Preferred Stock plus any accrued but unpaid dividends thereon, as of the date of liquidation.
Registration Rights: The holders of Series A Preferred Stock have the right to request the Company to file a Registration Statement to register “Registrable Securities” (which include the common stock into which the Series A Preferred Stock and Warrants are convertible). Upon such request, no later than 30 days upon receipt of such request (the “Required Filing Date”) the Company should use its commercially reasonable efforts to register the Common Stock underlying the Registrable Securities and have the Registration Statement declared effective by the SEC which is not later than the earlier of (x) 150 calendar days after the Required Filing Date, or (y) if the Registration Statement is not reviewed by the SEC, 5 business days after oral or written notice to the Company or its counsel from the SEC that there will not be a review.
Effect of failure to file and obtain and maintain effectiveness of Registration Statement - the Company shall pay to each holder of Registrable Securities an amount in cash equal to 1% of the aggregate purchase price of the Securities owned by such holder as liquidated damages, but in no event shall liquidated damages exceed 8% of the Purchase Price.
Accounting for Series A Preferred Stock
The Company has evaluated the terms of the Series A Preferred Stock and determined that the Series A Preferred Stock, without embodying an obligation for the Company to repurchase or to settle by transferring assets, is not a liability in accordance with the guidance provided in ASC Topic 480, Distinguishing Liabilities from Equity.
Also, the Series A Preferred Stock has no redemption clause at all, it is not a mezzanine equity (out of permanent equity) in accordance with the requirement of ASC 480-10-S99.
The Series A Preferred Stock is not subject to redemption (except on liquidation) and the holders of the Series A Preferred Stock are entitled to vote together with common stock holders on an as-converted basis. The Series A Preferred Stock, excluding the embedded conversion option, are considered to be an equity instrument and accordingly, the embedded conversion option has not been separated and accounted for as a derivative instrument liability.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 12 STOCKHOLDERS’ EQUITY (CONTINUED)
Accounting for Series A Preferred Stock (continued)
During the year ended December 31, 2011 and 2010, 49,886 shares and nil, respectively, of Series A Preferred Stock were converted into 498,860 shares of common stock at a 1 for 10 ratio. In addition, during the year ended December 31, 2011, 23,540 shares of common stock were issued to the investors as settlement of stock dividends of $65,638.
Common Stock Purchase Warrants
Series C Warrants
In connection with the issuance of the Series A Preferred Stock, the Company issued Series C Warrants to the investors and the placement agent to purchase up to 592,327 and 24,681 shares, respectively, of common stock on June 7, 2010 and 356,634 and 14,859 shares, respectively, on June 28, 2010, respectively, all at an exercise price of $3.40 per share issued and outstanding. The Series C Warrants have a term of exercise expiring 3 years from the issuance date. The Series C Warrants at the option of the holder, may be exercised by cash payment of the exercise price or, the holder may acquire the underlying shares of common stock through a "cashless exercise."
The Company will not receive any additional proceeds to the extent that the Series C Warrants are exercised by cashless exercise.
The exercise price and number of shares of common stock issuable upon exercise of the Series C Warrants may be adjusted for: 1) upon issuance of additional stock lower than the exercise price; 2) upon subdivision or combination of common stocks; or 3) upon distribution of assets and other dilutive events.
Accounting for Series A, Series B and Series C Warrants
Series A and Series B Warrants issued to certain investors on December 17, 2009 to purchase 500,000 shares of the Company’s common stock remained outstanding at December 31, 2011 had a term of three years and exercise prices of $3.25 and $4.00 per share, respectively. These warrants contain standard anti-dilution provisions for stock dividends, stock splits, stock combination, recapitalization and a change of control transaction. Because these warrants do not contain any contingent exercise provisions and their settlement amount will equal the difference between the fair value of a fixed number of the Company’s equity shares and a fixed strike price, these warrants, which are freestanding instruments, qualify for the scope exception under the guidance provided in ASC 815-40-15-5 through 815-40-15-8, and are considered indexed to the Company’s own stock. Accordingly, Series A and Series B Warrants have been classified as equity.
Since the Series C Warrants issued to the investors and the placement agent in June 2010 contain reset exercise price provisions, the Company had determined to classify these warrants as derivative liabilities. The reset exercise provisions of the warrants issued to the investors and the placement agent in June 2010 were recorded at their relative fair values at issuance of $1,182,860 and will continue to be recorded at fair value at each subsequent balance sheet date. Any change in value between reporting periods will be recorded as other income (expense). These warrants will continue to be reported as a liability until such time when they are exercised or expire. The fair value of these warrants is estimated using Monte-Carlo simulation methods.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 12 STOCKHOLDERS’ EQUITY (CONTINUED)
Accounting for Series A, Series B and Series C Warrants (continued)
As of December 31, 2011, the fair value of these outstanding Series C Warrants was determined to be $144,411, accordingly, the Company recorded ($1,053,862) and $15,413 in other income related to the change in the fair value of the Series C Warrants during the years ended December 31, 2011 and 2010, respectively.; There is no cash flow impact for the warrant liability until the Series C Warrants are exercised.
The following table presents a reconciliation of the warrant liabilities measured at fair value on a recurring basis using Level 2 from January 1, 2010 to December 31, 2011:
IR Warrants
On May 27, 2010, the Company entered into an investor relations agreement with a consultant in which the consultant would provide certain consulting services to the Company for a term of one year. In exchange for the consulting services provided, the consultant should receive (i) a cash fee of $100,000 and (ii) 100,000 warrants (the “IR Warrants”) at an exercise price of $3.80 and a term of three years from issuance date. The above 100,000 IR Warrants were issued on July 1, 2010. The grant date fair value of these IR warrants was estimated at $89,435 using Black-Scholes valuation model and $37,265 and $52,170 were charged as general and administrative expenses during the years ended December 31, 2011 and 2010, respectively.
Warrants issued and outstanding at December 31, 2011, and changes during the two years then ended, are as follows:
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 13 STATUTORY RESERVES
In accordance with the PRC Companies Law, the Company’s PRC subsidiaries and VIEs were required to transfer 10% of their profits after tax, as determined in accordance with accounting standards and regulations of the PRC, to the statutory surplus reserve and a percentage of not less than 5%, as determined by management, of the profits after tax to the public welfare fund. However, the Company’s PRC subsidiaries and VIEs were not required to transfer any profit after tax to the statutory surplus reserve after the accumulated statutory surplus reserves reached 50% of registered capital of the Company’s PRC subsidiaries and VIEs. With the amendment of the PRC Companies Law which was effective from January 1, 2006, enterprises in the PRC were no longer required to transfer any profit to the public welfare fund. Any balance of the public welfare fund brought forward from December 31, 2005 should be transferred to the statutory surplus reserve. The statutory surplus reserve is non-distributable.
NOTE 14 SHARE-BASED COMPENSATION
Stock options granted to CFO
On January 1, 2010, the Company entered into a stock option agreement with Mr. Daniel K. Lee (“Mr. Lee”), the then Chief Financial Officer of the Company, under the Company’s 2009 Equity Incentive Plan. Pursuant to the terms of the Stock Option Agreement, Mr. Lee was granted options (the “Options”) to purchase an aggregate 250,000 shares of common stock of the Company, among which, an option to purchase 100,000 shares will be vested in 2011 with an exercise price of $7.00 per share, an option to purchase 100,000 shares will be vested in 2012 with an exercise price of $10.00 per share and an option to purchase 50,000 shares will be vested in 2013 with an exercise price of $10.00 per share. Each of the Options expires three years after its respective vesting date.
According to the stock option agreement, in the event Mr. Lee’s employment with the Company is terminated for any reason except for death or disability, he may exercise the options only to the extent that the options would have been exercisable on the termination date and no later than three months after the termination date. If Mr. Lee’s employment is terminated because of his death or disability, the options may be exercised only to the extent that such options would have been exercisable by Mr. Lee on the termination date and must be exercised by Mr. Lee no later than twelve months after the termination date. If Mr. Lee is terminated for cause, the options will terminate immediately. In no event will the options be exercised later than December 31, 2015.
On January 1, 2010, the Company also entered into a restricted shares grant agreement under the Company’s 2009 Equity Incentive Plan with Mr. Lee. Pursuant to the terms of the restricted shares grant agreement, the Company granted to Mr. Lee 140,000 restricted shares of the Company’s common stock subject to the vesting schedule therein. If Mr. Lee’s service with the Company ceases for any reason other than Mr. Lee’s (a) death, (b) Disability, (c) Retirement, or (d) termination by the Company without cause, any nonvested restricted shares will be automatically forfeited to the Company.
The Restricted Shares vest under the following schedule:
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 14 SHARE-BASED COMPENSATION (CONTINUED)
Stock options granted to CFO (continued)
On May 5, 2010, Mr. Lee resigned as the Chief Financial Officer and Treasurer of the Company, effectively immediately.
As a result of the resignation of Mr. Lee, his employment agreement with the Company, dated November 16, 2009, the stock option agreement with the Company, dated January 1, 2010, and the restricted shares grant agreement with the Company, dated January 1, 2010 were terminated, effective on May 5, 2010. In addition, upon his resignation, the unvested 105,000 restricted shares and the unvested options to purchase 250,000 shares of the Company’s common stock granted to Mr. Lee were cancelled. No expense has been recognized related to the Options which were forfeited because the requisite service for the Options has not been rendered.
The Company recognizes compensation cost for an award with only service conditions that has a graded vesting schedule on a straight-line basis over the requisite service period for the entire award, provided that the compensation cost recognized at any date must at least equal the portion of the grant-date value of the award that is vested at that date. No compensation cost is recognized for instruments that employees forfeit because a service condition or a performance condition is not satisfied.
Accordingly, the Company recognized compensation expense of $105,875, related to the restricted shares granted to Mr. Lee, which vested before his resignation, for the year ended December 31, 2010, based on the estimated grant-date fair value of $3.025 of the Company’s common stock.
On July 16, 2010, the Company entered into a stock option agreement with Mr. Robert Tick (“Mr. Tick”), the Chief Financial Officer of the Company, under the Company’s 2009 Equity Incentive Plan. Pursuant to the terms of the stock option agreement, Mr. Tick was granted options to purchase an aggregate of 150,000 shares of common stock of the Company, consisting of an option to purchase 75,000 shares that will vest in 2011 with an exercise price of $5.00 per share, and an option to purchase 75,000 shares that will vest in 2012 with an exercise price of $7.00 per share. Each of these options expires three years after their respective vesting dates.
According to the stock option agreement, in the event Mr. Tick’s employment with the Company is terminated for any reason except for death or disability, he may exercise these options only to the extent that these options would have been exercisable on the termination date and no later than three months after the termination date. If Mr. Tick’s employment is terminated because of his death or disability, these options may be exercised only to the extent that these options would have been exercisable by Mr. Tick on the termination date and must be exercised by Mr. Tick no later than twelve months after the termination date. If the employment is terminated for Cause as defined in the stock option Agreement, these options will terminate immediately. In no event will these options be exercised later than December 31, 2015.
On January 24, 2011, the Compensation Committee of the Board approved the repricing of the options that the Company granted to Mr. Tick on July 16, 2010. As a result, each such option outstanding has an exercise price of $3.50 per share which is higher than the closing price of the Company’s common stock on the OTC Bulletin Board on the date of repricing. In addition, the vesting schedules of the outstanding options granted to Mr. Tick were changed from vesting on an annual basis to vesting on a semi-annual basis.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 14 SHARE-BASED COMPENSATION (CONTINUED)
Stock options granted to CFO (continued)
Summary of options issued and outstanding at December 31, 2011 and the movements during the two years then ended are as follows:
(1)
The market value of the Company’s common stock at December 31, 2011 was $2.00. The outstanding options to Mr. Tick had no intrinsic value at December 31, 2011.
In accordance with the guidance provided in ASC Topic 718, Stock Compensation, the compensation costs associated with these options are recognized, based on the grant-date fair values of these options, over the requisite service period, or vesting period. Also in accordance with ASC Topic 718, incremental compensation cost is measured as the excess, if any, of the fair value of the modified award over the fair value of the original award immediately before its terms are modified. Accordingly, the Company recognized compensation expense of $69,903 and $12,096 in relation to the options granted to the CFO for the two years ended December 31, 2011 and 2010, respectively.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 14 SHARE-BASED COMPENSATION (CONTINUED)
Restricted shares granted to CFO
On July 16, 2010, the Company also entered into a restricted shares grant agreement (the "Restricted Shares Grant Agreement") under the Company’s 2009 Equity Incentive Plan with Mr. Tick. Pursuant to the terms of the Restricted Shares Grant Agreement, the Company granted to Mr. Tick 150,000 restricted shares (the “Restricted Shares”) of the Company’s common stock subject to the vesting schedule therein. If Mr. Tick’s service with the Company ceases for any reason other than Mr. Tick’s (a) death, (b) disability, (c) retirement, or (d) termination by the Company without cause, any unvested restricted shares will be automatically forfeited to the Company.
The Restricted Shares vest under the following schedule:
The Company recognizes compensation cost for an award with only service conditions that has a graded vesting schedule on a straight-line basis over the requisite service period for the entire award, provided that the compensation cost recognized at any date must at least equal the portion of the grant-date value of the award that is vested at that date. No compensation cost is recognized for instruments that are forfeited by the Company because a service condition or a performance condition is not satisfied.
Accordingly, the Company recognized compensation expense of $155,000 and $70,000, related to the restricted shares granted to Mr. Tick for the two years ended December 31, 2011 and 2010, respectively, based on the estimated grant-date fair value of the Company’s common stock of $3.00.
Restricted shares granted to independent directors
On October 5, 2010, the Company entered into separate restricted shares grant agreements with the Company’s newly elected independent directors Mr. Henry Ngan, Ms. Virginia P’an and Mr. Jianbing Zhong. Pursuant the agreements, the Company granted, under the Company’s 2009 Equity Incentive Plan, to Mr. Ngan 40,000 restricted shares of the Company’s common stock, Ms. P’an 30,000 restricted shares and Mr. Zhong 20,000 restricted shares, as compensation for the services to be provided by them as independent directors.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 14 SHARE-BASED COMPENSATION (CONTINUED)
Restricted shares granted to independent directors (continued)
On January 24, 2011, the Company entered into an independent director contract and an indemnification agreement with Mr. Kurtzig, whereby the Company agreed to grant, under the Company’s 2009 Equity Incentive Plan, to Mr. Kurtzig 20,000 restricted shares of the Company’s common stock as compensation for the services to be provided by him and indemnify Mr. Kurtzig against expenses, judgments, fines, penalties or other amounts actually and reasonably incurred by Mr. Kurtzig in connection with any proceeding if Mr. Kurtzig acted in good faith and in the best interests of the Company.
On August 11, 2011, the Company entered into a restricted shares grant agreement with Mr. Kurtzig, whereby the Company agreed to grant, under the Company’s 2009 Equity Incentive Plan, to Mr. Kurtzig 10,000 restricted shares of the Company’s common stock as compensation for the services to be provided by him.
The restricted shares granted to independent directors will vest in equal installments on a semi-annual basis over a two-year period. If the independent director’s service with the Company ceases for any reason other than the independent director’s (a) death, (b) disability, (c) retirement, or (d) termination by the Company without cause, any unvested restricted shares will be automatically forfeited to the Company.
Accordingly, the Company recognized a total compensation expense of $169,304 and $31,920 related to the restricted shares granted to the directors for the two years ended December 31, 2011 and 2010 based on the estimated grant-date fair values of the Company’s common stock of $2.98 on October 5, 2010, $3.28 on January 24, 2011 and $2.41 on August 11, 2011.
Restricted shares granted to consultant
On May 25, 2011, the Company entered into an investor relations agreement with a consultant in which the consultant would provide certain consulting services to the Company for a term of one year. In exchange for the consulting services provided, the consultant should receive 15,000 restricted shares, 7,500 of which shall vest on June 1, 2011 and 7,500 shall vest on December 1, 2011. The Company recognized a total compensation expense of $42,150 related to the restricted shares granted to the consultant during the year ended December 31, 2011, based on the estimated grant-date fair values of the Company’s common stock of $2.81 on May 25, 2011.
NOTE 15 INCOME TAXES
The Company’s VIEs and subsidiaries incorporated in the PRC are subject to PRC enterprise income tax (“EIT”). Before January 1, 2008, the PRC EIT rate was generally 33%. In March 2007, the PRC government enacted a new PRC Enterprise Income Tax Law, or the New EIT Law, and promulgated related regulations, Implementation Regulations for the PRC Enterprise Income Tax Law. The New EIT Law and Implementation Regulations became effective on January 1, 2008. The New EIT Law, among other things, imposes a unified income tax rate of 25% for both domestic and foreign invested enterprises registered in the PRC.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 15 INCOME TAXES (CONTINUED)
The New EIT Law provides a grandfathering on tax holidays which were granted under the then effective tax laws and regulations. Therefore, one of the Company’s VIEs, Daqing Shuaiyi, being engaged in growing and sales of organic and specialty food products, has continued to be entitled to a preferential tax treatment: an EIT holiday for the two years ended December 31, 2006 and 2007 and a 50% reduction on the EIT rate for the three years ended December 31, 2008, 2009 and 2010.
Harbin Shuaiyi was subject to an EIT rate of 25% for the year ended December 31, 2010.
Daqing Shuaiyi, Harbin Shuayi and Heilongjiang Shuaiyi are subject to an EIT rate of 25% for the year ended December 31, 2011. No provision for PRC taxes was made for Heilongjiang Shuaiyi which had no taxable income in the PRC.
Harbin Baixin has been subject to an EIT rate of 25% since its incorporation. No provision for PRC taxes was made as Harbin Baixin had no taxable income in the PRC.
No provision for other overseas taxes is made as none of Nutrastar, New Resources and Oriental Global has any taxable income in the U.S., British Virgin Islands or Hong Kong, respectively.
The Company’s income tax expense consisted of:
A reconciliation of the provision for income taxes determined at the U.S. federal corporate income tax rate to the Company’s effective income tax rate is as follows:
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 15 INCOME TAXES (CONTINUED)
The Company had deferred tax assets as follows:
As of December 31, 2011 and 2010, Nutrastar had $2,314,333 and $1,557,472 net operating loss carryforwards available to reduce future taxable income, respectively, which will expire in various years through 2030. Management believes it is more-likely-than-not that the Company will not realize these potential tax benefits as the Company’s U.S. operations will not generate any operating profits in the foreseeable future. Therefore, the Company recorded a full valuation allowance on its deferred tax assets.
As of December 31, 2011 and 2010, the Company has no material unrecognized tax benefits which would favorably affect the effective income tax rate in future periods and does not believe that there will be any significant increases or decreases of unrecognized tax benefits within the next twelve months. No interest or penalties relating to income tax matters have been imposed on the Company during the years ended December 31, 2011 and 2010, and no provision for interest and penalties is deemed necessary as of December 31, 2011 and 2010.
According to the PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational errors made by the taxpayer or its withholding agent. The statute of limitations extends to five years under special circumstances, which are not clearly defined. In the case of a related party transaction, the statute of limitation is ten years. There is no statute of limitation in the case of tax evasion.
NOTE 16 EARNINGS PER SHARE
The following table is a reconciliation of the net income and the weighted average shares used in the computation of basic and diluted earnings per share for the two years presented:
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 16 EARNINGS PER SHARE (CONTINUED)
Diluted earnings per share is calculated by adjusting the weighted average number of common shares outstanding to assume the issuance of all dilutive potential common shares upon conversion.
The diluted earnings per share calculation for the year ended December 31, 2011 did not include the warrants, CFO options and restricted shares to purchase up to 1,588,501 shares, 150,000 shares and 156,250 shares of common stock, respectively, because their effect was anti-dilutive.
The diluted earnings per share calculation for the year ended December 31, 2010 did not include the convertible preferred stock, and the warrants and options to purchase up to 1,071,031 and 75,000 shares of common stock respectively, because their effect was anti-dilutive.
NOTE 17 RELATED PARTY TRANSACTIONS
Other than disclosed elsewhere in these financial statements, the Company also had the following related party balances and transactions:-
(a)
Due to related parties
The amount due to Ms. Han was non-interest bearing, unsecured and without a fixed repayment date.
(b)
Lease of land
For the years ended December 31, 2011 and 2010, the Company paid rental expense of $55,970 and $9,085 for the land leased from Heilongjiang Shuaiyi Technology Development Co., Ltd. (“Shuaiyi Technology”), respectively. Shuaiyi Technology and the Company are under common control and management.
(c)
Acquisition of corporate headquarter premise
On April 15, 2011, Heilongjiang Shuaiyi entered into an asset transfer agreement (the “Transfer Agreement”) with Ms. Han. Pursuant to the Transfer Agreement, Heilongjiang Shuiayi acquired an office building located at 54-1 Ganshui Road, Xiangfang District, Harbin, with a construction area of 1,854.1 square meters, from Ms. Han at a cash consideration of RMB 12.75 million (approximately $1.95 million including other incidental costs), which was fully paid in April 2011. The purchase price was determined based on a real property valuation report issued by an independent appraisal firm, Harbin Guoxin Real Estate Appraisal and Consulting Co., Limited on November 11, 2010. Management believes the terms of the purchase transaction and the consideration that the Company paid in connection with this transaction were comparable to the terms available and the amounts that would be paid in an arm’s-length transaction.
Management intends to move the corporate headquarters in China to this new office building in 2012.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 18 CONCENTRATION RISK
(a) Concentration of credit risk
As of December 31, 2011 and 2010, almost all of the Company’s cash included cash on hand and deposits in accounts 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 bank failure. However, the Company has not experienced any losses in such accounts and believes it is not exposed to any risks on its cash in bank accounts.
For the years ended December 31, 2011 and 2010, all of the Company’s sales arose in the PRC. In addition, all accounts receivable as of December 31, 2011 and 2010 also arose in the PRC.
The following individual customer accounted for 10% or more of the Group’s revenues for the years ended December 31, 2011 and 2010:
Individual customer amounts receivable that represented 10% or more of total accounts receivable as of December 31, 2011 and 2010 were as follows:
(b) Concentration of operating risk
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; export duties, quotas, and embargoes; domestic and international customs and tariffs; changing taxation policies; foreign exchange restrictions; and political conditions and governmental regulations.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 19 COMMITMENTS AND CONTINGENCIES
(a) Operating leases
The Company has entered into tenancy agreements for the leases of an exhibition hall and land with a third party and a related company, Shuaiyi Technology (see 17(b)), respectively, for the purposes of the operation of its VIEs. The Company’s commitments for minimum lease payments under these operating leases for the next five years and thereafter as of December 31, 2011 are as follows:
During the years ended December 31, 2011 and 2010, rental expenses under operating leases amounted to $120,520 and $59,310, respectively.
(b) Capital commitments - contracted but not provided for:
(c) PRC employee costs
According to the prevailing laws and regulations of the PRC, the Company’s subsidiaries and VIEs in the PRC are required to cover its employees with medical, retirement and unemployment insurance programs. Management believes that due to the transient nature of its employees, they do not need to provide all employees with such social insurances, and have not paid the social insurances for all employees.
In the event that any current or former employee files a complaint with the PRC government, the Company’s subsidiaries and VIEs may be subject to making up the social insurances as well as administrative fines. As the Company believes that these fines would not be material, no provision has been made in this regard.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 19 COMMITMENTS AND CONTINGENCIES (CONTINUED)
(d) Indemnification agreement
On October 5, 2010, the Company entered into an indemnification agreement with each of its newly elected independent directors, Mr. Henry Ngan, Ms. Virginia P’an and Mr. Jianbing Zhong, pursuant to which the Company agreed to indemnify the independent directors against expenses, judgments, fines, penalties or other amounts actually and reasonably incurred by the Independent directors in connection with any proceeding if the independent directors acted in good faith and in the best interests of the Company.
Also on October 5, 2010, the Company entered into an indemnification agreement with Mr. Tick pursuant to which the Company agreed to indemnify Mr. Tick against expenses, judgments, fines, penalties or other amounts actually and reasonably incurred by Mr. Tick in connection with any proceeding if Mr. Tick acted in good faith and in the best interests of the Company.
On January 24, 2011, the Company entered into an indemnification agreement with Mr. Joshua Kurtzig, its newly elected independent director, pursuant to which the Company agreed to indemnify Mr. Kurtzig against expenses, judgments, fines, penalties or other amounts actually and reasonably incurred by the independent director in connection with any proceeding if the independent director acted in good faith and in the best interests of the Company.
NOTE 20 SEGMENT INFORMATION
The Company operates in three business segments identified by product, “Chinese Golden Grass”, “beverages” and “organic and specialty food products”. The Chinese Golden Grass segment consists of the growing and sales of Chinese Golden Grass, which business is conducted through Daqing Shuaiyi. The beverages segment consists of the manufacturing of functional health beverages featuring the Chinese Golden Grass as a core ingredient, which business is also conducted through Daqing Shuaiyi and was launched in the fourth quarter of 2010. The organic and specialty food products segment consists of the sales of rice, flour, silage corn and other agricultural products which business is mainly conducted through Harbin Shuaiyi.
During the years ended December 31, 2011 and 2010, all of the Company’s operations were carried out in one geographical segment - China.
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 20 SEGMENT INFORMATION (CONTINUED)
The Company’s segment revenue and results for the years ended December 31, 2011 and 2010 are as follows:
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 21 RESTRICTED NET ASSETS
The Company’s operations are primarily conducted through its VIEs Daqing Shuaiyi and Harbin Shuaiyi. Daqing Shuaiyi and Harbin Shuaiyi may only pay dividends out of its retained earnings determined in accordance with the accounting standards and regulations in the PRC and after it has met the PRC requirements for appropriation to statutory reserves (see Note 13).
In addition, Daqing Shuaiyi and Harbin Shuaiyi’s businesses and assets are primarily denominated in RMB, which is not freely convertible into foreign currencies. All foreign exchange transactions take place either through the People’s Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rates quoted by the People’s Bank of China. Approval of foreign currency payments by the People’s Bank of China or other regulatory institutions requires; submitting a payment application form together with suppliers’ invoices, shipping documents and signed contracts. These currency exchange control procedures imposed by the PRC government authorities may restrict the ability of Daqing Shuaiyi and Harbin Shuaiyi to transfer their net assets to the Company through loans, advances or cash dividends, which consisted of paid-up capital, retained earnings and statutory reserves and which aggregate amount of approximately RMB438 million (or $70 million) exceeded 25% of the Company’s consolidated net assets. Accordingly, condensed parent company financial statements have been prepared in accordance with Rule 5-04 and Rule 12-04 of SEC Regulation S-X. These supplemental condensed parent company financial statements should be read in conjunction with the notes to the Company’s Consolidated Financial Statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted.
As of December 31, 2011 and 2010, there were no material contingencies, significant provisions for long-term obligations, or guarantees of the Company, except as separately disclosed in the Consolidated Financial Statements, if any.
Condensed Balance Sheets
NUTRASTAR INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2011 and 2010
NOTE 21 RESTRICTED NET ASSETS (CONTINUED)
Condensed Statement of Income and Comprehensive Income
Condensed Statement of Cash Flows
EXHIBIT INDEX
*Filed herewith.