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EX-32.1 - ZHONGPIN INC.v192924_ex32-1.htm
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EX-31.1 - ZHONGPIN INC.v192924_ex31-1.htm
EX-10.1 - ZHONGPIN INC.v192924_ex10-1.htm

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

FORM 10-Q

(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

or

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

For the transition period from
To

Commission File Number :
  001-33593

 
Zhongpin Inc.
 
(Exact name of registrant as specified in its charter)

Delaware
 
54-2100419
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)

21 Changshe Road, Changge City, Henan Province, People’s Republic of China
 
461500
(Address of principal executive offices)
 
(Zip Code)

 
011 86 10-8286-1788
 
(Registrant’s telephone number, including area code)

 
Not Applicable
 
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety (90) days. YES x NO ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES ¨ NO ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO x

As of August 5, 2010, 34,725,104 shares of the registrant’s common stock were outstanding.

 
 

 

ZHONGPIN INC.

FORM 10-Q

INDEX

       
Page
         
Part I
Financial Information
   
         
 
Item 1.
Unaudited Financial Statements:
  1
         
   
Consolidated Balance Sheets as of June 30, 2010 (unaudited) and December 31, 2009
  2
         
   
Consolidated Statements of Operations and Comprehensive Income (unaudited) for the three-month and six-month periods ended June 30, 2010 and 2009
  3
         
   
Consolidated Statements of Cash Flows (unaudited) for the six- month periods ended June 30, 2010 and 2009
  4
         
   
Notes to Consolidated Financial Statements (unaudited)
  5
         
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
  19
         
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
  36
         
 
Item 4.
Controls and Procedures
  37
         
Part II
Other Information
   
         
 
Item 1.
Legal Proceedings
  38
         
 
Item 1A.
Risk Factors
  38
         
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
  38
         
 
Item 3.
Defaults Upon Senior Securities
  38
         
 
Item 4.
(Removed and Reserved)
  38
         
 
Item 5.
Other Information
  38
         
 
Item 6.
Exhibits
  38
         
Signatures
  39

 
 

 

ZHONGPIN INC.

Part I - Financial Information

Item 1. Financial Statements

The accompanying unaudited consolidated balance sheets, statements of operations and comprehensive income, and statements of cash flows and the related notes thereto, have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the disclosures required by GAAP for complete financial statements. The financial statements reflect all adjustments, consisting only of normal, recurring adjustments, which are, in the opinion of management, necessary for a fair presentation for the interim periods.

The accompanying financial statements should be read in conjunction with the notes to the aforementioned financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2009.

The results of operations for the three-month and six-month periods ended June 30, 2010 are not necessarily indicative of the results to be expected for the entire fiscal year or any other period.
 
 
 

 

ZHONGPIN INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in U.S. dollars)

   
June 30,
2010
   
December 31,
2009
 
   
(Unaudited)
       
ASSETS
           
Current assets
           
Cash and cash equivalents
  $ 39,748,050     $ 68,982,259  
Restricted cash
    22,505,742       14,490,575  
Bank notes receivable
    14,710,863       7,997,172  
Accounts receivable, net of allowance for doubtful accounts of $1,853,283 and $1,132,038
    33,915,825       20,419,797  
Other receivables, net of allowance for doubtful accounts of $177,310 and $290,436
    1,590,510       652,523  
Purchase deposits
    4,026,654       5,653,192  
Inventories
    44,187,778       33,859,420  
Prepaid expenses and deferred charges
    760,695       186,030  
Allowance receivable
    4,436,779        
VAT recoverable
    18,393,417       14,064,185  
Deferred tax assets
    257,558       256,151  
Other current assets
    137,480       120,709  
Total current assets
    184,671,351       166,682,013  
                 
Long-term investment
    441,768        
Property, plant and equipment (net)
    265,309,166       189,588,904  
Deposits for purchase of land use rights
    20,835,887       8,718,740  
Construction in progress
    30,566,969       70,192,150  
Land use rights
    61,292,261       61,128,431  
Deferred charges
    25,714       39,855  
Other non-current assets
    1,771,386       1,761,709  
Total assets
  $ 564,914,502     $ 498,111,802  
                 
LIABILITIES AND EQUITY
               
Current liabilities
               
Short-term loans
  $ 69,357,134     $ 84,661,697  
Bank notes payable
    24,207,395       9,560,353  
Long-term loans - current portion
    18,994,424       4,539,215  
Capital lease obligation - current portion
    6,883,036       7,480,098  
Accounts payable
    22,465,257       9,260,750  
Other payables
    17,254,810       12,882,316  
Accrued liabilities
    8,874,838       7,377,850  
Deposits from customers
    4,410,989       5,335,907  
Tax payable
    1,268,243       1,918,057  
Total current liabilities
    173,716,126       143,016,243  
                 
Deferred tax liabilities
    249,307       247,945  
Deposits from customers
    2,500,939       1,987,579  
Capital lease obligation
    8,492,139       11,104,435  
Long-term loans
    54,429,968       44,912,744  
Total liabilities
    239,388,479       201,268,946  
                 
Equity
               
Common stock: par value $0.001; 100,000,000 authorized; 34,725,104 and 34,662,314 shares issued and outstanding
    34,725       34,662  
Additional paid in capital
    167,458,825       166,169,902  
Retained earnings
    137,315,286       111,699,375  
Accumulated other comprehensive income
    20,717,187       18,938,917  
Total equity
    325,526,023       296,842,856  
Total liabilities and equity
  $ 564,914,502     $ 498,111,802  

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

 
2

 

ZHONGPIN INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Amount in U.S. dollars) (Unaudited)

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Revenues
                       
Sales revenues
  $ 215,072,583     $ 161,847,101     $ 419,357,498     $ 315,696,550  
Cost of sales
    (189,738,151 )     (142,879,580 )     (369,104,716 )     (277,585,227 )
Gross profit
    25,334,432       18,967,521       50,252,782       38,111,323  
                                 
Operating expenses
                               
General and administrative expenses
    (5,691,468 )     (4,239,704 )     (11,749,609 )     (8,847,990 )
Selling expenses
    (4,638,672 )     (2,787,080 )     (8,975,500 )     (5,580,358 )
Research & development expenses
    (35,871 )     5,227       (76,723 )     (25,351 )
Gain on disposal of a subsidiary
    -       654,086       -       654,086  
Amortization of loss from sale-leaseback transaction
    -       (16,672 )     -       (33,329 )
Impairment loss
    (1,007,447 )     -       (1,007,447 )     -  
Total operating expenses
    (11,373,458 )     (6,384,143 )     (21,809,279 )     (13,832,942 )
                                 
Income from operations
    13,960,974       12,583,378       28,443,503       24,278,381  
                                 
Other income (expense)
                               
Interest expense, net
    (1,900,389 )     (1,263,975 )     (3,335,850 )     (2,763,495 )
Other income
    104,768       121,943       669,527       291,349  
Government subsidies
    1,244,925       127,453       1,870,081       222,408  
Total other expense
    (550,696 )     (1,014,579 )     (796,242 )     (2,249,738 )
                                 
Net income before taxes
    13,410,278       11,568,799       27,647,261       22,028,643  
Provision for income taxes
    (1,044,833 )     (845,351 )     (2,031,353 )     (1,563,896 )
                                 
Net income
  $ 12,365,445     $ 10,723,448     $ 25,615,908     $ 20,464,747  
                                 
Foreign currency translation adjustment
  $ 1,692,005     $ 115,825     $ 1,778,270     $ (263,147 )
Comprehensive income
  $ 14,057,450     $ 10,839,273     $ 27,394,178     $ 20,201,600  
                                 
Basic earnings per common share
  $ 0.36     $ 0.36     $ 0.74     $ 0.69  
Diluted earnings per common share
  $ 0.35     $ 0.36     $ 0.73     $ 0.69  
Basic weighted average shares outstanding
    34,725,104       29,709,893       34,720,312       29,694,105  
Diluted weighted average shares outstanding
    35,108,264       29,905,720       35,122,896       29,852,635  

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

 
3

 

ZHONGPIN INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amount in U.S. dollars) (Unaudited)

   
Six Months Ended June 30,
 
   
2010
   
2009
 
Cash flows from operating activities:
           
Net income
  $ 25,615,908     $ 20,464,747  
Adjustments to reconcile net income to net cash provided by (used in) operations:
               
Depreciation
    6,093,089       3,772,108  
Amortization
    649,049       400,476  
Provision for allowance for bad debt
    597,245       204,524  
Impairment loss
    1,007,447       -  
Other income
    -       (105,725 )
Gain on disposal of a subsidiary
    -       (649,669 )
Non-cash compensation expense
    1,075,636       754,034  
                 
Changes in operating assets and liabilities:
               
Accounts receivable
    (14,027,015 )     (12,807,660 )
Other receivables
    (815,504 )     654,943  
Purchase deposits
    1,649,138       402,479  
Prepaid expense
    (571,257 )     42,697  
Inventories
    (10,090,670 )     (11,012,841 )
Allowance receivables
    (4,414,158 )     -  
VAT recoverable
    (5,237,751 )     (3,588,961 )
Other current assets
    (16,025 )     (69,793 )
Deferred charges
    14,286       -  
Accounts payable
    13,086,579       2,632,558  
Other payables
    4,282,762       5,533,564  
Accrued liabilities
    1,453,078       258,905  
Taxes payable
    (656,983 )     181,024  
Deposits from clients
    (949,361 )     (32,698 )
Deposits from clients – Long term portion
    499,881       -  
Net cash provided by operating activities
    19,245,374       7,034,712  
                 
Cash flows from investing activities:
               
Deposits for purchase of land use rights
    (12,007,724 )     (7,245,146 )
Construction in progress
    (33,850,846 )     (19,063,158 )
Additions to property and equipment
    (6,733,687 )     (6,064,018 )
Additions to land use rights
    (477,998 )     (15,896,295 )
Proceeds on disposal of fixed assets
    -       50,023  
Increase in restricted cash
    (7,895,117 )     (3,758,823 )
Used to invest in a subsidiary
    (439,515 )     -  
Proceeds from disposal of a subsidiary
    -       1,226,182  
Net cash used in investing activities
    (61,404,887 )     (50,751,235 )
                 
Cash flows from financing activities:
               
Proceeds from (repayment of) bank notes, net
    7,884,362       78,593  
Proceeds from (repayment of) short-term bank loans
    (20,085,130 )     14,342,993  
Proceeds from long-term bank loans
    30,985,833       14,635,501  
Repayment of long-term bank loans
    (3,009,908 )     (70,776 )
Proceeds from capital lease obligations
    (3,294,553 )     (720,604 )
Proceeds from warrants exercise
    213,350       -  
Net cash provided by financing activities
    12,693,954       28,265,707  
                 
Effects of rate changes on cash
    231,350       (61,483 )
Increase (decrease) in cash and cash equivalents
    (29,234,209 )     (15,512,299 )
Cash and cash equivalents, beginning of period
    68,982,259       41,857,166  
Cash and cash equivalents, end of period
  $ 39,748,050     $ 26,344,867  
                 
Supplemental disclosures of cash flow information:
               
Cash paid for interest
  $ 4,006,111     $ 3,438,560  
Cash paid for income taxes
  $ 1,955,733     $ 1,503,753  

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

 
4

 

ZHONGPIN INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1.
ORGANIZATION AND NATURE OF OPERATIONS
 
Zhongpin Inc. (the “Company”) was established under the laws of the State of Delaware on February 4, 2003.  The Company is a public holding company holding equity interests in its subsidiaries outside the U.S.  Its operating subsidiaries are located in the People’s Republic of China (the “PRC”) and focus on two business divisions: pork and pork products, and vegetables and fruits. The pork and pork products division is involved primarily in the processing of live hogs into fresh, frozen and processed pork products which are sold domestically to branded stores, food retailers, food service distributors, restaurants, hotel chains and non-commercial food service establishments, such as schools, governments, healthcare facilities, the military and other food processors, as well as to certain international markets in a limited scope.  The vegetables and fruits segment is involved primarily in the processing of frozen vegetables and fruits that are sold to the Company’s branded stores and food retailers.

The Company holds a 100% interest in Falcon Link Investment Limited, a company organized under the laws of the British Virgin Islands (“Falcon”), through which the Company holds a 100% interest in its China-based subsidiaries, each of which was organized under the laws of the PRC.  The Company’s China-based subsidiaries include the following:

   
Date of
 
Registered
   
Percentage
 
Name
 
Incorporation
 
Capital
   
of Ownership
 
                 
Henan Zhongpin Food Company Limited
 
May.20, 2005
 
$137,300,000
      100 %
                     
Henan Zhongpin Food Share Company Limited (“Henan Zhongpin”)
 
Jan. 20, 2000
 
 
1,000,000,000 RMB
($146,492,243)
      100 %(1)
                     
Henan Zhongpin Import and Export Trading Company Limited
 
Aug. 11, 2004
 
5,060,000 RMB
($611,111)
      100 %
                     
Zhumadian Zhongpin Food Company Limited
 
June 7, 2006
 
60,000,000 RMB
($8,585,399)
      100 %
                     
Anyang Zhongpin Food Company Limited
 
Aug. 21, 2006
 
34,800,000 RMB
($5,094,422)
      100 %
                     
Henan Zhongpin Fresh Food Logistics Company Limited
 
Sept. 14, 2006
 
1,500,000 RMB
($189,665)
      100 %
                     
Deyang Zhongpin Food Company Limited
 
Sept. 25, 2006
 
15,000,000 RMB
($1,893,652)
      100 %
                     
Henan Zhongpin Business Development Company Limited
 
Sept. 27, 2006
 
5,000,000 RMB
($632,215)
      100 %
                     
Heilongjiang Zhongpin Food Company Limited (“Heilongjiang Zhongpin”)
 
Oct. 17, 2006
 
1,000,000 RMB
($126,406)
      100 %(2)
                     
Luoyang Zhongpin Food Company Limited (“Luoyang Zhongpin”)
 
Jan.18, 2007
 
60,000,000 RMB
($8,783,487)
      100 %
                     
Yongcheng Zhongpin Food Company Limited
 
Mar. 1, 2007
 
60,000,000 RMB
($8,783,487)
      100 %
 
 
5

 

ZHONGPIN INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

   
Date of
 
Registered
   
Percentage
 
Name
 
Incorporation
 
Capital
   
of Ownership
 
                 
Tianjin Zhongpin Food Company Limited
 
Sept. 14, 2007
 
100,000,000 RMB
($14,639,145)
      100 %
                     
Hengshui Zhongpin Food Company Limited
 
Nov. 17, 2008
 
1,000,000 RMB
($146,428)
      100 %
                     
Jilin Zhongpin Food Company Limited
 
Dec. 11, 2008
 
1,000,000 RMB
($145,688)
      100 %
                     
Henan Zhongpin Agriculture and Animal Husbandry Industry Development Company Limited
 
Dec. 26, 2008
 
10,000,000 RMB
($1,461,796)
      100 %
                     
Taizhou Zhongpin Food Company Limited
 
May 12, 2010
 
50,000,000 RMB
($7,362,794)
      100 %
 

(1)         Includes a 1.7% ownership interest of another six stockholders with respect to which Henan Zhongpin Food Company Limited is entitled to all economic benefits and the right to vote pursuant to the terms of a trust agreement with such stockholders.
(2)         Includes a 10% ownership interest of another stockholder with respect to which Henan Zhongpin is entitled to all economic benefits and the right to vote pursuant to the terms of a trust agreement with such stockholder.

2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Consolidation and Basis of Presentation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated during the process of consolidation. The consolidated financial statements were prepared in accordance with GAAP.

Use of Estimates

The preparation of unaudited interim condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited interim condensed consolidated financial statements and the reported amounts of revenue and expenses during the period reported. Actual results could materially differ from those estimates.

Certain accounting principles require subjective and complex judgments to be used in the preparation of financial statements. Accordingly, a different financial presentation could result depending on the judgments, estimates, or assumptions that are used. Such estimates and assumptions include, but are not specifically limited to, those required in the valuation of long-lived assets, allowance for doubtful accounts, reserves for inventory obsolescence, valuation allowances for value added tax (“VAT”) recoverable, and determination of stock based compensation.

Foreign Currency Translations and Transactions

RMB, the national currency of the PRC, is the primary currency of the economic environment in which the Company’s China-based subsidiaries are operating. The United States dollar (“U.S. dollar”) is the functional currency used by the Company and Falcon to record all of their activities. The Company uses the U.S. dollar for financial reporting purposes.

 
6

 

ZHONGPIN INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company translates assets and liabilities into U.S. dollars using the middle rate published by the People’s Bank of China as of the balance sheet date. The consolidated statement of income is translated at average rates during the reporting period. Adjustments resulting from the translation of financial statements from RMB into U.S. dollars are recorded in stockholders' equity as part of accumulated comprehensive loss translation adjustments. Gains or losses resulting from transactions in currencies other than RMB are reflected in income for the reporting period.

Revenue Recognition

Revenues generated from the sales of various meat products and vegetables and fruits are recognized when these products are delivered to customers in accordance with previously agreed upon pricing and delivery arrangements, and the collectability of these sales is reasonably assured. Since the products sold by the Company are primarily perishable and frozen food products, the right of return is only for a few days and has been determined to be insignificant by the management of the Company. Accordingly, no provision has been made for returnable goods. Revenues presented on the consolidated statements of operations and comprehensive income are net of sales taxes.

Cash and Cash Equivalents

The Company considers all highly-liquid investments with maturity of three months or less to be cash equivalents. The Company maintains its cash accounts at creditworthy financial institutions and closely monitors the movements of its cash positions.

Restricted Cash and Bank Notes Payable

Under the terms of the credit agreements with certain of its lenders, Henan Zhongpin has agreed to maintain with such lenders in a deposit account an amount of cash that will serve as collateral for its delivery of bank promissory notes of such lenders as payment instruments for its procurement purposes. The amount of bank promissory notes of such lenders that can be delivered by Henan Zhongpin can be up to twice the amount of such deposits. As such deposits may not be withdrawn by Henan Zhongpin without restriction, such cash deposits are presented as “restricted cash” on the consolidated balance sheets.

Bank Notes Receivable

The Company only accepts notes issued by banks in the normal course of business as payment for products sold by the Company. These bank notes receivable have maturity dates of up to 180 days and bear no interest. The Company can hold the bank notes until the maturity date and collect the amount from the issuing banks, or the Company can use these bank notes as a means for payment for goods or services received. The Company accrues no provision for these bank notes because such bank notes have little risk of default in the PRC.

Accounts Receivable

During the normal course of business, the Company's policy is to ask larger customers to make deposits in reasonable and meaningful amounts on a case-by-case basis. For certain newly-developed customers, the Company may extend unsecured credit.

The Company regularly evaluates and monitors the creditworthiness of each of its customers in accordance with the prevailing practice in the meat industry and based on general economic conditions in the PRC. The Company maintains a general policy of providing 100% allowance for doubtful accounts in an amount equal to the aggregate amount of those accounts that are not collected within one year plus an amount equal to 5% of the aggregate amount of accounts receivable less than one year old. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. The Company also examines the credit terms of significant customers regularly and asks for more cash deposits if these customers appear to have any indicators of delaying their payments to the Company.  Such deposits are usually applied for the collection of the outstanding accounts receivable during the year.  With such a practice in place, the Company did not have any specific allowance for doubtful accounts provided against specific customers at June 30, 2010 and December 31, 2009, respectively.

 
7

 

ZHONGPIN INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
 
The following table presents allowance activities in accounts receivable.

   
June 30,
2010
   
December 31,
2009
 
             
Beginning balance
  $ 1,132,038     $ 1,215,901  
Additions charged to (reduction in) expense
    721,245       (83,863 )
Ending balance
  $ 1,853,283     $ 1,132,038  

Inventories

Inventories are stated at the lower of cost or the market based on the weighted average method. Production cost components include the purchase cost of live hogs, direct labor, depreciation, packaging material, utility expense and other manufacturing overhead. By using a systematic costing system, the production cost is allocated to various products at the stage of work-in-progress and finished goods, respectively. Net realizable value is the estimated selling price in the ordinary course of business, less estimated costs to complete and dispose. The Company regularly inspects the shelf life of prepared foods and, if necessary, writes down their carrying value based on their salability and expiration dates into cost of goods sold.

Property, Plant and Equipment

Property, plant and equipment are recorded at cost and are stated net of accumulated depreciation. Depreciation expense is determined using the straight-line method over the estimated useful lives of the assets, as follows:

   
Estimated Useful
Economic Life
 
Plants and buildings
 
5-30 years
 
Machinery and equipment
 
5-20 years
 
Office furniture and equipment
 
3-5 years
 
Vehicles
 
5 years
 
         
Maintenance and repairs are charged directly to expense as incurred, whereas improvements and renewals are generally capitalized in their respective property accounts. When an item is retired or otherwise disposed of, the cost and applicable accumulated depreciation are removed and the resulting gain or loss is recognized and reflected as a line item before operating income (loss).

Land Use Rights

The Chinese government owns all of the parcels of land on which the Company's plants are built. In the PRC, land use rights for commercial purposes are granted by the PRC government typically for a term of 40-50 years. The Company is required to pay a lump sum of money to the State Land and Resource Ministry of the applicable locality to acquire such rights. In accordance with the provision of Statement of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification 350, Intangibles Goodwill and Other, the Company capitalizes the lump sum of money paid and amortizes these land use rights by using the straight line method over the term of the land use license granted by the applicable governmental authority.
 
 
8

 

ZHONGPIN INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Construction in Progress and Interest Capitalization

Construction in progress is stated at cost. The cost accumulation process starts from the time the construction project is set-up and ends at the time the project has been put into service and all regulatory permits and approvals have been received. The Company borrows bank loans from time to time for these construction projects. The interest costs incurred for these construction projects have been capitalized during the construction process.

Impairment of Long-Lived Assets

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable through the estimated undiscounted cash flows expected to result from the use and eventual disposition of that asset.  Whenever any such impairment exists, an impairment loss will be recognized for the amount by which the carrying value exceeds the fair value.

Fair Value of Financial Instruments

The carrying amount of cash and cash equivalents, accounts receivable, other receivables, advance to vendor, accounts payable and accrued liabilities, capital lease obligations and short term and long term loans are reasonable estimates of their fair value because of the short maturity of these items. The fair value of amounts due from/to related parties and stockholders are a reasonable estimate of their fair value as the amounts will be collected and paid off in a period less than one year.  The carrying amounts of capital lease obligations approximate their fair value based on the Company’s current incremental borrowing rates for similar types of arrangements.  Long term debt approximates fair value since the bank term loans are fixed rate instruments and bear interest at the rate dictated and published by the People's Bank of China. The current rates approximate the rate of the debts.

Shipping and Handling Cost

All shipping and handling fees are included in selling expenses.

Value Added Tax

All China-based enterprises are subject to a VAT imposed by the PRC government on their domestic product sales. The output VAT is charged to customers who purchase goods from the Company and the input VAT is paid when the Company purchases goods from its vendors. Input VAT rates are 13% for most of the purchasing activities conducted by the Company. Output VAT rate is 13% for chilled pork products, frozen pork products and vegetable and fruit products, and 17% for prepared meat products. The input VAT can be offset against the output VAT. The VAT payable or recoverable balance presented on the consolidated balance sheets represents either the input VAT less than or larger than the output VAT. The debit balance represents a credit against future collections of output VAT instead of a receivable.

Share-Based Payment

The Company receives employee and certain non-employee services in exchange for (a) equity instruments of the Company or (b) liabilities that are based on the fair value of the Company’s equity instruments or that may be settled by the issuance of such equity instruments.  The Company accounts for stock options granted using a fair-value-based method.

Earnings Per Share

Basic earnings per share includes no dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution of securities that could share in the earnings of an entity, similar to fully-diluted earnings per share. All of such securities are included in the computation of diluted earnings per share. The number of shares of common stock underlying the outstanding stock warrants and options at June 30, 2010 and 2009 were 1,679,490 and 1,960,827, respectively, which were included in the computation of diluted earnings per share.
 
 
9

 
ZHONGPIN INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Government Subsidies

The Company's subsidiaries in the PRC receive government subsidies from local Chinese government agencies in accordance with relevant Chinese government policies. In general, the Company presents the government subsidies received as part of other income unless the subsidies received are earmarked to compensate a specific expense, which have been accounted for by offsetting the specific expense, such as research and development expense or interest expenses. The information relating to government subsidies received and recognized is presented in Note 11.

Research and Development Expenses

Research and development costs are expensed as incurred. Gross research and development expenses for new product development and improvements of existing products by the Company incurred for the three-month periods ended June 30, 2010 and 2009 were $1,220,000 and $492,000, respectively, and for the six-month periods ended June 30, 2010 and 2009 were $2,150,000 and $1,018,000, respectively.

Comprehensive Income (Loss)

The Company adopted FASB Accounting Standards Codification 220, Comprehensive Income, which establishes standards for reporting and presentation of comprehensive income (loss) and its components in a full set of general-purpose financial statements. The Company has chosen to report comprehensive income (loss) in the statements of operations and comprehensive income.  Comprehensive income (loss) is comprised of net income and all changes to stockholders' equity except those due to investments by owners and distributions to owners.

Recently Adopted Accounting Pronouncements
 
Adoption of FASB ASU 2010-17

In April 2010, the FASB issued an Accounting Standard Update (“ASU”) No. 2010-17, “Revenue Recognition – Milestone Method (Topic 605), which provides guidance on defining milestones under Topic 605 and determining when it may be appropriate to apply the milestone method of revenue recognition for research and development deliverables in an arrangement in which one or more payments are contingent upon achieving uncertain future events or circumstances. ASU 2010-17 shall be applied prospectively to milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010 and is not expected to have a material impact on the Company’s consolidated financial position or results of operation.

Adoption of FASB ASU 2010-13

In April 2010, the FASB issued ASU No. 2010-13, "Compensation—Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades," which addresses the classification of a share-based payment award with an exercise price denominated in the currency of a market in which the underlying equity security trades. Topic 718 is amended to clarify that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades shall not be considered to contain a market, performance, or service condition. Therefore, such an award is not to be classified as a liability if it otherwise qualifies as equity classification. The amendments in this ASU should be applied by recording a cumulative-effect adjustment to the opening balance of retained earnings. The cumulative-effect adjustment should be calculated for all awards outstanding as of the beginning of the fiscal year in which the amendments are initially applied, as if the amendments had been applied consistently since the inception of the award. ASU 2010-13 is effective for interim and annual periods beginning on or after December 15, 2010 and is not expected to have a material impact on the Company’s consolidated financial position or results of operations.
 
 
10

 

ZHONGPIN INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
3. 
INVENTORIES
 
Inventories at June 30, 2010 and December 31, 2009 consisted of the following:
 
   
June 30
2010
   
December 31, 
2009
 
   
(Unaudited)
       
             
Raw materials
  $ 2,944,211     $ 4,941,774  
Low value consumables and packing materials
    1,199,603       961,009  
Work in progress
    1,875,675       3,020,589  
Finished goods
    38,168,289       24,936,048  
Total
  $ 44,187,778     $ 33,859,420  
 
4. 
PROPERTY, PLANT AND EQUIPMENT
 
A summary of property, plant and equipment at June 30, 2010 and December 31, 2009 is as follows:

   
June 30
2010
   
December 31, 
2009
 
   
(Unaudited)
       
             
Plants and buildings
  $ 191,359,950     $ 130,399,711  
Machinery and equipment
    87,723,050       68,060,172  
Office furniture and equipment
    2,963,550       2,658,598  
Vehicles
    3,336,818       3,144,368  
Accumulated depreciation and amortization
    (20,074,202 )     (14,673,945 )
Total
  $ 265,309,166     $ 189,588,904  
 
The depreciation and amortization expenses for the three-month periods ended June 30, 2010 and 2009 were $3,363,115 and $2,183,491, respectively, and for the six-month periods ended June 30, 2010 and 2009 were $6,093,089 and $4,172,584, respectively.
 
Property, plant and equipment under the sale-leaseback agreement at cost at June 30, 2010 and December 31, 2009 was as follows:
 
   
June 30
2010
   
December 31, 
2009
 
   
(Unaudited)
       
             
Plants and buildings
  $ 694,759     $ 707,433  
Machinery and equipment
    25,669,370       26,239,328  
Office furniture and equipment
    31,446       28,937  
Vehicles
    3,994       3,939  
Accumulated depreciation
    (1,347,667 )     (631,251 )
Total
  $ 25,051,902     $ 26,348,386  
 
 
11

 

ZHONGPIN INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
The deferred losses included in the property and equipment balance were $3,443,950 and $4,149,415 at June 30, 2010 and December 31, 2009, respectively, and would be amortized over the lease term. Of the depreciation expenses, $724,543 and $709,314 were amortization of deferred loss and depreciation expense from assets under capital lease, respectively, for the six months ended June 30, 2010; $33,329 and $181,348 were amortization of deferred loss and depreciation expense from assets under capital lease, respectively, for the six months ended June 30, 2009.
 
5. 
LAND USE RIGHTS
 
The Company’s land use rights at June 30, 2010 and December 31, 2009 are as follows:
 
   
June 30
2010
   
December 31,
 2009
 
   
(Unaudited)
       
             
Land use rights
  $ 64,241,186     $ 63,412,436  
Accumulated amortization
    (2,948,925 )     (2,284,005 )
Total
  $ 61,292,261     $  61,128,431  
 
The amortization expenses for the three months ended June 30, 2010 and 2009 were $321,659 and $212,618, respectively, and for the six-month periods ended June 30, 2010 and 2009 were $649,049 and $400,476, respectively.
 
6. 
CONSTRUCTION IN PROGRESS
 
Construction in progress at June 30, 2010 and December 31, 2009 consisted of the following:
 
Construction Project
    
Date or
Estimated Date
Put in Service(1)
 
June 30
2010
   
December 31, 
2009
 
                     
Production line for prepared pork in Changge industrial park
 
January 2010
  $     $ 75,203  
Production facility for prepared pork products in Changge industrial park
 
March 2010
     4,418        17,145,694  
Water solution station in Changge industrial park
 
April 2010
          64,439  
Replacement and maintenance in Changge industrial park
 
April 2010
    181,191       121,187  
Dormitories and other infrastructure in Changge industrial park
 
April 2010
          2,844,349  
Production facility for food oil in Changge industrial park
 
April 2010
          4,515,099  
Production  facility for chilled and frozen pork in Tianjin
 
April 2010
          38,100,295  
Zhengzhou office  
May 2010
    36,019       12,390  
Distribution center in Zhumadian
 
July 2010
    5,373,804       3,611,201  
Facility upgrade and distribution center in Anyang
 
August 2010
    11,359,494       2,958,320  
Distribution center in Luoyang
 
September 2010
    5,514,926       743,973  
Distribution center in Changge
 
April 2011
    8,097,117        
Total
      $ 30,566,969     $ 70,192,150  
   
 
Estimated cost to complete current construction in process is $9.9 million.
 
 
 

 
12

 

ZHONGPIN INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


 (1)
Represents date all regulatory permits and approvals are received and project is placed in service. In certain cases, construction of a project may be substantially completed and the project may be operational during a testing period prior to such date.
 
7.
SHORT-TERM BANK LOANS
 
Short-term bank loans are due within one year. Of the $69.4 million aggregate principal amount of short-term bank loans at June 30, 2010, loans in the principal amount of $16.0 million were secured by the Company’s plants located primarily in Henan province, loans in the aggregate principal amount of $10.5 million were guaranteed by the Company’s subsidiaries, and loans in the aggregate principal amount of $10.3 million were guaranteed by Henan Huanghe Enterprises Group Co., Ltd., an unaffiliated third party (“Huanghe Group”). These loans bear interest at prevailing lending rates in the PRC ranging from 4.78 % to 5.40% per annum.
 
8. 
LONG-TERM BANK LOANS
 
Amounts outstanding under the Company’s long-term debt arrangements at June 30, 2010 and December 31, 2009 were as follows:
 
Bank
 
June 30
2010
   
December 31, 
2009
 
   
(Unaudited)
       
             
China Construction Bank
  $ 13,253,030     $ 7,322,574  
China Minsheng Bank
    7,362,794       7,322,574  
Agriculture Bank of China
    28,567,642       10,251,605  
Rabobank Nederland Shanghai
    8,835,353       11,716,118  
China CITIC Bank
          4,393,544  
Canadian Government Transfer Loan
    1,416,264       1,489,099  
China Merchants Bank
    13,989,309       6,956,445  
Current portion
    (18,994,424 )     (4,539,215 )
Total long-term portion
  $ 54,429,968     $ 44,912,744  

In June 2010, Henan Zhongpin entered into a loan agreement with China Construction Bank pursuant to which Henan Zhongpin borrowed RMB 40 million ($5.9 million). All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (5.40% per annum on June 30, 2010) and are payable on June 29, 2013.  Borrowings under the loan agreement are guaranteed by the land use right, property and plant of Henan Zhongpin.

In March 2010, Henan Zhongpin entered into a loan agreement with Agriculture Bank of China pursuant to which Henan Zhongpin borrowed RMB 53 million ($7.8 million). All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (5.76% per annum on June 30, 2010) and are payable in installments on March 18, 2012, 2013 and 2014 and December 27, 2014.  Borrowings under the loan agreement are guaranteed by the land use right, property and plant of Luoyang Zhongpin.

In March 2010, Henan Zhongpin entered into a loan agreement with China Merchants Bank pursuant to which Henan Zhongpin borrowed RMB 47.5 million ($7.0 million). All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (5.76% per annum on June 30, 2010) and are payable on November 26, 2014.  Borrowings under the loan agreement are guaranteed by Luoyang Zhongpin.

 
13

 

ZHONGPIN INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In February 2010, Henan Zhongpin entered into a loan agreement with Agriculture Bank of China pursuant to which Henan Zhongpin borrowed RMB 71 million ($10.4 million). All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (5.40% per annum on June 30, 2010) and are payable on February 3, 2013.  Borrowings under the loan agreement are guaranteed by the land use right, property and plant of Luoyang Zhongpin.

In December 2009, Henan Zhongpin entered into a loan agreement with Agriculture Bank of China pursuant to which Henan Zhongpin borrowed RMB 70 million ($10.3 million). All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (5.76% per annum on June 30, 2010) and are payable on December 27, 2014.  Borrowings under the loan agreement are guaranteed by the land use right, property and plant of Luoyang Zhongpin.

In November 2009, Henan Zhongpin entered into a loan agreement with China Merchants Bank pursuant to which Henan Zhongpin borrowed RMB 47.5 million ($7.0 million). All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (5.76% per annum on June 30, 2010) and are payable on November 26, 2014.  Borrowings under the loan agreement are guaranteed by Luoyang Zhongpin.

In June 2009, Henan Zhongpin entered into a loan agreement with China Construction Bank pursuant to which Henan Zhongpin borrowed RMB 50 million ($7.4 million). All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (5.40% per annum on June 30, 2010) and are payable on June 10, 2011.  Borrowings under the loan agreement are guaranteed by the land use right, property and plant of Henan Zhongpin.

In May 2009, Henan Zhongpin entered into a loan agreement with China Minsheng Bank pursuant to which Henan Zhongpin borrowed RMB 50 million ($7.4 million). All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (5.40% per annum on June 30, 2010) and are payable on May 6, 2011. Borrowings under the loan agreement are guaranteed by the Company’s wholly-owned subsidiary, Yongcheng Zhongpin Food Company Limited.

In May 2008, Henan Zhongpin entered into a credit agreement with Rabobank Nederland Shanghai Branch that provided for a three-year term loan of up to RMB 80 million ($11.8 million).  On June 10, 2008, the first 50% of the long-term loan was funded by the bank.  The remaining 50% of the long-term loan was drawn down by Henan Zhongpin on July 10, 2008.  Amounts currently outstanding under the long-term loan bear interest at the rate published by the People’s Bank of China for loans with the same or similar terms. The accrued interest on this loan is payable on a quarterly basis. Of the outstanding principal under the long-term loan, 25% is payable 24 months after the first drawdown date (June 10, 2008), 37.5% is payable 30 months after the first drawdown date and the balance is payable 36 months after the first drawdown date.  Henan Zhongpin repaid $2.9 million of the loan on June 10, 2010 and $8.9 million remained outstanding as of June 30, 2010.

Borrowings under the term loan agreement are guaranteed by the Company’s subsidiaries, Anyang Zhongpin Food Co., Ltd. and Zhumadian Zhongpin Food Co., Ltd., are secured by mortgages on the Company’s prepared pork production facilities located in Changge City, Henan province and are subject to various financial and non-financial covenants, including a debt-to-net-worth ratio, a debt-to-EBITDA ratio, an interest coverage ratio, a required minimum tangible net worth, restrictions on investments in fixed assets and financial assets, on inter-company indebtedness and on consolidated contingent liabilities and a requirement that a minimum percentage of Henan Zhongpin’s consolidated EBITDA be generated by Henan Zhongpin and the guarantors.  Henan Zhongpin also is prohibited from paying dividends in an amount in excess of 50% of its retained earnings during the term of the credit facility. We are in compliance with both the financial and non-financial covenants.

 
14

 

ZHONGPIN INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In May 2002, Henan Zhongpin entered into a loan agreement with Bank of Communications, Zhengzhou Branch, which is the intermediary bank for a 40-year term loan in the amount of $2,504,969 from the Canadian government.  Under the terms of the loan agreement, 58% of the principal amount ($1,452,882) of this loan bears interest at the fixed rate of 6.02% per annum and remaining principal amount of this loan is interest free.  The loan is repayable in a fixed amount of $145,671, which includes both principal and interest, that is payable on a semi-annual basis through May 15, 2042.  Borrowings under the loan agreement are guaranteed by the Financing Department, Henan province.
 
9. 
EQUITY TRANSACTIONS
 
On April 24, 2009, the Company granted stock options to its 22 employees to purchase an aggregate of 720,000 shares of the Company’s common stock, exercisable in accordance with the following schedule:  240,000 options vesting on April 24, 2010 with an exercise price of $8.93 per share, equal to the closing price of the Company’s common stock on April 24, 2009, 240,000 options vesting on April 24, 2011 with an exercise price of $13.42 per share, equal to the closing price of the Company’s common stock on April 23, 2010, the last trading day before April 24, 2010 (Saturday), and 240,000 options vesting on April 24, 2012 with an exercise price equal to the closing price of the Company’s common stock on April 22, 2011, the last trading day before April 24, 2011 (Sunday),.  Each tranche of options expires on the fourth anniversary of its respective vesting dates.

The Company adopted the fair value recognition to measure and recognize compensation expense for all stock-based payment awards made to the Company’s employees and directors, including stock options and employee stock purchases.  Stock-based compensation expense for stock options was based on the grant-date fair value.  During the process of estimating the fair value of the stock options granted and recognizing share-based compensation, the following assumptions were adopted.

The fair value for these awards was estimated using the Black-Scholes option pricing model with the following weighted average assumptions, assuming no expected dividends:

   
Six Months Ended June 30,
 
   
2010
   
2009
 
Expected life (years)
    3-5       3-5  
Expected volatility
    65.11 %     39.91 %
Risk-free interest rate
    1.42 %     1.36 %
Dividend yield
    %     %

The expected volatilities are based on the historical volatility of the Company’s common stock.  The observation is made on a weekly basis.  The observation period covered is consistent with the expected life of the options.  The risk-free rate is consistent with the expected terms of the stock options and is based on the United States Treasury yield curve in effect at the time of grant. In estimating expected lives of the options, the Company considered the contractual and vesting terms of awards, along with historical experience; however, due to insufficient historical data from which to reliably estimate expected lives, the Company used estimates based on the “simplified method” set forth by the SEC in Staff Accounting Bulletin No. 107, where expected life is estimated by summing the award’s vesting term and contractual term and dividing that result by two. Insufficient historical data from which to reliably estimate expected lives is expected to exist for the foreseeable future due to different terms associated with awards granted in recent years, along with other factors.

For the three-month periods ended June 30, 2010 and 2009, the stock-based compensation expenses were $602,163 and $464,117, respectively, and for the six-month periods ended June 30, 2010 and 2009, the stock-based compensation expenses were $1,075,635 and $754,034, respectively.
 
10. 
EARNINGS PER SHARE
 
The following table shows the computation of basic and diluted net earnings per share for the periods indicated:

 
15

 

ZHONGPIN INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
 
 
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
Numerator: 
                                   
Net income attributable to common shareholders
  $ 12,365,445     $ 10,723,448     $ 25,615,908     $ 20,464,747  
                                 
Denominator:
                               
Weighted average number of common shares outstanding – basic
    34,725,104       29,709,893       34,720,312       29,694,105  
                                 
Dilutive effect of stock options
    383,160       195,827       402,584       158,530  
                                 
Weighted average number of common shares outstanding – diluted
    35,108,264       29,905,720       35,122,896       29,852,635  
                                 
Basic earnings per share
  $ 0.36     $ 0.36     $ 0.74     $ 0.69  
                                 
Diluted earnings per share
  $ 0.35     $ 0.36     $ 0.73     $ 0.69  
 
11. 
GOVERNMENT SUBSIDIES
 
The central and local government provided Henan Zhongpin with various subsidies to encourage its research and development activities, building new facilities using information technology, building cold chain logistic and distribution networks, and for other contributions to the local community, such as increasing employment opportunities. The government subsidies are generally classified as earmarked (such as research and development activities) or non-earmarked. The interest subsidies were earmarked to offset the Company’s interest expenses incurred in relation to the construction of its fruit and vegetable production facility. All subsidies were accounted for based on evidence that cash has been received and the earmarked activities have taken place. In accordance with internationally prevailing practice, subsidies earmarked for research and development activities were first offset against relevant research and development expenses incurred, and interest subsidies were offset against the relevant interest expense incurred. Non-earmarked subsidies are generally recognized as other income.
 
Government subsidies received by the Company during the three-month and six-month periods ended June 30, 2010 and 2009 were as follows:

 
16

 

ZHONGPIN INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
Deferred subsidies opening balance:
                       
Interest subsidies
  $     $     $     $  
Earmarked subsidies
                       
Non-earmarked subsidies
                       
Total
  $       $       $     $    
                                 
Subsidies received:
                               
Interest subsidies
  $     $ 390,767     $ 307,045     $ 390,767  
Earmarked subsidies
          43,907             43,907  
Non-earmarked subsidies
    1,244,925       127,453       1,870,081       222,408  
Total
  $ 1,244,925     $ 562,127     $ 2,177,126     $ 657,082  
                                 
Subsidies recognized:
                               
Interest subsidies
  $     $ 390,767     $ 307,045     $ 390,767  
Earmarked subsidies
          43,907             43,907  
Non-earmarked subsidies
    1,244,925       127,453       1,870,081       222,408  
Total
  $ 1,244,925     $ 562,127     $ 2,177,126     $ 657,082  
                                 
Deferred subsidies year ending balance:
                               
Interest subsidies
  $     $     $     $  
Earmarked subsidies
                       
Non-earmarked subsidies
                       
Total
  $     $     $     $  

Subsidies received and other income recognized are translated at the average exchange rate. The beginning and ending balances are translated at the period-end exchange rates.

12. 
SEGMENT REPORTING
 
The Company operates in only one segment: meat production. The Company’s vegetables and fruits operations, both financially and operationally, do not represent a significant enough portion of its business to constitute a separate segment. However, the Company’s product lines are divided into two divisions: pork and pork products, and vegetables and fruits.
 
The pork and pork products division is involved primarily in the processing of live hogs into fresh, frozen and processed pork products. The pork and pork products division markets its products domestically to branded stores and to food retailers, foodservice distributors, restaurant operators and noncommercial foodservice establishments, such as schools, hotel chains, healthcare facilities, the military and other food processors, as well as in certain international markets on a limited basis.
 
The vegetables and fruits division is involved primarily in the processing of fresh vegetables and fruits. The Company contracts with more than 100 farms in Henan province and nearby areas to produce high-quality vegetable varieties and fruits suitable for export purposes. The proximity of the contracted farms to operations ensures freshness from harvest to processing. The Company contracts with those farms to grow more than 34 categories of vegetables and fruits, including asparagus, sweet corn, broccoli, mushrooms, lima beans and strawberries.

 
17

 

ZHONGPIN INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
   
Sales by Division
(U.S. dollars in millions)
 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
Pork and Pork Products:
                       
Chilled pork
  $ 114.3     $ 83.3     $ 229.0     $ 169.8  
Frozen pork
    58.3       55.0       108.7       99.0  
Prepared pork products
    36.8       20.4       73.1       42.3  
Vegetables and Fruits
    5.7       3.1         8.6       4.6  
Total
  $ 215.1     $ 161.8     $ 419.4     $ 315.7  
                                 
Cost of Sales:
                               
Pork products
  $ 184.9     $ 140.4     $ 361.9     $ 273.8  
Vegetables and fruits
  $ 4.8     $ 2.5     $ 7.2     $ 3.8  
                                 
Gross Profit Margin:
                               
Pork products
    11.7 %     11.5 %     11.9 %     12.0 %
Vegetables and fruits
    15.8 %     19.4 %     16.3 %     17.4 %

 
18

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Disclosure Regarding Forward-Looking Statements
 
The statements contained in this Report with respect to our financial condition, results of operations and business that are not historical facts are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 21E of the Exchange Act. Forward-looking statements can be identified by the use of forward-looking terminology, such as “estimates,” “projects,” “plans,” “believes,” “expects,” “anticipates,” “intends,” or the negative thereof or other variations thereon, or by discussions of strategy that involve risks and uncertainties. Management wishes to caution the reader of the forward-looking statements that any such statements that are contained in this Report reflect our current beliefs with respect to future events and involve known and unknown risks, uncertainties and other factors, including, but not limited to, economic, competitive, regulatory, technological, key employee, and general business factors affecting our operations, markets, growth, services, products, licenses and other factors discussed in our other filings with the Securities and Exchange Commission, and that these statements are only estimates or predictions. No assurances can be given regarding the achievement of future results, as actual results may differ materially as a result of risks facing our company, and actual events may differ from the assumptions underlying the statements that have been made regarding anticipated events.
 
These forward-looking statements are subject to numerous assumptions, risks and uncertainties that may cause our actual results to be materially different from any future results expressed or implied by us in those statements. Some of these risks are described in “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2009 and in Part II, Item 1A of this Report.
 
These risk factors should be considered in connection with any subsequent written or oral forward-looking statements that we or persons acting on our behalf may issue. All written and oral forward looking statements made in connection with this Report that are attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Given these uncertainties, we caution investors not to unduly rely on our forward-looking statements. We do not undertake any obligation to review or confirm analysts’ expectations or estimates or to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this Report or to reflect the occurrence of unanticipated events. Further, the information about our intentions contained in this Report is a statement of our intention as of the date of this Report and is based upon, among other things, the existing regulatory environment, industry conditions, market conditions and prices, the economy in general and our assumptions as of such date. We may change our intentions, at any time and without notice, based upon any changes in such factors, in our assumptions or otherwise.
 
Overview
 
We are principally engaged in the meat and food processing and distribution business in the PRC. Currently, we have 13 processing plants located in Henan, Jilin and Sichuan provinces and in Tianjin in the PRC. Our total production capacity for chilled pork and frozen pork is approximately 1,504.9 metric tons per day, based on an eight-hour working day, or approximately 541,760 metric tons on an annual basis. We also have production capacity for prepared meats of approximately 250 metric tons per eight-hour day, or approximately 90,000 metric tons on an annual basis, and for fruits and vegetables of approximately 83.3 metric tons per eight-hour day, or approximately 30,000 metric tons on an annual basis. In addition, we also have annual production capacity for food oil (pork oil) of approximately 20,000 metric tons. We use state-of-the-art equipment in all of our slaughterhouses and processing facilities.
 
In December 2009, the PRC Ministry of Commerce issued the Hog Slaughtering Industry Development Guidelines (2010-2015). The guidelines state that the government will control the number of slaughterhouses  in China and specifically that there should be no more than four slaughterhouses in cities with a population of 5 million or more.
 
In June 2010, the China Meat Association (“CMA”) announced the China Meat Industry Development Strategy Report (2011-2015). In that report, CMA provided a development roadmap and targets for the meat industry for the coming five years:

 
19

 
 
 
Ø
By 2015, to decrease sales of room temperature pork to below 50% of total pork sales in cities at or above county level in China;
 
 
Ø
By 2015, to increase sales of chilled pork from 10% to around 30% of total pork sales in China;
 
 
Ø
By 2015, to decrease outstanding licenses for slaughterhouses from more than 21,000 to around 3,000 in China; and
 
 
Ø
To build pork and pork products production bases in north China, north-east China, east China and south-west China.
 
The report  indicates to us and other companies with strong brand recognition in China's meat industry, high standard facilities, high quality products, strict quality control systems and cold chain logistics capabilities, that there is an opportunity to consolidate and integrate the industry. Our growth strategy will include consideration of opportunities to expand our production capacity in these strategic areas in response to the suggestions in the report. We plan to build new facilities for chilled and frozen pork, as well as new facilities for prepared pork products and cold chain logistic distribution centers. We may also explore opportunities to acquire companies with strong regional brand recognition, that produce prepared pork products, and with high quality facilities. We expect that these new facilities, together with our existing ones, will help us to build “Zhongpin” into a stronger, national brand, increase our market share, revenue and net profit and more importantly, strengthen our ability to consolidate the meat industry in China.
 
We will be investing approximately $61.5 million to build a slaughtering and processing plant, low temperature prepared pork plant, logistics center, and research and development center in Nong'an county in the Jilin province of China. This facility will have a production capacity of approximately 70,000 metric tons for chilled pork, 25,000 metric tons for frozen pork, and 30,000 metric tons for prepared pork products. The construction work will start from the third quarter of 2010. We expect to put the new facility for chilled and frozen pork into operation in the fourth quarter of 2011 and the new facility for prepared pork products into operation in the third quarter of 2012.
 
We will be investing approximately $63.0 million to build a production facility, warehouse and distribution center in Taizhou, Jiangsu province. This facility will have a production capacity of approximately 100,000 metric tons for chilled and frozen pork, of which 80% will be for chilled pork including easy-to-cook products and 20% for frozen pork, and 30,000 metric tons for prepared pork products. The construction work will start in August 2010. We expect to put the new facility for chilled and frozen pork into operation in the third quarter of 2011 and the new facility for prepared pork products into operation in the first quarter of 2012.
 
In January 2010, we put the new facility in Tianjin with a production capacity of approximately 100,000 metric tons for chilled and frozen pork into operation. We will commence the construction of phase two of the facility, with a production capacity of approximately 36,000 metric tons for prepared pork products in the fourth quarter of 2010 and expect to put it into operation in the third quarter of 2011.
 
We are also investing approximately $6.3 million to further improve our facility in Anyang, Henan province. We plan to improve the facility’s pre-cooling room and equipment so as to increase its annual capacity from 63,000 metric tons currently to 85,000 metric tons. After the expansion, chilled pork will account for about 70% of the facility’s capacity, up from the current 60%. This improvement project will be completed in August 2010 and there is no impact on our operations in Anyang.
 
Our products are sold under the “Zhongpin” brand name. At June 30, 2010, our customers included approximately 60 international or domestic fast food companies in the PRC, 75 processing factories and 1,650 school cafeterias, factory canteens, army posts and national departments.  As of that date, we also sold directly to 3,243 retail outlets, including supermarkets, within the PRC.
 
We have established distribution networks in 20 provinces and four cities with special legal status in the North, East, South and South Midland regions of the PRC, and also have formed strategic business alliances with leading supermarket chains and the catering industry in the PRC. In addition, we export products to Europe, Hong Kong and other selected countries in Asia.
 
 
20

 
 
As of June 30, 2010, we had 7,013 employees, of whom 5,305 were operating personnel, 1,248 were sales personnel, 108 were research and development personnel and 352 were administrative personnel.
 
Critical Accounting Policies
 
Unless otherwise noted, all translations from RMB to U.S. dollars were made at the middle rate published by the People’s Bank of China, or the middle rate, as of June 30, 2010, which was RMB6.7909 to $1.00. We make no representation that the RMB amounts referred to in this Quarterly Report on Form 10-Q could have been or could be converted into U.S. dollars at any particular rate or at all. On August 5, 2010, the middle rate was RMB6.7783 to $1.00.
 
Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles.  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses.  We evaluate, on an on-going basis, our estimates for reasonableness as changes occur in our business environment.  We base our estimates on experience, the use of independent third-party specialists, and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions.
 
Critical accounting policies are defined as those that are reflective of significant judgments, estimates and uncertainties, and potentially result in materially different results under different assumptions and conditions.  We believe the following are our critical accounting policies:
 
Revenue Recognition.  Revenues generated from the sale of various meat products and vegetables and fruits are recognized when these products are delivered to customers in accordance with previously-agreed-upon pricing and delivery arrangements, and the collectability of these sales is reasonably assured.  Since the products sold by us are primarily perishable and frozen food products, the right of return is only for a few days and has been determined to be insignificant by our management.  Accordingly, no provision has been made for returnable goods.  Revenues presented on our consolidated income statements are net of sales taxes.
 
Accounts Receivable. During the normal course of business, our policy is to ask larger customers to make deposits in reasonable and meaningful amounts on a case-by-case basis.  For certain newly-developed customers, we may extend unsecured credit.
 
We regularly evaluate and monitor the creditworthiness of each of our customers in accordance with the prevailing practice in the meat industry and based on general economic conditions in the PRC.  If any particular customer appears to be delaying or deferring payments for our products, we generally request a deposit from, or an increase in the deposits of, such customer.  Such deposits are typically applied against the outstanding accounts receivable of the applicable customer during the year.  As a result, we did not have a bad debt allowance provided against any specific customer at June 30, 2010.
 
We maintain a general policy of providing 100% allowance for doubtful accounts in an amount equal to the aggregate amount of those accounts that are not collected within one year plus an amount equal to 5% of the aggregate amount of accounts receivable less than one year old.  After all attempts to collect a receivable have failed, the receivable is written off against the allowance.  
 
Inventories.  Inventories are stated at the lower of cost or the market based on the weighted average method. Production cost components include the purchase cost of live hogs, direct labor, depreciation, packaging material, utility expense and other manufacturing overhead. By using a systematic costing system, the production cost is allocated to various products at the stage of work-in-progress and finished goods, respectively. Net realizable value is the estimated selling price in the ordinary course of business, less estimated costs to complete and dispose. We regularly inspect the shelf life of prepared foods and, if necessary, writes down their carrying value based on their salability and expiration dates into cost of goods sold.
 
 
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Property, Plant, and Equipment.   Property, plant, and equipment are recorded at cost and are stated net of accumulated depreciation.  Depreciation expense is determined using the straight-line method over the estimated useful lives of the assets as follows:
 
   
Estimated Life
Plants and buildings
 
5-30 years
Machinery and equipment
 
5-20 years
Office furniture and equipment
 
3-5 years
Vehicles
 
5 years
 
Maintenance and repairs are charged directly to expense as incurred, whereas improvements and renewals are generally capitalized in their respective property accounts.  When an asset is retired or otherwise disposed of, the cost and applicable accumulated depreciation are removed and the resulting gain or loss is recognized and reflected as a line item before operating income (loss).
 
Results of Operations
 
In 2010, we intend to continue to focus on the implementation of our strategic plan to sustain the growth we have experienced since becoming a U.S. public company in 2006. Over the next 12 months, we expect to continue to expand our distribution channel and develop new markets. Through our aggressive marketing campaign, we also expect to increase our brand awareness and customer loyalty. We also intend to further streamline our supply chain management to further advance and extend our unified, safe and efficient cold-chain logistics system. We also have invested in employee training and development to help sustain our rapid and healthy growth while maintaining a satisfactory profit margin.
 
Hog and pork prices decreased approximately 10% in the second quarter of 2010, compared to the same period last year, primarily because the supply of hogs was higher than the demand in the market. The imbalance between supply and demand was primarily due to two factors: (i) an oversupply of hogs, and (ii) the outbreak of hog diseases in south China that affected the hog breeding and pork industries.
 
Since the end of the second quarter of 2010 to date, hog and pork prices have increased approximately 20% primarily because (i) the government stepped into the market and built up frozen pork reserves in the first half of the year to stabilize the price and protect the interests of hog breeding farmers; (ii) the drought in south-west China and flood in south, north-east and other regions in China increased the price of agriculture products, including pork; and (iii) a better balance of supply and demand has been achieved.
 
The Chinese government maintains a national frozen pork reserve, for which it buys in the pork market and sells into the same pork market. The government’s primary objective is to maintain an adequate national reserve and to maintain the stability of hog and pork prices within a varying price range in the national market. The government outsources hog slaughtering and frozen storage services to qualified companies and provides financial subsidies to those service providers. The frozen pork reserves normally are preserved for 12 months, then sold. We are a service provider for both hog slaughtering and frozen pork storage. When pork consumption was expected to increase during the Chinese New Year period in early 2010 and some of the reserve was soon to reach the end of its 12 month holding period, the government sold some of the national pork reserve into the market. Zhongpin and other companies bought portions of that released frozen pork reserve from the government. Because the pork price can decline somewhat after the government sells into the market, which happened in this case, the government paid us an allowance for the difference between our purchase price for the frozen pork from the national reserve and the subsequent lower price in the market.
 
We expect that hog prices will continue to increase and remain at a higher level during the second half of 2010.

 
22

 
 
Comparison of Three Months Ended June 30, 2010 and 2009
 
Revenue. Total revenue increased from $161.8 million for the three months ended June 30, 2009 to $215.1 million for the three months ended June 30, 2010, which represented an increase of $53.3 million, or approximately 33%. The increase in revenues during the second quarter of 2010 was primarily due to increased sales volume in our meat and meat products divisions resulting from the effects of the continuing increases in the number of our retail channels, geographic expansion, and increased sales to chain restaurants, food service providers, and wholesalers and distributors in the PRC. The following table presents our sales by product division for the three months ended June 30, 2010 and 2009.
 
   
Sales by Division
(unaudited)
 
   
Three Months Ended
June 30, 2010
   
Three Months Ended
June 30, 2009
 
   
Metric
Tons
   
Sales
Revenues
(in millions)
   
Average
Price/
Metric
Ton
   
Metric
Tons
   
Sales
Revenues
(in millions)
   
Average
Price/
Metric
Ton
 
                                     
Pork and Pork Products
                                   
Chilled pork
    71,200     $ 114.3     $ 1,605       52,086     $ 83.3     $ 1,599  
Frozen pork
    39,084       58.3       1,492       36,231       55.0       1,518  
Prepared pork products
    18,747       36.8       1,963       10,189       20.4       2,002  
Vegetables and Fruits
    5,341       5.7       1,067       2,731       3.1       1,135  
Total
    134,372     $ 215.1     $ 1,601       101,237     $ 161.8     $ 1,598  
 
The pork market in China is highly fragmented and in the markets in which we sell our products, no single supplier has a significant impact on the market price of pork or related pork products. We have been pricing our products based on the value of our brand, the quality of our products, hog prices in the applicable period, and pricing trends for similar products in the regions in which we operate.
 
In the second quarter of 2010, we increased our sales of chilled pork products by approximately $31.0 million over the amount of our sales of such products in the second quarter of 2009. As shown in the table above, our average price during the second quarter of 2010 was approximately $1,605 per metric ton for chilled pork, compared to $1,599 during the second quarter of 2009, an increase of 0.4%.  The number of metric tons of chilled pork sold during the second quarter of 2010 increased by 19,114, or 37% from the second quarter of 2009.  Our total revenue increased primarily due to successful capacity expansion, increased sales to existing customers, and significantly increased volume of sales of our products as we entered new geographic markets, expanded our points of sales, and acquired new customers, and partially due to the effect of the slight increase in average price in the second quarter of 2010 as a result of market fluctuations.

In the second quarter of 2010, we increased our sales of frozen pork products by approximately $3.3 million over the amount of our sales of such products in the second quarter of 2009. Our average price during the second quarter of 2010 was approximately $1,492 per metric ton for frozen pork compared to $1,518 during the second quarter of 2009, a decrease of 2%.  The number of metric tons of frozen pork sold during the second quarter of 2010 increased by 2,853, or 8% from the second quarter of 2009.  Despite the decrease in average price in the second quarter of 2010 as a result of market fluctuations, our total revenue still increased due to successful capacity expansion, increased sales to existing customers, and significantly increased volume of sales of our products as we entered new geographic markets, expanded our points of sales, and acquired new customers.

In the second quarter of 2010, we increased our sales of prepared pork products by approximately $16.4 million over the amount of our sales of such products in the second quarter of 2009. Our average price during the second quarter of 2010 was approximately $1,963 per metric ton for prepared pork products compared to $2,002 during the second quarter of 2009, a decrease of 2%. The number of metric tons of prepared pork products sold during the second quarter of 2010 increased by 8,558, or 84% from the second quarter of 2009.  This product division is becoming more important to our business as customers increasingly demand prepared pork products and are willing to pay higher average prices for the convenience of such products. We plan to gradually increase sales from prepared pork products by building up our brand recognition and expanding our capacities for this division.

 
23

 
 
The sales of pork and vegetable products are closely related to the particular regional markets in which our distribution channels are located. Therefore, the increase in metric tons sold for the second quarter of 2010 was partly attributable to our success in expanding our distribution channels. The following table shows the changes in our distribution channels:
 
   
Numbers of Stores and Cities Generating Sales Volume
(unaudited)
 
   
June 30,
   
Net
   
Percentage
 
   
2010
   
2009
   
Change