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EX-32.2 - EXHIBIT 32.2 - CHINA MARINE FOOD GROUP LTDv330269_ex32-2.htm
EX-31.2 - EXHIBIT 31.2 - CHINA MARINE FOOD GROUP LTDv330269_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - CHINA MARINE FOOD GROUP LTDv330269_ex31-1.htm
EX-32.1 - EXHIBIT 32.1 - CHINA MARINE FOOD GROUP LTDv330269_ex32-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-K/A

(Amendment No. 2)

 

 

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2011

 

OR

 

o 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 001-34422

 

 

CHINA MARINE FOOD GROUP LIMITED

(Exact name of registrant as specified in its charter)

 

NEVADA   87-0640467
(State or other jurisdiction of   (IRS Employer Identification No.)
Incorporation or organization)    

 

Da Bao Industrial Zone, Shishi City

Fujian, China

362700

(Address of principal executive offices)

 

86-595-8898-7588

(Issuer's telephone number, including area code)

 

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

COMMON STOCK

 

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

NONE

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes  o No x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

Yes x      No ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

 

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

Large accelerated filer ¨           Accelerated filer ¨            Non-accelerated filer ¨           Smaller Reporting Company x

 

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

 

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $47,125,093 based on the June 30, 2011 closing sale price of $2.73 as reported on the NYSE AMEX.

 

As of March 26, 2012, there were 29,697,976 shares of common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

XBRL Exhibits 101 incorporated by reference from Form 10-K/A filed March 28, 2012.

 

 
 

 

Explanatory Note

 

This amendment No.2 on Form 10-K/A (“Amendment No.2”) amends the Annual Report on Form 10-K/A (“Amendment No.1”) for the year ended December 31, 2011, which was filed with the Securities and Exchange Commission (the “SEC”) on March 28, 2012. We are filing this Amendment No.2 solely to revise the disclosure on “Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” to remove TradeLink Securities, LLC as a beneficial owner of more than 5% of the registrant’s Common Stock. Except for this change, no other change has been made to the Amendment No.1, including the financial statements. This Amendment No. 2 does not reflect subsequent events occurring after the original filing date of the Amendment No.1 or modify or update disclosures made in the Amendment No.1.

 

China Marine Food Group Limited

 

FORM 10-K/A

(Amendment No. 2)

 

For the Year Ended December 31, 2011

 

TABLE OF CONTENTS

 

PART I      
ITEM 1.   Business 4
ITEM 1A.   Risk Factors 28
ITEM 1B.   Unresolved Staff Comments 41
ITEM 2.   Properties 41
ITEM 3.   Legal Proceedings 43
ITEM 4.   Mine Safety Disclosures 43
       
PART II      
ITEM 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 43
ITEM 6.   Selected Financial Data 44
ITEM 7.   Management's Discussion and Analysis of Financial Condition and Results of Operations 44
ITEM 7A.   Quantitative and Qualitative Disclosures About Market Risk 63
ITEM 8.   Financial Statements F-1 – F-28
ITEM 9.   Changes In and Disagreements with Accountants on Accounting and Financial Disclosure 64
ITEM 9A.   Controls and Procedures 65
ITEM 9B.   Other Information 65
       
PART III      
ITEM 10.   Directors and Executive Officers of the Registrant and Corporate Governance 66
ITEM 11.   Executive Compensation 69
ITEM 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 73
ITEM 13.   Certain Relationships and Related Transactions, and Director Independence 75
ITEM 14.   Principal Accountant Fees and Services 76
       
PART IV      
ITEM 15   Exhibits, Financial Statement 77
       
SIGNATURES     81

 

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INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

 

This Annual Report on Form 10-K contains forward-looking statements. These statements relate to future events or our future financial performance. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expect," "plan," "anticipate," "believe," "estimate," "predict," "potential" or "continue," the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially.

 

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We undertake no duty to update any of the forward-looking statements after the date of this report to conform such statements to actual results or to changes in our expectations.

 

Readers are also urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the factors which affect our business, including without limitation the disclosures made in PART I. ITEM 1A. “Risk Factors” and PART II. ITEM 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" included herein.

 

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PART I.

 

ITEM 1.Business

 

Overview

 

Through our direct, wholly owned subsidiary, Ocean Technology (China) Company Limited (“Ocean Technology’) and its subsidiaries, Shishi Rixiang Marine Food Co., Ltd. (“Rixiang”), Shishi Huabao Jixiang Water Products Co., Ltd.(“Jixiang”), Shishi Huabao Mingxiang Foods Co., Ltd. (“Mingxiang”) and Shishi Xianglin Trading Co., Ltd. (“Xianglin”), we engage in the business of processing, distribution and sale of processed seafood-based snack foods, as well as the sale of fresh and frozen marine catch. In 2010, we also became a manufacturer of algae-based soft drinks through our acquisition of Shishi Xianghe Food Science and Technology Co., Ltd. (“Xianghe”), which is also an operating subsidiary of Ocean Technology. Our objective is to establish ourselves as a leading producer of processed seafood and algae-based beverage products in the PRC and overseas markets.

 

Our dried and flavored seafood-based snack foods are predominantly sold under our registered trademark, the “Mingxiang” brand. These products are sold to 18 exclusive distributors in five provinces in the PRC, including Fujian, Guangdong, Shandong, Zhejiang and Liaoning in turn sub-distributed to about 3,200 retail points in the PRC (including major supermarkets and retailers such as Wal-Mart and Carrefour) throughout these provinces. Founded in 1994, China Marine has grown steadily and positioned its "Mingxiang" brand as a category leader. We have received "Famous Brand" and "Green Food" awards. Our marine catch is sold to trading companies and distributors in Fujian, Shandong and Liaoning provinces, and overseas customers in the Philippines and Indonesia.

 

Our business premises, including our production plant, cold storage facility, office tower and staff dormitory, are located close to Xiangzhi Port, the largest fishing port in Fujian Province, which is one of the largest coastal provinces in the PRC and a vital navigation hub between the East China Sea and the South China Sea.

 

On January 1, 2010, Mingxiang acquired shares representing 80% of the registered capital stock of Xianghe. Xianghe is a manufacturer of the branded Hi-Power algae-based soft drinks. Xianghe developed a network of distributors, initially in Fujian and later in Zhejiang provinces. The distributors, who have exclusive territories, sell Hi-Power to retail food stores, restaurants food supply dealers and the hospitality industry. The algae-based beverage products are sold to seven exclusive distributors and in turn sub-distributed to about 15,000 retail points in Fujian and Zhejiang provinces.

 

Our principal executive offices are located at Da Bao Industrial Zone, Shishi City, Fujian, China, 362700, and our telephone number at that location is 86-595-8898-7588.

 

Our Corporate Structure

 

We are a holding company organized under the laws of Nevada and Ocean Technology is a holding company organized under the laws of Hong Kong. The other subsidiaries are organized under the laws of the PRC. All subsidiaries are wholly-owned except for Xianghe, the beverage company, in which we own an 80% interest.

 

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Our Corporate History

 

We were incorporated in the State of Nevada on October 1, 1999 under the name New Paradigm Productions, Inc. to engage in the production and marketing of meditation music and related supplies. Pursuant to a registration statement on Form SB-2 that was declared effective on October 26, 2000, we sold 77,000 shares of our common stock, raising a total of $77,000 in gross proceeds. We discontinued our principal operations as of December 2002.

 

On September 13, 2007, we entered into a Stock Purchase Agreement (“SPA”) with Halter Financial Investments, L.P., a Texas limited partnership (“HFI”) pursuant to which we agreed to sell to HFI, 1,005,200 shares of our post reverse stock-split common stock for $400,000. After consummation of the transaction, HFI became the holder of 1,005,200 shares of our common stock, or 87.5% of the 1,148,826 shares of our then outstanding common stock. Effective on September 25, 2007, we effectuated a 7.5 to 1 reverse stock split and increased our authorized shares of common stock to 100,000,000.

 

Acquisition of Ocean Technology and Related Financing

 

On November 17, 2007, we completed a reverse acquisition transaction with Ocean Technology through a share exchange with Ocean Technology’s former stockholders. Pursuant to the share exchange agreement, the shareholders of Ocean Technology exchanged 100% of their outstanding capital stock in Ocean Technology for approximately 15,624,034 shares of our common stock, or approximately 93.15% shares of our outstanding common stock after the share exchange. In connection with the share exchange, we changed our name from New Paradigm Productions, Inc. to China Marine Food Group Limited on January 9, 2008. Concurrently with the closing of the reverse acquisition on November 17, 2007, we completed a private placement of units consisting one share of common stock and a warrant to purchase one-fifth of one share of our common stock. We sold an aggregate of 6,199,441 shares of our common stock and warrants to purchase an aggregate of 1,239,888 shares of our common stock at $3.214 per unit. Each warrant issued to the investors had a term of three years and as exercisable for a price equal to $4.1782 in cash or on a cashless exercise basis.

 

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In connection with the private placement, our principal stockholder, Pengfei Liu, entered into a make good agreement pursuant to which Mr. Liu agreed, subject to certain conditions discussed below, to place into an escrow account, 6,199,441 shares of common stock of the Company.  Since the net income target of $10.549 million for 2008 and $14.268 million for 2009 were met, no transfer of the escrowed shares was made to the private placement investors.

 

For accounting purposes, the share exchange transaction was treated as a reverse acquisition with Ocean Technology as the acquirer and China Marine Food Group Limited as the acquired party. When we refer herein to business and financial information for periods prior to the consummation of the reverse acquisition, we are referring to the business and financial information of Ocean Technology on a consolidated basis unless the context suggests otherwise.

 

On January 25, 2010, we sold an aggregate of 4,615,388 shares of common stock for an aggregate purchase price of $30,000,022 at a price of $6.50 per share pursuant to a shelf registration statement on Form S-3.

 

Background History of Ocean Technology

 

Prior to the establishment of Mingxiang, Pengfei Liu, our founder, Executive Chairman and CEO of our Company, was engaged in the trading of marine catch from 1983 to 1994. He bought marine catch from local suppliers and sold them to seafood traders in other regions such as Zhejiang province.

 

In March 1994, Mr. Liu, through his company Shishi City Xiangzhi Dabao Seafood Processing Factory, entered into a joint venture with Zhoushan Fishery Processing Factory to establish Mingxiang, to engage in the processing and sale of seafood products. Mingxiang established its place of business close to Xiangzhi (Shishi) Port, which is one of the largest fishing ports in the Fujian Province, occupying premises with a land area of about 3,300 sq. m. Mingxiang then commenced business as a small enterprise processing and supplying roasted file fish to customers in Fujian and Zhejiang provinces.

 

Our business grew steadily between 1994 and 1997. In 1997, to protect the goodwill that had been built up for our products sold under our “Mingxiang (明祥)” brand, we registered the “Mingxiang” brand in the PRC as a trademark. The trademark covers marine food products such as dried fish slices, roasted shelled prawns and shredded squid.

 

In 1998, we added shredded roasted squid to our range of products and expanded our production facilities to occupy a land area of about 8,000 sq. m. At that time, we employed about 40 employees. We also commenced the construction of cold storage facilities occupying a land area of about 2,000 sq. m. and with a storage capacity of 1,000 tons.

 

In 1999, we completed the construction of our cold storage facilities. The new cold storage facilities increased the shelf-life of and enabled the prolonged storage of the raw materials, works-in-progress and finished products of our processed seafood products. With the cold storage facilities, we became less susceptible to seasonal fluctuations in market demand and supply of raw materials and products. This significantly increased our processed seafood production capacity.

 

In 2000, we expanded our product range to include roasted prawns. We also acquired an additional land of about 7,300 sq. m. at our business premises to build additional production facilities as well as office and staff dormitory facilities.

 

Through a series of equity transfers agreements from 1996, Mr. Liu and his spouse Yazuo Qiu acquired full control of Mingxiang in 2001. With the change in shareholders’ control and the expanded scope of business to include export activities, we obtained a new business license for Mingxiang on April 9, 2001. In the same year, we obtained an import-export license from the Fujian Province International Trade Cooperation Bureau. We believe we were one of the first domestic companies in the processed seafood industry in Quanzhou City, Fujian Province to obtain this license. This was a significant milestone in our history as the license allowed us to export these products to foreign markets.

 

In 2002, our “Mingxiang” brand was recognized as a “Fujian Province Famous Brand”. In June of the same year, we commenced our marine catch business, through the chartering of two fishing vessels with an aggregate net tonnage of 44 tons.

 

In May 2004, Ocean Technology, a company incorporated in Hong Kong and wholly-owned by Mr. Liu, established Rixiang, a limited liability company with a registered capital of US$1,000,000. Rixiang carried on the main businesses of processing and storage of marine food and marine catch. Since January 2005, Rixiang has been the operating subsidiary of our Company.

 

In 2003, we also completed the construction of additional cold storage facilities. The new cold storage facilities increased our cold storage capacity from 1,000 tons to 2,020 tons.

 

In April 2006, our subsidiary Rixiang entered into a memorandum of understanding for research and development collaboration with the Ocean University of China in order to further develop our product development capabilities. We continue to collaborate with the university.

 

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In November 2009, Mingxiang won the auction for the purchase of the 40-year use right of a land parcel in Shishi City, Fujian.  Covering an area of 8,691.4 sq. m., the land is located alongside the fishing port and near the Company’s processing facilities in Shishi City. In the third quarter of 2010, we commenced building a new cold storage facility on the land with a capacity of approximately 20,000 tons. The construction is expected to be completed in the first half of 2012. See “Description of Business - Production Facilities and Process.”

 

In November 2009, Mingxiang entered into a Credit or Share Purchase Option Agreement (the “Option Agreement”) with Qiu Shang Jing, the former sole shareholder of Xianghe. Under the Option Agreement, Mingxiang loaned Xianghe RMB180,500,000 (approximately $26,400,000). In consideration for the loan, Mingxiang received the option to buy shares from Mr. Qiu representing eighty percent (80%) of Xianghe. The purchase price payable to Mr. Qiu consisted of RMB9,500,000 (approximately $1,400,000) payable by Mingxiang and RMB180,500,000 (approximately $26,400,000) payable by Xianghe. On January 1, 2010, Mingxiang exercised its option to acquire eighty percent (80%) of the registered capital stock of Xianghe. Xianghe began operations in June 2009. We expanded the distribution of Hi-Power in both Fujian and Zhejiang provinces to about 15,000 retail points by the end of 2011.

 

We have grown from a domestic market-oriented seafood enterprise with over 80 employees in 2003 into a medium-sized nationwide seafood enterprise with advanced processing facilities and equipment. As of December 31, 2011, we had 848 employees.

 

OUR PRINCIPAL PRODUCTS AND THE MARKET

 

We are a seafood producer engaged in the processing, distribution and sale of processed seafood products under our “Mingxiang” brand, as well as the trading of marine catch. In 2010, we also became a manufacturer of algae-based soft drinks through our acquisition of Xianghe.

 

Our business philosophy may be summarized in the following phrase:

 

“To achieve benefits through innovation, and to develop new markets through branding”

 

Algae-based Beverage Product

 

Our branded “Hi-Power” algae-based soft beverage product was developed by the Yellow Sea Fisheries Research Institute Chinese Academy of Fishery Science in coordination with Xianghe’s founder, Qiu Shang Jing. Hi-Power beverage is marketed as a high-protein drink, low in calories and fat. Our target market focuses on middle class health-conscious consumers in China’s fast-growing beverage market. We have developed a network of exclusive distributors in China’s Fujian and Zhejiang provinces, which sell our Hi-Power beverage product to retail food stores, restaurant food supply dealer and hospitality industry in their respective distribution territories. The algae-based beverage products are sold to seven exclusive distributors and in turn sub-distributed to about 15,000 retail points located in two provinces. We intend to expand distribution of the Hi-Power soft drinks to other parts of the PRC.

 

Our objective is to establish ourselves as a leading producer of processed seafood and algae-based beverage products in the PRC and overseas markets.

 

Processed Seafood Products

 

Using a combination of Japanese traditional seafood processing methods and modern scientific seafood processing techniques, as of December 31, 2011, our product development efforts have yielded 32 processed seafood products comprising dried seafood products such as roasted squid, roasted file fish, roasted prawns, shredded roasted squid, barbecued squid, sliced barbecued squid, sliced roasted octopus, spicy sliced octopus, spicy baby squid, spicy sliced squid and spicy squid head. Our production facilities are located at Dabao Industrial Zone, Xiangzhi Town, Shishi City, Fujian Province, occupying a total land area of 17,600 sq. m. This includes cold storage facilities with a capacity of 2,020 tons. We have four production lines for the processing of our roasted file fish, roasted prawns, shredded roasted squid and roasted squid and one production line for frozen processed seafood products.

 

We have established sales networks in various large and medium sized cities in the PRC. Although we have not had any export sales since 2009, we believe we will have opportunities to trade with overseas customers in the future. Our dried processed seafood products are mainly sold in supermarkets in Fujian and Zhejiang provinces and their surrounding areas, and through our sales network through 18 distributors, each of whom have its own sales network and are authorized by us to distribute our products exclusively in a specific vicinity. We intend to continue our marketing efforts in the PRC in view of its potential opportunities and attractive returns.

 

Our dried processed seafood products are predominantly sold under our registered trademark, the “Mingxiang” brand.

 

We discontinued sales of frozen processed seafood products in 2009 because management decided to focus on domestic sales of our products and the demand for the frozen processed seafood products was primarily from overseas. We maintain our production line for frozen processed seafood products and may sell the products again in the future.

 

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With respect to preparation of our products, a portion of our frozen processed seafood products are consumed directly by end-consumers with little or no additional processing. All our dried and frozen processed seafood products are manufactured free of preservatives. We use ingredients such as sugar, salt and spices in the production of our dried processed seafood products. The raw materials for our processed seafood products are obtained through fresh marine catch and not from seafood breeding farms.

 

We have obtained the “Green Food” awards in respect of our roasted file fish, frozen fish, roasted king prawns and shredded squid. We are committed to the highest standards of quality control in the production of our processed seafood products, as evidenced by our ISO9001, ISO14001, HACCP certification and the EU export registration.

 

Our credit-worthiness, quality and processed seafood products have received considerable acknowledgement and favorable feedback from the public. Please refer to the section “Awards and Certification” for further details of the awards and certifications that we have received.

 

Although we didn’t have significant export sales since 2009, we may have opportunities to trade with overseas customers in the future. We are a State-designated base for quality assurance testing of marine products. Please see the section “Quality Assurance” for more details.

 

Marine Catch

 

Starting from 2008, we did not charter any fishing vessels nor harvest the marine catch ourselves. Instead, we buy the marine catch from the suppliers and then sell to customers or trading companies on a direct basis. Trading of marine catch is performed as opportunistic purchases and sales of frozen seafood materials and therefore the sales volume could fluctuate significantly. The marine catch is predominantly sold to trading companies and distributors in Fujian, Shandong and Liaoning provinces and to overseas customers in the Philippines and Indonesia.

 

Our Products

 

Our products can be divided into three main categories, namely (1) processed seafood products; (2) marine catch; and (3) “Hi-Power” algae-based beverage product. The production of the processed seafood products, marine catch and algae-based beverage products are either undertaken by our subsidiaries, Rixiang or Mingxiang.

 

The following table sets out some of our main products, as well as the main markets in which they are sold:

 

Products   Products / Species   Main Markets
in the PRC
  Foreign Markets
             
Dried processed seafood products  

Roasted file fish, shredded roasted squid, roasted squid, roasted prawn, barbecued squid, sliced barbecued squid, sliced roasted octopus, spicy sliced octopus, spicy baby squid, spicy sliced squid, spicy squid head

 

 

Zhejiang Province

Fujian Province

Shandong Province

Greater Shanghai Region till April 2011

Guangdong Province

Liaoning Province

  Japan in 2008
             
Marine Catch   Cuttlefish (Sepia esculenta), hairtail fish (Trichiurus japonicus), Japanese butter fish (Psenepis Anomala), squid (Loligo bleekeri), horse mackerel  

Fujian Province

Shandong Province

Lianoing Province 

 

 

The Philippines

and Indonesia

             

“Hi-Power” Algae-Based Beverage Product

 

     

Fujian Province

Zhejiang Province 

  Nil

 

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Processed Seafood Products

 

 
       
Roasted file fish Roasted squid Roasted prawn  

 

We purchase fresh seafood, the primary ingredient from which our dried processed seafood products are manufactured, from fishermen and traders. Our raw materials are primarily stored in cold storage facilities located at our production facilities. The production processes of our dried processed seafood products are described in further detail under the section “Production Facilities and Process”.

 

The main dried processed seafood products manufactured by us are roasted file fish, shredded roasted squid, roasted squid and roasted prawn.

 

The ingredients used in the production of our dried processed seafood products are fresh seafood (such as fish, prawns and cuttlefish), natural flavoring, sugar, salt and spices.

 

Marine Catch

 

The principal species of marine catch sold by our Company are as follows:

 

Cuttlefish (Sepia esculenta)     
     
  Cuttlefish is commonly found in the East China Sea and the Taiwan Strait. Cuttlefish is often processed and sold as fresh sushi and snacks.
     
Hairtail Fish (Trichiurus japonicus)    
     
  Hairtail fish, usually found in the East China Sea and the Taiwan Strait, is one of the best-selling marine catch in the PRC. It is a regular dish for home working and fine-dining restaurants
     
Japanese Butter Fish (Psenepis Anomala)     
     
 

Japanese butter fish is usually found in the East China Sea and the Taiwan Strait between September and November every year.

 

 

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Squid (Loligo bleekeri)     
     
  Squids are commonly found in the seas of the Taiwan Strait and Pacific Ocean. Squid contains many nutrients such as proteins, fats, carbohydrate, calcium and phosphorus. Its fine taste and springy texture makes the squid a popular food with consumers.

 

“Hi-Power” Algae-Based Beverage Product

 

  “Hi Power” drink is high in protein and low in calories and fat, which provides the consumers a combination of immune system benefits, improved digestion and reductions in hyperglycemia and hypertension.

 

Production Facilities and Process

 

The production of our dried and frozen processed seafood products is carried out at our production facilities in Dabao Industrial Zone, Xiangzhi Town, Shishi City, Fujian Province. At December 31, 2011, we own four production lines for the manufacture of dried processed seafood products and one production line for the manufacture of frozen processed seafood products. After the upgrade of our production facilities in 2009, the maximum annual production capacities of our production lines increased to about 19,000 tons of dried processed seafood products and 1,000 tons of frozen processed seafood products. The construction of our new facilities was completed and commenced full operation by the third quarter end of 2009. We also own cold storage facilities with cold storage capacity of 2,020 tons.

 

On November 6, 2009, Mingxiang won the auction for the purchase of the 40-year use right of a land parcel in Shishi City, Fujian. Covering an area of 8,691.4 sq. m., the land is located alongside the fishing port and near our processing facilities in Shishi City. The fishing port in Shishi is one of the five largest fishing ports in the PRC. The purchase price for the land use right is RMB 15.55 million ($2.28 million). We are building cold storage facilities on the land, with a capacity of approximately 20,000 tons, to take advantage of its proximity to the port where we obtain fresh seafood catch to be processed into seafood products. The facility will increase our cold storage capacity from 2,000 tons to 22,000 tons. We are financing the total estimated $26.5 million in land use right and construction costs from funds generated by operations and expect to complete the construction in the first half of 2012. A small delay was experienced due to adverse weather conditions and the shortage of labor during the Chinese Lunar New Year period.

 

We place great emphasis on quality assurance at every stage of our production process and have clearly defined procedures to manufacture products of consistently high quality. Please refer to the section “Quality Assurance” for more details.

 

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Dried Processed Seafood Products

 

The key stages of our production process for our dried processed seafood products are as follows:

 

 

1.Receiving and storing raw and packaging materials. All raw materials undergo visual inspection to ensure freshness and firmness before they are accepted and stored. Inspection is carried out by way of random sampling.

 

Samples are taken from each batch of raw materials and sent to the quality control department where physical (e.g. visual inspection), chemical and micro-organism tests are conducted. Raw materials which do not adhere to our requirements are rejected.

 

Our other ingredients such as salt, sugar and spices are sourced from suppliers within the PRC. They are stored in warehouses or temperature-controlled facilities after inspection and approval.

 

Our packaging materials are kept in a warehouse after they have been inspected and approved.

 

2.Ice-packing. To maintain the freshness of our raw materials, a portion of the raw materials is packed in ice and transported directly to our production facilities for processing, whereas the remaining raw materials are packed in ice and transported to our cold storage facilities for storage at minus two to two degrees Celsius in less than 24 hours from purchase. The raw materials will remain frozen in our cold storage facilities until they must be delivered to the production facilities for processing.

 

3.Cleaning. At the production facilities, the raw materials are cleaned by removing unwanted portions such as heads, innards and shells.

 

4.Slicing. The raw materials are then sliced on stainless steel tables.

 

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5.Washing and draining. The raw materials are then sent to the washing pool for washing so as to remove oil, blood stains, remnant innards and other stains. After washing, the raw materials are drained to remove excess water content.

 

6.Marinating and adding flavoring. Other ingredients such as salt, sugar and spices are then added in the required amounts according to our recipes, left to marinate for a set period and mixed at stipulated intervals.

 

7.Steam-drying / Roasting. The raw materials are arranged on wire mesh trays, which are stacked in trolleys and rolled into a heating machine. Roasting takes place under controlled temperatures via a roasting conveyor belt, where moisture levels are monitored. Depending on the product, we will slice or shred the raw materials after roasting.

 

8.Weighing, packaging and metal detection. The dried processed seafood products are then packed into their respective packaging materials and sealed. After a calibrated metal detector to ensure that the products do not contain any traces of metal particles. Metal contamination might have been inherent in the raw materials or caused by production process of which some stages are automated.

 

9.Packing and delivery. The packets of dried processed seafood products are then packed into boxes, which are then stored in our warehouse. Our products are delivered to customers on a “first in, first out” basis.

 

“Hi-Power” Algae-Based Beverage Products

 

The “Hi-Power” beverage products are produced for us by two manufacturers. The key stages of our production process for our “Hi-Power” algae-based beverage products are as follows:

 

 

1.Procurement of raw materials. Choose and buy natural algaes as raw materials from unpolluted sea areas.

 

Samples are taken from each batch of raw materials by way of random sampling and sent to the quality control department where physical (e.g. visual inspection), chemical and micro-organism tests are conducted. Raw materials which cannot meet our requirements are rejected.

 

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2.Cleaning. The algaes are cleaned to remove sediment and impurities.

 

3.Stewing. The algaes are stewed in water at ratio of 30:70 at 80°C for 3 to 5 hours.

 

4.Enzymolysis. Adding a certain amount of enzyme into stewed algae juice for enzymolysis at 50-60°C for 1 to 2 hours.

 

5.Filtration and decolorization. After enzymolysis, the stewed algae juice will go through a process of filtration in the ultrafiltration machine. The filtered algae juice will become clear, transparent and free from impurities. The transparent algae juice will then be pumped into the resin tank for process of decolorization.

 

6.Blending. The processed algae juice should be blended with the extract of honeysuckle, bamboo leaves, licorice and other auxiliary materials in accordance with a pre-defined formula.

 

7.Heating and homogenizing. Using the tubular heater to heat the blended algae juice at 80-90°C for 5-10 seconds and then put it into the homogenizer at 20Mpa.

 

8.Filtration. Put the drinks into 1μ filter for filtration.

 

9.Canning. Washing the can, before canning and sealing by using the automated canning machine.

 

10.Sterilization. Sterilizing the canned drinks with a sterilizing pot. Temperature should be controlled at 125°C for 15 minutes.

 

11.Cooling. Cooling the drinks by using the spray cooling method at 30-40°C. Tune the production date and shelf life. Regular check on coding and ensure the accuracy of coding position. Packaging should refer to the specification of daily order requests.

 

12.Delivery. The drinks can be sold and delivered.

 

Awards and Certifications

 

As testimony to the quality of our products, our credit worthiness in the PRC business community as well as our management capabilities, we have received several awards and certification in the course of our history, as listed below:

 

Year   Subsidiary   Award   Period   Awarding Body   Significance
                     

September,

2011

  Mingxiang   Fujian Province Famous Brand   September 2011 - September 2014   Fujian Province Branded Products Authentication Committee   Recognition of our brand and our branding efforts
                     
May 17, 2010   Mingxiang   Green Food - roasted file fish   May 2010 - May 2013   China Green Food Development Centre   Recognition of environmental awareness, non-pollution in our production chain
                     
May 17, 2010   Mingxiang  

Green Food - dried shredded squid

 

  May 2010 - May 2013   China Green Food Development Centre   Recognition of environmental awareness, non-pollution in our production chain
                     
May 17, 2010   Mingxiang  

Green Food - frozen fish

 

  May 2010 - May 2013   China Green Food Development Centre   Recognition of environmental awareness, non-pollution in our production chain

 

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May 17, 2010   Mingxiang  

Green Food - roasted king prawn

 

  May 2010 - May 2013   China Green Food Development Centre   Recognition of environmental awareness, non-pollution in our production chain
                     
May 17, 2010   Rixiang   Green Food - roasted file fish   May 2010 - May 2013   China Green Food Development Centre   Recognition of environmental awareness, non-pollution in our production chain
                     
May 17, 2010   Rixiang   Green Food - dried shredded squid   May 2010 - May 2013   China Green Food Development Centre   Recognition of environmental awareness, non-pollution in our production chain
                     
May 17, 2010   Rixiang   Green Food - roasted yellow croaker   May 2010 - May 2013   China Green Food Development Centre   Recognition of environmental awareness, non-pollution in our production chain
                     
May 17, 2010   Rixiang   Green Food - roasted prawn   May 2010 - May 2013   China Green Food Development Centre   Recognition of environmental awareness, non-pollution in our production chain
                     
May 17, 2010   Rixiang   Green Food - roasted shredded squid   May 2010 - May 2013   China Green Food Development Centre   Recognition of environmental awareness, non-pollution in our production chain
                     
May 17, 2010   Rixiang   Green Food - roasted fish bones   May 2010 - May 2013   China Green Food Development Centre   Recognition of environmental awareness, non-pollution in our production chain
                     
May 17, 2010   Rixiang   Green Food - roasted squid   May 2010 - May 2013   China Green Food Development Centre   Recognition of environmental awareness, non-pollution in our production chain
                     
May 17, 2010   Rixiang   Green Food - squid slices   May 2010 - May 2013   China Green Food Development Centre   Recognition of environmental awareness, non-pollution in our production chain

 

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May 17, 2010   Rixiang   Green Food - roasted searobin fillet   May 2010 - May 2013   China Green Food Development Centre   Recognition of environmental awareness, non-pollution in our production chain
                     
September, 2008   Mingxiang  

Key Leading Enterprise (Province level)

 

  2008 - 2009  

Fujian Province Agriculture Industrialization Leading Group

 

  Recognition of our efforts and contribution in the development of processed agricultural products
                     
December , 2006   Mingxiang  

A-Grade Tax Payer Credit Enterprise

 

  2004 - 2005   Quanzhou National Tax Bureau, Quanzhou District Tax Bureau   Recognition of our tax creditworthiness
                     
December, 2004   Mingxiang   National Foodstuff Industry Excellent Leading Enterprise   2003 - 2004   China Foodstuff Industry Association   Recognition of quality of our products
                     
January, 2004   Mingxiang  

Civilized and Creditworthy Enterprise

 

  2002 -2003   Shishi City Government Civilization Bureau, Shishi City Economic Bureau, Shishi National Tax Bureau, Shishi District Tax Bureau   Recognition of our regard for integrity in our operations, our creditworthiness and contribution to the economy

 

DISTRIBUTION

 

PROCESSED SEAFOOD PRODUCTS

 

Sales and Marketing

 

Our sales and marketing team comprises 39 employees, headed by our Executive Chairman, Director and CEO Mr. Pengfei Liu. The team is responsible for monitoring domestic sales, which includes co-coordinating orders from customers as well as distributing our products to the customers.

 

Distribution Network

 

We have established a wide distribution network which allows us to maintain our competitiveness in the industry. As of December 31, 2011, we have 18 distributors in six provinces in the PRC, including Fujian, Guangdong, Shandong, Zhejiang and Liaoning, as follows:

 

Province   No. of Distributors
Fujian   7
Guangdong   1
Shandong   2
Zhejiang   6
Liaoning    1
Other   1
Total   18

 

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These distributors in turn sub-distribute our dried processed seafood products to about 3,200 retail points (including major supermarkets and retailers such as Wal-Mart and Carrefour) throughout these provinces.

 

One of our main considerations when appointing distributors is the purchasing and consumer spending power in the particular region in which we intend to distribute our products.

 

Before we appoint new distributors or extend the distribution arrangement with existing distributors to distribute our products in a particular region or country, the potential distributor or existing distributor is subject to our stringent selection or review process. We will only appoint distributors who are able to meet our sales target requirements.

 

We select each distributor based on four criteria:

 

a.Strong Financial Background. We require the distributor to provide us with its most recent audited financial statements so we may verify whether its financial status is strong and healthy. We further require the distributor to settle the bills in cash, without offering any credit terms, in the first year of doing business with us.

 

b.Strong Distribution Network. The distributor should have a strong, well-established marketing and distribution network in the corresponding region.

 

c.Good Reputation and Track Record. We only select those distributors with good reputations in the industry in regard to their business background, marketing experience and distribution network. In particular, the distributor should have a track record in developing and maintaining the brand images of the products it distributes.

 

d.Marketing Strategy. We require the distributor to implement our overall marketing strategy for our products and to supplement it by designing its own marketing plans specifically for the respective region. The distributor should be able to assist us in building our brand image and achieving a significant market share in a said period of time.

 

We appoint different distributors for different products in different regions in the PRC.

 

We usually appoint one exclusive distributor to cover a specific county, district, city or province. Under the distributorship agreements, our distributors are obliged to price and sell our products in accordance with the indicative prices which we provide, and are not permitted to arbitrarily adjust the sale price of the products except in accordance with product promotions. The distributors must also duly carry out market operation activities and promotional methods which are jointly developed with us, and to bear the costs of its own advertisements and marketing activities. The distributorship agreements also contain provisions for the protection of our intellectual property rights.

 

Our sales and marketing team is also responsible for marketing our products within the PRC. The team contacts and visits our customers regularly to obtain feedback and suggestions on our products, and to foster and build our relationships with them. We normally sign distributorship agreements with a one-year term. Our agreements stipulate the price range in which the distributors may sell our products and also stipulate sales targets which our distributors have to achieve before the agreements are renewed.

 

We advertise our products regularly through supermarket brochures, free tasting and outdoor billboards. We also participate in exhibitions in the PRC such as the China Export Trade Fair and the China Seafood Exposition, as well as overseas exhibitions such as those in South Korea, Japan and Boston, USA.

 

“HI-POWER” ALGAE-BASED BEVERAGE PRODUCTS

 

Sales and Marketing

 

Our sales and marketing team comprises 134 employees, headed by our Executive Chairman, Director and CEO Mr. Pengfei Liu. The team is responsible for developing and implementing the Company’s overall development and promotional strategy for our algae-based beverage products, which includes co-coordinating orders from customers as well as distributing our products to the customers.

 

Distribution Network

 

We have developed a network of distributors with exclusive territories in Fujian and Zhejiang provinces, which sell Hi-Power to retail food stores, restaurant food supply dealers and the hospitality industry. Distributors of our algae-based drink must adhere to the same stringent selection process used for dried seafood distributors.

 

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NEW PRODUCTS

 

We rely on our own research and development team and strategic collaboration with Ocean University of China for the development of new processes and products that are well-received by consumers which is vital to our continued success. From time to time, we may launch new products to the market depending on market demand, current competition and our production capacity through a series of stringent research and development processes and market research. For details, please refer to the section “Research and Development”.

 

COMPETITION

 

We operate in a competitive environment and we expect to face more intense competition from our existing competitors and new market entrants in the future. We believe that the principal competitive factors in our industry include, inter alia, brand awareness, product range and quality, customer and supplier relationships, cost and quality of raw materials, technical expertise in production and pricing. Of these factors, we believe that product quality is the most important.

 

To the best of our knowledge, our principal competitors within the PRC are the following major seafood product manufacturers in the PRC:

 

Business   Principal Competitors
Dried and Frozen Processed Seafood Products  

(1)  China Aquatic Zhoushan Marine Fisheries Corporation; and

(2)  Liaoning Dalian Seafood Industry Group Co., Ltd.

     
    Both in terms of their size and operations.
     
Marine Catch Products  

(1) Fujian Seafood Industry Co., Ltd; and

(2) Fujian Huayang Aquatic Products Group Co., Ltd.

     
    Both in terms of their geographical proximity to our customer base.
     
“Hi-Power” Algae-Based Beverage Product   No direct competitor.

 

There may be companies based in other countries which offer a similar product range as we do but which currently operate in different markets from us. In the future, we may face competition from these companies as we expand into their markets and vice versa.

 

Competitive Strengths

 

We believe that our competitive strengths are as follows:

 

1. We have a wide distribution network

 

We have established a wide distribution network for our processed seafood products which allows us to maintain our competitiveness in the industry. We have 18 exclusive distributors in five provinces in the PRC such as Fujian, Guangdong, Shandong, Zhejiang and Liaoning. These distributors in turn sub-distribute our dried processed seafood products to about 3,200 retail points (including major supermarkets and retailers such as Wal-Mart and Carrefour) throughout these provinces.

 

Besides, we has developed a network of distributors with exclusive territories in Fujian and Zhejiang provinces which in turn sub-distribute Hi-Power to about 15,000 retail points, including retail food stores, restaurants food supply dealers and the hospitality industry.

 

Please refer to the section “Major Customers” for further details.

 

2. We have an established brand name and track record

 

We have been involved in the production of processed seafood products since commencing our operations in 1994. Our “Mingxiang” brand has been conferred the “Famous Brand” award. In addition, we have also obtained the “Green Food” award in respect of our roasted file fish, shredded roasted squid, roasted king prawn and frozen fish products. This attests to the established standing of our “Mingxiang” brand and the high quality of our products. We have also received several other awards and accreditations as described in the section “Awards and Certifications”. We believe such accolades attest to our established reputation in the industry.

 

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We also believe that our established track record in the processed seafood industry instills confidence in our products and attracts new customers from domestic and overseas markets. Our stable customer base and large distributor network in Fujian and Zhejiang provinces have enabled our Company to introduce new products into these markets in a shorter time and gain quicker market acceptance and recognition.

 

3.  We develop high quality products

 

We use fresh seafood as the primary ingredient for our processed seafood products. Our superior recipes and production know-how enable us to develop and produce products with high-quality taste and texture and which are well-received by end-consumers.

 

We have been awarded HACCP certification and have obtained the EU export registration, which enable us to export our products to the US and the EU, respectively. In addition, our products, namely our roasted file fish, shredded roasted squid, roasted squid, roasted prawn and frozen fish have been certified as “Green Food”, a recognition that the production of our products is carried out under certain sanitary conditions with limited use of chemical additives. We believe we are one of the first companies in the seafood industry in Fujian province to be awarded this certification, which is a further testament to the quality of our products.

 

4.  We have a strong leadership as well as a dedicated and experienced management and procurement team

 

Our Company is led by our Executive Chairman and CEO, Pengfei Liu, who has more than 30 years of experience in the seafood industry. Mr. Liu’s drive and passion have been instrumental in our success to-date. He has conceptualized and implemented our strategies in the past and successfully led us in our transition from a small and local seafood enterprise to a nationwide seafood enterprise with advanced seafood processing facilities.

 

Mr. Liu is ably supported by a team of experienced managers, most of whom have an average of five to ten years’ experience in their respective fields. These personnel support our Executive Chairman and CEO in charting and managing our growth. We believe the members of our procurement team have a strong grasp and good understanding of industry trends, market cycles and seasonal factors, and have the ability to discern and procure high-quality seafood at reasonable prices.

 

The management team receives regular training in the course of our Company obtaining and renewing our ISO and HACCP qualifications. The training, which is conducted over 10 to 15 days every year, involves process management, quality control, sanitary and hygiene operating procedures and standards. We believe that such training raises our competence and environmental / sanitary awareness, and places us in an advantageous position compared to other operators in the seafood industry who do not undergo such training.

 

Besides, Hi-Power was developed by the Yellow Sea Fisheries Research Institute Chinese Academy of Fishery Sciences in coordination with the founder, Qiu Shang Jing, who had been engaged in the natural algae industry for over 10 years time and he had a profound expertise on algae products prior to his sale of Xianghe to us. We relied on executives and managers with extensive beverage knowledge and experience to run the business.

 

5. We have established strong relationships with our customers / distributors

 

We have maintained close working relationships with our customers who are reputable distributors of processed seafood products. Our relationships with some of our PRC customers and distributors have been established for more than ten years. In particular, we have enjoyed good relationships with, among others, Qingdao Haizhan Seafood Co., Ltd. (“Qingdao Haizhan”), Wenzhou Rixin Foodstuff Co., Ltd. (“Wenzhou Rixin”), and Zhejiang Ruian Laodu Seafood Wholesale Proprietor (“Zhejiang Ruian Laodu”), for an average of approximately 15 years.

 

Qingdao Haizhan is in the business of distributing dried and frozen seafood products. To the best of our knowledge, Qingdao Haizhan has a distribution network of over 1,100 retailers and a sales workforce of about 92 people.

 

Wenzhou Rixin is a distributor of dried seafood in Wenzhou City, Zhejiang Province. To the best of our knowledge, Wenhou Rixin has a distribution network of about 1,100 retailers and a sales workforce of about 102 people.

 

Zhejiang Ruian Laodu is a large distributor of dried seafood in Ruian City, Zhejiang Province. To the best of our knowledge, Zhejiang Ruian Laodu has a distribution network of about 600 retailers and a sales workforce of about 71 people.

 

Regarding the percentage of sales represented by each party listed above, please refer to the section “Major Customers” for details.

 

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We view our customers as long-term business partners who are important in the strategic growth of our operations and broadening the geographic reach of our products.

 

6. We are strategically located

 

We are based in Fujian province which is situated in southeast China on the coast of the East China Sea. Fujian is one of the nine coastal provinces in the PRC and is a vital navigation hub between the East China Sea and the South China Sea. It is also rich in agricultural and marine resources.

 

Our main raw materials for our marine catch business come from the Taiwan Strait, which is also where we conduct our marine catch operations. The Taiwan Strait is rich in marine resources. Our business operations and production facilities are located at Shishi City, Fujian Province, where Xiangzhi (Shishi) Port has been designated as one of the national-level fishing ports. It is the largest port in Fujian province and is one of the five largest fishing ports in the PRC in terms of supply of marine catch and tonnage of fishing vessels. Fujian province is rich in agricultural and marine resources, which enables our procurement of raw materials for our processed seafood business at low cost. We believe our strategic location gives us access to an abundant supply of fresh marine products and hence allows us to manage our costs more effectively.

 

7.  We have strong research and development capabilities

 

We place strong emphasis on the quality of our products and on our ability to develop new products. To ensure that our products are well-received by our customers and consumers, we have carried out research and development to improve the taste, texture and packaging of our processed seafood products. Through our research and development efforts, we have developed new products and improved the quality of our existing products, which have been well-received by our customers and end consumers. These products include our crispy fish-bone snacks, roasted squid and roasted prawns, spicy sliced octopus, spicy baby squid, spicy sliced squid and spicy squid head.

 

Our strong product development capabilities allow us to constantly introduce new products into the market and maintain consumer interest and loyalty in our “Mingxiang” brand products. We believe that our strategic collaboration with the Ocean University of China will further strengthen our research and development capabilities.

 

Besides, Hi-Power was developed by the Yellow Sea Fisheries Research Institute Chinese Academy of Fishery Sciences in coordination with the founder. We will leverage the strong research and development capabilities from the Yellow Sea Fisheries Research Institute Chinese Academy of Fishery Sciences together with the Ocean University of China on product development going forward.

 

8.  We are a designated National Marine Products Quality Assurance Testing Base

 

We have been designated as a quality assurance testing base by the National Marine Foods Quality Supervision Testing Centre and our testing base is the only assessment base in the southern provinces of the PRC. We test the hygiene and quality of ingredients and products according to industrial standards. Our testing base caters to seafood processing companies from Fujian, Guangdong, Guangxi and Zhejiang provinces, the PRC. We believe our role in quality assurance testing further strengthens our reputation as a producer of quality processed seafood products.

 

For the above reasons, we believe that we will be able to maintain our market position and competitive edge over our competitors.

 

MAJOR SUPPLIERS

 

The following table sets out our five major suppliers of raw materials for processed seafood products, marine catch and algae-based beverage products for the years ended December 31, 2011 and 2010:

 

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   As a Percentage of Our Purchases of Raw
Materials (%)
 
   Year Ended December 31, 
   2011   2010 
         
Dalian Ocean Fishery Group of Corporations   38.2    - 
           
Dalian Kangwei Trading Company Limited   17.2    13.3 
           
Shishi City Dongfan Seafood Products Trading Proprietor   14.4    20.6 
           
Shishi City Fugui Seafood Products Trading Proprietor   11.0    19.0 
           
Shishi City Tianwang Seafood Products Trading Proprietor   7.2    18.5 
           
Jinjiang City Shenhu Town Hongyuan Seafood Products Trading Proprietor   -    10.3 
           
TOTAL   88.0    81.7 

 

Trading in fresh fish and other seafood is mainly carried out by fishing companies and individual fishermen, who ply their trade in and around various fishing ports in the PRC. Some of the above major suppliers are fish and seafood traders in markets in and surrounding Shishi City, Fujian Province. We procure from these suppliers for fresh fish and other seafood, which are used as raw materials in the production of our processed seafood products. These suppliers also supply fresh fish and other seafood to other companies.

 

Though certain of our major suppliers accounted for more than 10% of our total purchases individually for the fiscal year ended December 31, 2011, we believe we are able to source our raw materials from alternative suppliers should the need arise.

 

None of our directors, executive officers and controlling shareholders is related to or has any interest in any of our major suppliers listed above. To the best of our knowledge, same as disclosed above, none of our major suppliers is related to or has any interest in one another, and none of our major suppliers is related to or has any interest in the customers stated in the section “Major Customers” below.

 

MAJOR CUSTOMERS

 

The following table sets out our major customers accounting for 5.0% or more of our Company’s sales of processed seafood products, marine catch and algae-based beverage products for the years ended December 31, 2011 and 2010:

 

    As a Percentage of Our Sales (%) 
    Year Ended December 31, 
  Products  2011   2010 
            
Dalian Jiyang Import and Export Co., Ltd. (1)  Marine catch, namely cuttlefish, squid, hairtail fish   25.3    7.9 
              
Qingdao Xinqinghua Seafood Products Company (2)  Marine catch, namely cuttlefish, squid, hairtail fish   9.2    - 
              
Fuzhou Xinxutai Trading Ltd. (3)  Dried processed seafood and beverage products   6.6    - 
              
Xiamen Wansong Commercial and Trading Ltd. (4)  Dried processed seafood and beverage products   6.1    - 
              
Qingdao Haizhan Seafood Co., Ltd (2)  Dried and frozen processed seafood products   -    12.5 
              
Wenling City Xingfeng Foodstuff Co., Ltd. (5)  Dried processed seafood products   -    5.6 
              
Jinjiang City Dongshun Seafood Products Trading Proprietor (6)  Marine catch, namely cuttlefish, squid, hairtail fish   -    5.3 
              
Wenzhou Rixin Foodstuff Co., Ltd. (7)  Dried processed seafood products   -    5.1 
              
TOTAL     47.2    36.4 

 

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Notes:

 

1) Dalian Jiyang Import and Export Co., Ltd. is a trader of goods and import of technology in China, and has, to the best of our knowledge, a distribution network of about 19 retailers and a sales workforce of about 8 people. It has been our customer since 2008.
   
2) Qingdao Xinqinghua Seafood Products Company is a trader of fresh seafood in Qingdao City, Shandong Province. It sources and purchases supplies for Korean fishery companies and has been our customer since 1996. Besides, the company holds 100% of Qingdao Haizhan Seafood Co., Ltd., another of our major customer. Qingdao Haizhan Seafood Co., Ltd. deals in dried and frozen seafood products and, to the best of our knowledge, has a distribution network of over 1,108 retailers and a sales workforce of about 92 people. It has been our customer since 1996. Our sales to Qingdao Haizhan Seafood Co., Ltd. have increased as it expanded its sales network to include supermarkets, which have resulted in increased orders from them. We believe that we will be less reliant on Qingdao Haizhan Seafood Co., Ltd. and Qingdao Xinqinghua Seafood Products Company for our sales in future, as we enter new markets and increase market penetration of existing markets.
   
3) Fuzhou Xinxutai Trading Ltd. is a distributor of dried seafood and drinks, and has, to the best of our knowledge, a distribution network of about 206 retailers and a sales workforce of about 63 people. It has been our customer since 2010. Our sales to Fuzhou Xinxutai Trading Ltd. have increased as it expanded its sales network to meet growing market demand.
   
4) Xiamen Wansong Commercial and Trading Ltd. is a distributor of dried seafood and drinks, and has, to the best of our knowledge, a distribution network of about 115 retailers and a sales workforce of about 58 people. It has been our customer since 2010. Our sales to Xiamen Wansong Commercial and Trading Ltd. have increased as it expanded its sales network to meet growing market demand.
   
5) Wenling City Xingfeng Foodstuff Co., Ltd. is a distributor of dried seafood in Wenling City, Zhejiang Province, and has, to the best of our knowledge, a distribution network of over 846 retailers and a sales workforce of about 79 peoples. It has been our customer since 1997.
   
6) Jinjiang City Dongshun Seafood Products Trading Proprietor is a wholesaler of seafood products, has, to the best of our knowledge, a distribution network of about 2 retailers and a sales workforce of about 9 people. It has been our customer since 2003.
   
7) Wenzhou Rixin Foodstuff Co., Ltd. is a distributor of dried seafood in Wenzhou City, Zhejiang Province, and has, to the best of our knowledge, a distribution network of about 1,139 retailers and a sales workforce of about 102 people. It was one of our first distributors and has been our key business partner since 1994.

 

None of our directors, executive officers and controlling shareholders is related to or has any interest in any of our major customers listed above. To the best of our knowledge, same as disclosed above, none of our major customers is related to or has any interest in one another, and none of our major customers is related to or has any interest in the suppliers stated in the section “Major Suppliers”. We are not dependent on any one of our major customers as we are able to sell our fresh fish and seafood range, as well as our processed seafood and algae-based beverage products to other customers.

 

INTELLECTUAL PROPERTY

 

Except as disclosed below, we are not dependent on nor do we own any registered trademark or patent or any other intellectual property rights:

 

Trademarks

 

Our brand name distinguishes our products from that of our competitors and increase consumer awareness of our products. We have currently registered the following trademarks:

 

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 Trademark   Class  

Place of

Registration

 

Status / Validity

Period

(1)

 

 

Class 40 covering processed seafood, agricultural foods, processed teas, processed herbs, chemical testing and processing

 

 

PRC

 

 

Registered / January 28, 2003 to January 27, 2013

             
  Class 29 covering meat, fish, poultry and game; meat extracts; preserved, dried and cooked fruits and vegetables; jellies, jams, compotes; eggs, milk and milk products; edible oils and fats   PRC   Registered under the name of Mingxiang on July 8, 2009 and awaiting approval confirmation
             
  Class 30 covering coffee, tea, cocoa, sugar, rice, tapioca, sago, artificial coffee; flour and preparations made from cereals, bread, pastry and confectionery, ices; honey, treacle; yeast, baking-powder; salt, mustard; vinegar, sauces (condiments); spices; ice   PRC   Registered under the name of Mingxiang on July 8, 2009 and awaiting approval confirmation
             
  Class 32 covering beers; mineral and aerated waters and other non-alcoholic drinks; fruit drinks and fruit juices; syrups and other preparations for making beverages   PRC   Registered under the name of Mingxiang on July 8, 2009 and awaiting approval confirmation
             
  Class 32 covering beers; mineral and aerated waters and other non-alcoholic drinks; fruit drinks and fruit juices; syrups and other preparations for making beverages   PRC   Registered under the name of Mingxiang on August 27, 2009 and awaiting approval confirmation

 

Note:

 

  1) The above “Mingxiang” trademark was originally registered under the name of “Fujian Province Shishi City Huabao Mingxiang Foods Development Co.” on January 14, 1997. In a Confirmation of Approval to Trademark Transfer dated June 14, 2001, the PRC Trademark Bureau approved the transfer of this trademark to Mingxiang and the trademark is now registered in Mingxiang’s name under a Trademark Registration Certificate No. 930539.

 

We intend to further develop our “Mingxiang” brand image in the markets where we currently operate, and to promote it in new markets. In that regard, we intend to apply for registration of our trademark in the overseas markets where we conduct our sales, as we consider appropriate.

 

Save as disclosed above, our business or profitability is not materially dependent on any other trademarks, copyrights, patents, grant of licenses from third parties, new manufacturing processes and intellectual property rights.

 

GOVERNMENT REGULATIONS

 

The following is a description of the material licenses and permits issued to subsidiaries of our Company in order for us to carry out our operations, other than those pertaining to general business registration requirements:

 

Hygiene Certificates

 

We view hygiene control as a critical aspect of food production operations and place great emphasis on the hygienic preparation of our processed seafood products to ensure they are safe for consumption. We have received the following hygiene certificates in relation to our operations:

 

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Subsidiary   Name of  Certificate   Description of  License/Permit   Issuing Authority   Period of  Validity
                 
Mingxiang   Hygiene License   Permit to process seafood products   Shishi City Hygiene Bureau   May 18, 2008 to May 17, 2012 (1)
                 
Rixiang   Hygiene License   Permit to process seafood and agricultural products, research and processing biochemical products.   Shishi City Hygience Bureau   May 18, 2008 to May 17, 2012 (1)
                 
Rixiang   Certificate of Hygiene Registration   Registration of conformity with hygiene standards for the export of the following food products: frozen processed seafood products (excluding double-shelled categories and dried processed seafood products)   National Accreditation Supervision Committee   May 31, 2009 to May 31, 2012 (1)

 

Note:

 

(1)The renewal of such certificates with related authorities in PRC is under process for additional four-year terms.

 

Other Licenses and Permits

 

Our other licenses and permits are as follows:

 

Subsidiary   Name of  Certificate   Description of  License/Permit   Issuing Authority   Period of  Validity
                 
Mingxiang   National Industrial Product Manufacturing License   Permit to process seafood (dried)   Fujian Province Quality Technology Supervisory Bureau   November 1, 2011 to October 31, 2014
                 
Rixiang   National Industrial Product Manufacturing License   Permit to process seafood (dried)   Fujian Province Quality Technology Supervisory Bureau   June 1, 2010 to April 15, 2013
                 
Rixiang   Customs Registration Certificate   Permit to file import-export documents with China Customs   China Customs   June 20, 2009 to June 19, 2012
                 
Mingxiang   Certificate of Approval for Enterprises with Foreign Trade Rights in the People’s Republic of China   To import-export company’s products and technologies, raw materials, facilities, equipment   Fujian Foreign Trade Economic Cooperation Department   September 4, 2000; no expiration date
                 
Rixiang   EU Export Registration   Approval for Rixiang to export marine products to EU   European Commission   October 6, 2006; no expiration date

 

Same as disclosed above, as at the date of this Form 10-K, our business or profitability is not materially dependent on any other licenses and permits.

 

RESEARCH AND DEVELOPMENT

 

We believe that constant innovation in developing new processes and products that are well-received by consumers is vital to our continued success. As of December 31, 2011, our research and development team comprised 8 personnel. The focus of our research and development is directed towards satisfying the preferences of consumers, with the following objectives:

 

1.To improve our products in the areas of safety and quality (of taste, texture, hygiene and packaging);

 

2.To develop new products;

 

3.To achieve full customer satisfaction;

 

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4.To reduce costs and create value; and

 

5.To develop products for low-value fish types and to increase the value of processing by-products.

 

Our main research and development activities include: (1) experimenting with various small fish species for the production of fish mash, (2) improving the taste and texture of our dried processed seafood products, (3) finding new uses for leftovers such as fish heads, prawn heads and shells which would otherwise be disposed, (4) developing natural high energy beverage using advanced bio-engineering technology, and (5) developing new products, including marine health products. Our research and development efforts enable us to develop efficient production processes which lower the cost of production, yet produce superior-quality products.

 

Some of the highlights of our research and development activities are set out below.

 

Product Development

 

Through our research and development activities, we have developed products which have been well-received by consumers and improved our production processes. We have through our research and development introduced 32 processed seafood products, including Sakura squid, sliced squid, spicy sliced octopus, spicy baby squid, spicy sliced squid and spicy squid head. We believe that our constant product innovation has led to our increasing reputation as a producer of processed natural seafood products.

 

Collaboration with Ocean University of China

 

On April 28, 2006, our subsidiary Rixiang entered into a memorandum of understanding for collaboration with the Ocean University of China’s Food Sciences and Engineering Institute. The Ocean University of China is one of the renowned institutions in the PRC for ocean studies. The collaboration with Ocean University of China allows us to tap into its technical know-how, to acquire new technical knowledge and processing techniques. In turn, we serve as a research base of the research and development work of Ocean University of China. We believe that we will benefit from the exchange of information and technological know-how.

 

The Ocean University of China provides technical and training support in the development of production techniques upon request. The research and development activities are conducted at our production facilities at Dabao Industrial Zone, Xiangzhi Town, Shishi City, Fujian Province.

 

Hi-Power was developed by the Yellow Sea Fisheries Research Institute Chinese Academy of Fishery Sciences in coordination with the founder, Qiu Shang Jing, who was engaged in the natural algae industry for over 10 years and had significant expertise on algae products.

 

Our research and development expenses amounted to approximately $85,000 and $213,000 for 2011 and 2010, respectively. Research and development expenses are presented as part of general and administrative expenses in the financial statements.

 

QUALITY ASSURANCE

 

We believe that the quality of our products is the key to our continued growth and success. We place great emphasis on quality assurance and the consistent quality of our products at all stages of our production processes. We attribute our success to date to our commitment to and production of quality products. As such, we believe that good quality control has been a key competitive strength of our Company. Our aim is that our “Mingxiang” and “Hi-Power” brands should continue to be identified with tasty and high-quality processed marine seafood products.

 

As a testimony to our commitment to quality products and processes, we have been awarded the following awards and certifications:

 

Subsidiary   Award/Certification   Awarding/Certification Body   Validity Period
Rixiang   Validation of conformity with HACCP standards(1) for the export of marine products to the US   CIQ   November 5, 2010 to November 4, 2011 (renewal of certificate was applied for the third quarter of 2011 and is now under process)
             
Rixiang   EU(2) export registration for export of our marine products to the EU   European Commission   No validity period
             
Mingxiang   ISO9001:2008(3) quality management system certification   CNAB & CCIC Quality Certification Centre   December 9, 2009 to December 8, 2012
             
Mingxiang   ISO14001:2004(4)  environmental management system certification in respect of the processing of fish and prawn-type marine food products and the relevant environmental management   CNAB & CCIC Conformity Assessment Services Co, Ltd.   November 21, 2011 to November 20, 2014

 

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Notes:

 

1) Under the PRC’s Regulations on Administration of Certification of Hazard Analysis and Critical Control Point System (HACCP), applicants for the HACCP certification have to apply to CNAB-recognized certification and accreditation entities and comply with domestic and international sanitary criteria set out in various legislation including the PRC Sanitary Requirements for Export Food Manufacturing Enterprises and the HACCP System and Guidelines for its Application by the Codex Alimentarius Commission. CIQ, a HACCP-certification authority, will verify an exporter’s HACCP certification if (a) the product to be exported falls within one of the following categories, namely (1) canned food, (2) marine food products (excluding live, fresh, dry and marinated products), (3) meat and meat products, (4) frozen vegetables, (5) fruit or vegetable juice, (6) instant frozen food containing meat or marine food products; or (b) where such verification is required by authorities in the destination country. We believe that the HACCP certification enables our products to be more widely accepted by our domestic and international customers and aid to increase the export of our products.
   
2) The EU certification process ensures that the product conforms to the appropriate provisions and relevant legislation which implements certain European Directives.  In the case of marine food products, the applicable European Directives include 91/493/EEC and 94/356/EC.
   
3) ISO9001:2008 is an international standard for quality management developed by the International Organization for Standardization.  It sets requirements as to how an organization should manage its processes that influence product quality, and evaluates an organization’s resource management, process management and evaluation process that ensure its products conform to customer and applicable regulatory requirements.
   
4) ISO14001:2004 is an internationally recognized standard for environment management systems, including energy management, waste management and process improvement.

 

Please refer to the section “Awards and Certifications” for further details of awards and certifications which we have obtained in respect of our products. To attain and maintain these accreditations, we have set up a quality control program in accordance with ISO9001:2008 standards. We have a comprehensive document management system in respect of our quality control system manuals, program documents, records and related documentation, which encompasses issuance, amendment, filing, recovery and destruction of the documents. Our quality control measures are designed to ensure we meet the standards under Sanitation Standard Operating Procedures (“SSOP”), Good Manufacturing Practice (“GMP”) and HACCP quality assurance systems, production control and product quality specifications. SSOP is an action plan that details procedures to maintain sanitary conditions throughout a food processing facility. This includes procedures on food handling and sanitation practices such as proper thawing methods, prevention of contamination and certain aspects of employee and environmental hygiene. GMP includes regulations promulgated by the U.S. Food and Drug Administration under the authority of the Federal Food, Drug and Cosmetic Act, which requires manufacturers, processors and packagers of drugs, medical devices and food to take proactive steps to ensure that their products are safe, pure and effective.

 

Our quality control program requires our employees to undergo training conducted internally in relation to our quality control policies, targets and procedures, as well as production and processing techniques and operational procedures.

 

We have established the following quality control procedures to ensure the high standard of quality of our processed seafood products:

 

In-coming

 

All incoming raw materials are inspected and approved by our quality control department. The quality control checks include hygiene, freshness and safety checks and dimensional checks (for packaging materials) to ensure that the raw materials conform to our health, freshness and safety standards and required specifications. Inspection is carried out by way of random sampling. Samples are extracted from each batch of raw materials and sent to the quality control department, where physical and chemical tests are conducted in our laboratory.

 

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Raw materials that pass the quality control checks are then sent for storage in the cold storage facilities until they are required in the production process.

 

In-process

 

At each stage in the production process, we have quality inspectors who are responsible for sieving out inferior products, and to do random selection of products for testing in our laboratory. In our laboratory, these samples are tested for micro-organisms and to ensure that they fulfill hygiene and safety standards. Our machinery and equipment are also inspected regularly to ensure that they are in good working condition.

 

Finished products

 

The finished products undergo a final round of inspection before they are sent to the warehouse for storage to await delivery to our customers. Random samples are selected and brought to our laboratory for testing to ensure that they fulfill hygiene, safety and product standards. In respect of product standards, for example, we test our dried processed products to ensure that there is adequate but not excessive water content. Our finished products also go through a specially calibrated metal detector to ensure that products are not contaminated by metal particles from the production equipment.

 

After-sales

 

Our quality control department is also responsible for after-sales service, to address customers’ feedback or complaints. 

 

Quality Assurance Testing Base

 

In January 2001, we were designated as a quality assurance testing base by the National Marine Foods Quality Supervision Testing Centre. The National Marine Foods Quality Supervision Testing Centre was established in 1986 and is based in Qingdao City, Shandong Province. This testing body is responsible for quality testing of the state’s designated products, research and development and grading of marine products, including fresh, frozen, dried and pickled marine processed products. As a designated testing base, we test the hygiene and quality of ingredients and products according to industrial standards. Our testing base caters to seafood processing companies from Fujian, Guangdong, Guangxi and Zhejiang provinces, all in the PRC. We believe that we benefit in the provision of such services, as we are kept informed of industry news and technological developments. Currently we do not charge a fee for such services.

 

TAXATION

 

On March 16, 2007, the National People's Congress of China passed a new Enterprise Income Tax Law, or EIT Law, and on November 28, 2007, the State Council of China passed its implementing rules, which took effect on January 1, 2008. Before the implementation of the EIT Law, foreign invested enterprises, or FIEs, established in the PRC, unless granted preferential tax treatments by the PRC government, were generally subject to an earned income tax, or EIT, rate of 33.0%, which included a 30.0% state income tax and a 3.0% local income tax. The EIT Law and its implementing rules impose a unified EIT of 25.0% on all domestic-invested enterprises and FIEs, unless they qualify under certain limited exceptions.

 

In addition to the changes to the current tax structure, under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a resident enterprise and will normally be subject to an EIT of 25% on its global income. The implementing rules define the term “de facto management bodies” as “an establishment that exercises, in substance, overall management and control over the production, business, personnel, accounting, etc., of a Chinese enterprise.” If the PRC tax authorities subsequently determine that we should be classified as a resident enterprise, then our organization’s global income will be subject to PRC income tax of 25%. For detailed discussion of PRC tax issues related to resident enterprise status, see Item 1A, “Risk Factors-Risks Related to Doing Business in China-Under the New Enterprise Income Tax 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.

 

In addition, the EIT Law and its implementing rules generally provide that a 10% withholding tax applies to China-sourced income derived by non-resident enterprises for PRC enterprise income tax purposes unless the jurisdiction of incorporation of such enterprises’ shareholder has a tax treaty with China that provides for a different withholding arrangement. Mingxiang and Rixiang are considered FIEs and are either directly or indirectly held by our subsidiary in Hong Kong. According to a 2006 tax treaty between the Mainland and Hong Kong, dividends payable by an FIE in China to the company in Hong Kong who directly holds at least 25% of the equity interests in the FIE will be subject to a no more than 5% withholding tax. We expect that such 5% withholding tax will apply to dividends paid to Ocean Technology, if any, but this treatment will depend on our status as a non-resident enterprise.

 

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ENVIRONMENTAL LAW COMPLIANCE

 

On December 16, 2010, we received a Certificate of Environment Management System, certifying that we have been assessed and are in compliance with the environment management standard ISO14001: 2004. The scope of certification is for the production and the relative environmental management activity of fish, shrimp and other marine food. The registration number of the certificate is 00111E21827R1M/3502. The certificate is renewed in 2011 which is valid until November 20, 2014.

 

When our production plant was constructed, it was designed to comply with these environmental laws by directly disposing of the use water to a nearby sewage treatment plant for further handling. Because our production plant was built to comply with these environmental laws, we are not required to pay for any ongoing fees to the sewage treatment plant, nor has there been any material effects on our capital expenditures, earnings and competitive position.

 

Since China does not have additional environmental regulations dealing with climate change that apply to our operations, we have not planned material capital expenditures for environmental control facilities or changes in our business practices specific to climate change.

 

EMPLOYEES

 

We set out below the total number of our employees and the various functions which they serve with respect to our processed seafood products, marine catch and algae-based beverage products as at December 31, 2011 and 2010, respectively.

 

  As at December 31, 
Functions  2011   2010 
Sales and Marketing   173    203(1)
Finance and Administration   81    74(1)
Procurement   4    3 
Production, Research & Development and Quality Control   590(2)   692 
TOTAL   848    972 

 

Note:

 

1)The increase in number of employees was in line with the expansion of our production capacities and marketing efforts since the acquisition of the beverage operation.
2)The decrease in number of employees mainly resulted from the downsizing of the sales of our processed seafood products due to consumers’ perception of food safety in relation to the nuclear radiation leaks in Japan during the year.

 

Almost all of our employees are based in the PRC. Our PRC permanent employees are unionized. We have not experienced any strikes, labor disputes or work stoppages by our employees and believe our relationship with our employees is good.

 

Staff Training

 

We view our human resource as one of our key assets and place great emphasis on staff training that not only imparts job skills but also inculcates desirable working attitudes.

 

Therefore, our employees at all levels are required to undergo training relevant for their positions. The training includes technical training which is conducted by both internal and external trainers. Training aspects include quality control, export trading procedures, permits, quality standards and compliance with quality standards, as well as management training.

 

In addition, a new employee undergoes orientation on hygiene requirements, compliance with company policies and procedures as well as the required technical skills before taking up his appointment.

 

Website Access to our SEC Reports

 

You may obtain a copy of the following reports, free of charge through the SEC’s website at www.sec.gov as soon as reasonably practicable after electronically filing them with, or furnishing them to, the SEC: our previous Annual Reports on Form 10-K; our Quarterly Reports on Form 10-Q; our Current Reports on Form 8-K; and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Our internet website and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K.

 

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The public may also read and copy any materials filed with the SEC at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The Public Reference Room may be contact at (800) SEC-0330. You may also access our other reports via that link to the SEC website.

 

ITEM 1A.         Risk Factors

 

RISKS RELATED TO OUR BUSINESS

 

We are dependent on the supply of fresh seafood in our production of processed seafood products and disruptions in the supply of fresh seafood could adversely affect our business operations.

 

We use fresh seafood as the primary ingredient in our processed seafood products. Our processed seafood products accounted for approximately 41.0% and 57.4% of our sales in the fiscal years ended December 31, 2011 and 2010, respectively. Our production of processed seafood products is largely dependent on the continuous supply of fresh seafood, which in turn could be affected by a large number of factors, including but not limited to, environmental factors, the availability of seafood stock, weather conditions, water contamination, the policies and regulations of the governments of the relevant territories where such fishing is carried out, the ability of the fishing companies and fishermen that supply us to continue their operations and pressure from environmental or animal rights groups.

 

Specifically, fishing activities in waters around the PRC are restricted in certain months to ensure sustainable aquatic resources. In particular, the PRC Ministry of Agriculture imposes restrictions against fishing in the South China Sea in the months of June and July. There is no assurance that the PRC government may not impose more stringent fishing regulations, including but not limited to longer or more frequent periods that restrict fishing. Such restrictions against fishing or unfavorable weather conditions have a direct impact on the availability of the raw materials required for the production of our processed seafood products, and could lead to a shortage and/or an increase in the prices of our raw materials. Any shortage in the supply of or increase in the prices of the raw materials for our processed seafood products will adversely affect our business, profitability and financial condition.

 

The nuclear disaster in Japan that occurred in 2011, can also affect the continuous supply and pricing of our supply of the fresh materials although we have not experienced any material problems with the supply or pricing of such supply to date.

 

Our profitability will be affected by fluctuations in the prices of our major raw materials.

 

Our financial performance may be affected by changes in production costs brought about by fluctuations in the prices of our raw materials. Our major raw materials are fresh seafood which accounted for approximately 72.9% and 75.4% of our total cost of revenue of processed seafood products in the fiscal years ended December 31, 2011 and 2010, respectively. The prices of our major raw materials may fluctuate due to changes in supply and demand conditions. Any shortage in supply or upsurge in demand of our major raw materials may lead to an increase in prices, which may adversely affect our profitability due to increased production costs and lower profit margins.

 

We are dependent on several major customers. In the event any one of these major customers ceases to purchase or reduce their purchases from us, and we are unable to secure new contracts, our sales will be adversely affected.

 

Our top five major customers accounted for approximately 51.6% and 36.4% of our sales in the fiscal years ended December 31, 2011 and 2010, respectively. The largest customer accounted for 25.3% and 12.5% of our sales in the fiscal years ended December 31, 2011 and 2010, respectively. In the event these customers do not continue to purchase from us or reduce their purchases from us or develop their own abilities to manufacture the products that we sell to them, and we are unable to secure new contracts or new customers that can replace the loss of these customers within a short time frame, our business and profitability may be adversely affected. Please see the section “Major Customers” for more details.

 

We are dependent on certain major suppliers for our raw materials. In the event we are no longer able to secure raw materials from these suppliers and are unable to find alternative sources of supply at similar or more competitive rates, our operations and profitability will be adversely affected.

 

For the production of our processed seafood and algae-based beverage products, we rely on our major suppliers for a significant portion of the supply of raw materials. Purchases from our top five suppliers of raw materials accounted for approximately 88.0% and 81.7% of our total purchases of raw materials in the fiscal years ended December 31, 2011 and 2010, respectively. In the event that we are unable to secure our raw materials from these suppliers and we are unable to find alternative sources of supply at similar or more competitive rates, our business and operations will be adversely affected. Please see the section “Major Suppliers” for more details.

 

Our profitability and continued growth is dependent on our ability to yield commercially viable products, to enhance our product range and expand our customer base.

 

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The seafood processing industry is highly competitive. The growth potential of the seafood processing industry is dependent on population growth and consumer preferences. Therefore, we believe that our profitability and continued growth is dependent on our ability to expand our customer base in existing and new markets by introducing new products that are fast growing and profitable in the populations that we serve, as well as our ability to develop commercially viable products through our product development efforts. If we do not succeed in these efforts, the growth of our sales may slow down and adversely affect our profitability. Please refer to the section “Research and Development” for further details of our research and development efforts.

 

Since we do not have long-term contracts with our suppliers and customers there is no guarantee that our suppliers will continue to supply us with raw materials, or that our customers will continue to purchase our products.

 

We do not have long-term contracts with our suppliers and our customers. Accordingly, there can be no assurance that we will continue to be able to obtain sufficient quantities of raw materials in a timely manner from our existing suppliers on acceptable terms, or that our existing customers will continue to purchase our products on terms that are acceptable to us or at all. In the event that we are unable to source for new suppliers or new customers on terms that are acceptable to us, our business and operations will be adversely affected.

 

There is no assurance that we will be able to execute our future plans successfully, or that our future plans will result in commercial success.

 

We intend to, inter alia and expand our operations and production capacity in the PRC by constructing new cold storage facilities. There can be no assurance that the construction of the new cold storage facility will be completed and start operating in the first half of 2012 as expected. Our expansion plans involve a number of risks, including inter alia the costs of investment in fixed assets, costs of working capital tied up in inventories, as well as other working capital requirements.

 

Our expansion will also depend on our ability to secure new customers and/or sufficient orders. Failure to secure new customers or sufficient orders or to meet our customers’ orders would materially and adversely affect our business and financial performance. There is no assurance that our future plans will result in commercial success. If we are unable to execute our expansion plans successfully, our business and financial performance would be materially and adversely affected.

 

The construction of our new cold storage facility will be subject to a number of development risks, which could cause cost overruns and delays or prevent completion of the project .

 

Construction of our new cold storage facility in Shishi City with a capacity of approximately 20,000 tons is scheduled to be completed in the first half of 2012 but there can be no assurance that the construction, which was originally scheduled to be completed by December 31, 2011, will be completed by such date. A small delay was experienced due to adverse weather conditions and the shortage of labor during the Chinese Lunar New Year period. Delays in the construction of the new cold storage facility project beyond the estimated development periods, as well as cost overruns, could increase the cost of completion beyond the amounts that we estimate. Any delay in completion of the new cold storage facility project may also reduce or delay in the receipt of revenues projected from the expansion project. As a result, any significant construction delay, whatever the cause, could have a material adverse effect on our business, results of operations, financial condition and prospects.

 

Changes in consumer preferences or discretionary consumer spending could adversely impact our results.

 

Our continued growth and success depends in part on the popularity of our products. Sales of our processed seafood products, marine catch and algae-based beverage products as a percentage of our total sales for the period under review were as follows:

 

   Year Ended December 31, 
Products  2011   2010 
   (%)   (%) 
         
Processed seafood products   41.0    57.4 
           
Marine catch   38.4    21.4 
           
Algae-based beverage products   20.6    21.2 

 

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Shifts in consumer preferences or dieting habits in the PRC away from processed seafood products or algae-based beverage products will materially affect our business. Consumer preferences regarding health and food safety are evolving in the PRC and the success of our food products depends on our ability to identify the tastes and dietary habits of consumers and to offer products that appeal to their preferences, including concerns of consumers regarding health and wellness, food safety, product attributes, and ingredients. In addition, our continued success depends, in general, on the economic conditions, disposable income and consumer confidence in the countries in which we sell our products, all of which can affect discretionary consumer spending in such countries. Adverse changes in these factors would reduce the flow of customers and limit our pricing which will reduce our profitability.

 

Our business activities are subject to certain laws and regulations and our operations may be affected if we should fail to have in force the requisite licenses and permits.

 

We are required to obtain various licenses and permits in order to conduct our business of production and export of processed seafood products. These include the Hygiene Registration Certificate, which is a requirement in order to carry on the production of food products in the PRC, as well as the HACCP certificate and EU export registration, which is a requirement in order to export our processed seafood products to certain countries. Our business is also subject to applicable laws and regulations. Please see the section “Government Regulations” of this Form 10-K for a summary of the material laws and regulations that apply to our Company.

 

Any failure to comply with the conditions stipulated in our licenses and permits may lead to their revocation or non-renewal. Any failure to observe the applicable laws and regulations may lead to the termination or suspension of some or all of our business activities or penalties being imposed on us. The occurrence of any of these events may adversely affect our business, financial condition and results of operations.

 

Our processed seafood products may be illegally tampered with such that they are rendered unfit for consumption and have to be recalled and destroyed.

 

Our processed seafood products are packed in plastic materials that can be illegally tampered with. Illegal tampering of our processed seafood products could result in such products being rendered unfit for consumption or cause them to fail to meet customer specifications, health and/or safe handling requirements. This may lead to a loss of customer confidence in our products, affect our reputation, cause product recalls and/or product destruction. In addition, we may incur substantial litigation costs and may be ordered to compensate consumers in the event of any illness or death caused by the consumption of an illegally tampered seafood product.

 

In the event that our processed seafood products are recalled or destroyed as a result of illegal tampering or a claim is made against us arising from the consumption of our products, our reputation, business goodwill and sales will be adversely affected.

 

Product or raw material deterioration will lead to loss of sales, higher costs, negative publicity, and payment of compensation to our customers and/or product liability claims.

 

Our raw materials, frozen and processed seafood products, being perishable in nature, may deteriorate due to various reasons such as malfunctioning cold storage facilities, delivery delays or poor handling. This may lead to a delay in production or delivery of our products, a loss in revenue, costs incurred in the purchase of replacement raw materials and payment of compensation to our customers. Any deterioration in our raw materials or processed seafood products could have a material adverse effect on our business, operations and reputation.

 

Currently, we do not have any product liability insurance in respect of our products. We believe that premiums for product liability insurances are high compared to the risk of claims. In the event that the consumption of our processed seafood products causes harm, illness or death to a consumer of our products, whether as a result of product deterioration, spoiling, sabotage, willful action, omission or negligence, we may be liable to complaints, lawsuits and claims from consumers of our products which in turn could generate negative publicity and materially and adversely affect our business, financial condition and our operations.

 

Outbreak of disease or widespread contamination in any of the raw materials that we use in our production or any food scares may lead to a loss in consumer confidence and reduce the demand for our processed seafood products.

 

One of our competitive strengths is our established brand name and track record. We have received several awards and certificates for our high quality products, including the “Green Food” award. Any outbreak of disease or widespread contamination in any of the raw materials that we use in the production of our products or food scares in the markets in which our processed seafood products are manufactured or sold may have an adverse impact on our business as it may lead to a loss in consumer confidence and reduce the demand of our processed seafood products. It may also affect our sources of supply and we may have to look for alternative sources of supply which may be more costly, or which may not be available. If this develops into actual events, our operations and profitability will be adversely affected.

 

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Any failure to meet food safety regulation may result in the suspension of licenses, accreditations or the loss of our ability to sell our products.

 

The manufacture and marketing of food products is heavily regulated in the PRC under the Food Safety Law enacted in 2009. If we fail to comply with the Food Safety Law or any other applicable laws and regulations, we may be subject to investigations, criminal sanctions or civil remedies, including fines, injunctions, prohibitions on exporting, seizures or debarments from government contracts or the loss of liquor licenses. The cost of compliance or the consequences of non-compliance, including debarments, could have a material adverse effect on our business and results of operations. In addition, governmental units may make changes in the regulatory frameworks within which we operate that may require either the corporation as a whole or individual businesses to incur substantial increases in costs in order to comply with such laws and regulations.

 

In May 2011, inspectors of the government of Taiwan detected dangerous levels of industrial plasticizers in sports drinks and soft drinks, used to substitute for palm oil as clouding agents in drinks, with levels far in excess of the daily allowed intake. One plasticizer, known as DEHP, is a possible carcinogen, and thought capable of wreaking havoc with children’s reproductive organs. Since then, the plasticizers have been found in a range of foods and drinks. China, Hong Kong, South Korea and the Philippines have recalled beverage bottles suspected of contamination imported from Taiwan. Although none of our products were subject to the recall, the beverage products sector in the East Asia region was adversely affected by the food scandal, and new legislation with higher food safety standard of beverage products may be implemented in the PRC. The DEHP crisis may affect our beverage products business as a result of any failure to comply with the new standard or adverse changes in the beverage products sector.

 

Any failure to meet health and hygiene standards may result in the suspension of licenses, accreditations or the loss of our ability to import and export our products.

 

We are subject to annual checks carried out by the General Administration of Quality Supervision, Inspection and Quarantine of the PRC (CIQ). The CIQ’s annual check encompasses the inspection of food preparation, production and processing operations, as well as health checks on our employees. Failure to meet the required standards may result in our being required to take remedial measures to meet the health and hygiene standards, or in extreme cases, the cancellation or suspension of the license(s) and accreditation(s) required for us to carry on our operations. In the event that this should occur, our operations and financial condition will be materially and adversely affected and could lead to a loss in customer confidence in our products.

 

In addition, the CIQ makes random inspections on the processed seafood and algae-based beverage products that we export. Failure to meet the required standards of hygiene may affect our ability to export our processed seafood and algae-based beverage products and meet our customers’ orders on time. It may also lead to a restriction on our ability to export our processed seafood and algae-based beverage products which will materially and adversely affect our business, financial condition and operations.

 

We bear the risk of loss in shipment of our products and have no insurance to cover such loss.

 

Under the shipping terms of our standard customer contracts, we bear the risk of loss in shipment of our products and do not insure this risk. Since management considers the risk of loss to be minimal, with export sales representing less than 0.4% of our total sales for the years ended December 31, 2011 and 2010, respectively. Moreover, we believe that the shipping companies that we use carry adequate insurance or are sufficiently solvent to cover any loss in shipment. Nevertheless, there can be no assurance that we will be adequately reimbursed upon the loss of a significant shipment of our products.

 

We are dependent on our Executive Directors and Executive Officers. Any loss in their services without suitable replacement may adversely affect our operations.

 

Our success to date has been largely due to the contribution of Pengfei Liu, our Executive Chairman and CEO. Mr. Liu is the founder of our Company, and has spearheaded our expansion and growth. He is responsible for our operations, marketing, public relations, strategic planning and development of new products and markets. Our continued success is dependent, to a large extent, on our ability to retain his services.

 

The continued success of our business is also dependent on our key management and operational personnel. We rely on their experience in the processed seafood and marine catch industry, product development, sales and marketing and on their relationships with our customers and suppliers.

 

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The loss of the services of any of our executive directors or executive officers without suitable replacement or the inability to attract and retain qualified personnel will adversely affect our operations and hence, our revenue and profits.

 

We are dependent on our customers’ ability to maintain and expand their sales and distribution channels. Should these distributors be unsuccessful in maintaining and expanding their distribution channels, our results of operations will be adversely affected.

 

Demand for our products from end-consumers and our prospects depend on the retail growth and penetration rate of our products to end-consumers. Sales of our products are conducted mainly through distributors, over whom we have limited control. As of December 31, 2011, our distribution network is comprised of 18 exclusive distributors for our dried processed seafood products located in five provinces and seven exclusive distributors for our algae-based beverage products located in two provinces. These distributors sub-distribute our dried processed seafood products to about 3,200 retail points and our algae-based beverage products to about 15,000 retail points, including major supermarkets. We are thus dependent on the sales and distribution channels of our distributors for broadening the geographic reach of our products. Should these distributors be unable to maintain and expand their distribution channels, our results of operations and financial position will be adversely affected.

 

Failure to compete effectively in a competitive environment may affect our profitability.

 

We operate in the highly competitive processed seafood industry. We believe that our major competitors include international and domestic seafood processors. Some of these competitors may have significantly greater financial, technical and marketing resources, stronger brand name recognition and larger existing customer base than we do.

 

We also believe that these competitors may have the ability to respond more quickly to new or emerging technologies or may adapt more quickly to changes in customer requirements or may devote greater resources to the development, promotion and sales of their products than us.

 

There is no assurance that we will be able to continue competing successfully against present and future competitors. We believe that important factors to achieving success in our industry include maintaining customer loyalty by cultivating long-term customer relationships, achieving consistent product renewal and maintaining the quality of our products. If we are unable to attain these, we may lose our customers to our competitors and this will adversely affect our market share. Increased competition may also force us to lower our prices, thus reducing our profit margins and affecting our financial performance and condition. Such competition may have a material adverse effect on our business, financial position and results of operations. Please refer to the section captioned “Description of Business - Competition” for further details as to our present competitors.

 

Any outbreak of earthquake, tsunami, adverse weather or oceanic conditions or other calamities may result in disruption in our operations and could adversely affect our sales.

 

We are based in Fujian province which is situated in southeast China on the coast of the East China Sea. Fujian is a vital navigation hub between the East China Sea and South China Sea, and is also rich in agricultural and marine resources. Our main raw materials for our marine catch business come from the Taiwan Strait, which is also where we conduct our marine catch operations.

 

In March 2011, the northern region of Japan experienced a severe earthquake followed by a tsunami. The earthquake and tsunami caused extensive and severe structural damage in Japan, including heavy damage to roads and railways as well as fires in many areas, and damage to several nuclear reactors. Although to date the damage caused by the earthquake tsunami or radiation leaks have not significantly damaged our access to or price of materials or the quality of such raw materials, there can be no assurance that such access, price or quality may not be affected. In addition, public concern about seafood contamination can also adversely affect our sales of seafood products as a result of consumers’ perception of food safety issues resulting from nuclear radiation leaks in Japan.

 

Due to the location of our business, we may be at risk of experiencing another tsunami, earthquake or other adverse weather or oceanic conditions. This may result in the breakdown of our facilities, such as our cold storage facilities, which will in turn lead to deterioration of our products with the potential for spoilage. This could adversely affect our ability to fulfill our sales orders and adversely affect our profitability.

 

Adverse weather conditions affecting the fishing grounds where the fishing vessels chartered by us operate such as storms, cyclones and typhoons or cataclysmic events such as tsunamis may also decrease the volume of our fish catches or may even hamper our fishing operations. Our operations may also be adversely affected by major climatic disruptions such as El Nino which in the past has caused significant decreases in seafood catches worldwide.

 

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We may be affected by global climate change or by legal, regulatory or market responses to such changes.

 

The growing political and scientific sentiment is that increased concentrations of carbon dioxide and other greenhouse gases in the atmosphere are influencing global weather patterns. Fresh products, including seafood products used as our raw materials, are vulnerable to adverse weather conditions, including windstorms, floods, drought and temperature extremes, which are quite common but difficult to predict and may be influenced by global climate change. Similarly, changing weather patterns, along with the increased frequency or duration of extreme weather conditions, could impact the availability or increase the cost of key raw materials that we use to produce our products.

 

Concern over climate change, including global warming, has led to legislative and regulatory initiatives directed at limiting greenhouse gas (GHG) emissions. For example, proposals that would impose mandatory requirements on GHG emissions may be considered by policy makers in the territories that we operate. Laws enacted that directly or indirectly affect our production, distribution, packaging, cost of raw materials, fuel, ingredients, and water could all impact our business and financial results.

 

We are in the business of processing, distributing and selling processed seafood products and marine catch. Thus, a dramatic reduction in fish resources may adversely affect our business.

 

We are in the business of processing, distributing, and selling processed seafood products, as well as selling marine catch. As such, 100% of our raw materials are obtained through fishing. Due to over-fishing, the stocks of certain species of fish may be dwindling and to counteract such over-fishing, governments may take action that may be detrimental to our ability to conduct our operations. If the solution proffered or imposed by the governments controlling the fishing grounds either restrict our ability to procure seafood supply or if such action limits the types, quantities and species of fish that we are able to procure or catch, our operations and prospects may be adversely affected.

 

Our purchase of the beverage business involves the risks of entering into a new business.

 

On January 1, 2010, we purchased Xianghe, a beverage company, and entered into a new business segment where we needed to rely on the current management for the business acquired. Xianghe is a Fujian based manufacturer of the branded Hi-Power algae-based soft drinks. We did not have prior experience in the beverage business and the success of Xianghe is subject to all of the uncertainties regarding the development of a new business. Although we have started integrating the product into Mingxiang’s distribution network and further expanded the distribution into other untapped areas, there can be no assurance regarding the successful distribution and market acceptance of the beverage products.

 

We may not be able to respond successfully to changes in the highly competitive beverage marketplace domestically and internationally.

 

We operate in the highly competitive beverage industry and face strong competition from other general and specialty beverage companies. Our response to continued and increased competitor and customer consolidations and marketplace competition may result in lower than expected net pricing of our products. Our ability to gain or maintain share of sales or gross margins may be limited by the actions of our competitors, who may have advantages in setting their prices because of lower costs. Competitive pressures in the markets in which we operate may cause channel and product mix to shift away from more profitable channels and packages.

 

The beverage industry is highly competitive. The principal areas of competition are pricing, packaging, development of new products and flavors and marketing campaigns. Our products will compete with a wide range of drinks produced by a relatively large number of manufacturers, any of which have substantially greater financial, marketing and distribution resources than we do.

 

Important factors affecting our ability to compete successfully include taste and flavor of products, trade and consumer promotions, rapid and effective development of new, unique cutting edge products, attractive and different packaging, branded product advertising and pricing. We will also compete for distributors who will concentrate on marketing our products over those of our competitors, provide stable and reliable distribution and secure adequate shelf space in retail outlets. Competitive pressures in the healthy beverage market could cause our products to be unable to gain market share, or we could experience price erosion, which could have a material adverse effect on our business and results.

 

We compete with major international beverage companies that operate in multiple geographic areas, as well as numerous firms that are primarily local in operation. Our ability to gain or maintain share of sales or gross margins in the Chinese markets and ability to grow the business in global market may be limited as a result of actions by competitors.

 

We compete not only for customer acceptance but for maximum marketing efforts by multi-brand licensed bottlers, brokers and distributors, many of which have a principal affiliation with competing companies and brands. Certain large companies such as The Coca-Cola Company and Pepsico Inc. market and/or distribute products in that market segment.

 

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Our beverage business is dependent on sales in Fujian province and any significant disruption in sales in this province could adversely affect our beverage business.

 

During the year ended December 31, 2011, approximately 85.9% of our sales of the beverage product were in Fujian province. Although we have experienced strong growth in sales in Fujian province and have expanded our sales to Zhejiang province and intend to expand our sales to other provinces, any significant disruption in sales in Fujian could adversely affect our beverage business.

 

Our beverage business is heavily regulated by China State Food and Drug Administration (“SFDA”) and other government agencies for the production and packaging of beverage products, and failure to comply these regulation may adversely affected our beverage business.

 

The production, distribution and sale in China of our beverage products are the production, distribution and sale in the Chinese market of our products are subject to the PRC State Food, Drug, and Cosmetic Act, state consumer protection laws, the Occupational Safety and Health Act, various environmental statutes; and various other state and local statutes and regulations applicable to the production, transportation, sale, safety, packaging, advertising, labeling and ingredients of such products. Although we expect that we will comply with all relevant regulations and rules in our production and distribution of beverage products, there is risk that those regulations may be violated and capital expenditures, net income or competitive position as a result of the violation may be adversely affected.

 

Water scarcity and poor quality could negatively impact our beverage production costs and capacity.

 

Water is the main ingredient in our beverage product. It is also a limited resource in many parts of the world, facing unprecedented challenges from overexploitation, increasing pollution and poor management. As demand for water continues to increase in China and as the quality of available water deteriorates, our system may incur increasing production costs or face capacity constraints which could adversely affect our profitability or net operating revenues in the long run.

 

Changes in the nonalcoholic beverages business environment could impact our financial results.

 

The nonalcoholic beverages business environment is rapidly evolving as a result of, among other things, changes in consumer preferences, changes in consumer lifestyles, increased consumer information and competitive product and pricing pressures. If we are unable to successfully adapt to this rapidly changing environment, our net income, share of sales and volume growth could be negatively affected.

 

Adverse weather conditions could reduce the demand for our beverage products.

 

The sales of our beverage products are influenced to some extent by weather conditions in the markets in which we operate. Unusually cold weather during the summer months may have a temporary effect on the demand for our beverage products and contribute to lower sales, which could have an adverse effect on our results of operations for those periods.

 

We are dependent on certain major manufacturers for production of beverage products.

 

For the production of our beverage products, we rely on two manufacturers for all of the production of our beverage products. We believe that alternate manufacturers are available but there may be some disruption in supplies until we can obtain product from such manufacturers. In the event we are no longer able to secure product from these manufacturers, our operations and profitability of the beverage business will be adversely affected.

 

We are exposed to the credit risk of our customers which may cause us to make larger allowances for doubtful trade receivables or incur bad debt write-offs.

 

Our customers may default on their payments to us. Although we review the credit risk of our customers regularly, such risks will nevertheless arise from events or circumstances that are difficult to anticipate or control, such as an economic downturn.

 

Our trade receivables turnover days were approximately 81 and 71 days in 2011 and 2010, respectively. Our allowances for doubtful trade receivables as at December 31, 2011 and 2010 were approximately $345,000 and $244,000, respectively; and at about 0.5% of our gross trade receivables.

 

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As a result of this credit risk exposure of our customers defaulting on their payments to us, we may have to make larger allowances for doubtful trade receivables or incur bad debt write-offs, both of which may have an adverse impact on our profitability. 

 

We may be subject to foreign exchange risk and may incur losses arising from exchange differences upon settlement.

 

We sell our processed seafood products, marine catch and algae-based beverage products mainly to local customers. Direct exports as a percentage of our sales ranged between 0.1% to 2.6% during the period under review. Our sales are denominated in RMB and US$, while our purchases are denominated in RMB.

 

For the fiscal year of 2011 and 2010, the percentages of our sales denominated in RMB and US$ were as follows:

 

   Year Ended December 31, 
   2011   2010 
   (%)   (%) 
           
RMB   99.9    99.6 
           
US$   0.1    0.4 

 

We may incur losses arising from exchange differences upon settlement. To the extent that our sales, purchases and expenses are not naturally matched in the same currency and there are timing differences between collections and payments, we will be exposed to any adverse fluctuations in the exchange rates between the various foreign currencies and the RMB. Any restrictions over the conversion or timing of conversion of foreign currencies may also expose us to adverse fluctuations in exchange rates. As a result, our earnings may be materially and adversely affected.

 

On July 21, 2005, the Renminbi was unpegged against the US$ and pegged against a basket of currencies on a “managed float currency regime”. As at December 31, 2011, the closing exchange rate was approximately US$1.00 to 6.3523. There is no assurance that the PRC’s foreign exchange policy will not be further altered. In the event that the PRC’s policy is altered, significant fluctuations in the exchange rates of RMB against the US$ will arise. As a result, we will be subject to significant foreign exchange exposure and in the event that we incur foreign exchange losses, our financial performance will be adversely affected.

 

Please refer to the section “Description of Business - Foreign Exchange Exposure” for further details.

 

Our products and brand name may be replicated or counterfeited which will in turn have an adverse effect on our Company and we may be affected by intellectual property rights disputes.

 

We have registered certain trademarks in the PRC, details of which are set out in the section “Intellectual Property” of our Form 10-K. Despite the protection of our trademark under the intellectual property laws of the PRC, such laws may not be adequate or effectively enforced against third parties who may violate our proprietary rights by illegally using our trademarks or our brand name. Our products and brand names may be replicated or counterfeited, which in turn may adversely affect our reputation and brand image.

 

Policing unauthorized use of our trademarks or brand is difficult and costly, particularly in countries where the laws may not fully protect our proprietary rights. There can be no assurance that our means of protecting our proprietary rights will be adequate. Any unauthorized use of our trademarks and brand may damage our brand, recognition and reputation. This may lead to our customers losing confidence in our brand and products, which, in turn, may lead to a loss in our business and hence sales.

 

Our business may be adversely affected by conditions in the financial markets and economic conditions generally.

 

Negative market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and provision for credit losses. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us. Furthermore, should China’s economic growth slow or should China’s economy contract, or the economies of the provinces that are our principal markets experience slower growth or economic contraction, consumer demand for our products and/or our ability to charge desired prices for our products could be adversely affected.

 

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Worldwide economic conditions may remain depressed for the foreseeable future. These conditions make it difficult for us to accurately forecast and plan future business activities, and could cause us to slow or reduce spending on our research and development activities. Furthermore, during challenging economic times, we may face issues gaining timely access to financings or capital infusion, which could result in an impairment of our ability to continue our business activities. We cannot predict the timing, strength or duration of any economic slowdown or subsequent economic recovery, worldwide, Europe, United States, or in our industry. These and other economic factors could have a material adverse effect on our financial condition and operating results.

 

During 2008 and 2009, worldwide economic conditions deteriorated in many countries and regions, resulting in weak equity markets, tightening of business credit and liquidity, a contraction of consumer credit, business failures, increased unemployment and declines in consumer confidence and spending. Despite more positive trends beginning in the second half of 2009, the current turmoil in the sovereign debt markets as a result of the European debt crisis from 2011 has resulted in general market uncertainty and in worsening economic conditions particularly in Europe. If global economic and financial market conditions remain uncertain and/or weak for an extended period of time, any of the following factors, among others, could have a material adverse effect on our financial condition and results of operations:

 

·slower consumer spending may result in reduced demand for our products, reduced orders from customers for our products, order cancellations, lower revenues, increased inventories, and lower gross margins;

 

·continued volatility in the global markets and fluctuations in exchange rates for foreign currencies and contracts in foreign currencies could negatively impact our reported financial results and condition;

 

·continued volatility in the prices for commodities and raw materials we use in our products could have a material adverse effect on our costs, gross margins, and ultimately our profitability;

 

·if our customers experience declining revenues, or experience difficulty obtaining financing in the capital and credit markets to purchase our products, this could result in reduced orders for our products, order cancellations, inability of customers to timely meet their payment obligations to us, extended payment terms, higher accounts receivable, reduced cash flows, greater expense associated with collection efforts and increased bad debt expense;

 

·a severe financial difficulty experienced by our customers may cause them to become insolvent or cease business operations, which could reduce the availability of our products to consumers; and

 

·any difficulty or inability on the part of manufacturers of our products or other participants in our supply chain in obtaining sufficient financing to purchase raw materials or to finance general working capital needs may result in delays or non-delivery of shipments of our products.

 

RISKS RELATED TO DOING BUSINESS IN CHINA

 

Our operations in the PRC are subject to the laws and regulations of the PRC and any changes in the laws or policies of the PRC may have a material impact on our operations and financial performance.

 

As our processed seafood products, marine catch and algae-based beverage products businesses are carried out in the PRC, we are subject to and have to operate within the framework of the PRC legal system. Any changes in the laws or policies of the PRC or the implementation thereof, for example in areas such as foreign exchange controls, tariffs, trade barriers, taxes, export license requirements and environmental protection, may have a material impact on our operations and financial performance.

 

The corporate affairs of our companies in the PRC are governed by their articles of association and the corporate and foreign investment laws and regulations of the PRC. The principles of the PRC laws relating to matters such as the fiduciary duties of directors and other corporate governance matters and foreign investment laws in the PRC are relatively new. Hence, the enforcement of investors or shareholders' rights under the articles of association of a PRC company and the interpretation of the relevant laws relating to corporate governance matters remain largely untested in the PRC.

 

Introduction of new laws or changes to existing laws by the PRC government may adversely affect our business if stricter regulations are imposed on the overseas business practices of PRC companies.

 

Our operations are carried out through our wholly-owned subsidiaries which are located in the PRC. As such, the laws of the PRC govern our businesses and operations. The PRC legal system is a codified system of written laws, regulations, circulars, administrative directives and internal guidelines. The PRC government is still in the process of developing its legal system to encourage foreign investment and to align itself with global practices and standards. As the PRC economy is undergoing development at a faster rate than the changes to its legal system, some degree of uncertainty exists in connection with whether and how existing laws and regulations apply to certain events and circumstances. Some of the laws and regulations and the interpretation, implementation and enforcement of such laws and regulations are also at an experimental stage and are subject to policy changes. Hence, precedents on the interpretation, implementation and enforcement of certain PRC laws are limited and court decisions in the PRC do not have binding effect on lower courts. Accordingly, the outcome of dispute resolutions and litigation may not be as consistent or predictable as in other more developed jurisdictions and it may be difficult to obtain swift and equitable enforcement of the laws in the PRC, or to obtain enforcement of a judgment by a court or another jurisdiction.

 

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In particular, on August 8, 2006, six PRC regulatory bodies, including the Ministry of Commerce (MOFCOM) and the China Securities Regulatory Commission (“CSRC”), jointly promulgated the new “Regulations on Foreign Investors Merging with or Acquiring Domestic Enterprises”, which took effect on September 8, 2006 (“2006 M&A Rules”). The 2006 M&A Rules regulate, inter alia, the acquisition of PRC domestic companies by foreign investors.

 

On September 21, 2006, the CSRC promulgated the “Guidelines on Domestic Enterprises Indirectly Issuing or Listing and Trading their Stocks on Overseas Stock Exchanges” (the “CSRC Guidelines”).

 

Under the 2006 M&A Rules and the CSRC Guidelines, the listing of overseas special purpose vehicles (“SPV”) which are controlled by PRC entities or individuals are subject to the prior approval of the CSRC.

 

The 2006 M&A Rules and the CSRC Guidelines do not provide any express requirement for an SPV to retroactively obtain CSRC approval where the restructuring steps had been completed prior to September 8, 2006.

 

Yuan Tai Law Offices, our Legal Adviser on PRC Law, is of the opinion that (i) we have obtained all the necessary governmental approvals from PRC authorities for the restructuring of our subsidiaries prior to September 8, 2006, (ii) we do not need to obtain CSRC approval and (iii) it is not necessary for us to comply retroactively with the requirement of obtaining the prior approval of the CSRC for our public listing in the U.S.

 

There is no assurance that these PRC authorities will not issue further directives, regulations, clarifications or implementation rules requiring us to obtain further approvals in relation to our public listing in the U.S.

 

Restrictions under PRC law on our PRC subsidiaries’ ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, pay dividends to you, and otherwise fund and conduct our business.

 

Substantially all of our sales are earned by our PRC subsidiaries. However, PRC regulations restrict the ability of our PRC subsidiaries to make dividends and other payments to their offshore parent company. PRC legal restrictions permit payments of dividends by our PRC subsidiaries only out of their accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Our PRC subsidiaries are also required under PRC laws and regulations to allocate at least 10% of their annual after-tax profits determined in accordance with PRC GAAP to a statutory general reserve fund until the amounts in said fund reaches 50% of our registered capital. Allocations to these statutory reserve funds can only be used for specific purposes and are not transferable to us in the form of loans, advances, or cash dividends. Any limitations on the ability of our PRC subsidiaries to transfer funds to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.

 

Furthermore, our PRC subsidiaries, which are foreign investment entities (“FIEs”), are subject to the PRC rules and regulations on currency conversion. In the PRC, the State Administration of Foreign Exchange (“SAFE”) regulates the conversion of the RMB into foreign currencies. Currently, foreign investment enterprises (including wholly foreign-owned enterprises) are required to apply to the SAFE for “Foreign Exchange Registration Certificates for FIEs”. With such registration certification (which have to be renewed annually), FIEs are allowed to open foreign currency accounts including the “current account” and “capital account”. Currently, transactions within the scope of the "current account" (for example, remittance of foreign currencies for payment of dividends) can be effected without requiring the approval of the SAFE. However, conversion of currency in the “capital account” (for example, for capital items such as direct investments, loans and securities) still requires the approval of the SAFE. Our PRC operating subsidiary Rixiang has obtained the "Foreign Exchange Registration Certificates for FIEs", which is subject to annual review.

 

There is no assurance that the PRC regulatory authorities will not impose restrictions on the convertibility of the RMB for FIEs. In 2011 and 2010, approximately 99.9% and 99.6% of our sales, respectively, was denominated in RMB. As such, any future restrictions on currency exchanges may limit our ability to utilize funds generated in the PRC to fund any potential business activities outside the PRC or to distribute dividends to our shareholders.

 

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Our subsidiaries, operations and significant assets are located outside the U.S. Shareholders may not be accorded the same rights and protection that would be accorded under the Securities Act. In addition, it could be difficult to enforce a U.S. judgment against our Directors and officers.

 

Our subsidiaries, operations and assets are mostly located in the PRC. Our subsidiaries are therefore subject to the relevant laws in the PRC. U.S. law may provide shareholders with certain rights and protection which may not have corresponding or similar provisions under the laws of the PRC. As such, investors in our common stock may or may not be accorded the same level of shareholder rights and protection that would be accorded under the Securities Act. In addition, all our current executive directors are non-residents of the U.S. and the assets of these persons are mainly located outside the U.S. As such, there may be difficulty for our shareholders to affect service of process in the U.S., or to enforce a judgment obtained in the U.S. against any of these persons.

 

We are subject to the PRC's environmental laws and regulations and in the event stricter rules are imposed to protect the environment, we may have to incur higher costs to comply with such rules.

 

Our production facilities in the PRC are subject to environmental laws and regulations imposed by the PRC authorities, inter alia, in respect of air protection, waste management and water protection. In the event stricter rules are imposed on air protection, waste management and water protection by the PRC authorities, we may have to incur higher costs to comply with such rules. Accordingly, our financial performance may be adversely affected. In addition, we require license for the discharge of pollutants for our operations, which is subject to annual review and renewal. In the event that we fail to renew our license with the relevant authority, our operations and financial performance will be adversely affected.

 

The outbreak of avian influenza and/or other communicable diseases, if uncontrolled, could affect our financial performance and prospects.

 

The avian influenza virus is a virus found chiefly in birds, but infections with these viruses can occur in humans. In January of 2004, the first case of the avian influenza was reported in Guangxi, Hunan and Hubei provinces. Later reports also came from Anhui, Liaoning, Shanghai and Guangdong provinces. Since 2003, there have been 37 recorded cases of the avian influenza in the PRC.

 

Because our operations are carried out through our wholly-owned subsidiaries located in the PRC, the outbreak of avian influenza and/or other communicable diseases, if uncontrolled, can have an adverse effect on business sentiments and environment. In addition, if any of our employees, our customers or our suppliers, is affected by the outbreak of communicable diseases, it can adversely affect, among others, our operations, our customers’ orders and our supply of raw materials. Accordingly, our sales and profitability will be materially and adversely affected.

 

Changes in China’s political or economic situation could harm us and our operating results.

 

Economic reforms adopted by the Chinese government have had a positive effect on the economic development of the country, but the government could change these economic reforms or any of the legal systems at any time. This could either benefit or damage our operations and profitability. Some of the things that could have this effect are:

 

·Level of government involvement in the economy;

 

·Control of foreign exchange;

 

·Methods of allocating resources;

 

·Balance of payments position;

 

·International trade restrictions; and

 

·International conflict.

 

The Chinese economy differs from the economies of most countries belonging to the Organization for Economic Cooperation and Development, or OECD, in many ways. As a result of these differences, we may not develop in the same way or at the same rate as might be expected if the Chinese economy were similar to those of the OECD member countries.

 

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The Chinese government exerts substantial influence over the manner in which we must conduct our business activities. Government action in the future may require us to divest ourselves of any interest we hold in Chinese properties.

 

China only recently has permitted provincial and local economic autonomy and private economic activities. The Chinese 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 continue to operate in China may be affected 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.

 

Price inflation in China could affect our results of operations if we are unable to pass along production cost price increases to our customers.

 

Inflation in China has recently increased substantially. The annual inflation rate in China was reported at 4.1 percent in December 2011. These factors have led to the adoption by the Chinese government, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation. Price inflation can affect our results of operations if we are unable to pass along production cost price increases to customers. Similarly, the cost of the ongoing construction of our new facility and the installation of our equipment may increase as a result of these recent inflationary trends, which are expected to continue in the near future. Accordingly, inflation in China may weaken our competitiveness domestically or in international markets.

 

Restrictions on currency exchange may limit our ability to receive and use our revenues effectively.

 

The majority of our revenues will be settled in Renminbi, and any future restrictions on currency exchanged may limit our ability to use revenue generated in Renminbi to fund any future business activities outside China or to make dividend or other payments in the U.S. dollars. Although the Chinese government introduced regulations in 1996 to allow greater convertibility of the Renminbi for current account transactions, significant restrictions still remain, including primarily the restriction that foreign-invested enterprises may only buy, sell or remit foreign currencies after providing valid commercial documents, at those banks in China authorized to conduct foreign exchange business. In addition, conversion of Renminbi for capital account items, including direct investment and loans, is subject to governmental approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. We cannot be certain that the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the Renminbi.

 

The value of our securities will be affected by the foreign exchange rate between U.S. dollars and Renminbi.

 

The value of our common stock will be affected by the foreign exchange rate between U.S. dollars and Renminbi, and between those currencies and other currencies in which our sales may be denominated. For example, to the extent that we need to convert U.S. dollars into Renminbi for our operational needs and should the Renminbi appreciate against the U.S. dollar at that time, our financial position, the business of the company, and the price of our common stock may be harmed. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of declaring dividends on our common stock or for other business purposes and the U.S. dollar appreciates against the Renminbi, the U.S. dollar equivalent of our earnings from our subsidiaries in China would be reduced.

 

RISKS RELATED TO THE MARKET FOR OUR STOCK

 

Pengfei Liu has significant influence over the outcome of matters submitted to Shareholders for approval.

 

As of December 31, 2011, Mr. Liu owns approximately 41.0% of our outstanding common stock. As a result, he can exercise significant influence over all matters requiring shareholder approval, including the appointment of our directors and the approval of significant corporate transactions. His ownership and control may also have the effect of delaying or preventing a future change in control, impeding merger, consolidation, takeover or other business combination or discourage a potential acquirer from making a tender offer.

 

Our share price may be volatile, which can result in substantial losses for investors who purchase our common stock.

 

The market price of our common stock may be highly volatile and can fluctuate significantly and rapidly in response to, inter alia, the following factors, some of which are beyond our control:

 

·Variations in our operating results;

 

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·Success or failure of our management team in implementing business and growth strategies;

 

·Gain or loss of an important business relationship or adverse financial performance by a significant customer or group of customers;

 

·Changes in securities analysts’ recommendations, perceptions or estimates of our financial performance;

 

·Changes in conditions affecting the seafood packaging and processing industry, the general economic conditions or stock market sentiments or other events or factors in the PRC;

 

·Changes or developments in laws, regulations or taxes in the seafood processing and packaging industry in the PRC;

 

·The temporary or permanent loss of our seafood processing and packaging facilities due to casualty, weather or any extended or extraordinary maintenance or inspection that may be required.

 

·Changes in market valuations and share prices of companies with similar businesses that may be listed in the U.S. or anywhere else in the world;

 

·Additions or departures of key personnel;

 

·Fluctuations in stock market prices and volume; or

 

·Involvement in litigation.

 

Additional funds raised through issue of new shares for our future growth will dilute Shareholders’ equity interests.

 

Although we have identified our expansion plans as avenues to pursue growth in our business, we may also find other opportunities to grow, including acquisitions which cannot be predicted at this juncture. Under such circumstances, we may seek to sell additional equity or debt securities or obtain a credit facility. If new shares placed to new and/or existing shareholders are issued in the future, they may be priced at a discount to the then prevailing market price of our shares trading on the NYSE/AMEX or any other stock exchanges, in which case, existing shareholders' equity interest will be diluted. If we fail to utilize the new equity to generate a commensurate increase in earnings, our earnings per share will be diluted and this could lead to a decline in our share price. Any additional debt financing may, apart from increasing interest expense and gearing, contain restrictive covenants with respect to dividends, future fund raising exercises and other financial and operational matters.

 

Negative publicity may adversely affect our share price.

 

One of our competitive strengths is our established brand name and track record. We have been involved in the production of processed seafood products since commencing our operations in 1994. Our “Mingxiang” brand has been conferred the “Famous Brand” award, and our products have received several other awards such as the “Green Food” award. Please see “Description of Business - Competition”. We have also established a track record in the processed seafood industry which instills confidence in our products and attracts new customers from domestic and overseas markets. Negative publicity involving us, any of our directors or executive officers may adversely affect our stock market price whether or not such negative publicity is justified.  

 

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 reverse merger transactions, have been the subject of intense scrutiny, criticism and negative publicity by investors, financial commentators and regulatory agencies, such as the United States Securities and Exchange Commission. 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, 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 impacted and your investment in our stock could be rendered worthless.

 

40
 

 

Certain provisions of our Amended Articles of Incorporation may make it more difficult for a third party to effect a change in control.

 

Our Amended 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 our Board of Directors without further action by the stockholders. These terms may include voting rights including the right to vote as a series on particular matters, 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 the 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.

 

ITEM 1B.Unresolved Staff Comments

 

Not applicable.

 

ITEM 2.Properties

 

LAND USE RIGHTS

 

There is no private ownership of land in China and all urban land ownership is held by the government of the PRC, its agencies and collectives. Land use rights can be obtained from the government for a period of up to 50 years for industrial usage, 40 years for commercial usage and 70 years for residential usage, and are typically renewable. Land use rights can be transferred upon approval by the land administrative authorities of the PRC (State Land Administration Bureau) upon payment of the required land transfer fee.

 

On November 6, 2009, our subsidiary Mingxiang won the auction for the purchase of the 40-year use right of a land in Shishi City, Fujian. Covering an area of 8,691.4 square meters, the land parcel is located alongside the fishing port and near the Registrant’s processing facilities in Shishi City. The fishing port in Shishi is one of the five largest fishing ports in the PRC. The purchase price for the land use right was RMB 15.55 million ($2.28 million).

 

As of December 31, 2011, we owned the following land-use rights in Dabao Industrial Zone, Xiangzhi Town, Shishi City, Fujian Province:

 

Certificate

Reference No.

  Location   Use  

Date of Expiration

of  Tenure

 

Land Area

(square meters)

  Encumbrance
Shi Xiang Guo Yong    Dabao Industrial   Industrial   December 31, 2052   3,374.05   Nil
(2006)  No. 0005    Zone, Xiangzhi                
    Town, Shishi City,                
    Fujian Province                
                     
Shi Di Xiang Guo Yong   Plot II,   Industrial   December 31, 2052   3,638.25   Nil
(2007)  No. 0004   Dabao Industrial                
    Zone, Xiangzhi                
    Town, Shishi City,                
    Fujian Province                
                     
Shi Di Xiang Guo Yong   Plot III,   Industrial   December 31, 2052   3,955.84   Nil
(2007)  No. 0003    Dabao Industrial                
    Zone, Xiangzhi                
    Town, Shishi City,                
    Fujian Province                 
                     
Shi Di Xiang Guo Yong   Dabao Industrial   Industrial   December 31, 2052   6,721.40   Nil
(2007)  No. 0002   Zone, Xiangzhi                
    Town, Shishi City,                
    Fujian Province                 
                     
Shi Di Xiang Guo Yong   Central Fishing Port   Commercial   January 6, 2050   8,691.40   Nil
(2010)  No. 0005   Xiangzhi Town,                
    Shishi City,                
    Fujian Province                

 

41
 

 

BUILDINGS

 

As at December 31, 2011, we owned the following building ownership rights in Dabao Industrial Zone, Xiangzhi Town, Shishi City, Fujian Province:

 

Reference No.   Location   Use  

Date of

Expiry

of Tenure

 

Land/Floor Area

(square meters)

  Encumbrance

Shi Jian Fang

Quan Zheng

Xiang Zhi Zi

No. 00109

 

Block A at Plot II

Dabao Industrial

Zone, Xiangzhi Town,

Shishi City,

 

Production and

packaging

facilities

  June 5, 2051   705.60/1,489.60   Nil
    Fujian Province                
                     

Shi Jian Fang

Quan Zheng

Xiang Zhi Zi

No. 00110

 

Block B at Plot II

Dabao Industrial

Zone, Xiangzhi Town,

Shishi City,

  Boiler facilities   June 5, 2051   145.38/145.38   Nil
    Fujian Province                
                     

Shi Jian Fang

Quan Zheng

Xiang Zhi Zi

No. 00111

 

Block C at Plot II

Dabao Industrial

Zone, Xiangzhi Town,

Shishi City,

Fujian Province

 

Production and

cutting/slicing

facilities

  June 5, 2051   934.46/1,991.29   Nil
                     

Shi Jian Fang

Quan Zheng

Xiang Zhi Zi

No. 00112

 

Cold storage facility at

Plot III

Dabao Industrial

Zone, Xiangzhi Town,

Shishi City,

Fujian Province

  Cold Storage   June 5, 2051   1,224.84/1,214.16   Nil
                     

Shi Jian Fang

Quan Zheng

Xiang Zhi Zi

No. 00114

 

Block A at

Daobao Industrial

Zone, Xiangzhi Town,

Shishi City, Fujian

Province

  Staff dormitory   June 5, 2051   1,561.17/3,413.79   Nil
                     

Shi Jian Fang

Quan Zheng

Xiang Zhi Zi

No. 00115

 

Block B at

Daobao Industrial

Zone, Xiangzhi Town,

Shishi City, Fujian

Province

  Office   September 28, 2052   942.19/3,268.41   Nil
                     

Issuance of Property Ownership

Certificate is now

under process

 

Additional floor of

Block A at

Daobao Industrial

Zone, Xiangzhi Town,

Shishi City, Fujian

Province

  Staff dormitory   June 5, 2051   1,561.17/About 1,670.00   Nil

 

42
 

 

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 pending legal proceedings which involve us or any of our properties or subsidiaries.

 

ITEM 4Mine Safety Disclosure

 

Not applicable.

 

 

PART II.

 

ITEM 5.             Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities

 

MARKET INFORMATION

 

Our common stock is currently quoted on NYSE AMEX and, prior to August 14, 2009, was quoted on OTC Bulletin Board, under the trading symbol CMFO. The CUSIP number is 16943R 106. The following table shows the high and low prices of our common shares on the NYSE AMEX and OTC Bulletin Board for each quarter within the last three fiscal years.

 

   High ($)   Low ($) 
Year Ended December 31, 2011          
First Quarter   5.21    3.50 
Second Quarter   4.10    2.42 
Third Quarter   3.55    1.64 
Fourth Quarter   1.85    1.18 
           
Year Ended December 31, 2010          
First Quarter   8.63    5.78 
Second Quarter   6.94    3.07 
Third Quarter   6.53    3.84 
Fourth Quarter   7.15    4.85 

 

The above quotations for our common stock reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not represent actual transactions.

 

HOLDERS

 

As of March 26, 2012, there were 37 holders of record of our common stock.

 

RECENT SALES OF UNREGISTERED SECURITIES

 

On April 1, 2011, the Company granted compensatory stock awards totaling 700,000 common shares to certain of its officers, directors and employees. These stock awards vested in full on the date of the grant but are subject to forfeiture in full if the grantee ceases to be employed by the Company for any reason within one year from the date of the grant, pursuant to stock award agreements between the Company and grantees dated April 1, 2011. Based on the closing stock price of the grant date, the fair value of these stock awards are estimated to be approximately $2.7 million, which will be recognized as compensation expense, using the straight-line method, over the service period of one year from April 1, 2011 to March 31, 2012.

 

On February 15, 2011, the Company entered into an Investor Relations Consulting Agreement with Hayden Communications International, Inc (“HCI”) to provide consulting services for the Company. In connection with such service, the Company agreed to issue 20,000 shares of restricted common stock to HCI. The shares of common stock were valued at $51,800 or $2.59 per share and issued on July 14, 2011.

 

DIVIDENDS

 

During the year ended December 31, 2010, the Company’s subsidiary, Xianghe, declared final dividend of $1,313,080 (equivalent to RMB 8,901,106) relating to the pre-acquisition result for the fiscal year 2009 to Mr. Qiu and was fully paid in April 2010.

 

43
 

 

Other than the cash dividend describe above, we have never paid or declared dividends. However, holders of our common stock are entitled to dividends if declared by our Board of Directors out of funds legally available. We do not, however, anticipate the declaration or payment of any dividends in the foreseeable future. We intend to retain earnings, if any, to finance the development and expansion of our business. Future dividend policy will be subject to the discretion of our Board of Directors and will be contingent upon future earnings, if any, our financial condition, capital requirements, general business conditions and other factors. Therefore, there can be no assurance that any dividends of any kind will ever be paid.

 

ITEM 6.Selected Financial Data

 

Not Applicable

 

ITEM 7.Management's Discussion and Analysis of Financial Condition and Results of Operation

 

Forward Looking Statements

 

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included elsewhere in this document. The following discussion contains forward-looking statements. China Marine Food Group Limited is referred to herein as “we”, “us”, “our”, or the “Company.”

 

The words or phrases “would be,” “will allow,” “expect to”, “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” or similar expressions are intended to identify forward-looking statements. Such statements include, among others, those statements concerning our expected financial performance, our corporate strategy and operational plans. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of risks and uncertainties, including, among others: (a) those risks and uncertainties related to general economic conditions in China, including regulatory factors that may affect such economic conditions; (b) whether we are able to manage our planned growth efficiently and operate profitable operations, including whether our management will be able to identify, hire, train, retain, motivate and manage required personnel or that management will be able to successfully manage and exploit existing and potential market opportunities; (c) whether we are able to generate sufficient revenues or obtain financing to sustain and grow our operations; and (d) whether we are able to successfully fulfill our primary requirements for cash which are explained below under “Liquidity and Capital Resources”. Unless otherwise required by applicable law, we do not undertake, and we specifically disclaim any obligation, to update any forward-looking statements to reflect occurrences, developments, unanticipated events or any other circumstances after the date of such statement unless required by law. For additional information regarding these risks and uncertainties, see “Risk Factors”. Our consolidated financial statements have been prepared in accordance with U.S. GAAP.

 

OVERVIEW

 

We are a holding company whose primary business operations are conducted through our direct, wholly owned subsidiary, Ocean Technology (China) Company Limited (“Ocean Technology”), and its subsidiaries, Shishi Rixiang Marine Foods Co., Ltd. (“Rixiang”) and Shishi Huabao Mingxiang Foods Co., Ltd. (“Mingxiang”), Shishi Huabao Jixiang Water Products Co., Ltd. (“Jixiang”), and Shishi Xianglin Trading Co., Ltd. (“Xianglin”), which are incorporated in the PRC. We engage in the business of processing, distribution and sale of processed seafood products and algae-based beverage products, as well as the trading of marine catch. Our objective is to establish ourselves as a leading producer of processed seafood products and algae-based beverage products in the PRC and overseas markets.

 

Reverse acquisition and private placement

 

On November 17, 2007, we completed a reverse acquisition transaction with Ocean Technology through a share exchange with Ocean Technology’s former stockholders.

 

Pursuant to the Share Exchange Agreement, the former shareholders of Ocean Technology exchanged 100% of their outstanding capital stock in Ocean Technology for approximately 15,624,034 shares of our common stock, or approximately 93.15% of our outstanding shares of common stock after the share exchange.

 

Concurrently with the closing of the reverse acquisition on November 17, 2007, we completed a private placement of our securities to certain accredited investors who subscribed for an aggregate of 6,199,441 shares of our common stock and warrants to purchase an aggregate of 1,239,888 shares of our common stock at $3.214 per unit, each unit consisting of one share of common stock and a warrant to purchase one-fifth of one share of our common stock. Each warrant issued to the investors had a term of three years and all unexercised warrants expired in November 2010.

 

44
 

 

Sales

 

We are a seafood producer engaged in the processing, distribution and sale of seafood products and algae-based beverage products, as well as the trading of marine catch. In 2010, we became a manufacturer of algae-based soft drinks through our acquisition of an 80% interest in Xianghe, which is also an operating subsidiary of Ocean Technology.

 

All rental income, which is relatively immaterial compared to our principal revenues from sale of processed seafood products, beverage products and trading of marine catch, is recognized as "Other Income" in our financial statements. In particular, Mingxiang and Jixiang are responsible for the rental income related to the collection on the 31 and 6 shop spaces, respectively, at our factory in Dabao Industrial Zone. The rental contracts are based on a one-year lease term.

 

Our dried processed seafood products include dried prawns, dried squids, dried file fish, roasted prawns, shredded roasted squids, roasted squids, roasted file fish and other seafood items. The raw materials for our processed seafood products are solely purchased from independent fishermen in nearby markets for further processing. Our dried processed seafood is predominantly sold under our registered trademark, the “Mingxiang” brand name. Our brand name has been awarded the “Fujian Famous Brand” award by the Fujian Commerce Authority. Our dried processed seafood products are mainly sold to distributors in Fujian and Zhejiang provinces, as well other nearby provinces, who in turn distribute them to major supermarkets and retailers throughout these provinces.

 

For marine catch, we buy the marine catch from the suppliers and then sell to either trading companies or distributors on a direct basis as opportunistic purchases and sales according to the seasonality of respective seafood species. The marine catch is predominantly sold to distributors in Liaoning, Fujian and Shandong provinces, and overseas customers in the Philippines and Indonesia.

 

Our branded “Hi-Power” was developed by the Yellow Sea Fisheries Research Institute at Chinese Academy of Fishery Sciences in coordination with the founder, Qiu. Hi-Power is marketed as a high-protein content drink, low in calories and fat, which provides the consumers a combination of immune system benefits, improved digestion and reductions in hyperglycemia and hypertension. Hi-Power’s target market focuses on health-conscious consumers in China’s fast-growing beverage market. Xianghe has a network of distributors in Fujian and Zhejiang which sell Hi-Power to retail food stores, restaurants, food supply dealers and the hospitality industry.

 

Sales of our processed seafood products accounted for approximately 41.0% and 57.4%of our total sales in 2011 and 2010, respectively. Trading of our marine catch accounted for approximately 38.4% and 21.4%of our total sales in 2011 and 2010, respectively. Sales of our algae-based beverage products accounted for approximately 20.6% and 21.2% of our total sales in 2011 and 2010, respectively. We expect the sales of our algae-based beverage products will remain strong in the coming years given our continuous expansion into untapped areas and contribution over the related sales and marketing campaigns since our acquisition at the beginning of 2010.

 

A detailed breakdown of our sales by major geographical markets is set out in the section “Results of Operations” herein.

 

Factors that can affect our sales are as follows:

 

·The level of sales is dependent on the supply of raw materials on a timely basis. Raw material costs accounted for approximately 72.9% and 75.4% of our total cost of revenue of processed seafood products in year 2011 and 2010, respectively. The availability of these raw materials could be affected by a large number of factors, including, inter alia, the availability of fish stock, weather conditions, water contamination, government policies and regulations where such fishing is carried out, the stability of supplies from fishermen and pressure from environmental or animal rights groups.

 

·Specifically, fishing activities in waters around the PRC are restricted in June and July each year to ensure sustainable aquatic resources. As such, some of our suppliers such as fishermen are restricted from fishing during this period due to the restrictions against fishing along the Taiwan Strait imposed by the PRC’s Ministry of Agriculture. There is no assurance that the PRC government may not impose more stringent fishing regulations, including but not limited to longer or more frequent periods that restrict fishing.

 

·Any shortage or contamination in the supply of or increase in the prices of the raw materials for our processed seafood and algae-based beverage products will adversely affect our sales and profit margins.

 

45
 

 

·In March 2011, the northern region of Japan experienced a severe earthquake followed by a tsunami. The earthquake and tsunami caused extensive and severe structural damage in Japan, including heavy damage to roads and railways as well as fires in many areas, and a dam collapse and damage to several nuclear reactors. Although to date the damage caused by the earthquake and tsunami have not damaged our access to raw materials, there can be no assurance that such access may not be affected. Even though government officials and health experts in Japan and China stated the doses of nuclear radiation leaks are low and not a threat to human health unless the tainted products are consumed in abnormally excessive quantities, concern of seafood contamination adversely affected our sales of seafood and algae-based beverage products as a result of consumers’ perception of food safety in relation to the nuclear radiation leaks in Japan.

 

·In May 2011, inspectors of the government of Taiwan detected dangerous levels of industrial plasticizers in sports drinks and soft drinks, used to substitute for palm oil as clouding agents in drinks, with levels far in excess of the daily allowed intake. One plasticizer, known as DEHP, is a possible carcinogen, and thought capable of wreaking havoc with children’s reproductive organs. Since then, the plasticizers have been found in a range of foods and drinks. China, Hong Kong, South Korea and the Philippines have recalled beverage bottles suspected of contamination imported from Taiwan. The beverage products sector in the East Asia region was adversely affected by the food scandal, and new legislation with higher food safety standard of beverage products may be implemented in the PRC. The DEHP crisis may affect our beverage products business as a result of any failure to comply with the new standard or adverse changes in the beverage products sector.

 

·Our ability to maintain existing accreditations such as HACCP, ISO9001:2000, ISO14001:2004 and the EU Export Certification accreditations will affect our ability to maintain our presence in our existing market and to expand into new market territories.

 

·Our ability to price our products competitively against existing competitors and new market entrants by achieving economies of scale.

 

·Our ability to build on our established track record and reputation as a supplier of high quality processed seafood products and capability to deliver products in a timely manner.

 

·Our ability to maintain existing business relationships and to secure new customers, which may be affected by the general economic or political conditions in our local and overseas markets.

 

·Our ability to introduce new products to capture a wider group of consumers and to cater to different and changing consumers’ preferences.

 

·Our purchase of the beverage business involves the risk of entering into a new business.

 

·Our ability to respond successfully to changes in the highly competitive beverage marketplace domestically and internationally.

 

Please refer to the section “Risk Factors” herein for further information on other factors that may affect our revenue.

 

Production facilities and employees

 

 

Our production facilities are located at Dabao Industrial Zone, Xiangzhi Town, Shishi City, Fujian Province, in the PRC. We have four production lines for the processing of dried processed seafood products: roasted file fish, roasted prawns, shredded roasted squid and roasted squids, and one production line for the processing of frozen seafood products.

 

As at December 31, 2011, we employed 848 employees.

 

Seasonality

 

We do not experience any significant seasonality in relation to sales for our processed seafood and algae-based beverage products. However, sales for our processed seafood products are usually higher before and during the Chinese New Year and lower during summer time. Sales for our algae-based beverage products are expected to be higher before and during the Chinese New Year and during summer time.

 

46
 

 

NEW BUSINESS DEVELOPMENT

 

Development of cold storage facilities

 

On November 6, 2009, we won the auction for the purchase of the 40-year use right of a land in Shishi City, Fujian. In September 2010, we entered into an agreement with a third party contractor and began to build cold storage facilities on the land with a capacity of approximately 20,000 tons, to take advantage of its proximity to the port where we obtain fresh marine catch to be processed into seafood products. We are financing the total estimated $26.5 million in land use rights and construction costs from funds generated by operations. The facilities are expected to be operational in the first half of 2012. We have paid approximately $22.9 million in relation to the construction costs as at December 31, 2011 and the total estimated construction costs are approximately $24.2 million.

 

We intend to provide high standard, modernized cold storage, freezing and ice making services to the port area through the exclusive cold storage facilities. We may utilize certain cold storage spaces on our own going forward which will not only help to reduce storage costs but also expect to improve margins for our current seafood segments as a result of bulk purchases at favorable prices.

 

RESULTS OF OPERATIONS

 

We derive our sales from the sales of processed seafood products, marine catch and algae-based beverage products, the breakdown of our sales and gross profit by product, as well as by geographical location of our customers for the years ended December 31, 2011 and 2010 are set out below:

 

Breakdown of our past performance by principal products and geographical region

 

Sales by product

 

   Year Ended December 31, 
   2011   2010 
   US$’000   %   US$’000   % 
                 
Processed seafood products   58,967    41.0    70,467    57.4 
Marine catch   55,304    38.4    26,194    21.4 
Algae-based beverage products   29,677    20.6    26,018    21.2 
Total   143,948    100.0    122,679    100.0 

 

Sales by geographical region

 

   Year Ended December 31, 2011 
     
   Processed seafood
products
   Marine catch   Algae-based
beverage products
   Total 
   US$’000   %   US$’000   %   US$’000   %   US$’000   % 
PRC                                        
Shandong   5,223    8.9    13,027    23.6    -    -    18,250    12.7 
Zhejiang   24,699    41.9    -    -    4,178    14.1    28,877    20.1 
Fujian   25,085    42.5    5,779    10.4    25,499    85.9    56,363    39.1 
Guangdong/ Shenzhen   2,866    4.9    -    -    -    -    2,866    2.0 
Jiangsu/ Shanghai   1,090    1.8    -    -    -    -    1,090    0.8 
Sichuan/ Chongqing   -    -    -    -    -    -    -    - 
Others (1)   4    0.0    36,353    65.7    -    -    36,357    25.2 
Total PRC (2)   58,967    100.0    55,159    99.7    29,677    100.0    143,803    99.9 
Asia (3)   -    -    145    0.3    -    -    145    0.1 
Total   58,967    100.0    55,304    100.0    29,677    100.0    143,948    100.0 

 

47
 

 

   Year Ended December 31, 2010 
   Processed seafood
products
   Marine catch   Algae-based
beverage products
   Total 
   US$’000   %   US$’000   %   US$’000   %   US$’000   % 
PRC                                        
Shandong   6,040    8.6    -    -    -    -    6,040    4.9 
Zhejiang   30,870    43.8    -    -    141    0.5    31,011    25.3 
Fujian   23,372    33.2    15,982    61.0    24,329    93.5    63,683    51.9 
Guangdong/ Shenzhen   4,478    6.3    -    -    1,042    4.0    5,520    4.5 
Jiangsu/ Shanghai   3,939    5.6    -    -    -    -    3,939    3.2 
Sichuan/ Chongqing   1,761    2.5    -    -    460    1.8    2,221    1.8 
Others (1)   7    0.0    9,741    37.2    46    0.2    9,794    8.0 
Total PRC (2)   70,467    100.0    25,723    98.2    26,018    100.0    122,208    99.6 
Asia (3)   -    -    471    1.8    -    -    471    0.4 
Total   70,467    100.0    26,194    100.0    26,018    100.0    122,679    100.0 

 

(1)Sales to PRC Others mainly relate to the trading of marine catch transacted in Liaoning province.
(2)Sales to PRC include sales to local PRC distributors who in turn sell our products to Taiwan and South Korea. Such sales amounted to $0.01 million and $0.4 million in year 2011 and 2010, respectively.
(3)Sales to Asia mainly relate to exports to the Philippines and Indonesia.

 

Year 2011 compared to Year 2010

 

Sales

 

Our revenue increased by approximately $21.2 million or 17.3% from $122.7 million in 2010 to $143.9 million in 2011. The increase in revenue was mainly due to the increase in sales of marine catch and the newly acquired algae-based beverage business, partially offset by the decrease in sales of our processed seafood products. Sales of our processed seafood products decreased by $11.5 million or 16.3% year over year to $59.0 million, whereas sales of algae-based beverage products increased by $3.7 million or 14.1% to $29.7 million. Sales of our marine catch segment increased by $29.1 million or 111.1% for the same periods under review.

 

The processed seafood products operations continued to grow significantly in the first quarter of 2011 as our products continue to gain market acceptance, particularly in Fujian and Zhejiang provinces. As a result of consumers’ perception of food safety in relation to the nuclear radiation leaks in Japan which occurred in March 2011, sales of processed seafood products have been significantly affected since the second quarter of 2011. However, we believe that our sales have stabilized by the end of third quarter in 2011. While we are confident that the seafood we use to produce our processed seafood products are safe, it is unclear how long it will take for consumer confidence in seafood products to normalize.

 

This is the second year to recognize sales of our algae-based beverage products since the acquisition on January 1, 2010. In 2010, our distribution network for the beverage segment was solely Fujian province. After gaining experience in Fujian in the prior year, we expanded our distribution into Zhejiang province in the second quarter of 2011. The growth from Zhejiang was offset due to the public concern over the plasticizer contamination in the beverage industry in the second half of 2011, as well as the lower-than-expected temperature in the southern regions during the summer time. However, given our continuous contribution to the related sales and marketing campaigns and our expansion plan into more untapped areas, we expect the sales of our beverage segment to remain strong in the coming years. Accordingly, the number of sales staff has increased significantly since January 1, 2010 from 23 to a staff of 134, as of December 31, 2011.

 

Trading of marine catch is deemed as opportunistic purchases and sales of frozen seafood materials and therefore the sales volume fluctuates significantly from period to period. We intend to buy marine catch in blocks from suppliers when their supplies are high and sell the stocks to customers when market prices go up. Usually the inventory cycle will be less than a year. Though the profit margin from the trading segment is relatively lower compared to that of both processed seafood and algae-based beverage products, the trading segment is a good source of revenue and profit given our expertise in the seafood industry and surplus cash in hand.

 

Cost of revenue

 

Our cost of revenue comprises the cost of our processed seafood and algae-based beverage products operations, as well as the cost of our marine catch. The breakdown is as follows:

 

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   Year Ended December 31, 
US$ ’000  2011   2010 
         
Processed seafood products   41,412    46,141 
Marine catch   53,058    23,730 
Algae-based beverage products   17,754    15,348 
Total   112,224    85,219 

 

Cost of revenue – Processed seafood products

 

Our cost of revenue comprises mainly raw materials, packaging materials, direct labour and manufacturing overhead. The following table sets out details of our cost of revenue:

 

   Year Ended December 31, 
   2011   2010 
   US$’000   %   US$’000   % 
                 
Raw materials   30,181    72.9    34,803    75.4 
Packaging materials   4,977    12.0    5,926    12.9 
Direct labor   2,928    7.1    2,394    5.2 
Manufacturing overhead   3,326    8.0    3,018    6.5 
Total   41,412    100.0    46,141    100.0 

 

Raw materials

 

Raw materials comprise mainly seafood such as fish, prawns and squids. We use seafood which are fished from the open sea and not bred through aquaculture. The costs of these raw materials are dependent on the prevailing market prices. There is a stable and abundant supply from the existing market. We are located close to the Xiangzhi (Shishi) fishing port, which is one of the largest fishing ports in Fujian province, and one of the state-level fishing port centres in the PRC.

 

We believe our strategic location allows us to have up-to-date information on the market price of our raw materials and this has allowed us to purchase our raw materials at the best available price. Our proximity to our suppliers has also allowed us to have fresh supplies of raw materials and this has enabled us to ensure freshness and quality in our finished products. The proximity has also enabled us to reduce raw material transportation costs and lead-time to obtain our supplies.

 

Since the nuclear disaster in Japan earlier this year, there was an upward pressure on the prices of our raw materials, including small-sized seafood materials, as a result of fiercer competition with the breeding farms where the small-sized seafood materials are used as feeds.

 

Raw material costs accounted for approximately 72.9% and 75.4% of our cost of revenue in year 2011 and 2010, respectively. The decrease was primarily because the percentage of increase in direct labor costs and manufacturing overhead was higher than that in raw material costs for the periods under review.

 

The decrease in raw material costs for the periods under review was mainly due to our decreased production and sales of processed seafood products, whereas direct labor and manufacturing overhead are relatively considered as invariable cost factors comparing to raw materials and packaging materials.

 

The percentage of raw materials cost as a proportion of the total cost of revenue is affected by the product mix of the relevant financial year and the market price of the raw materials. We mitigate the fluctuation in market prices of raw materials by bulk purchasing and stock management. We are able to stock up our raw materials when prices are lower, as we have our own cold storage facility and we can also utilize other nearby facilities for storage when needs arise. This will ensure a steady supply of raw materials for the processing of seafood products throughout the year.

 

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Packaging materials

 

Packaging materials accounted for approximately 12.0% and 12.9% of our cost of revenue in year 2011 and 2010, respectively. The decrease was primarily because the percentage of increase in direct labor costs and manufacturing overhead was higher than that in packaging costs for the periods under review. The decrease in packaging material costs for the periods under review was mainly due to the decreased production and sales of processed seafood products.

 

Direct labor

 

Direct labor costs accounted for approximately 7.1% and 5.2% of our cost of revenue for the year ended 2011 and 2010, respectively. Direct labor includes mainly salaries and wages paid to employees who are involved in the production process. Direct labor costs are dependent on factors such as production volume, number of employees, wage rate and applicable government regulations (including minimum wage requirements, statutory welfare and insurance fund contributions). The fluctuation in direct labor costs as a percentage of costs of sales is dependent on the degree of processing required for the end products. The increase in our production scale over the past few years has enabled us to enjoy economies of scale and higher productivity through job specialization and training.

 

The total headcount for the processed seafood segment as at December 31, 2011 has decreased to 582 from 682 as at the end of 2010. The increase in direct labor costs for the year ended 2011 was mainly due to the increased wage rates since April 2011 to cope with the market standard.

 

Manufacturing overhead

 

Manufacturing overhead comprises depreciation, water, electricity and other fuel costs which are used directly in the production of finished goods. The increase in manufacturing overhead for the years under review was mainly due to the increased costs from the expansion of production facilities along the years for increased production

 

Cost of revenue - Marine catch

 

   Year Ended December 31, 
   2011   2010 
   US$’000   %   US$’000   % 
                 
Raw materials   52,785    99.5    23,339    98.4 
Other expenses   273    0.5    391    1.6 
Total   53,058    100.0    23,730    100.0 

 

Raw materials

 

We buy the marine catch from the suppliers and then sell to the customers on a direct basis. The marine catch is predominantly sold to distributors in Liaoning, Fujian and Shandong provinces, and overseas customers in the Philippines and Indonesia. The cost of the raw material is based on the market price at the time of purchase. The increase in raw material costs for the years ended are in line with the increased revenue from sales of marine catch.

 

Other expenses

 

Other expenses mainly relate to the costs of packaging materials and ice required to keep the marine catch fresh.

 

Cost of revenue - Algae-based beverage products

 

Our cost of revenue comprises mainly raw materials, packaging materials and manufacturing overhead. The following table sets out details of our cost of revenue:

 

   Year Ended December 31, 
   2011   2010 
   US$’000   %   US$’000   % 
                 
Raw materials   2,517    14.2    2,585    16.8 
Packaging materials   12,134    68.3    10,174    66.3 
Manufacturing overhead   3,103    17.5    2,589    16.9 
Total   17,754    100.0    15,348    100.0 

 

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Raw materials

 

Raw materials comprise mainly the algae extracts and other beverage ingredients such as herbal powder and sugar. The costs of these raw materials are dependent on the prevailing market prices, which are relatively stable as there is a stable and abundant supply from the existing market.

 

Raw material costs accounted for approximately 14.2% and 16.8% of our cost of revenue in year 2011 and 2010, respectively. The percentage of raw materials cost as a proportion of the total cost of revenue is affected by changes in ingredient mix from time to time and the market price of the raw materials.

 

Packaging materials

 

Packaging materials comprise iron and aluminium foils, which are used to produce the cans, and paper boxes. The costs of these raw materials are dependent on the prevailing market prices with a stable and abundant supply from the existing market.

 

Packaging materials accounted for approximately 68.3% and 66.3% of our cost of revenue in year 2011 and 2010, respectively. The increase in the percentage of packaging materials cost as a proportion of the total cost of revenue during the years was mainly due to the increased packaging materials cost.

 

Manufacturing overhead

 

We utilize two third party manufacturers to produce our algae-based beverage products. Manufacturing costs are charged based on the production volume. We are going to use a number of manufacturers going forward so as to mitigate the concentration risks. The increase in the percentage of manufacturing overhead as a proportion of the total cost of revenue during the years was mainly due to the increased manufacturing costs.

 

Gross profit by product

 

   Year Ended December 31, 
   2011   2010 
   US$’000   %   US$’000   % 
                 
Processed seafood products   17,555    55.3    24,326    64.9 
Marine catch   2,246    7.1    2,464    6.6 
Algae-based beverage products   11,923    37.6    10,670    28.5 
Total   31,724    100.0    37,460    100.0 

 

Gross profit margin by profit

 

   Year Ended December 31, 
   2011   2010 
   %   % 
         
Processed seafood products   29.8    34.5 
Marine catch   4.1    9.4 
Algae-based beverage products   40.2    41.0 
Total   22.0    30.5 

 

Gross profit

 

Gross profit dropped by 15.3% or $5.7 million, from $37.4 million in 2010 to $31.7 million in 2011. Overall gross profit margin dropped by 8.5% from 30.5% in 2010 to 22.0% in 2011. Gross profit margin for the processed seafood products operations decreased from 34.5% in 2010 to 29.8% this year which was mainly due to the decreased scale of production and the increased costs of raw materials, packaging materials, direct labor and manufacturing overhead. Gross profit margin for the marine catch segment dropped from 9.4% in 2010 to 4.1% this year. Marine catch sales are deemed as opportunistic trading of frozen seafood in blocks and therefore the corresponding profit margin is dependent on the prevailing market conditions which could be fluctuated significantly from time to time. Gross profit margin for the algae-based beverage segment decreased from 41.0% to 40.2% for the same years under review mainly due to the increased costs of packaging materials and manufacturing overhead.

 

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Depreciation and amortization

 

Depreciation and amortization accounted for approximately 1.9% and 2.1% of our total revenue in year 2011 and 2010, respectively. Depreciation and amortization was mainly related to the amortization of intangible assets associated with the acquisition of the beverage business declared effective at the beginning of 2010. The algae-based beverage know-how is amortized over its estimated useful life of 10 years, on a straight-line basis, at a yearly amortization charge of approximately $2.5 million.

 

Sales and marketing expenses

 

Our sales and marketing expenses comprise mainly salaries of sales and marketing staff, investor relations fees, advertising and promotional costs.

 

Our sales and marketing expenses accounted for approximately 9.8% and 5.2% of our total revenue in year 2011 and 2010, respectively. The increase in the sales and marketing expenses in 2011 was mainly due to the increase of advertising and promotional costs so as to strengthen brand position and improve market awareness in both existing and new markets and cope with the marketing strategies associated with the newly acquired beverage products. Accordingly, the number of sales staff has increased from 47 in 2010 to 173 as at December 31, 2011, of which 134 were related to the beverage products segment.

 

General and administrative expenses

 

Our general and administrative expenses comprise mainly salaries and staff benefits for employees, legal and professional fees, research and development costs, traveling and entertainment expenses.

 

Our general and administrative expenses accounted for approximately 1.8% and 2.6% of our total revenue in year 2011 and 2010, respectively. The decrease in the general and administrative expenses from 2010 to 2011 was mainly attributable by the lower R&D costs due to the softness of seafood demand and the reduced discretionary bonus for the executive directors for the year of 2011.

 

Stock-based compensation

 

On April 1, 2011, the Company granted compensatory stock awards totaling 700,000 common shares to certain of its officers, directors and employees.  Based on the closing stock price of the grant date, the fair value of these stock awards are estimated to be approximately $2.7 million, which is recognized as compensation expense, using the straight-line method, over the service period of one year from April 1, 2011 to March 31, 2012.

 

Other income

 

Other income relates mainly to rental income, government subsidies and interest income.

 

Rental income relates to the collection of rent on the 37 shop spaces at our factory in Dabao Industrial Zone. The rental contracts are based on a one year lease term. The government subsidies mainly relates to grants by Shishi City Municipal People's Government for the achievement of Key Leading Enterprise of Agricultural Industrialization in 2011. Interest income is earned from cash balances with banks as a result of operational cash inflow and registered direct offering of common stock which took place in January 2010.

 

Interest expense

 

Our interest expense relates to interest costs incurred on the various short-term bank borrowings taken by us for working capital requirements. Our interest expense accounted for approximately 0.01% and 0.03% of our total revenue in year 2011 and 2010, respectively. In the fourth quarter of 2011, a short-term loan of $2.5 million was drawn down for working capital needs and to maintain the effectiveness of the facility line with the bank.

 

Income before income tax

 

Our income before income tax decreased by $15.0 million or 58.5%, from $25.6 million in 2010 to $10.6 million in 2011. The decrease was mainly due to the combination of the decrease in sales of 17.3% for the processed seafood segment, the decrease in corresponding gross profit margin by 4.7%, and the increase in the sales and marketing expenses and the stock-based compensation costs, which was partially offset by the increase in sales of 14.1% for the algae-based beverage segment and the lower general and administrative expenses, as a result of the factors described above.

 

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Income tax expense

 

Our profit is subject to the prevailing tax rate applicable to the respective jurisdictions in which we operate.

 

Rixiang, Jixiang, Mingxiang, Xianghe and Xianglin are subject to the Corporate Income Tax governed by the Income Tax Law of the People’s Republic of China, at a unified income tax rate of 25%.

 

In 2009, Mingxiang received a notice of recognition as an enterprise of new and high technology in 2009, which was jointly issued by The Science and Technology Department of Fujian, The Finance Department of Fujian, The State Tax Bureau of Fujian and The Local Taxation Bureau of Fujian for the Company engaged in advanced food processing technologies for the Fujian province. As a new and high technology company, Mingxiang is qualified for a reduced tax rate of 15% on its assessable income for the period of three years, through 2012.

 

Income tax expenses for the years ended December 31, 2011 and 2010 and were approximately $2.0 million and $4.5 million, respectively. The effective tax rates were 19.3% and 17.4%, respectively, for those years.

 

REVIEW OF FINANCIAL POSITION

 

Current assets

 

As at December 31, 2010, our current assets increased to $74.2 million, representing 59.9% of our total assets of $123.8 million. Current assets were consisted of cash and cash equivalents of $15.6 million, accounts receivable of $48.5 million, inventories of $10.0 million and other receivables and prepayments of $0.1 million.

 

As at December 31, 2011, our current assets increased to $79.0 million, representing 56.9% of our total assets of $138.9 million. Current assets were consisted of cash and cash equivalents of $0.6 million, accounts receivable of $68.6 million, inventories of $8.9 million and other receivables and prepayments of $0.9 million.

 

The decrease in cash and cash equivalents as at December 31, 2011 was mainly due to increased accounts receivable related to significant marine catch sales of $47.2 million during the fourth quarter of 2011 and the addition of fixed assets and construction in progress during the year.

 

Accounts receivable were mainly represented by amounts due from distributors and wholesalers. We usually extended unsecured credit period to long established customers up to 3 months. Since our practice is to perform constant credit checks and pursue the past due accounts proactively, there was no material uncollectible debts identified in the past. Increase in accounts receivable was mainly in line with the increase in sales volume of the last quarter of 2011.

 

Inventories were mainly related to raw materials and work-in-progress comprising mainly frozen prawns, fish and squids which would be used for the production of processed seafood products. Our inventories also included some finished goods and packaging materials.

 

Non-current assets

 

As at December 31, 2011, our non-current assets amounted to $59.9 million and accounted for approximately 43.1% of our total assets. Our non-current assets comprised mainly property, plant and equipment of $11.2 million, land use rights of $3.0 million, and construction in progress of $22.9 million. As of December 31, 2011, the carrying value of intangible assets and goodwill were approximately $20.2 million and $2.6 million, respectively.

 

As at December 31, 2011, our property, plant and equipment amounting to $11.2 million were made up mainly of buildings amounting to $8.7 million and plant and machinery amounting to $2.0 million. Buildings related to our production plant, cold room, office buildings and workers’ dormitories. Plant and machinery related mainly to our production lines, freezing machines, roasting and drying machines. The remaining $0.5 million related to office equipment and motor vehicles.

 

The increase in non-current assets relates to the cold storage facility we are building on the land we purchased in 2009. The facility is expected to be operational in the first half of 2012 and therefore the associated construction costs are being recognized as construction in progress as at December 31, 2011. Total estimated construction costs are approximately $24.2 million. As of December 31, 2011 and 2010, the Company recorded approximately $22.9 million and $11.6 million, respectively, as construction in progress.

 

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Current liabilities

 

As at December 31, 2010, our current liabilities amounted to $9.4 million and comprised accounts payable of $3.8 million, amount due to a shareholder of $0.3 million, income tax payable of $0.5 million and other payables of $4.8 million.

 

As at December 31, 2011 our current liabilities of $8.8 million comprised of short-term borrowing of $2.5 million, accounts payable of $2.6 million, amount due to a shareholder of $0.1 million, income tax payable of $0.2 million and other payables of $3.4 million.

 

The short-term bank loans were used for our working capital requirements. The weighted average effective interest rate on the borrowing is about 5.49% and 5.31% per annum in 2011 and 2010, respectively.

 

Regarding the accounts payable, the related turnover day was less than two weeks due to the short credit period allowed by the fishermen which was consistent with the market practice.

 

The amount due to a shareholder was unsecured, interest free and with no fixed terms of repayment.

 

The decrease in other payables from 2011 to 2010 mainly relates to the decrease of value-added tax provision.

 

Shareholders’ equity

 

As at December 31, 2010, our shareholders’ equity amounted to $114.4 million and consisted of additional paid-in capital of $47.4 million, statutory reserve of $9.3 million, accumulated other comprehensive income of $7.4 million, retained earnings of $49.9 million and non-controlling interests of $0.4 million.

 

Our shareholders’ equity of $130.1 million as at December 31, 2011 consisted of additional paid-in capital of $50.1 million, statutory reserve of $9.7 million, accumulated other comprehensive income of $11.9 million, retained earnings of $58.0 million and non-controlling interests of $0.4 million.

 

The increase in shareholders’ equity from 2010 to 2011 is due to the current operating profit of $8.6 million, increased in additional paid in capital of $2.7 million for stock awards and increase in other comprehensive income of $4.5 million due to translation adjustments.

 

Statutory reserve is established for the purpose of providing employee facilities and other collective benefits to the employees and is non-distributable other than in liquidation. Under the PRC law, appropriation to the statutory reserve should be at least 10% of the after-tax net income until the reserve is equal to 50% of the registered capital. We appropriated about 15% of our after-tax net income to the reserve on a yearly basis.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Our operations are funded through a combination of shareholders’ equity, borrowings and internally generated funds from our operations. Our cash and cash equivalents as at December 31, 2011 amounted to approximately $0.6 million, with a new short-term loan of $2.5 million being drawn down in the fourth quarter of 2011.

 

A summary of our cash flows for 2011 and 2010 is as follows:

 

   Year Ended December 31, 
US$’000  2011   2010 
         
Net cash used in operating activities   (8,431)   (6,257)
Net cash used in investing activities   (11,005)   (12,760)
Net cash provided by financing activities   2,339    24,836 
Net change in cash and cash equivalents   (17,097)   5,819 
Foreign currency translation adjustment   2,127    2,595 
Cash and cash equivalents at the beginning of the year   15,557    7,143 
Cash and cash equivalents at the end of the year   587    15,557 

 

Year 2011

 

Net cash used in operating activities

 

In 2011, our net cash used in operating activities amounted to approximately $8.4 million. The major source of cash inflow from operating activities was from net income of $8.6 million. Changes in operating assets and liabilities included cash outflow resulting from increase in accounts receivable of $20.1 million. This was partially offset by cash inflow from a decrease in inventories of $1.1 million and non-cash amortization of intangible assets of $2.5 million.

 

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The increase in accounts receivable was mainly due to the block sales of marine catch trading materials of $47.2 million in the fourth quarter of 2011, which was collected during the first quarter of 2012.

 

Our trade receivables turnover days were approximately 81 and 71 days in 2011 and 2010, respectively. Our allowances for doubtful trade receivables as at December 31, 2011 and 2010 were approximately $345,000 and $244,000, respectively; and were about 0.5% of our gross trade receivables.

 

Net cash used in investing activities

 

In 2011, our net cash used in investing activities was approximately $11.0 million, which was mainly attributable to the addition of construction in progress of $11.0 million for the development of the cold storage facilities.

 

Net cash provided by financing activities

 

In 2011, our cash provided by financing activities was approximately $2.3 million. The increase was mainly attributable to the proceeds from short-term borrowing of $2.5 million, partially offset by the repayment of amounts due to a shareholder of $0.2 million.

 

Year 2010

 

Net cash used in operating activities

 

In 2010, our net cash used in operating activities amounted to approximately $6.3 million. The major source of cash inflow from operating activities was from net income of $21.1 million. Changes in operating assets and liabilities included cash outflow resulting from increase in accounts receivable of $29.8 million and inventories of $6.1 million. This was partially offset by the increase in accounts payable of $2.9 million and other payables of $2.5 million.

 

The increase in accounts receivable was mainly due to the extension of the credit period to our major customers so as to cope with the current market practice and the block sales of marine catch trading materials of $25.3 million in December 2010, which was collected during the first quarter of 2011. The increase in inventory related to the build of product for the expected sales for the Chinese New Year, which occurred in February 2011.

 

Net cash used in investing activities

 

In 2010, our net cash used in investing activities was approximately $12.8 million, which was mainly attributable to addition of fixed assets of $0.2 million and construction in progress of $13.4 million for the development of the cold storage facilities, partially offset by the acquisition of a subsidiary of $1.0 million.

 

Net cash provided by financing activities

 

In 2010, our cash provided by financing activities was approximately $24.8 million. The increase was mainly attributable to the net proceeds of $28.3 million from the registered direct offering of common stock taken place in January 2010 and the proceeds from cash exercise of warrants of $1.9 million, partially offset by the repayment of short-term bank loans during the first quarter of 2010 of $4.1 million and dividend paid related to the pre-acquisition result for the fiscal year 2009 to a non-controlling shareholder of a subsidiary amounting to $1.3 million.

 

Capital resources

 

We believe that after taking into account of our cash position, available bank facilities and cash generated from operating activities, we have adequate working capital to satisfy our current operating expenditures for the next twelve months. From time to time, we may identify new expansion opportunities for which there will be a need to use cash. We manage our cash based on thorough consideration of our corporate strategy as well as the macro economic situation. Factors we take into account when managing our cash include interest rates, foreign currency fluctuation as well as the flexibility in executing our acquisition and operational strategies.

 

We are financing the total estimated $26.5 million in land use rights and construction costs for our new cold storage facility from available funds and expect to run the new facility in the first half of 2012. We have paid approximately $22.9 million in relation to the construction costs as at December 31, 2011.

 

After the registered direct offering of common stock and repayment of bank loans during 2010, the relative cost of capital resources decreased correspondingly given the increase in the equity financing and reduced level of debt borrowings.

 

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In the fourth quarter of 2011, a short-term loan of $2.5 million was drawn down for working capital needs and to maintain the effectiveness of the facility line with the bank.

 

Apart from the expansion plan discussed above and the commitments set out in the section of “Commitments and Contingencies”, we do not have any other material commitments for capital expenditures and other expenditures. We believe that the current operating activities would be able to generate adequate cash flows supporting the daily operations for the next twelve months. We do not have present plans to raise additional funds.

 

CAPITAL EXPENDITURES AND INVESTMENTS

 

A summary of our capital expenditures for the last three financial years ended December 31, 2011 and 2010 is as follows:

 

   Year Ended December 31, 
US$’000  2011   2010 
         
Land use rights   -    70 
Buildings   609    1,608 
Plant and machinery   10,376    11,818 
Office equipment   20    34 
Motor vehicles   -    182 
    11,005    13,712 

 

In 2010, total capital expenditures of $13.7 million were mainly attributable to the construction of cold storage facilities and an additional floor at the existing staff quarter.

 

In 2011, total capital expenditures of $11.0 million were mainly attributable to the construction of cold storage facilities, an additional floor at the existing staff quarter and an algae extraction equipment line.

 

COMMITMENTS AND CONTINGENCIES 

 

Operating lease commitments

 

Ocean Technology leased certain office space under a non-cancellable operating lease agreement with a term of 3 years with fixed monthly rentals expiring on February 17, 2014, and generally not containing significant renewal options. Total rent expenses for the years ended December 31, 2011 and 2010 was $79,618 and $77,145, respectively. Future minimum rental payments due under the non-cancelable operating lease agreement are approximately $171,000 in total in the following three years.

 

Capital commitments

 

In 2010, Mingxiang entered into an agreement with an independent third party (the “Third Party Contractor”) in relation to the construction of a cold storage facility. A supplementary agreement was then entered into between Mingxiang and the Third Party Contractor in September 2011 related to additional gross areas, machineries and equipment required for the facility. The construction is expected to be completed in the first half of 2012. Total estimated construction costs are expected to be approximately $24.2 million. As of December 31, 2011, the Company recorded approximately $22.9 million as construction in progress. Hence the aggregated contingent payments related to the Third Party Contractor are approximately $1.3 million as of December 31, 2011.

 

Guarantees

 

As of December 31, 2011, Mingxiang was contingently liable as guarantor with respect to the loan of $472,270 (equivalent to RMB3,000,000) to an unrelated third party, Shishi Han Jiang Hua Lian Knitting and Clothing Factory (“Han Jiang Hua Lian”). The term of this guarantee is for the period from November 2008 through December 2017. Pursuant to the loan agreement, Han Jiang Hua Lian will repay the loan by installments and be fully settled by December 31, 2017. Should Han Jiang Hua Lian fail to make its debt payments due at any time from the date of guarantee, Mingxiang will be obligated to perform under the guarantee by primarily making the required payments, including late fees and penalties. The maximum potential amount of future payments that the Mingxiang is required to make under the guarantee is $472,270 (equivalent to RMB3,000,000).

 

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As of December 31, 2010, Mingxiang was contingently liable as guarantor with respect to the loans of $787,116 (equivalent to RMB 5,000,000) to an unrelated third party, Shishi Yu Ching Knitting and Clothing Company (“Yu Ching”). The term of this guarantee is for the period from January 2009 through January 2011. During 2011, Yu Ching repaid the principal amount of the loan in the amount of $787,116 (equivalent to RMB 5,000,000) but left the amount of loan interest unsettled due to a disagreement between Yu Ching and the creditor in relation to the calculation of the loan interest. Should Yu Ching fail to make its loan interest payments due at any time from the date of guarantee, Mingxiang will be obligated to perform under the guarantee by primarily making the required payments, including late fees and penalties.

 

According to the Personal Guarantee Agreement between Mingxiang and Mr. Liu, CEO, Mr. Liu agreed to bear all liabilities and costs incurred from a direct claim by the creditor if either Han Jiang Hua Lian or Yu Ching fails to make payments to the creditor upon due dates.

 

In accordance with Accounting Standard Codification (“ASC”) 460-10 “Guarantees”, a guarantor must recognize a liability for the fair value of the obligations it assumes under certain guarantees. Mingxiang did not receive any consideration for the guarantee and has determined the fair value of the indemnification to be insignificant. As of December 31, 2011, the Company has not recorded any liabilities under these guarantees.

 

ISSUANCE OF COMMON STOCK

 

On April 1, 2011, the Company granted compensatory stock awards totaling 700,000 common shares to certain of its officers, directors and employees. These stock awards vested in full on the date of the grant but are subject to forfeiture in full if the grantee ceases to be employed by the Company for any reason within one year from the date of the grant, pursuant to stock award agreements between the Company and grantees dated April 1, 2011. Based on the closing stock price of the grant date, the fair value of these stock awards are estimated to be approximately $2.7 million, which will be recognized as compensation expense, using the straight-line method, over the service period of one year from April 1, 2011 to March 31, 2012.

 

On February 15, 2011, the Company entered into an Investor Relations Consulting Agreement with Hayden Communications International, Inc (“HCI”) to provide consulting services for the Company. In connection with such service, the Company agreed to issue 20,000 shares of restricted common stock to HCI. The shares of common stock were valued at $51,800 or $2.59 per share and issued on July 14, 2011.

 

CRITICAL ACCOUNTING POLICIES & RECENT ACCOUNTING PRONOUNCEMENTS

 

·Non-controlling interest

 

Non-controlling interests in our subsidiaries are recorded in accordance with the provisions of ASC 810, “Consolidation”, and are reported as a component of our equity, separate from the parent’s equity. Purchase or sale of equity interests that do not result in a change of control are accounted for as equity transactions. Results of operations attributable to the non-controlling interests are included in our consolidated results of operations and, upon loss of control, the interest sold, as well as interest retained, If any, will be reported at fair value with any gain or loss recognized in earnings.

 

Under ASC 810-10-45-21, losses attributable to the parent and the non-controlling interest in a subsidiary may exceed their interests in the subsidiary’s equity. The excess, and any further losses attributable to the parent and the non-controlling interest, shall be attributed to those interests. That is, the non-controlling interest shall continue to be attributed its share of losses even if that attribution results in a deficit non-controlling interest balance.

 

·Use of estimates

 

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and also requires disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Significant estimates made by management include revenue recognition estimates, valuation of equity instruments and allowance for doubtful accounts.

 

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·Accounts receivable and allowance for doubtful accounts

 

Accounts receivable are recorded at the invoiced amount and do not bear interest. Management reviews the adequacy of the allowance for doubtful accounts on an ongoing basis, using historical collection trends and aging of receivables. Management also periodically evaluates individual customer’s financial condition, credit history, and the current economic conditions to make adjustments in the allowance when it is considered necessary. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company does not have any off-balance-sheet credit exposure related to its customers.

 

·Inventories

 

Inventories consist of frozen products from marine catch, processed seafood products, algae-based beverage products and materials used in the manufacture of the Company’s products. Inventories are stated at the lower of cost or net realizable value, with cost being determined on a weighted average basis. Costs include purchased cost of raw materials, direct labor, packaging and manufacturing overhead costs. The Company periodically reviews historical sales activity to determine excess, slow moving items and potentially obsolete items and also evaluates the impact of any anticipated changes in future demand. The Company provides inventory allowances based on excess and obsolete inventories determined principally by customer demand.

 

As of December 31, 2011 and 2010, the Company did not record an allowance for obsolete inventories, nor have there been any write-offs.

 

·Goodwill and intangible assets

 

Goodwill and intangible assets were the result of the acquisition of Xianghe. Goodwill represents the cost of the acquired algae-based drink business in excess of the fair value of identifiable tangible and intangible net assets purchased. Intangible assets include trademarks and algae-based beverage know-how and are recorded at cost less accumulated amortization and any recognized impairment loss. The algae-based beverage know-how is amortized over its estimated useful life of 10 years on a straight-line basis, which coincides with the timing provided from the PRC protection guidelines for our product. For the year ended December 31, 2011, the Company engaged an independent valuation expert to assist in determining the fair value of the identifiable tangible and intangible net assets of the acquired business.

 

The Company evaluates the valuation of its goodwill according to the provisions of Accounting Standards Codification (“ASC”) 350 to determine if the current value of goodwill has been impaired. The Company has also adopted Accounting Standard Update (ASU) No. 2011-08, Intangibles-Goodwill and Other (Topic 350). With ASU No. 2011-08, an entity is given the option to make a qualitative evaluation of goodwill impairment to determine whether it should calculate the fair value of its reporting unit. The Company made its qualitative evaluation of its goodwill considering, among other things, the general macroeconomic conditions, industry and market considerations, cost factors, overall financial performance and other relevant entity-specific events. Based on this qualitative evaluation, the Company concluded that it was more likely than not that its goodwill was not impaired and it wasn’t required to calculate the fair value of its reporting unit as of December 31, 2011. Goodwill of a reporting unit will be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. We performed our annual goodwill impairment during the fourth quarter of each calendar year.

 

In accordance with ASC Topic 360-10-5, “Impairment or Disposal of Long-Lived Assets”, the Company engaged a third party valuation firm to review the Company’s algae-based intangible assets for impairment. The Company performed its annual impairment test for its intangible assets during the fourth quarter of each calendar year. The intangible assets balance related to the algae-based drink business reporting unit. The test involved the assessment of the fair market value of the Company’s intangible assets, using a form of the income approach known as the excess earnings method and concludes that a discount rate of 21.5% is considered appropriate for valuing the Company. The market and cost approaches were not applied due to the lack of information deemed to be reliably indicative of value using either approach. The result of the assessment of the Company’s intangible assets indicated that its fair values exceeded its carrying amounts.

 

In particular, the Company provided a forecasted discounted cash flows analysis for the reporting unit based on discrete fifteen-year financial forecasts developed by management for planning purposes. Cash flows beyond the fifteen-year discrete forecasts were estimated using a terminal value calculation, which incorporated historical and forecasted financial trends for the reporting unit and considered long-term earnings growth rates for publicly traded peer companies.

 

The key assumptions used in determining the fair value of the reporting unit are:

 

-The financial projections were prepared by the Management with due care and consideration reflecting the reasonable estimate of future relevant events.

 

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-All information provided by the Management is true, accurate and complete.

 

-There will be no major changes in the existing political, legal, fiscal and economic conditions in countries in which the Company will carry on its business.

 

-There will be no major changes in the current taxation law in countries in which the Company operates.

 

-Future exchange rates and interest rates will not differ materially from those prevailing market expectations.

 

-The availability of finance will not be a constraint on the future growth of the Company’s operation.

 

-The Company will retain and have competent management, key personnel, and technical staff to support its ongoing operation.

 

-Industry trends and market conditions for related industries will not deviate significantly from economic forecasts.

 

-The forecasted average annual growth rate of revenue is 3% to 70% from 2012 to 2026. This reflects the following assumptions:

 

1)Increased market penetration into six provinces;

 

2)Increased demand in China for health related drinks; and

 

3)A long term growth rate into perpetuity has been determined to be 3% with reference to the birth rate, market penetration and other related factors.

 

-Cost of goods sold is forecasted to grow by 3% to 72% from 2012 to 2026.

 

-The discount rate applied to the cash flows is based on the weighted average cost of capital (“WACC”) of the Company. WACC is the weighted average of the estimated rate of return required by equity and debt holders for an investment of this type. Our analysis concluded that a discount rate of 21.5% is considered appropriate for valuing the Company.

 

-Publicly available information regarding our market capitalization was also considered in assessing the reasonableness of the cumulative fair values of our reporting units estimated using the excess earnings method.

 

Based upon the valuation report prepared by an independent valuation expert, it is concluded that the fair value of the intangible asset as of December 31, 2011 is reasonably stated by the amount of $21,173,433. During the years ended December 31, 2011 and 2010, we determined that there had been no impairment of intangible assets.

 

·Revenue recognition

 

In accordance with the ASC Topic 605, “Revenue Recognition”, the Company recognizes revenue when persuasive evidence of an arrangement exists, transfer of title has occurred or services have been rendered, the selling price is fixed or determinable and collectability is reasonably assured.

 

The Company derives revenues from the processing, distribution and sale of processed seafood products, sale of marine catch, and the sale and distribution of algae-based beverage products. The Company recognizes its revenues net of value-added taxes (“VAT”). The Company is subject to VAT which is levied on the majority of the products at the rate ranging from 13% to 17% on the invoiced value of sales. Output VAT is borne by customers in addition to the invoiced value of sales and input VAT is borne by the Company in addition to the invoiced value of purchases to the extent not refunded for export sales.

 

The Company recognizes revenue from the sale of processed seafood products and algae-based beverage products upon receipt of the delivery confirmation provided by the distributor’s carrier and the title and risk of loss of the product has transferred to the distributor. The distributor agreements do not provide chargeback, price protection, or stock rotation rights. The Company recognizes revenue from marine catch when title has transferred to the buyer. The Company experienced no product returns and recorded no reserve for sales returns for the years ended December 31, 2011 and 2010.

 

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The Company offers sales incentives to customers based on yearly sales targets. These are non-cash incentives and are solely used for promotional activities purposes. These amounts are accrued as sales and marketing expenses during the same month revenue is recognized.

 

Rental income from operating leases on real estate properties is recognized on a straight-line basis over the lease period.

 

·Income taxes

 

The provision for income taxes is determined in accordance with the provisions of ASC Topic 740, “Income Taxes” (“ASC 740”). Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted income tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Any effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

ASC 740 prescribes a comprehensive model for how companies should recognize, measure, present, and disclose in their financial statements uncertain tax positions taken or expected to be taken on a tax return. Under ASC 740, tax positions must initially be recognized in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions must initially and subsequently be measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and relevant facts.

 

For the years ended December 31, 2011 and 2010, the Company did not have any interest and penalties associated with tax positions. As of December 31, 2011 and 2010, the Company did not have any significant unrecognized uncertain tax positions.

 

The Company conducts major businesses in the PRC and is subject to tax in this jurisdiction. As a result of its business activities, the Company files tax returns that are subject to examination by the foreign tax authority.

 

·Foreign currencies translation

 

Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transaction. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency using the applicable exchange rates at the balance sheet dates. The resulting exchange differences are recorded in the consolidated statement of operations and comprehensive income.

 

The reporting currency of the Company is the United States Dollars ("US$"). The Company's subsidiaries in the PRC maintain their books and records in its local currency, the Renminbi Yuan ("RMB"), which is functional currency as being the primary currency of the economic environment in which these entities operate.

 

In general, for consolidation purposes, assets and liabilities of its subsidiaries whose functional currency is not the US$ are translated into US$, in accordance with ASC Topic 830-30, “Translation of Financial Statement”, using the exchange rate on the balance sheet date. Revenues and expenses are translated at average rates prevailing during the period. The gains and losses resulting from translation of financial statements of foreign subsidiaries are recorded as a separate component of accumulated other comprehensive income within the statement of changes in shareholders’ equity.

 

Translation of amounts from RMB into US$1 has been made at the following exchange rates for the respective years:

 

   2011   2010 
Year-end exchange rates RMB:US$1   6.3523    6.5918 
Average yearly exchange rates RMB:US$1   6.4544    6.7788 

 

The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into US$ at the rates used in translation.

 

·Stock-based compensation

 

The Company adopts ASC Topic 718-20, "Compensation - Stock Compensation" ("ASC 718-20"), using the fair value method. Under ASC 718-20, stock-based compensation cost is measured at the grant date based on the fair value of the award or using the Black-Scholes pricing model and is recognized as expense over the appropriate service period.

 

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On April 1, 2011, the Company granted compensatory stock awards totaling 700,000 common shares to certain of its officers, directors and employees. These stock awards vested in full on the date of the grant but are subject to forfeiture in full if the grantee ceases to be employed by the Company for any reason within one year from the date of the grant, pursuant to stock award agreements between the Company and grantees dated April 1, 2011.

 

Based on the closing stock price of the grant date, the fair value of these stock awards are estimated to be approximately $2.6 million, which are recognized as compensation expense, using the straight-line method, over a period of one year from April 1, 2011 to March 31, 2012.

 

·Fair value measurement

 

ASC Topic 820-10, “Fair Value Measurements and Disclosures” ("ASC 820-10") establishes a new framework for measuring fair value and expands related disclosures. Broadly, ASC 820-10 framework requires fair value to be determined based on 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. ASC 820-10 establishes a three-level valuation hierarchy based upon observable and non-observable inputs. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

 

For financial assets and liabilities, fair value is the price the Company would receive to sell an asset or pay to transfer a liability in an orderly transaction with a market participant at the measurement date. In the absence of active markets for the identical assets or liabilities, such measurements involve developing assumptions based on market observable data and, in the absence of such data, internal information that is consistent with what market participants would use in a hypothetical transaction that occurs at the measurement date.

 

·Recent accounting pronouncements

 

The Company has reviewed all recently issued, but not yet effective, accounting pronouncements and does not believe the future adoption of any such pronouncements may be expected to cause a material impact on its financial condition or the results of its operations.

 

During December 2011, the Financial Accounting Standards Board (“FASB”) issued ASU 2011-11, “Disclosures about Offsetting Assets and Liabilities.” The amendments in ASU 2011-11 require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The adoption of ASU 2011-11 results in changes to presentation and disclosure only and is not expected to have an impact on our consolidated results of operations and financial condition.

 

During September 2011, the FASB issued ASU 2011-08, “Testing Goodwill for Impairment.” The amendments in ASU 2011-08 are intended to reduce the cost and complexity associated with goodwill impairment tests required under the Accounting Standard Codification Topic 350 Intangibles - Goodwill and Other. The update permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. The amendments in this update are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The Company elected to early adopt ASU 2011-08, which resulted in the elimination of the additional requirements under Topic 350.

 

During June 2011, the FASB issued ASU 2011-05, “Presentation of Comprehensive Income.” ASU 2011-05 eliminates the option to report other comprehensive income and its components in the statement of changes in stockholders’ equity and requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement or in two separate but consecutive statements. Effective December 31, 2011, the Company elected to early adopt ASU No. 2011-05. The Company's early adoption of this new guidance only resulted in a change in how the Company presents the components of comprehensive income, which is currently presented within the consolidated statements of operations and comprehensive (loss) income.

 

During May 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”).” This pronouncement was issued to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and IFRS. ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements particularly for level 3 fair value measurements. This pronouncement is effective for reporting periods beginning on or after December 15, 2011. The adoption of ASU 2011-04 is not expected to have a significant impact to our consolidated financial position or results of operations.

 

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During January 2010, the FASB issued ASU No. 2010-6 to improve the disclosure and transparency of fair value measurements. These amendments clarify the level of disaggregation required, and the necessary disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. We adopted this ASU beginning January 1, 2011 and it did not have a significant impact on our consolidated financial position or results of operations.

 

FOREIGN EXCHANGE EXPOSURE

 

Our sales are denominated in RMB and US dollars whilst our purchases and operating expenses are mostly denominated in RMB. As such, we may be exposed to any significant transactional foreign exchange exposure for our operations. However, to the extent that we may enter into transactions in currencies other than RMB in the future, particularly as we penetrate into overseas markets, our financial results may be subject to fluctuations among those foreign currencies and RMB.

 

The percentage of our sales denominated in RMB and US dollars are as follows:

 

   Year Ended December 31, 
(%)  2011   2010 
Sales          
RMB   99.9    99.6 
US dollars   0.1    0.4 
Total   100.0    100.0 

  

On July 21, 2005, the RMB was unpegged against the US dollars and pegged against a basket of currencies on a “managed-float currency regime”. As at December 31, 2011, the exchange rate was approximately US$1.00 to RMB6.3523. There is no assurance that the PRC's foreign exchange policy will not be further altered. In the event that the PRC's policy is altered, significant fluctuations in the exchange rates of RMB against US dollars may arise. As a result, we will be subject to significant foreign exchange exposure and in the event that we incur foreign exchange losses, our financial performance will be adversely affected.

 

Our net foreign exchange losses for the last two financial years ended December 31, 2011 and 2010 are as follows:

 

   Year Ended December 31, 
   2011   2010 
         
Net foreign exchange losses (US$’000)   (3)   (13)
As a percentage of income before tax (%)   0.03    0.05 

  

We do not have a formal hedging policy with respect to our foreign exchange exposure as our foreign exchange gains/ losses for the period under review have been relatively insignificant. We will continue to monitor our foreign exchange exposure in the future and will consider hedging any material foreign exchange exposure should the need arise. Should we enter into any hedging transaction in the future, such transaction shall be subject to review by our Board of Directors. In addition, should we establish any formal hedging policy in the future, such policy shall be subject to review and approval by our board prior to implementation.

 

INFLATION

 

During the periods under review, inflation has a moderate impact on our financial performance as a result of increased raw materials, direct labor, packaging materials and other overhead costs. If prices for our products do not rise at a rate that is sufficient to fully absorb inflation-driven increases in our costs of supplies in the future, our profitability can be further adversely affected.

 

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ITEM 7A.Quantitative and Qualitative Disclosures about Market Risks

 

Foreign Exchange Risk

 

While our reporting currency is the US dollar, almost all of our consolidated revenues and consolidated costs and expenses are denominated in RMB. All of our assets are denominated in RMB except for some cash and cash equivalents and accounts receivables. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between US dollar and RMB. If the RMB depreciates against the US dollar, the value of our RMB revenues, earnings and assets as expressed in our US dollar financial statements will decline. We have not entered into any hedging transactions in an effort to reduce our exposure to foreign exchange risk.

 

Inflation

 

Inflationary factors such as increases in the costs of our products and overhead costs may adversely affect our operating results. Inflation in China has recently increased substantially. The inflation rate in China was reported at 4.1 percent in December 2011. These factors have led to the adoption by the Chinese government, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation. Price inflation can affect our ability to maintain current levels of gross margin and selling and distribution, general and administrative expenses as a percentage of net revenues if we are unable to pass along raw material price increases to customers. Similarly, the cost of the ongoing construction of our new facility and the installation of our equipment may increase as a result of these recent inflationary trends, which are expected to continue in the near future. Accordingly, inflation in China may weaken our competitiveness domestically or in international markets.

 

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ITEM 8.Financial Statements

 

CHINA MARINE FOOD GROUP LIMITED

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

  Page
   
Report of Independent Registered Public Accounting Firm, BDO China Dahua CPA Co., Ltd.(Formerly known as BDO China Li Xin Da Hua CPA Co., Ltd.) F-2
   
Audited Consolidated Balance Sheets as of December 31, 2011 and 2010 F-3
   
Audited Consolidated Statements of Operations and Comprehensive Income for the Years Ended December 31, 2011 and 2010 F-4
   
Audited Consolidated Statements of Cash Flows for the Years Ended December 31, 2011 and 2010 F-5
   
Audited Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2011 and 2010 F-6
   
Notes to Consolidated Financial Statements as of December 31, 2011 and 2010 F-7 - F-28

 

F-1
 

 

Report of Independent Registered Public Accounting Firm

 

 

Board of Directors and Shareholders

China Marine Food Group Limited

Shishi City, Fujian, China

 

We have audited the accompanying consolidated balance sheets of China Marine Food Group Limited as of December 31, 2011 and 2010 and the related consolidated statements of income and comprehensive income, shareholders’ equity, and cash flows for each of the two years in the period ended December 31, 2011 and 2010. 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 the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of China Marine Food Group Limited at December 31, 2011 and 2010, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2011 and 2010, in conformity with accounting principles generally accepted in the United States of America.

 

 

/s/ BDO China Dahua CPA Co., Ltd. (Formally known as BDO China Li Xin Da Hua CPA Co., Ltd.)

 

 

Shenzhen, P.R. China

March 27, 2012

 

F-2
 

 

CHINA MARINE FOOD GROUP LIMITED

CONSOLIDATED BALANCE SHEETS

(Currency expressed in United States Dollars (“US$”), except for number of shares)

 

   December 31, 
   2011   2010 
ASSETS          
Current assets:          
Cash and cash equivalents  $586,914   $15,556,772 
Accounts receivable, net   68,643,678    48,530,539 
Inventories   8,886,234    9,992,870 
Prepaid expenses and other current assets   849,419    105,640 
           
Total current assets   78,966,245    74,185,821 
           
Property, plant and equipment, net   11,199,244    8,801,267 
Land use rights, net   3,023,569    2,991,459 
Construction in progress   22,923,143    13,409,068 
Intangible assets, net   20,225,220    21,926,593 
Goodwill   2,553,757    2,460,971 
 
TOTAL ASSETS
  $138,891,178   $123,775,179 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
Current liabilities:          
Short-term borrowings  $2,550,257   $- 
Accounts payable, trade   2,583,549    3,764,722 
Amount due to a shareholder   50,361    261,789 
Income tax payable   174,525    537,751 
Accrued liabilities and other payables   3,424,288    4,858,694 
           
Total current liabilities   8,782,980    9,422,956 
           
Commitments and contingencies (see Note 21)          
           
Shareholders’ equity:          
Common stock, $0.001 par value; 100,000,000 shares authorized; 29,697,976 and 28,977,976 shares issued and outstanding as of December 31, 2011 and 2010   29,698    28,978 
Additional paid-in capital   50,074,952    47,377,872 
Statutory reserve   9,696,177    9,263,241 
Accumulated other comprehensive income   11,897,382    7,402,582 
Retained earnings   58,053,435    49,922,756 
Total China Marine Food Group Limited shareholders’ equity   129,751,644    113,995,429 
Non-controlling interests   356,554    356,794 
Total shareholders’ equity   130,108,198    114,352,223 

 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

  $138,891,178   $123,775,179 

 

See accompanying notes to consolidated financial statements

 

F-3
 

 

CHINA MARINE FOOD GROUP LIMITED

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(Currency expressed in United States Dollars (“US$”), except for number of shares)

 

   Year Ended December 31, 
   2011   2010 
REVENUE, NET          
Processed seafood products  $58,967,200   $70,466,645 
Marine catch   55,304,114    26,194,480 
Algae-based beverage products   29,676,358    26,018,510 
    143,947,672    122,679,635 
           
COST OF REVENUE (inclusive of depreciation and amortization)          
Processed seafood products   (41,411,881)   (46,140,571)
Marine catch   (53,057,915)   (23,730,303)
Algae-based beverage products   (17,753,909)   (15,348,486)
    (112,223,705)   (85,219,360)
           
GROSS PROFIT   31,723,967    37,460,275 
           
OPERATING EXPENSES:          
Depreciation and amortization   (2,714,603)   (2,522,058)
Sales and marketing   (14,045,894)   (6,359,641)
General and administrative   (2,576,019)   (3,230,177)
Stock-based compensation   (2,034,197)   - 
 
TOTAL OPERATING EXPENSES
   (21,370,713)   (12,111,876)
           
           
INCOME FROM OPERATIONS   10,353,254    25,348,399 
           
OTHER INCOME (EXPENSES):          
Subsidy income   14,719    82,168 
Rental income   101,326    92,199 
Interest income   154,515    111,955 
Interest expense   (11,483)   (40,032)
INCOME BEFORE INCOME TAXES   10,612,331    25,594,689 
 
INCOME TAX EXPENSE
   (2,048,956)   (4,455,167)
           
NET INCOME   8,563,375    21,139,522 
           
Less: net loss (income) attributable to non-controlling interests   240    (570)
           
NET INCOME ATTRIBUTABLE TO CHINA MARINE FOOD GROUP LIMITED  $8,563,615   $21,138,952 
           
Other comprehensive income:          
- Foreign currency translation gain   4,494,800    3,826,447 
           
COMPREHENSIVE INCOME  $13,058,415   $24,965,399 
 
Net income per share attributable to China Marine Food Group Limited
          
- Basic  $0.29   $0.75 
- Diluted  $0.29   $0.73 
           
Weighted average shares outstanding
- Basic
   29,514,744    28,301,949 
- Diluted   29,514,744    28,971,080 

 

See accompanying notes to consolidated financial statements

 

F-4
 

 

CHINA MARINE FOOD GROUP LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Currency expressed in United States Dollars (“US$”))

 

   Year Ended December 31, 
   2011   2010 
         
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net income  $8,563,375   $21,139,522 
Adjustments to reconcile net income to net cash used in operating activities:          
Depreciation and amortization   3,014,783    2,793,954 
Stock issued to an executive   -    143,100 
Stock issued for service   51,800    109,725 
Allowance for doubtful accounts   101,071    149,229 
Loss on disposal of property, plant and equipment   22,045    - 
  Compensatory stock awards   2,646,000    - 
Changes in operating assets and liabilities:          
Accounts receivable   (20,214,210)   (29,845,706)
Inventories   1,106,636    (6,115,920)
Prepaid expenses and other current assets   (743,779)   46,013 
Accounts payable, trade   (1,181,173)   2,879,436 
Income tax payable   (363,226)   (80,913)
Accrued liabilities and other payables   (1,434,406)   2,524,310 
           
Net cash used in operating activities   (8,431,084)   (6,257,250)
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Purchase of property, plant and equipment   (36,717)   (233,121)
Cash paid to construction in progress   (10,968,232)   (13,409,068)
Addition to land use right   -    (69,778)
Net cash received from acquisition of a subsidiary   -    952,170 
           
Net cash used in investing activities   (11,004,949)   (12,759,797)
           
CASH FLOWS FROM FINANCING ACTIVITIES:          
(Repayment of) Advance from amount due to a shareholder   (211,428)   192,202 
Advance to a non-controlling shareholder of a subsidiary   -    (145,999)
Proceeds from the registered direct offering, net of expenses   -    28,328,466 
Proceeds from exercise of warrants   -    1,913,613 
Proceeds from short-term borrowings   2,550,257    - 
Repayment on short-term borrowings   -    (4,139,121)
Dividends paid   -    (1,313,080)
           
Net cash provided by financing activities   2,338,829    24,836,081 
           
NET CHANGE IN CASH AND CASH EQUIVALENTS   (17,097,204)   5,819,034 
           
Effect of exchange rate changes in cash and cash equivalents   2,127,346    2,594,506 
           
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR   15,556,772    7,143,232 
           
CASH AND CASH EQUIVALENTS, END OF YEAR  $586,914   $15,556,772 
           
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION          
Cash paid for income taxes  $2,412,182   $4,536,080 
Cash paid for interest  $11,483   $40,032 

 

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING TRANSACTIONS
Transfer from prepayment to land use rights  $-   $2,274,323 
Transfer from construction in progress to property, plant and equipment  $1,812,921   $- 
           

ACQUISITION OF XIANGHE
Transfer from note receivable to paid for acquisition of Xianghe  $-   $26,399,696 
Consideration paid by Xianghe on behalf of Mingxiang  $-   $1,400,304 

 

See accompanying notes to consolidated financial statements

 

F-5
 

 

CHINA MARINE FOOD GROUP LIMITED

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Currency expressed in United States Dollars (“US$”), except for number of shares)

 

 

   China Marine Food Group Limited shareholders’ equity 
                   Accumulated            
           Additional       other      Non-   Total 
   Common stock   paid-in   Statutory   comprehensive  Retained   controlling   shareholders’ 
   No. of shares   Amount   capital   reserve   income  earnings   interests   equity 
Balance as of December 31, 2009   23,413,639   $23,414   $16,888,532   $5,614,517   $3,576,135  $33,745,608   $-   $59,848,206 
                                       
Stock issued under the registered direct offering, net of expenses   4,792,388    4,792    28,323,674    -   -   -    -    28,328,466 
Stock issued to an executive   30,000    30    143,070    -   -   -    -    143,100 
Stock issued for service   17,500    17    109,708    -   -   -    -    109,725 
Cashless exercise of warrants   266,427    267    (267)   -   -   -    -    - 
Cash exercise of warrants   458,022    458    1,913,155    -   -   -    -    1,913,613 
Net income for the year   -    -    -    -   -   21,138,952    570    21,139,522 
Appropriation to statutory reserve   -    -    -    3,648,724   -   (3,648,724)   -    - 
Distribution of dividend to a non-controlling shareholder   -    -    -    -   -   (1,313,080)   -    (1,313,080)
Share of non-controlling interests from business combination, net   -    -    -    -   -   -    356,224    356,224 
Foreign currency translation adjustment   -    -    -    -   3,826,447   -    -    3,826,447 

 

Balance as of December 31, 2010

   28,977,976   $28,978   $47,377,872   $9,263,241   $7,402,582  $49,922,756   $356,794   $114,352,223 
                                       
Compensatory stock awards   700,000    700    2,645,300    -   -   -    -    2,646,000 
Stock issued for service   20,000    20    51,780    -   -   -    -    51,800 
Net income / (loss) for the year   -    -    -    -   -   8,563,615    (240)   8,563,375 
Appropriation to statutory reserve   -    -    -    432,936   -   (432,936)   -    - 
Foreign currency translation adjustment   -    -    -    -   4,494,800   -    -    4,494,800 

 

Balance as of December 31, 2011

   29,697,976   $29,698   $50,074,952   $9,696,177   $11,897,382  $58,053,435   $356,554   $130,108,198 

 

 

See accompanying notes to condensed consolidated financial statements.

 

F-6
 

 

CHINA MARINE FOOD GROUP LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”))

 

1.            ORGANIZATION AND BUSINESS BACKGROUND

 

China Marine Food Group Limited (“China Marine” or “the Company”), formerly known as New Paradigm Productions, Inc., was incorporated in the State of Nevada on October 1, 1999. The Company is headquartered and the principal operations are in Shishi City, Fujian Province, People Republic of China (“PRC”). The Company, through its subsidiaries, manufactures and distributes processed seafood products and algae-based beverage products. The Company also trades marine catch sporadically throughout the year based on opportunities. The Company’s customers are located in domestic provinces in the PRC and overseas markets. The Company is publicly traded on the AMEX under the symbol “CMFO” and can be found on the worldwide web at www.china-marine.cn.

 

Recapitalization and reorganization

 

On November 17, 2007, China Marine completed a stock exchange transaction with the shareholders of Ocean Technology (China) Company Limited (“Ocean Technology”), whereby 15,624,034 shares of the Company’s common stock were issued to the shareholders of Ocean Technology in exchange for 100% of their outstanding capital stock in Ocean Technology. As a result of the stock exchange, the former shareholders of Ocean Technology owned approximately 93.15% of the issued and outstanding shares of common stock of the Company.

 

Ocean Technology became a wholly-owned subsidiary of China Marine. The stock exchange transaction was accounted for as a reverse acquisition and recapitalization of China Marine whereby Ocean Technology is deemed to be the accounting acquirer (legal acquiree) and China Marine to be the accounting acquiree (legal acquirer). The accompanying consolidated financial statements are in substance those of Ocean Technology, with the assets and liabilities, and revenues and expenses, of China Marine being included effective from the date of stock exchange transaction. China Marine is deemed to be a continuation of the business of Ocean Technology.

 

As of December 31, 2011, China Marine’s majority-owned subsidiaries were as follows

 

Business history of subsidiaries

 

 

 

Name

 

Place of incorporation

and kind of

legal entity

 

Principal activities

and place of operation

 

 

 

Particulars of issued/

registered share

capital

 

 

 

Effective interest

Held

                 
Ocean Technology (China) Company Limited (“Ocean Technology”)   Hong Kong, a limited liability company

 

 

Investment holding in Hong Kong

 

 

 

10,000 issued shares of HK$1 each   100%
                 

Shishi Rixiang Marine Foods Co., Ltd.

(“Rixiang”)

  The PRC, a limited liability company

 

 

Trading and distribution of

marine products in the PRC and overseas

 

 

$33,000,000   100%
                 

Shishi Huabao Mingxiang Foods Co., Ltd (“Mingxiang”)

 

  The PRC, a limited liability company

 

 

Trading and distribution of marine products in the PRC and overseas; Sales and distribution of algae-based beverage products

 

  RMB50,000,000   100%
Shishi Huabao Jixiang Water Products Co., Ltd (“Jixiang”)   The PRC, a limited liability company

 

 

Property holding   RMB4,500,000   100%

 

F-7
 

 

CHINA MARINE FOOD GROUP LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”))

 

 

 

Name

 

Place of incorporation

and kind of

legal entity

 

Principal activities

and place of operation

 

 

 

Particulars of issued/

registered share

capital

 

 

 

Effective interest

Held

                 
Shishi Xianghe Food Science and Technology Co., Ltd. (“Xianghe”)   The PRC, a limited liability company   Sale and distribution of algae-based beverage products   RMB5,000,000   80%
                 
Shishi Xianglin Trading Co., Ltd. (“Xianglin”)   The PRC, a limited liability company

 

 

Dormant   RMB800,000   100%
                 

China Marine and its subsidiaries are hereinafter referred to as “the Company”.

 

2.            SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

l   Basis of consolidation

 

These accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“US GAAP”). The audited consolidated financial statements include the financial statements of China Marine and its subsidiaries. All significant inter-company balances and transactions within the Company have been eliminated upon consolidation.

 

l   Non-controlling interest

 

Non-controlling interests in our subsidiaries are recorded in accordance with the provisions of Accounting Standard Codification (“ASC”) 810, “Consolidation”, and are reported as a component of our equity, separate from the parent’s equity. Purchase or sale of equity interests that do not result in a change of control are accounted for as equity transactions. Results of operations attributable to the non-controlling interests are included in our consolidated results of operations and, upon loss of control, the interest sold, as well as interest retained, If any, will be reported at fair value with any gain or loss recognized in earnings.

 

Under ASC 810-10-45-21, losses attributable to the parent and the non-controlling interest in a subsidiary may exceed their interests in the subsidiary’s equity. The excess, and any further losses attributable to the parent and the non-controlling interest, shall be attributed to those interests. That is, the non-controlling interest shall continue to be attributed its share of losses even if that attribution results in a deficit non-controlling interest balance.

 

l   Use of estimates

 

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and also requires disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Significant estimates made by management include revenue recognition estimates, valuation of equity instruments and allowance for doubtful accounts.

 

l   Cash and cash equivalents

 

Cash and cash equivalents are carried at cost and represent cash on hand, demand deposits placed with banks or other financial institutions and all highly liquid investments with an original maturity of three months or less as of the purchase date of such investments.

 

The Company maintains cash and cash equivalent balances at a financial institution in the PRC, which are insured by the People’s Bank of China. The Company had cash concentration risk of $538,132 and $14,364,156 as of December 31, 2011 and 2010, respectively, which amounts exclude Ocean Technology.

 

F-8
 

 

CHINA MARINE FOOD GROUP LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”))

 

l   Accounts receivable and allowance for doubtful accounts

 

Accounts receivable are recorded at the invoiced amount and do not bear interest. Management reviews the adequacy of the allowance for doubtful accounts on an ongoing basis, using historical collection trends and aging of receivables. Management also periodically evaluates individual customer’s financial condition, credit history, and the current economic conditions to make adjustments in the allowance when it is considered necessary. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company does not have any off-balance-sheet credit exposure related to its customers.

 

l   Inventories

 

Inventories consist of frozen products from marine catch, processed seafood products, algae-based beverage products and materials used in the manufacture of the Company’s products. Inventories are stated at the lower of cost or net realizable value, with cost being determined on a weighted average basis. Costs include purchased cost of raw materials, direct labor and manufacturing overhead costs. The Company periodically reviews historical sales activity to determine excess, slow moving items and potentially obsolete items and also evaluates the impact of any anticipated changes in future demand. The Company provides inventory allowances based on excess and obsolete inventories determined principally by customer demand. As of December 31, 2011 and 2010, the Company did not record an allowance for obsolete inventories, nor have there been any write-offs.

 

l   Property, plant and equipment

 

Property, plant and equipment are stated at cost less accumulated depreciation and accumulated impairment losses, if any. Depreciation is calculated on the straight-line basis over the following expected useful lives from the date on which they become fully operational and after taking into account their estimated residual values:

 

  Depreciable life   Residual value
Buildings 30-50 years   10%
Plant and machinery 5-30 years   10%
Motor vehicles 8-10 years   10%
Office equipments 5 years   10%

 

Expenditure for repairs and maintenance is expensed as incurred. When assets have retired or sold, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized in the results of operations.

 

l   Construction in progress

 

Construction in progress is stated at cost, which includes the cost of construction, acquisition of plant and equipment and other direct costs attributable to the construction. Construction in progress is not depreciated until such time as the assets are completed and put into operational use. No capitalized interest is incurred during the period of construction.

 

l   Land use rights

 

All lands in the PRC are owned by the PRC government. The government in the PRC, according to the relevant PRC law, may sell the right to use the land for a specified period of time. Thus, all of the Company’s land purchases in the PRC are considered to be leasehold land and are stated at cost less accumulated amortization and any recognized impairment loss. Amortization is provided over the term of the land use right agreements on a straight-line basis, which is 50 years and they will expire in 2052.

 

F-9
 

 

CHINA MARINE FOOD GROUP LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”))

 

l   Goodwill and intangible assets

 

Goodwill and intangible assets were the result of the acquisition of Xianghe. Goodwill represents the cost of the acquired algae-based drink business in excess of the fair value of identifiable tangible and intangible net assets purchased. Intangible assets include trademarks and algae-based beverage know-how and are recorded at cost less accumulated amortization and any recognized impairment loss. The algae-based beverage know-how is amortized over its estimated useful life of 10 years on a straight-line basis, which coincides with the timing provided from the PRC protection guidelines for our product. For the year ended December 31, 2011, the Company engaged an independent valuation expert to assist in determining the fair value of the identifiable tangible and intangible net assets of the acquired business.

 

The Company evaluates the valuation of its goodwill according to the provisions of Accounting Standards Codification (“ASC”) 350 to determine if the current value of goodwill has been impaired. The Company has also adopted Accounting Standard Update (ASU) No. 2011-08, Intangibles-Goodwill and Other (Topic 350). With ASU No. 2011-08, an entity is given the option to make a qualitative evaluation of goodwill impairment to determine whether it should calculate the fair value of its reporting unit. The Company made its qualitative evaluation of its goodwill considering, among other things, the general macroeconomic conditions, industry and market considerations, cost factors, overall financial performance and other relevant entity-specific events. Based on this qualitative evaluation, the Company concluded that it was more likely than not that its goodwill was not impaired and it wasn’t required to calculate the fair value of its reporting unit as of December 31, 2011. Goodwill of a reporting unit will be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. We performed our annual goodwill impairment during the fourth quarter of each calendar year.

 

In accordance with ASC Topic 360-10-5, “Impairment or Disposal of Long-Lived Assets”, the Company engaged a third party valuation firm to review the Company’s algae-based intangible assets for impairment. The Company performed its annual impairment test for its intangible assets during the fourth quarter of each calendar year. The intangible assets balance related to the algae-based drink business reporting unit. The test involved the assessment of the fair market value of the Company’s intangible assets, using a form of the income approach known as the excess earnings method and concludes that a discount rate of 21.5% is considered appropriate for valuing the Company. The market and cost approaches were not applied due to the lack of information deemed to be reliably indicative of value using either approach. The result of the assessment of the Company’s intangible assets indicated that its fair values exceeded its carrying amounts.

 

In particular, the Company provided a forecasted discounted cash flows analysis for the reporting unit based on discrete fifteen-year financial forecasts developed by management for planning purposes. Cash flows beyond the fifteen-year discrete forecasts were estimated using a terminal value calculation, which incorporated historical and forecasted financial trends for the reporting unit and considered long-term earnings growth rates for publicly traded peer companies.

 

The key assumptions used in determining the fair value of the reporting unit are:

 

-The financial projections were prepared by the Management with due care and consideration reflecting the reasonable estimate of future relevant events.

 

-All information provided by the Management is true, accurate and complete.

 

-There will be no major changes in the existing political, legal, fiscal and economic conditions in countries in which the Company will carry on its business.

 

-There will be no major changes in the current taxation law in countries in which the Company operates.

 

-Future exchange rates and interest rates will not differ materially from those prevailing market expectations.

 

-The availability of finance will not be a constraint on the future growth of the Company’s operation.

 

-The Company will retain and have competent management, key personnel, and technical staff to support its ongoing operation.

 

F-10
 

 

CHINA MARINE FOOD GROUP LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”))

 

-Industry trends and market conditions for related industries will not deviate significantly from economic forecasts.

 

-The forecasted average annual growth rate of revenue is 3% to 70% from 2012 to 2026. This reflects the following assumptions:

 

1)Increased market penetration into six provinces;

 

2)Increased demand in China for health related drinks; and

 

3)A long term growth rate into perpetuity has been determined to be 3% with reference to the birth rate, market penetration and other related factors.

 

-Cost of goods sold is forecasted to grow by 3% to 72% from 2012 to 2026.

 

-The discount rate applied to the cash flows is based on the weighted average cost of capital (“WACC”) of the Company. WACC is the weighted average of the estimated rate of return required by equity and debt holders for an investment of this type. Our analysis concluded that a discount rate of 21.5% is considered appropriate for valuing the Company.

 

-Publicly available information regarding our market capitalization was also considered in assessing the reasonableness of the cumulative fair values of our reporting units estimated using the excess earnings method.

 

Based upon the valuation report prepared by an independent valuation expert, it is concluded that the fair value of the intangible asset as of December 31, 2011, is reasonably stated by the amount of $21,173,433. During the years ended December 31, 2011 and 2010, we determined that there had been no impairment of intangible assets.

 

l   Impairment of long-lived assets

 

In accordance with the provisions of ASC Topic 360-10-5, “Impairment or Disposal of Long-Lived Assets”, all long-lived assets such as property, plant and equipment, land use rights and intangible assets held and used by the Company are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is evaluated by a comparison of the carrying amount of assets to estimated discounted net cash flows expected to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amounts of the assets exceed the fair value of the assets. There has been no impairment as of December 31, 2011 and 2010.

 

l   Revenue recognition

 

In accordance with the ASC Topic 605, “Revenue Recognition”, the Company recognizes revenue when persuasive evidence of an arrangement exists, transfer of title has occurred or services have been rendered, the selling price is fixed or determinable and collectability is reasonably assured.

 

The Company derives revenues from the processing, distribution and sale of processed seafood products, sale of marine catch, and the sale and distribution of algae-based beverage products. The Company recognizes its revenues net of value-added taxes (“VAT”). The Company is subject to VAT which is levied on the majority of the products at the rate ranging from 13% to 17% on the invoiced value of sales. Output VAT is borne by customers in addition to the invoiced value of sales and input VAT is borne by the Company in addition to the invoiced value of purchases to the extent not refunded for export sales.

 

The Company recognizes revenue from the sale of processed seafood products and algae-based beverage products upon receipt of the delivery confirmation provided by the distributor’s carrier and the title and risk of loss of the product has transferred to the distributor. The distributor agreements do not provide chargeback, price protection, or stock rotation rights. The Company recognizes revenue from marine catch when title has transferred to the buyer. The Company experienced no product returns and recorded no reserve for sales returns for the years ended December 31, 2011 and 2010.

 

F-11
 

 

CHINA MARINE FOOD GROUP LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”))

 

The Company offers sales incentives to customers based on yearly sales targets. These are non-cash incentives and are solely used for promotional activities purposes. These amounts are accrued as sales and marketing expenses during the same month revenue is recognized.

 

Rental income from operating leases on real estate properties is recognized on a straight-line basis over the lease period.

 

l   Advertising costs

 

Advertising costs are expensed as incurred under ASC Topic 720-35, “Advertising Costs”. The Company incurred advertising expense of $3,234,492 and $1,069,402 for the years ended December 31, 2011 and 2010, respectively.

 

l   Comprehensive income or loss

 

ASC Topic 220, “Comprehensive Income”, establishes standards for reporting and display of comprehensive income or loss, its components and accumulated balances. Comprehensive income or loss as defined includes all changes in equity during a period from non-owner sources. Accumulated other comprehensive income or loss, as presented in the accompanying statement of changes in shareholders’ equity, consists of changes in unrealized gains and losses on foreign currency translation. This comprehensive income is not included in the computation of income tax expense or benefit.

 

l   Income taxes

 

The provision for income taxes is determined in accordance with the provisions of ASC Topic 740, “Income Taxes” (“ASC 740”). Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted income tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Any effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

ASC 740 prescribes a comprehensive model for how companies should recognize, measure, present, and disclose in their financial statements uncertain tax positions taken or expected to be taken on a tax return. Under ASC 740, tax positions must initially be recognized in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions must initially and subsequently be measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and relevant facts.

 

For the years ended December 31, 2011 and 2010, the Company did not have any interest and penalties associated with tax positions. As of December 31, 2011 and 2010, the Company did not have any significant unrecognized uncertain tax positions.

 

The Company conducts major businesses in the PRC and is subject to tax in this jurisdiction. As a result of its business activities, the Company files tax returns that are subject to examination by the foreign tax authority.

 

l   Earnings per share

 

The Company calculates earnings per share in accordance with ASC Topic 260, “Earnings per Share.” Basic earnings per share is computed by dividing the net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed similar to basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common stock equivalents had been issued and if the additional common shares were dilutive.

 

l   Foreign currencies translation

 

Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transaction. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency using the applicable exchange rates at the balance sheet dates. The resulting exchange differences are recorded in the consolidated statement of operations and comprehensive income.

 

F-12
 

 

CHINA MARINE FOOD GROUP LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”))

 

The reporting currency of the Company is the United States Dollars ("US$"). The Company's subsidiaries in the PRC maintain their books and records in its local currency, the Renminbi Yuan ("RMB"), which is functional currency as being the primary currency of the economic environment in which these entities operate.

 

In general, for consolidation purposes, assets and liabilities of its subsidiaries whose functional currency is not the US$ are translated into US$, in accordance with ASC Topic 830-30, “Translation of Financial Statement”, using the exchange rate on the balance sheet date. Revenues and expenses are translated at average rates prevailing during the period. The gains and losses resulting from translation of financial statements of foreign subsidiaries are recorded as a separate component of accumulated other comprehensive income within the statement of changes in shareholders’ equity.

 

Translation of amounts from RMB into US$1 has been made at the following exchange rates for the respective years:

 

   2011   2010 
Year-end exchange rates RMB:US$1   6.3523    6.5918 
Average yearly exchange rates RMB:US$1   6.4544    6.7788 

 

The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into US$ at the rates used in translation.

 

l   Stock-based compensation

 

The Company adopts ASC Topic 718-20, "Compensation - Stock Compensation" ("ASC 718-20"), using the fair value method. Under ASC 718-20, stock-based compensation cost is measured at the grant date based on the fair value of the award or using the Black-Scholes pricing model and is recognized as expense over the appropriate service period.

 

l   Segment reporting

 

ASC Topic 280, “Segment Reporting” establishes standards for reporting information about operating segments on a basis consistent with the Company’s internal organization structure as well as information about geographical areas, business segments and major customers in financial statements. For the year ended December 31, 2011, the Company operates in three principal reportable segments: sale of processed seafood products, trading of marine catch and sale of algae-based beverage products in the PRC.

 

l   Fair value measurement

 

ASC Topic 820-10, “Fair Value Measurements and Disclosures” ("ASC 820-10") establishes a new framework for measuring fair value and expands related disclosures. Broadly, ASC 820-10 framework requires fair value to be determined based on 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. ASC 820-10 establishes a three-level valuation hierarchy based upon observable and non-observable inputs. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

 

For financial assets and liabilities, fair value is the price the Company would receive to sell an asset or pay to transfer a liability in an orderly transaction with a market participant at the measurement date. In the absence of active markets for the identical assets or liabilities, such measurements involve developing assumptions based on market observable data and, in the absence of such data, internal information that is consistent with what market participants would use in a hypothetical transaction that occurs at the measurement date.

 

F-13
 

 

CHINA MARINE FOOD GROUP LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”))

 

l   Financial instruments

 

Cash and cash equivalents, accounts receivable, prepaid expenses and other current assets, accounts payable, amount due to a shareholder, income tax payable and accrued liabilities and other payables are carried at cost which approximates fair value. The estimated fair value of short-term borrowing was $2.5 million and $nil million as of December 31, 2011 and 2010, respectively, based on current market prices or interest rates.

 

l   Recent accounting pronouncements

 

The Company has reviewed all recently issued, but not yet effective, accounting pronouncements and does not believe the future adoption of any such pronouncements may be expected to cause a material impact on its financial condition or the results of its operations.

 

During December 2011, the Financial Accounting Standards Board (“FASB”) issued ASU 2011-11, “Disclosures about Offsetting Assets and Liabilities.” The amendments in ASU 2011-11 require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The adoption of ASU 2011-11 results in changes to presentation and disclosure only and is not expected to have an impact on our consolidated results of operations and financial condition.

 

During September 2011, the FASB issued ASU 2011-08, “Testing Goodwill for Impairment.” The amendments in ASU 2011-08 are intended to reduce the cost and complexity associated with goodwill impairment tests required under the Accounting Standard Codification Topic 350 Intangibles – Goodwill and Other. The update permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. The amendments in this update are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The Company elected to early adopt ASU 2011-08, which resulted in the elimination of the additional requirements under Topic 350.

 

During June 2011, the FASB issued ASU 2011-05, “Presentation of Comprehensive Income.” ASU 2011-05 eliminates the option to report other comprehensive income and its components in the statement of changes in stockholders’ equity and requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement or in two separate but consecutive statements. Effective December 31, 2011, the Company elected to early adopt ASU No. 2011-05. The Company's early adoption of this new guidance only resulted in a change in how the Company presents the components of comprehensive income, which is currently presented within the consolidated statements of operations and comprehensive (loss) income.

 

During May 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”).” This pronouncement was issued to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and IFRS. ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements particularly for level 3 fair value measurements. This pronouncement is effective for reporting periods beginning on or after December 15, 2011. The adoption of ASU 2011-04 is not expected to have a significant impact to our consolidated financial position or results of operations.

 

During January 2010, the FASB issued ASU No. 2010-6 to improve the disclosure and transparency of fair value measurements. These amendments clarify the level of disaggregation required, and the necessary disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. We adopted this ASU beginning January 1, 2011 and it did not have a significant impact on our consolidated financial position or results of operations.

 

F-14
 

 

CHINA MARINE FOOD GROUP LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”))

 

3.                   ACQUISITION OF BRANDED ALGAE-BASED BEVERAGE COMPANY

 

On November 27, 2009, the Company entered into a Credit or Share Purchase Option Agreement (the “Option Agreement”) with Qiu Shang Jing (“Qiu”) and Shishi Xianghe Food Science and Technology Co., Ltd. (“Xianghe”). The Option Agreement provided the Company to make a loan to Xianghe in the amount of approximately $26.4 million to be used for working capital purposes, of which the maturity date was January 26, 2010. In consideration for the loan, the Company received the option to buy shares representing eighty percent (80%) of Xianghe from its sole shareholder, Qiu. The interest rate on the loan is 5.0% per annum. Qiu agreed to pledge all of his shares in Xianghe to guarantee the performance by Xianghe under the Option Agreement. The Company funded the loan from the currently available cash.

 

Xianghe is a Fujian based manufacturer of the branded Hi-Power algae-based soft drinks. Hi-Power was developed by the Yellow Sea Fisheries Research Institute Chinese Academy of Fishery Sciences in coordination with the founder, Qiu. Hi-Power is marketed as a high-protein content drink, low in calories and fat, which provides the consumers a combination of immune system benefits, improved digestion and reductions in hyperglycemia and hypertension. Hi-Power’s target market focuses on health-conscious consumers in China’s fast-growing beverage market. Xianghe has developed a network of distributors in Fujian, Zhejiang, Guangdong and Hunan which sell Hi-Power to retail food stores, restaurants food supply dealers and the hospitality industry.

 

On January 1, 2010, the Company exercised the option to acquire shares representing eighty percent (80%) of the registered capital stock (the “Shares”) of Xianghe pursuant to the terms of a Share Purchase Agreement (the “Purchase Agreement”). The Shares were purchased from Qiu and the purchase price for the Shares was approximately $27.8 million, paid as follows:

 

(i)Approximately $26.4 million, which Xianghe owed to the Company, was transferred to be the consideration for the purchase of the Shares of Xianghe which the Company shall pay to Qiu.

 

(ii)Approximately $1.4 million shall be paid by the Company to Qiu within 30 days after completion of the audit report of Xianghe for the year ended December 31, 2009, which was then fully settled.

 

The Purchase Agreement grants the Company a right of first refusal to purchase the 20% of the registered capital stock of Xianghe retained by Qiu for a maximum price of approximately $7.0 million if Qiu intends to sell his shares. The Purchase Agreement also provides that if Xianghe has any funding requirement from the shareholders, the Company and Qiu shall provide the capital into Xianghe on a pro rata basis according to respective shareholdings.

 

F-15
 

  

CHINA MARINE FOOD GROUP LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2011 AND 2010

(Currency expressed in United States Dollars (“US$”))

 

The following table summarizes the fair value of the assets acquired and liabilities assumed at the date of acquisition. The allocation of the purchase price consideration is presented as below:

     
Acquired assets:     
Cash and cash equivalents  $435,933 
Accounts receivable, net   1,391,457 
Inventories   10,871 
Amount due from an owner   1,442,623 
Property, plant and equipment, net   395 
Intangible assets, net   8,596 
      
Total assets acquired   3,289,875 
      
Less: liabilities assumed     
Accounts payable, trade   402,982 
Income tax payable   225,180 
Accrued liabilities and other payables   240,808 
      
Total liabilities assumed   868,970 
      
Less: non-controlling interests