-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Fyurm+5X9vkTsxS3sZ5rVQngB1uvTLAFJAd0b3p6nS0/v3Bp92/BfzatVGxg9D2C 96isNvRkTMZKUHJeM6pyaQ== 0000930413-07-002793.txt : 20070323 0000930413-07-002793.hdr.sgml : 20070323 20070323172735 ACCESSION NUMBER: 0000930413-07-002793 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20061231 FILED AS OF DATE: 20070323 DATE AS OF CHANGE: 20070323 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ZHONGPIN INC. CENTRAL INDEX KEY: 0001277092 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-HELP SUPPLY SERVICES [7363] IRS NUMBER: 542100419 STATE OF INCORPORATION: DE FISCAL YEAR END: 0216 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 333-112111 FILM NUMBER: 07716128 BUSINESS ADDRESS: STREET 1: C/O PRYOR CASHMAN SHERMAN & FLYNN LLP STREET 2: 410 PARK AVENUE CITY: NEW YORK STATE: NY ZIP: 10022 BUSINESS PHONE: 212-326-0846 MAIL ADDRESS: STREET 1: C/O PRYOR CASHMAN SHERMAN & FLYNN LLP STREET 2: 410 PARK AVENUE CITY: NEW YORK STATE: NY ZIP: 10022 FORMER COMPANY: FORMER CONFORMED NAME: STRONG TECHNICAL INC DATE OF NAME CHANGE: 20040121 10-K 1 c47555_10k.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______. COMMISSION FILE NO. 333-112111 ZHONGPIN INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 54-2100419 (STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER IDENTIFICATION NO.) OF INCORPORATION OR ORGANIZATION) 21 CHANGSHE ROAD, CHANGGE CITY, HENAN PROVINCE THE PEOPLE'S REPUBLIC OF CHINA (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) 011 86 374-6216633 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT: NONE SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE 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 [ ] 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 Act. Yes |X| No [ ] Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |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 |X| 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. (Check One): Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer |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| On March 15, 2007, 13,763,455 shares of the registrant's common stock, and 5,268,856 shares of the registrant's Series A preferred stock, each such share convertible into one share of the registrant's common stock, were outstanding. The aggregate market value of the registrant's voting stock held by non-affiliates of the registrant was approximately $87,447,000 as of June 30, 2006. Shares of voting stock held by each executive officer and director of the registrant and each person who beneficially owns 10% or more of the registrant's outstanding voting stock has been excluded from the calculation. This determination of affiliated status may not be conclusive for other purposes. Documents Incorporated by Reference: Portions of the registrant's proxy statement for its 2007 annual meeting of stockholders, which the registrant expects to file with the Securities and Exchange Commission within 120 days after December 31, 2006, are incorporated by reference into Part III of this report. TABLE OF CONTENTS PART I Item 1. Business Item 1A. Risk Factors Item 1B. Unresolved Staff Comments Item 2. Properties Item 3. Legal Proceedings Item 4. Submission of Matters to a Vote of Security Holders PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Item 6. Selected Financial Data Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 7A. Quantitative and Qualitative Disclosures About Market Risk Item 8. Financial Statements and Supplementary Data Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Item 9A. Controls and Procedures Item 9B. Other Information PART III Item 10. Directors and Executive Officers of the Registrant Item 11. Executive Compensation Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Item 13. Certain Relationships and Related Transactions Item 14. Principal Accountant Fees and Services PART IV Item 15. Exhibits and Financial Statement Schedules SIGNATURES THE STATEMENTS CONTAINED IN THIS REPORT THAT ARE NOT HISTORICAL FACTS ARE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 WITH RESPECT TO OUR FINANCIAL CONDITION, RESULTS OF OPERATIONS AND BUSINESS, WHICH CAN BE IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY, SUCH AS "ESTIMATES," "PROJECTS," "PLANS," "BELIEVES," "EXPECTS," "ANTICIPATES," "INTENDS," OR THE NEGATIVE THEREOF OR OTHER VARIATIONS THEREON, OR BY DISCUSSIONS OF STRATEGY THAT INVOLVE RISKS AND UNCERTAINTIES. MANAGEMENT WISHES TO CAUTION THE READER OF THE FORWARD-LOOKING STATEMENTS THAT SUCH STATEMENTS, WHICH ARE CONTAINED IN THIS REPORT, REFLECT OUR CURRENT BELIEFS WITH RESPECT TO FUTURE EVENTS AND INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS, INCLUDING, BUT NOT LIMITED TO, ECONOMIC, COMPETITIVE, REGULATORY, TECHNOLOGICAL, KEY EMPLOYEE, AND GENERAL BUSINESS FACTORS AFFECTING OUR OPERATIONS, MARKETS, GROWTH, SERVICES, PRODUCTS, LICENSES AND OTHER FACTORS DISCUSSED IN OUR OTHER FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION, AND THAT THESE STATEMENTS ARE ONLY ESTIMATES OR PREDICTIONS. NO ASSURANCES CAN BE GIVEN REGARDING THE ACHIEVEMENT OF FUTURE RESULTS, AS ACTUAL RESULTS MAY DIFFER MATERIALLY AS A RESULT OF RISKS FACING US, AND ACTUAL EVENTS MAY DIFFER FROM THE ASSUMPTIONS UNDERLYING THE STATEMENTS THAT HAVE BEEN MADE REGARDING ANTICIPATED EVENTS. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO NUMEROUS ASSUMPTIONS, RISKS AND UNCERTAINTIES THAT MAY CAUSE OUR ACTUAL RESULTS TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS EXPRESSED OR IMPLIED BY US IN THOSE STATEMENTS. SOME OF THESE RISKS ARE DESCRIBED IN "RISK FACTORS" IN ITEM 1A OF THIS REPORT. THESE RISK FACTORS SHOULD BE CONSIDERED IN CONNECTION WITH ANY SUBSEQUENT WRITTEN OR ORAL FORWARD-LOOKING STATEMENTS THAT WE OR PERSONS ACTING ON OUR BEHALF MAY ISSUE. ALL WRITTEN AND ORAL FORWARD LOOKING STATEMENTS MADE IN CONNECTION WITH THIS REPORT THAT ARE ATTRIBUTABLE TO US OR PERSONS ACTING ON OUR BEHALF ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THESE CAUTIONARY STATEMENTS. GIVEN THESE UNCERTAINTIES, WE CAUTION INVESTORS NOT TO UNDULY RELY ON OUR FORWARD-LOOKING STATEMENTS. WE DO NOT UNDERTAKE ANY OBLIGATION TO REVIEW OR CONFIRM ANALYSTS' EXPECTATIONS OR ESTIMATES OR TO RELEASE PUBLICLY ANY REVISIONS TO ANY FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE OF THIS DOCUMENT OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS. FURTHER, THE INFORMATION ABOUT OUR INTENTIONS CONTAINED IN THIS DOCUMENT IS A STATEMENT OF OUR INTENTION AS OF THE DATE OF THIS DOCUMENT AND IS BASED UPON, AMONG OTHER THINGS, THE EXISTING REGULATORY ENVIRONMENT, INDUSTRY CONDITIONS, MARKET CONDITIONS AND PRICES, THE ECONOMY IN GENERAL AND OUR ASSUMPTIONS AS OF SUCH DATE. WE MAY CHANGE OUR INTENTIONS, AT ANY TIME AND WITHOUT NOTICE, BASED UPON ANY CHANGES IN SUCH FACTORS, IN OUR ASSUMPTIONS OR OTHERWISE. PART I In this Annual Report on Form 10-K, we will refer to Zhongpin Inc., a Delaware corporation, as "our company," "we," "us" and "our." ITEM 1. - BUSINESS OVERVIEW We are principally engaged in the meat and food processing business in The People's Republic of China (the "PRC"). Our product line includes over 200 unique meat products, including chilled pork, frozen pork, pig by-products and prepared meats, that are sold on a wholesale basis and on a retail basis through an exclusive network of showcase stores, network stores and supermarket counters under our "Zhongpin" brand. Our six processing plants, which are located in Henan and Heilongjiang Provinces in the PRC, have a total of nine production lines with an aggregate processing capacity of approximately 446 metric tons per day, based on an eight-hour working day, or approximately 160,560 metric tons on an annual basis. We also produce and sell vegetables and fruits, and have contracts with more than 120 farms in Henan Province and nearby areas to produce high-quality vegetable varieties and fruits suitable for export purposes. Our products are sold under the "Zhongpin" brand names. According to an October 2006 report of the United States Department of Agriculture, the PRC is the largest food consuming nation in the world and is the world's largest pork producer and consumer. The meat and meat processing industry in the PRC is regarded by the central government as a "key" industry and certain participants in the industry, including our company, receive special tax incentives and technology subsidies. According to a market analysis of the fresh and processed meat industry in the PRC published in June 2005 by Access Asia Limited, an independent research organization ("Access Asia"): o In 2004, domestic demand for meat and related products in the PRC totaled 72,360,000 metric tons and such demand is expected to reach 100,000,000 metric tons by 2010; o The total domestic production value of meat and related products in the PRC in 2004 was US$84 billion and the estimated production value in 2010 is expected to reach US$120 billion; o Domestic per capita meat consumption in the PRC was estimated to be approximately 49 kg in 2004 and is expected to increase to 70-80 kg by 2010; and o Per capita consumption of meat in urban areas in the PRC is twice the amount of the national average. At December 31, 2006, our customers included over 16 international or domestic fast food companies in the PRC, over 36 export-registered processing factories and over 1,531 school cafeterias, factory canteens, army posts and national departments. At such date, we also sold directly to over 2,721 retail outlets, including supermarkets, within the PRC. To differentiate our company from other market incumbents, we also have successfully implemented a unique retail strategy that includes the establishment of a network of showcase stores, branded network stores and supermarket counters that are exclusive retailers of our product lines. At December 31, 2006, we had a total of 96 showcase stores, 856 network stores and 1,769 supermarket counter locations. We believe we are a market leader in the meat and meat products industry in the PRC and that the principal strengths of our company are as follows: o We have a vertically-integrated fresh meat, meat products, fresh produce and fruit supply chain from farming, slaughtering, cutting, processing and wholesaling to retailing; o We have a wide distribution network through major areas of the PRC; o The "Zhongpin" brand name is well recognized in major areas of the PRC as an established and leading brand; o We have advanced production equipment for the packaging of meat and food; 2 o Our customers include some of the largest supermarket chains, such as Lianhua Supermarket Group, Carrefour China and Metro (China) Group; o We have implemented a comprehensive logistics management program and have an efficient delivery system that utilizes 192 temperature-controlled container trucks and public railway services; o Based upon our historical growth rates, we believe our experienced management team, led by our founder and Chairman, Mr. Zhu Xianfu, has the ability to grow and expand our business; o We have an emphasis on quality assurance systems; o We have a comprehensive brand building strategy and brand equity management; o We have an innovative product development program, with approximately 156 new products now under development; and o We experienced compound annual revenue growth of 56.15% (cumulative growth of 594%) and compound annual profit growth of 56.77% (cumulative growth of 604%) during the five-year period ended December 31, 2006. DEVELOPMENT OF BUSINESS We are a holding company and conduct substantially all of our production, marketing, finance, research and development, and administrative activities through our indirect subsidiaries located in the PRC. In 1993, Changge Meat Factory was established in the PRC as a state-owned meat processing factory from a spin off of a larger state-owned enterprise. In 1997, certain members of our current management team purchased the business in connection with a privatization scheme and restructured the enterprise under the name Changge Zhongpin Food Industry Co., Ltd. as a privately-held entity with six shareholders. In 2000, Changge Zhongpin Food Industry Co., Ltd. changed its corporate name to "Henan Zhongpin Food Share Co., Ltd." ("Henan Zhongpin") and, in order to comply with regulations under Chinese law regarding the use of the word "Share" in Henan Zhongpin's corporate name, Henan Zhongpin Food Co., Ltd. was incorporated as a wholly-owned foreign enterprise ("WOFE"). In 2001, Henan Zhongpin purchased Yanling Meat Factory and established a share-holding subsidiary company, Henan Zhongpin Industry Co., Ltd. In 2004, Henan Zhongpin established a subsidiary company, Henan Zhongpin Imports and Exports Trade Co., Ltd., to conduct its international business operations. To enable Henan Zhongpin Food Co., Ltd. to raise equity capital from investors outside of the PRC, on July 21, 2005, Henan Zhongpin Food Co., Ltd. established a holding company by incorporating Falcon Link in the British Virgin Islands. On September 15, 2005, Falcon Link acquired all of the equity interests in Henan Zhongpin Food Co., Ltd., which is the controlling shareholder of Henan Zhongpin. Various regulatory bodies in the PRC have issued regulations restricting foreign investment in domestic enterprises. Pursuant to the "Notice of Relevant Issues Concerning Foreign Exchange Administration for PRC Residents to Engage in Financing and Inbound Investment via Overseas Special Purposes Vehicles," or SAFE Circular No. 75, issued by the PRC State Administration of Foreign Exchange ("SAFE") on October 21, 2005, (i) a PRC citizen residing in the PRC (a "PRC Resident") must register with the local branch of SAFE before it establishes or controls an overseas special purpose 3 vehicle (an "SPV") for the purposes of overseas equity financing (including convertible debts financing); (ii) when a PRC Resident contributes the assets of or its equity interests in a domestic enterprise into an SPV, or engages in overseas financing after contributing assets or equity interests into an SPV, such PRC Resident must register his or her interest in the SPV and the change thereof with the local branch of SAFE; and (iii) when the SPV undergoes a material event outside of the PRC, such as a change in share capital or merger and acquisition, the PRC Resident must, within 30 days from the occurrence of such event, register such change with the local branch of SAFE. PRC Residents who are shareholders of SPVs established before November 1, 2005 were required to register with the local SAFE branch before March 31, 2006. In connection with the formation of Falcon Link, the six individual shareholders of Henan Zhongpin each submitted a registration form to the local SAFE branch and received all required regulatory approvals with respect to his respective ownership interests in the offshore company. Such shareholders are required to file an amendment to such registration if Falcon Link or our company experiences material events, such as changes in share capital, share transfers, mergers and acquisitions or the use of assets in the PRC to guarantee offshore obligations. We believe we and our subsidiaries, and the six individual shareholders of Henan Zhongpin, are in compliance with SAFE Circular No. 75 and all other laws and regulations in the PRC involving the formation of an SPV or the financing of a PRC company by an offshore company controlled by PRC residents. We were incorporated in the State of Delaware under the name "Strong Technical, Inc." on February 4, 2003. Prior to March 30, 2005, we had been engaged in the business of supplying skilled workers and engineering professionals (engineers, designers and draftspersons) to businesses on a temporary basis. Our efforts were focused primarily in the petro-chemical, pharmaceutical and nuclear power industries, and the personnel we supplied to our customers were independent contractors to our company. In early January 2005, Richard Armstrong, our Chairman of the Board, Chief Executive Officer and Chief Financial Officer at that time and reportedly the beneficial owner at that time of 422,642 shares of our common stock, or approximately 84.1% of the outstanding shares of our common stock, retained Scott Neil as a consultant to Mr. Armstrong and his family to explore opportunities to maximize the value of their shares of common stock of our company. Based upon discussions with representatives of prior management of our company in connection with the preparation of this prospectus, we believe Mr. Neil was assigned the task of seeking industry partners or other strategic purchasers for the company as a whole and exploring alternatives for maximizing the value of the Armstrong family ownership of our company, including the possibility of selling control of our company through the sale and transfer of the shares of our common stock beneficially owned by members of the Armstrong family. We have been advised that Mr. Neil was not paid any cash compensation for his consulting efforts, but instead was offered the opportunity to purchase shares of our common stock from Mr. Armstrong's son, Christopher Armstrong, which shares were at that time registered for resale under the Securities Act under our registration statement on Form SB-2 that was declared effective by the Commission on October 21, 2004. In consideration for his consulting services, on or about January 5, 2005, Mr. Neil purchased 17,257 shares of our common stock from Christopher Armstrong for nominal consideration, of which 15,983 shares were re-sold by Mr. Neil on March 30, 2005 as described below. In late February 2005, Mr. Neil approached Halter Capital Corporation, a company with which Mr. Armstrong had no prior relationship or dealings ("Halter Capital"), regarding the desire of Mr. Armstrong to raise funds through the sale of his shares of our common stock. In early March 2005, Mr. Neil introduced Mr. Armstrong to Kevin Halter, Jr., the President of Halter Capital. Between the date of such meeting and March 15, 2005, Messrs. Armstrong and Halter reached agreement that Halter 4 Capital would purchase 414,014 of Mr. Armstrong's shares for an aggregate purchase price of $273,500, and a definitive purchase agreement was executed by Halter Capital, Mr. Armstrong and our company on or about March 15, 2005. During the course of such negotiations, Mr. Armstrong inquired as to whether Halter Capital knew of other potential purchasers for the purchase of additional outstanding shares of our common stock, and Halter Capital introduced Mr. Armstrong to two investors who agreed on or about March 15, 2005 to purchase an aggregate of 84,584 shares of our common stock from Mr. Armstrong and other holders of our common stock. The individual purchasers and sellers of such shares, the number of shares transferred and the amount paid for such shares, are as follows: Aggregate Seller Number of Shares Purchase Price Purchaser ------ ---------------- -------------- --------- Heather Roberts 21,217 $ 500 Patricia Gunter Brigette McLemore 21,217 500 Richard Coombe Scott Neil 15,983 274,000 Patricia Gunter Stacy Gilfry 14,145 500 Richard Coombe Richard Armstrong(1) 7,355 500 Richard Coombe Jonathan and Suzanne Rich 2,405 25,000 Patricia Gunter Don Rogers 1,697 50,000 Patricia Gunter Christopher Armstrong 565 500 Richard Coombe -------- 84,584 -------- - ----------- (1) Of the 422,642 shares of our common stock owned by Mr. Armstrong on March 30, 2005, 414,014 shares were sold on such date to Halter Capital, 7,355 shares were sold on such date to Richard Coombe and 483 shares were subsequently sold in the open market. We have been advised that Mr. Armstrong has retained ownership of 790 shares. In determining the respective purchase prices of the shares sold on March 30, 2005 by Mr. Armstrong and the other selling stockholders of our company, Mr. Armstrong, such sellers and the purchasers agreed that an aggregate purchase price of $625,000 would be paid by the purchasers, and that Mr. Armstrong would be able to allocate the proceeds among the sellers in his discretion. Messrs. Armstrong and Neil had previously agreed that in consideration of the consulting services rendered by Mr. Neil to the Armstrong family, Messrs. Armstrong and Neil would share equally in the gross proceeds received by them in any sale of shares of our common stock to a purchaser introduced by Mr. Neil, including Halter Capital. In allocating the proceeds of such sale, Messrs. Armstrong and Neil agreed that Messrs. Armstrong and Neil would each receive $274,000 of the gross proceeds of such sale, Don Rogers and Jonathan Rich, each of whom had participated in the operations of our temporary staffing business at such time, would receive $50,000 and $25,000, respectively, from such proceeds and the four remaining selling stockholders would each receive $500 of such proceeds. We have been advised by Halter Capital that, at the time it acquired a controlling interest in our company, Halter Capital had no interest in pursuing our then-existing business operations and that it acquired our company with the view of using our company as an acquisition vehicle to acquire an operating company located in the PRC. On March 30, 2005, Halter Capital acquired an 82.4% controlling interest in our company from Mr. Armstrong and on such date we discontinued our operations as a supplier of temporary personnel. In connection with such acquisition, all of our officers and directors at that time, including Mr. Armstrong, resigned as officers and directors of our company, Mr. Halter was elected as a director of our company and as our President and Chief Executive Officer and, pursuant to the purchase agreement relating to such acquisition, we transferred and assigned to 5 Mr. Armstrong all intellectual property rights, customer lists, provider lists and agreements, business methods and goodwill associated with the technical staffing business of our company. Commencing on March 30, 2005, we continued our operations as a public "shell" corporation with no significant revenues or assets as we attempted to develop various business opportunities in the PRC. In mid-December 2005, Mr. Halter was introduced by Halter Financial Group, L.P., which in turn was introduced by representatives of Pinnacle China Fund, L.P., an institutional investor that was at that time considering an investment in our company, to representatives of Falcon Link, which was in the process of raising capital in the United States and was seeking a public "shell" company with which it could enter into a business combination for the purpose of establishing a publicly-traded holding company in the United States. Between the date of such introduction and January 30, 2006, Mr. Halter negotiated with representatives of Falcon Link, including representatives of TN Capital Equities Ltd., the placement agent for Falcon Link's private placement in the United States, and Falcon Link's counsel, regarding the terms of a proposed business combination between our company and Falcon Link. On January 30, 2006, we acquired all of the outstanding shares of Falcon Link in exchange for the issuance by us of an aggregate of 11,250,005 restricted shares of our common stock to the shareholders of Falcon Link. In connection with such share exchange, all of our officers and directors at that time, including Mr. Halter, resigned as officers and directors of our company, and our current directors were elected to our board and our current executive officers were appointed. In addition, Falcon Link entered into an advisory agreement with HFG International Limited, a Hong Kong corporation affiliated with Halter Financial Group, L.P. ("HFG"), pursuant to which Falcon Link paid HFG a fee in the amount of $350,000 in consideration of advisory and consulting services to be rendered by HFG relating to Falcon Link's efforts to operate as a U.S. public company. As a result of our share exchange with Falcon Link, which is commonly referred to as a "reverse acquisition," Falcon Link became our wholly-owned subsidiary and we changed our corporate name to Zhongpin Inc. Our corporate organizational chart is set forth below. 6 - ----------------------------------------- ZHONGPIN, INC. - ----------------------------------------- | | 100% \|/ - ----------------------------------------- FALCON LINK INVESTMENT LIMITED (B.V.I.) - ----------------------------------------- | | 100% | | OUTSIDE CHINA \|/ ================================================================================ | | IN CHINA \|/ - ----------------------------------------- ---------------------------- HENAN ZHONGPIN FOOD CO. LTD. (WOFE) INDIVIDUAL SHAREHOLDERS(1) - ----------------------------------------- ---------------------------- | /|\ | | |------------| | | | 90% IN TRUST | 10% | | \|/ \|/ ------------------------------------------------------- HENAN ZHONGPIN FOOD SHARE CO., LTD. ------------------------------------------------------- | | 100% \|/ ------------------------------------------------------- HENAN ZHONGPIN INDUSTRY CO., LTD. HENAN ZHONGPIN IMPORTS AND EXPORTS TRADE CO., LTD. ZHUMADIAN ZHONGPIN FOOD LTD. ANYANG ZHONGPIN FOOD CO., LTD. DEYANG ZHONGPIN FOOD CO., LTD. HENAN ZHONGPIN FRESH FOOD LOGISTICS CO., LTD. HENAN ZHONGPIN BUSINESS DEVELOPMENT CO., LTD. ------------------------------------------------------- - ------------ (1) Under the laws of the PRC, Henan Zhongpin is required to have at least five individual shareholders to use the word "share" in its corporate name. In connection with the formation of Henan Zhongpin, each of the individual shareholders of Henan Zhongpin (Xianfu Zhu (7.16%), Baoke Ben (0.74%), Shuichi Si (0.53%), Qinghe Wang (0.54%), Chaoyang Liu (0.55%) and Juanjuan Wang (0.47%)) entered into an agreement with Henan Zhongpin Food Co., Ltd., the controlling shareholder of Henan Zhongpin, pursuant to which such individual shareholders irrevocably assigned to Henan Zhongpin Food Co., Ltd. all of the economic benefits to which he is or may be entitled as a shareholder of Henan Zhongpin. As a result of such agreements, Henan Zhongpin Food Co., Ltd., which is a wholly-owned indirect subsidiary of our company, is entitled to 100% of any cash dividends declared and paid by Henan Zhongpin and to vote all outstanding shares of capital stock of Henan Zhongpin in any action by the shareholders of Henan Zhongpin. In connection with Henan Zhongpin's formation of Falcon Link in July 2005, Falcon Link's share exchange with our company on January 30, 2006 and our private placement of Series A convertible preferred stock and warrants on January 31, 2006, we or our subsidiaries were advised by Greenstone Investment & Consultants, Ltd., a financial consulting firm based in the PRC ("Greenstone"), under consulting agreements entered into by Henan Zhongpin and Greenstone in April 2005. Pursuant to the terms of such agreements, we paid Greenstone consulting fees of $100,000 in each of 2005 and 2006 and a consulting fee of $414,000 in connection with the consummation of our January 2006 private placement and the acquisition of Falcon Link by our publicly-held "shell" corporation. INDUSTRY OVERVIEW THE MEAT INDUSTRY IN THE PRC. According to an October 2006 report of the United States Department of Agriculture, the market for pork in the PRC is the largest in the world, accounting for approximately 53% of global production and consumption. In value terms, the PRC's overall meat industry is the second largest sector in the country's entire retail food market basket. Historically, the 7 vast majority of meat sales in the PRC have taken place in free wet markets, most of which are to be found in open-air markets or on streets. These markets provide a venue through which the customer can buy live poultry or freshly slaughtered meat produce direct from local farmers. However, as a result of new hygiene regulations that were introduced by the Chinese government in 1995, governmental agencies recently have encouraged the replacement of open air markets by supermarkets and convenience stores, and the market share of open air markets has continued to decline. We believe this trend will favorably impact our wholesale business and will add additional customers for the network of showcase stores, branded network stores and supermarket counters that retail our products on an exclusive basis. The meat industry in the PRC is characterized by fragmentation, sanitation and hygiene issues, as well as social demographic trends. The meat industry is highly fragmented, and supply is extremely localized with limited distribution capability. The PRC's vast geography and under-developed transport infrastructure have made it difficult to create national or even regional level competition in the industry and thus, there are no genuine market leaders. According to a market analysis of the fresh and processed meat industry in the PRC prepared in June 2005 by Access Asia, o In 2004, the meat sector (fresh, frozen and processed) made up 13.23% of the total value of the PRC's retail food market basket, a proportion that has remained relatively constant; o The total retail value of the PRC's fresh meat sector was approximately RMB313.33 billion (US$37.86 billion) in 2004; and o The fresh meat sector continues to dominate the total meat and meat products market in the PRC, which registered a value of RMB334.96 billion (US$40.47 billion) in 2004. Social and demographic trends have dictated a switching of consumer preference from processed meat in the earlier decades to a growing demand for frozen and fresh/chilled meat. According to Access Asia, factors that initiated this structural change include: o Increasing demand and ownership in the PRC of household appliances, especially refrigerators and microwave ovens. By the early 1990's, the penetration rate for household ownership of refrigerators was close to 100% in many major cities, depending on the economic prosperity of the region. o Improvements in hygiene and sanitation, and the establishment of the cold chain infrastructure, in the PRC have elongated the wholesale and retail process. The cold chain infrastructure refers to the complex network of processes and services used to transport and preserve edible products in a controlled temperature environment. Modern preparation and storage methods in the PRC have resulted in longer life cycles for frozen and fresh/chilled meat products. Superior taste and nutrition, aided by the cold chain infrastructure have allowed fresh/chilled and frozen meat products to become preferences for today's consumers in the PRC, at the expense of highly processed meat products. 8 o Increases in per capita income in the PRC, as well as a proportionate share of such increase spent on food. In the PRC, roughly one-third of every new dollar of income is spent on food, and meat is a major target for much of the new spending. o The PRC's new middle class, defined as those with annual incomes of at least 40,000 RMB (US$5,000), numbered approximately 60 million people in 2002 and, according to Access Asia, is expected to climb sharply to 160 million by 2010. There are no governmental restrictions on the ability of foreign entities to enter the meat and food processing business in the PRC, which has been designated an encouraged industry for foreign investment. THE RETAIL MEAT MARKET. According to Access Asia, total volume sales of fresh and processed meat and meat products in the PRC increased to 25.69 million tons (23.30 million metric tons) in 2004, which represented an increase of approximately 46.74% from 1998 sales levels. Access Asia also reported that, as the market matures, total growth is expected to continue its slowdown, eventually settling at approximately 5-6% per annum in volume terms. Consumption volumes are likely to increase as more consumers reach a standard of living that enables them to eat meat and meat products at home on a more frequent basis. According to Access Asia, in 2004, the meat and meat products sector in the PRC accounted for 13.23% of the national retail food market basket in terms of value, which was second only to the vegetable sector. Prior to the economic reforms that commenced in the PRC in 1978, meat was traditionally eaten in the PRC only when money could allow, or on special occasions. As a result, as recently as 25 years ago, regular meat consumption was out of the reach of approximately 200 million people living under the absolute poverty line. The introduction of economic reforms in the PRC in the late 1970s has allowed the number of citizens living under absolute poverty levels to decline to less than 50 million individuals. This has enabled more consumers to enjoy meat on a regular basis. In the cities, most consumers can afford to eat meat at any time without regard to cost. As a result, not only are more people buying fresh meat in the PRC, but there also is increasing demand for a wider range of processed meat products. The market has quickly evolved to meet this demand, helped by the emergence and spread of efficiently managed grocery and retail chains - notably supermarkets, convenience stores and hypermarkets. The retail market for fresh and processed meat and meat products in the PRC has grown strongly over the past ten years due, primarily, to the following key factors: o Increased consumer spending power, which has lead to raised consumer aspirations and the ability of consumers to make more frequent purchases of fresh and processed meat and meat products, as well as purchases of more expensive products; o Rationalization and consolidation of the PRC's domestic industry has improved industry productivity and profitability, and has raised the level of market supply; o Development of more integrated distribution systems and infrastructure throughout the PRC, which has lead to better distribution around the country from manufacturer to retailer; and 9 o Increased market penetration of more organized retail outlets with chilled and frozen produce display cabinets which, in turn, has created a larger overall outlet for fresh and processed meat and meat products. These factors have led not only to increased consumer demand, but also to improvements in the ability of meat processors and distributors to get their products to consumers in fresher condition. The meat processors also have helped to increase demand by improving the variety of products they are able to supply. BUSINESS STRATEGY Our long-term business strategy is to establish our company as the leading provider of meats and fresh foods in the PRC. Our goal is to increase our market presence and to provide our customers with the highest quality, freshest, healthiest, most nutritious and safest meat and food products. The key elements of our growth strategy include the following: INCREASE OUR BRAND RECOGNITION. We believe sustainable growth can best be achieved through a recognizable brand name, and we are focused on building the best nationally-known brand name in the food business in the PRC. We intend to invest heavily in building our "Zhongpin" brand as a unique identity and to position our brand platform to create the perception and image of "HEALTH, NUTRITION, FRESHNESS AND QUALITY" in the minds of our customers. We intend to build our brand by building a comprehensive brand awareness program that will focus on advertising and promotion, pricing strategies, distribution channels and packaging design and functionality. In addition, in order to differentiate the quality of our products from those of our competitors and to help foster strong brand recognition with consumers, we have supplemented our wholesale distribution channels by establishing and implementing a network of specialty, high-end boutique grocery stores to showcase our meat, vegetable and fruit products. At December 31, 2006, we had 96 showcase stores, 856 network stores and 1,769 "Zhongpin" supermarket counters. We believe our retail stores will help create additional brand awareness that will benefit our wholesale customers and will showcase all of our products in a manner that will provide the consumer with a broader view of our strategies and goals. EXPAND OUR MARKET PRESENCE. In the PRC, the pork industry is highly fragmented and supply is extremely localized with limited distribution capability. The vast geography and under-developed transportation infrastructure in the PRC have made it difficult to create national or even regional competition in the meat and fresh foods industry, and no genuine market leaders have emerged. We regard our logistics capabilities as the keystone to our growth strategy and believe our comprehensive plan for logistics management, which includes the integration and coordination of our transportation, warehouse management and inventory control systems, as well as the integration of our marketing and manufacturing efforts, will enable us to accelerate our growth by expanding our operations across the PRC and internationally. At December 31, 2006, we operated sales offices and warehouses in over 50 cities in the PRC, including Shanghai, Beijing, Guangzhou, Zhengzhou, Wuhan and Xi'an. We plan to expand our network of sales offices and warehouses in up to 14 additional cities in the PRC by the end of 2007, and are targeting cities with over 1,000,000 residents, annual per capita income exceeding 10,000 RMB ($1,245) and good infrastructure, including transportation, telecommunications and a positive commercial environment. 10 We may also pursue an acquisition strategy to increase the number or type of products we offer, increase our manufacturing or production capabilities, acquire animal or agricultural farms to strengthen our sources of supply, or broaden our geographic reach and our ability to sell and distribute products in domestic and overseas regions in which we do not currently transact business. We believe the industry in which we operate is highly fragmented and that significant opportunities are available to a business that can consolidate production and sales capabilities and the resources of a number of existing producers in the fresh meat and produce markets, including the cost savings that are inherent in a vertically integrated business. EXPAND OUR PRODUCT LINES. At December 31, 2006, our product line included over 200 unique meat products and over 20 different categories of vegetables and fresh fruits. In 2000, we established a research and development center to help us develop new processing technologies and food products. We also work with 16 unaffiliated scientists and experts who act as our outside technical consultants in the development of new processes and products. Our strategic planning and marketing departments also conduct market studies, seek to spot developing trends in the meat and fresh foods industries and evaluate the ever-changing consumer consumption patterns in the PRC. We intend to strengthen our market position and accelerate our growth by introducing new lines of low temperature meat products with a view to maintaining customer interest and creating new demand. We also believe the introduction of new products will broaden our product range and make it more difficult for new competitors to enter the market or to attain significant sales or market share upon entry into the market. At December 31, 2006, we had approximately 156 new products under development. MAINTAIN OUR TECHNOLOGICAL SUPERIORITY. We have pursued an integrated approach in designing our operations and have formulated a strategy to address the current issues in the meat and fresh foods industry in the PRC, such as hygiene, sanitation and distribution capability, that have hindered the development of national brands by the larger incumbents in the industry. We have purchased state-of-the-art equipment and installed production lines with the most current technology in our processing plants. In addition, our advanced information technology capability furnishes management with real time information flow that enables all of our functional departments, including marketing, sales, strategic planning, logistics management, procurement, retail, trading and export, to exploit and utilize timely information on pricing, demand, transportation and inventory levels. We believe our logistics management capabilities also provide us a competitive advantage by allowing us to implement significant modifications in our logistics systems on a quick response basis. With feedback from our marketing and sales teams, procurement department and strategic planning group, we can modify our systems in response to changes in the marketplace, competition, government regulations and technology, such as the use of bar codes and electronic interchange to enhance the speed and accuracy of information. OUR PRODUCTS OUR PORK PRODUCTS. The chilled and frozen pork products we produce are sold as various cuts of meat, such as the shoulder, the ribs, the loin or the leg. Other parts of the pig, such as the head, ears, trotters and internal organs, have a ready market in the PRC and are also distributed and sold by us. The pork products produced by our abattoirs are sold to a wide variety of customers, such as meat and food distributors, wholesalers and importers, food and food processing companies and markets and supermarkets. Our pork products are distributed and sold locally in the domestic market and also are exported. 11 CHILLED PORK. In our production of chilled pork, meat is chilled but not frozen at a temperature of between 32o F (0oC) and 39.2oF (4oC), immediately after it is cut and packed, and thereafter maintained at that temperature during storage or transportation. This serves to preserve the freshness and quality of the meat. Chilled pork will usually have to be consumed within one week from the time of slaughter. While chilled pork generally is more costly than frozen pork, our market research indicates a trend among customers toward chilled pork and away from frozen pork. Most of the chilled pork we produce is distributed and sold to domestic customers who comprise mainly fresh food distributors and wholesalers, markets and supermarkets located within a 500 km delivery radius of our processing facilities. FROZEN PORK. In the production of our frozen pork, the meat is frozen at - -31oF (-35oC) to -40oF (-40oC) for 48 hours, after which it is stored or transported at a constant temperature of between -0.4oF (-18oC) to -13oF (-25oC). Generally, frozen pork can be kept for about six months from the time of slaughter. Frozen pork is cheaper relative to chilled pork at the retail level. Food and food processing companies usually require frozen pork in their production of processed meats such as luncheon meat and canned, stewed meat. In the PRC, most of the pork sold in markets, supermarkets and restaurants is frozen. The domestic customers for our frozen pork include food processing companies and food distributors. PIG BY-PRODUCTS & VARIETY MEATS. Pig heads, ears and trotters and the internal organs, such as the kidneys, livers, stomachs and intestines, are commonly used in Chinese cuisine and therefore have a ready market. We usually sell these by-products and variety meats to domestic customers. These items are also sold to food processing companies to be used as raw materials for other meat and meat-based products. PREPARED MEATS. We also produce a line of prepared meats, such as sausages, hams and Chinese cured hams, that includes more than 113 items that are marketed under our "Zhongpin" brand. OUR FRUIT AND VEGETABLE PRODUCTS. We contract with more than 120 farms in Henan Province and nearby areas to produce high quality vegetable varieties and fruits suitable for export purposes. We have contracted with farms close in proximity to our operations to ensure freshness from harvest to processing. The farms are relatively small, ranging in size from 24.7 acres to 123.5 acres (10-50 hectares), with the largest being approximately 1,358.5 acres (550 hectares). We contract to grow more than 20 categories of vegetables and fruit, including asparagus, sweet corn, broccoli, mushrooms, lima beans, strawberries and capsicum. In recent years, we have worked closely with the Henan Academy of Agricultural Sciences in the PRC to improve the yield and quality of crops. Since 2001, we have been contracting with farms to produce selected vegetables and fruits. Our technicians are sent to candidate farms to test the soil and water quality and to evaluate local climatic conditions. Vegetables and fruit grown at the candidate farms are evaluated in our laboratories. If the quality of the farm products meets our standards, we enter into a contract with the farm for the purchase of a stated minimum amount of products. Seeds, fertilizer and pesticides are generally provided by us to the contracted farm at wholesale prices. During the growing season, the vegetables or fruit at the contracted farms are monitored and tested. At harvest, produce is tested and purchased based on product criteria stated in the contract. 12 MANUFACTURING AND PRODUCTION For each of the years ended December 31, 2004, 2005 and 2006 substantially all of our assets, including all of our material assets, were located in the PRC. We own and operate two abattoirs, one in Changge City, Henan Province and the other in Yanling, Henan Province, and we lease and operate an additional abattoir in Hailun City, Heilongjiang Province, to carry out the business of slaughtering pigs and the production and sale of chilled and frozen pork products. The abattoirs include six processing plants, with a total of nine production lines. Our current total production capacity for chilled pork and frozen pork is 446 metric tons per day, based on an eight-hour working day, or approximately 160,560 metric tons on an annual basis. We also have production capacity for prepared meats of 40 metric tons per eight-hour day (or approximately 14,400 metric tons on an annual basis) and for fruits and vegetables of 35 metric tons per eight-hour day (or approximately 12,600 metric tons on an annual basis). We utilize state-of-the-art equipment in all of our abattoirs and processing facilities. We plan to increase our production capacity as follows: o On February 23, 2006, we put into production a third fully-dedicated case-ready plant in Zhongpin Industrial Park at which, on a daily eight-working-hour basis, we butcher and process an average of 2,000 pigs (approximately 166 metric tons). We plan to invest approximately $3 million to increase the prepared meat processing capacity at this plant by 10,800 metric tons on an annual basis. o We plan to invest approximately $14 million to construct a new production facility in southern Henan Province. This facility is designed with a production capacity for chilled and frozen pork of 200 metric tons per eight-hour working day, or approximately 72,000 metric tons on an annual basis, of which 60% of production capacity is designed for the production of chilled pork and 40% for the production of frozen pork. We plan to put this new plant into operation in the second quarter of fiscal 2007. o We plan to invest approximately $13.5 million to construct a new facility in northern Henan Province with a production capacity of 175 metric tons per eight-hour working day, or approximately 63,000 metric tons on an annual basis. Approximately 60% of the production capacity will be designed for the production of chilled pork and approximately 40% will be designed for the production of frozen pork. We plan to put this new plant into operation in the third quarter of fiscal 2007. We procure pigs from local pig farms and breeders located in the vicinity of Changge City, Henan Province for our abattoirs located in Henan Province. In addition, we procure pigs from local pig farms and breeders located in the vicinity of Hailun City, Heilongjiang Province for our leased facility in Heilongjiang Province. All the pigs we purchase for slaughtering in our abattoirs must have all the health certificates issued by the relevant authorities in the PRC to ensure that the pigs have been under strict and consistent supervision during the rearing period and are in good health when they are purchased by us. In addition, the pigs slaughtered in our abattoirs are also subject to inspections by our own team of certified veterinarians. PRODUCTION OF CHILLED AND FROZEN PORK PRODUCTS. Our veterinarians ensure that only healthy pigs are slaughtered at our abattoirs. We maintain all of the required licenses and certificates from the 13 relevant central and local government authorities with regard to our pork production business. In May 2002, we were awarded ISO 9001 certification that covers our production, research and development and sales activities. The ISO 9001 certification indicates that our abattoirs and pork production operations comply with international standards of quality assurance established by the International Organization of Standardization. All of our production lines have also passed HACCP (Hazard Analysis and Critical Control Point) under GMP (Good Manufacturing Practice) and SSOP (Sanitation Standard Operating Procedure in the PRC). When pigs arrive at the abattoirs, our certified veterinarians, together with the local Animal Husbandry Department inspectors, conduct a physical inspection of the pigs to ascertain whether they are fit for human consumption. Blood and urine samples are obtained from a random sample of pigs which are tested for disease. The pigs are then weighed and are quarantined for approximately 24 hours, during which time only water is provided to the pigs. After the quarantine period has passed, we conduct another physical inspection of the pigs. This physical inspection is conducted jointly with the inspectors from the Animal Husbandry Department. Pigs that are found fit for human consumption will be slaughtered while those found to be deficient are immediately culled. We shower the pigs with water before and after slaughter to clean them. Instruments used for slaughtering and cutting up the carcasses are sterilized several times a day. Quality control checks are conducted at all production stages to detect and remove meat that is spoiled or has been infected by bacteria. The appearance of the skin, internal organs and the meat itself are subject to physical observation and laboratory testing to see if the pig is diseased. Every pig that is slaughtered in our abattoirs is assigned a serial number so that a trace can be run on any processed pig. All of these quality control checks are conducted by our veterinarians and quality control staff. A high level of hygiene is maintained at our abattoirs. All staff and visitors who enter the abattoirs must first put on protective clothing and be sterilized with disinfectant. All packaging materials used for meat also must be sterilized. At December 31, 2006, a total of 106 employees worked in our quality assurance program, of which 18 were quality control engineers and 88 were staff. The quality control laboratory meets and exceeds all standards set by the authorities and relevant agencies in the PRC. STORAGE AND TRANSPORTATION OF PORK PRODUCTS. The pork products from freshly slaughtered pigs at our abattoirs are blast frozen after slaughtering to prevent deterioration of the meat caused by bacteria or chemical changes. Frozen meat is stored in cold storage facilities at a temperature of between-9.4oF (-23oC) and - -0.4oF (-18oC) for 24 hours before being transported. Chilled meat is chilled to between 32oF (0oC) and 39.2oF (4oC) before being transported to customers. The chilled and frozen pork is maintained within the requisite temperature ranges during subsequent handling, transportation and distribution to retain freshness and to prevent deterioration of the meat. SALES, MARKETING AND DISTRIBUTION Our key customers are principally supermarkets and large retailers in the PRC. For the years ended December 31, 2004, 2005 and 2006, sales to our five largest customers amounted in the aggregate to approximately $11.1 million, $15.5 million and $28.76 million, respectively, accounting for approximately 26%, 22% and 20%, respectively, of our total revenue. For the years ended December 31, 2004, 2005 and 2006, no customer accounted for 10% or more of our consolidated revenues. No material amount of our business is dependent on government contracts. 14 Sales volume for the meat industry typically increases during the period leading to the one-week celebration of the Chinese Spring Festival, which usually takes place in early February. In general, demand for pork tends to be the greatest during the first quarter of the year due to the tendency of consumers to eat greater amounts of meat during the Spring Festival and the colder period of the year. The third quarter typically is the slower season for the industry due to the slight drop in meat consumption during the hot summer months. In general, we do not expect a material seasonal impact on our revenues. We have sales offices and warehouses in 50 cities in the PRC, extending from Henan Province, in which our headquarters is located, to South China, East China, North China and the South midland of the PRC. We plan to further expand our network of sales offices and warehouses in 14 other cities in the PRC by the end of 2007 in order to meet consumer demand. We market our pork products through a sales team and a network of agents in 24 provinces, including four cities with special legal status, throughout the PRC. The sales team is responsible for securing orders for our pork products, maintaining and building relationships with existing customers and for securing new customers. Our sales team is also involved in identifying new markets in line with the existing customer base and our geographical expansion plans. Our sales teams travel to major cities in the PRC, such as Shanghai, Beijing, Wuhan and Zhengzhou, to market and sell our pork products to wholesale markets and selected retail chains in those cities. We usually transport pork products by refrigerated trucks. Railroads are used for transporting pork products to those cities that are located at a distance from our operations center in Changge City, Henan Province and our leased facility in Hailun City, Heilongjiang Province. In addition, our sales teams travel and market pork products, vegetables and fruits to potential customers in Europe, Russia, Hong Kong and selected countries in Asia and South Africa. During the years ended December 31, 2004, 2005 and 2006, we exported approximately 2,588 tons (2,630 metric tons), 4,011 tons (4,076 metric tons) and 5,031 tons (5,111 metric tons), respectively, of pork products, and 846 tons (860 metric tons), 1,102 tons (1,120 metric tons) and 4,653 tons (4,727 metric tons), respectively, of vegetables and fruits. The following table sets forth for the three years ended December 31, 2006 the amount and percentage of our revenues derived from our sales of products to customers located in the United States, the PRC and all foreign countries other than the PRC based upon the locations to which our products were shipped. YEAR ENDED DECEMBER 31, 2006 2005 2004 --------------------- --------------------- ---------------------- AMOUNT PERCENTAGE AMOUNT PERCENTAGE AMOUNT PERCENTAGE -------- ---------- ------- ---------- ------- ---------- (U.S. DOLLARS IN MILLIONS) The People's Republic of China.. $ 131.59 91.5% $ 65.91 89.8% $ 38.72 90.5% Other foreign countries......... 12.22 8.5 7.49 10.2 4.07 9.5 United States of America........ -- -- -- -- -- -- -------- ------- ------- ------- ------- ------- Totals................... $ 143.81 100.0% $ 73.40 100.0% $ 42.79 100.0% ======== ======= ======= ======= ======= =======
We also sell directly to selected chains and independent resellers. Some of the major selection criteria we employ to screen resellers are as follows: o Market potential of the reseller's location; 15 o Competitiveness of the local market; o Location and coverage; o Traffic density; and o Credibility of the operator and market development capacity. RETAIL OPERATIONS We have successfully established a unique, vertically-integrated fresh meat and meat products supply chain from farming, slaughtering, cutting, processing and wholesaling to retailing via an exclusive network of showcase stores, network stores and supermarket brand counters. We believe our unique business model differentiates our company from other major national meat and meat products producers in the PRC. We have supplemented our wholesale channels by establishing a unique retail network to establish a second sales channel while minimizing channel conflict. We believe that by broadening awareness of our entire product line, our retail stores will help drive the revenues of all of our business lines, including the revenues of the retailers that are wholesaling portions of our product line. Our advertising also generally promotes our brands rather than a particular store, in an effort to drive business to every retailer that carries our products and not just to our network of retail stores. The Company's marketing goals are not designed to take business from the supermarkets or other partners of our company, but to increase the overall number of buyers of our branded products. SHOWCASE STORES. Based on market research and evolving consumption trends, we have taken a customer-driven marketing approach and have focused on a core customer segment that consists of the new middle class in the PRC, which generally includes the rapidly increasing number of middle class households with annual income above RMB40,000 (U.S.$5,000). We believe this consumer segment has disposable income and a willingness to spend on quality goods and services. A study conducted by MasterCard International concluded the middle-class segment of the PRC numbered approximately 60 million people in 2002 and is expected to climb sharply to 160 million people by 2010. As a result, we are pursuing a first-mover advantage and have developed the concept of high-end specialty boutique grocery chain stores to offer our products and other merchandise for the convenience of a typical two-income, middle-class family that shops daily after work. The showcase stores are designed to highlight all of our products, as well as to provide customers with a broad view of our strategies and goals. At December 31, 2006, there were 96 showcase stores, most of which were located at "Main & Main" locations in major cities within Henan Province. The showcase stores are owned and operated by independent operators, but share the same design and physical layout, and are managed in accordance with our operating procedures. All employees of these stores are required to undergo our vigorous three-month training program. In addition, we establish the merchandising and pricing policies of these stores. On average, approximately 85% of all revenues generated in these stores are derived from sales of our products. NETWORK STORES. In addition to the showcase stores, we sell products through network stores that are owned and operated by independent operators. At December 31, 2006, there were 856 network stores that were generally located in the larger cities in Henan Province and adjoining provinces. We provide the operators of the network stores standardized physical designs and layouts for each store, and the 16 operators of the network stores manage the business following our management guidelines and pricing policies. Each store has the right to use "Zhongpin" logos and brands. On average, approximately 70% of the revenues generated from such stores are derived from the sale of our branded products. ZHONGPIN SUPERMARKET COUNTERS. We also have established "Zhongpin" supermarket counters in supermarkets and local markets. At December 31, 2006, there were 1,769 Zhongpin supermarket counters. The counters are exclusive purveyors of our meats and meat products. These counters are owned and operated by the supermarkets and local markets. A majority of the "Zhongpin" counters at supermarkets use our standardized physical design and layout in addition to related rules and guidelines provided by the supermarket partners. RESEARCH AND DEVELOPMENT Research and development continues to be a significant component of our strategy to extend our existing brands and product lines and expand into new branded items and product lines. In 1999, Henan Zhongpin founded Zhongpin Technology Research and Development Center, a food research institute in Changge City, Henan Province. In 2000, Henan Zhongpin established a technology center, which has evolved into the technical research center for the entire meat industry in Henan Province. At December 31, 2006, the research center employed 51 scientists and technicians. The mission of the research center is to develop new processing technologies and food products. In addition, our product development team works with the China Meat Processing Research Center, the premier research institute for meat processing technology in the PRC, and we have jointly established a research center in Beijing. We also work with scientists and researchers from Beijing University, China Agricultural University, the Chinese Academy of Agricultural Science, Henan Agricultural University and other universities to develop production technologies and innovative meat products. At December 31, 2006, we had relationships with 16 scientists and experts who act as our outside technical consultants. The meat and meat processing industry in the PRC is regarded by the central government as a "key" industry and certain participants in the industry, including our company, receive special technology subsidies and research grants for undertaking "technologies plan projects" for the government. To receive these subsidies and grants, the recipients must complete the research and development objectives assigned by the government, and all funds must be used to pay project-related costs, such as training fees, laboratory costs or the costs of importing technology. As a qualified company, we are undertaking research and development projects for both the central government and the Henan provincial government. During 2006, we launched over 40 new products that were developed in our technology center and we currently have approximately 156 new products under development. Our expenditures for research and development for the years ended December 31, 2004, 2005 and 2006 were approximately $435,000, $723,000 and $1,057,000, respectively. INTELLECTUAL PROPERTY We regard brand positioning as the core of our competitive strategy. Since the ultimate aim of our business strategy is to satisfy the customer, gaining a valued position in the minds of customers is of paramount importance. Our branding process seeks to create a unique identity and to properly position our brand platform. We intend to position our "Zhongpin" brand, and to protect our brand identity, in order to create the perception and image of "HEALTH, NUTRITION, FRESHNESS AND QUALITY" in the minds of our customers. 17 We have registered our "Zhongpin" trademark in the PRC, Australia, Belgium, France, Germany, Holland, Japan, Luxemburg, Russia, Singapore, South Korea, Spain and the United Kingdom. We have applied, or are in the process of applying, to register this mark in a number of other significant jurisdictions around the world, including the United States, Canada and the Philippines. We believe we have the right to use our "Zhongpin" trademark for the product categories for which it is currently used. However, there can be no assurance that any application we make to register such mark, or any other tradename or trademark we may seek to register, will be approved and/or that the right to the use of any such trademarks outside of their respective current areas of usage will not be claimed by others. If trademarks are issued, there can be no assurance as to the extent of the protection that will be granted to us as a result of having such trademarks or that we will be able to afford the expenses of any complex litigation that may be necessary to enforce our trademark rights. Our failure to enforce successfully our trademark rights may have a material adverse impact on our business. We also may seek to register our "Zhongpin" trademark, or any other tradenames or trademarks we may develop, in certain jurisdictions as a protective measure against the unauthorized use or registration of such marks by third parties that are not affiliated with our company. For example, while we have not in the past either directly or indirectly through our affiliates or, to our knowledge, indirectly through unaffiliated third-party distributors marketed or sold any of our products in North Korea, and we have no intention or plans to do so in the future, we took steps to register our "Zhongpin" mark in North Korea to protect against the use of such mark by unauthorized third parties. While such application for registration has been withdrawn, we may take similar steps to protect our marks and other intellectual property against unauthorized appropriation in other jurisdictions. COMPETITION The production and sale of meat and food products in the PRC and internationally are highly competitive. There are numerous producers of processed meat products in the PRC, a number of which market their products under different brand names. We believe most of these producers have only one or two lines of production facilities and sell their products primarily in the areas surrounding their facilities. Due to the lack of logistics capabilities, we believe there are no national market leaders in the meat industry in the PRC. As a result, our products compete with different brands in different areas of the PRC. A number of our competitors, including Henan Shuanghui (Shineway) Food Co., Ltd., Yurun Food Group Limited and People's Food Holdings Limited, have greater resources, own or control more processing plants and equipment, or offer a larger product line than we do. In addition, a number of the world's largest food processing companies have recently established joint ventures with food manufacturers or producers in the PRC, and we expect competition from these ventures to increase in the future. We believe all food segments in the PRC compete on the basis of price, product quality, brand identification and customer service. Through our aggressive marketing and strong quality assurance programs, our competitive strategy is to provide a higher quality of products that possess strong brand recognition, which will in turn support higher value perceptions from customers. GOVERNMENT REGULATION The PRC government is actively promulgating a plan for "safe meat" and is expected to raise the proportion of slaughtering automation to over 70% of all meat and actively enforce authorized slaughtering and quarantine. Special grants, subsidized financing, preferential tax policies, governmental 18 funding and other subsidies are provided to enterprises in order to acquire state of the art technology and equipment in meat processing. Such government incentives provide competitive advantages and opportunities to well-performing companies because such policies work to raise the bar for entering the industry and to eliminate inefficient companies in the industry. We expect such government support for the processing of agricultural products to continue for a number of years in the foreseeable future. However, the determination as to whether we can continue to benefit from such government programs in the future will depend on how the government administers its incentive programs and how well we perform. If we maintain the current trend in our performance, it is possible we may obtain further government support through such incentive programs. The 10th Five-Year Development Programming of the China Meat Industry, promulgated in 2001, set the following guidelines: o Encourage comprehensive improvements in automation of abattoirs in "First-Tier" and "Second-Tier" cities and key provinces to improve the sanitary condition and the safety of meat products consumption. In the PRC, First-Tier cities refer to provincial capitals, municipalities directly under the Central Government (such as Beijing, Shanghai, Tianjin, and Chongqing), and municipalities directly linked with the Central Government in taxation (i.e., such cities do not need to send revenues to the provincial government) (such as Shenzhen, Ningbo, Qingdao, Dalian and Xiamen), whereas Second-Tier cities refer to cities with a population above 500,000, not including First-Tier cities. o Develop efficient scale production of pork, beef, mutton, poultry and eggs; o Develop processed meat and poultry products, with emphasis on chilled fresh meat, packaged meat and ready-to-eat meat products; o Encourage consolidation of fragmented producers and distributors to form scale enterprises; o Foster quality brands and modern chain distribution networks with emphasis on developing cold storage chains; o Support the development of a competitive and quality domestic market; and o Develop exports to international markets. EMPLOYEES As of December 31, 2006, we employed 2,870 employees, of whom 2,037 were operating personnel, 532 were sales personnel, 67 were research and development personnel and 234 were administrative personnel. We are not subject to any collective bargaining agreement and we believe our relationship with our employees is good. 19 ITEM 1A. RISK FACTORS RISKS RELATING TO OUR BUSINESS OUR LIMITED OPERATING HISTORY MAKES IT DIFFICULT TO EVALUATE OUR FUTURE PROSPECTS AND RESULTS OF OPERATIONS. We have a limited operating history. While Henan Zhongpin was established as a state-owned meat processing factory in 1993, the current management team purchased the business via a privatization scheme and commenced a restructuring of the enterprise in 1997. Accordingly, you should consider our future prospects in light of the risks and uncertainties experienced by early stage companies in evolving markets such as the growing market for fresh meats and processed meat products in the PRC. Some of these risks and uncertainties relate to our ability to: o offer additional food products to attract and retain a larger customer base; o attract additional customers and increased spending per customer; o increase awareness of our brand and continue to develop customer loyalty; o respond to competitive market conditions; o respond to changes in our regulatory environment; o manage risks associated with intellectual property rights; o maintain effective control of our costs and expenses; o raise sufficient capital to sustain and expand our business; o attract, retain and motivate qualified personnel; and o upgrade our technology to support additional research and development of new food products. If we are unsuccessful in addressing any of these risks and uncertainties, our business may be materially and adversely affected. IF THERE ARE ANY INTERRUPTIONS TO OR A DECLINE IN THE AMOUNT OR QUALITY OF OUR LIVE PIGS, RAW PORK OR OTHER MAJOR RAW MATERIAL SUPPLY, OUR PRODUCTION OR SALES COULD BE MATERIALLY AND ADVERSELY AFFECTED. Live pigs and raw pork are the principal raw materials used in our production. We procure all of our live pigs and some of our raw pork from a number of third-party suppliers. Our third-party suppliers may not continue to be able to supply an adequate number of live pigs and raw pork to satisfy our present and future production needs. The supply of pork is dependent on the output of pig farms, which may be affected by outbreaks of diseases or epidemics. Our current suppliers may not be able to provide live pigs or raw pork of sufficient quality to meet our stringent quality control requirements. Any interruptions to or decline in the amount or quality of our live pigs or raw pork supply could materially disrupt our production and adversely affect our business. In addition to live pigs and raw pork, we also use additives and packaging in our production, which we source from third-party suppliers, and resell a 20 wide variety of fruits and vegetables, which we purchase from third-party farms. Any interruptions to or decline in the amount or quality of our additives or packaging supply, or in the fruits or vegetables we procure, could also disrupt our production or sales and adversely affect our business. We are vulnerable to further increases in the price of raw materials (particularly of live pigs and raw pork) and other operating costs, and we may not be able to entirely offset these increasing costs by increasing the prices of our products, particularly our processed meat products. We purchase agricultural products, such as live pigs, raw pork and a wide variety of fruits and vegetables, for use in our production process and for resale. The price of such raw materials is subject to fluctuations that are attributable to a number of factors, such as the price of animal feed, diseases and infections, and weather conditions. For example, during 2004, prices of live pigs rose sharply. According to the Ministry of Agriculture of the PRC, the average selling price of live pigs rose by approximately 35.6% from 2003 to 2004. During 2005 and 2006, however, the average prices of live pigs we purchased decreased by approximately 0.6% and increased by approximately 8%, respectively. If the costs of raw materials or other costs of production and distribution of our products increase further, and we are unable to entirely offset these increases by raising prices of our products, our profit margins and financial condition could be adversely affected. WE MAY BE UNABLE TO ANTICIPATE CHANGES IN CONSUMER PREFERENCES FOR PROCESSED MEAT PRODUCTS, WHICH MAY RESULT IN DECREASED DEMAND FOR OUR PRODUCTS. Our continued success in the processed meat products market is in large part dependent on our ability to anticipate and develop products that appeal to the changing tastes, dietary habits and preferences of customers. If we are not able to anticipate and identify new consumer trends and develop new products accordingly, demand for our products may decline and our operating results may be adversely affected. In addition, we may incur significant costs relating to developing and marketing new products or expanding our existing product lines in reaction to what we perceive to be a consumer preference or demand. Such development or marketing may not result in the level of market acceptance, volume of sales or profitability anticipated. IF THE CHILLED AND FROZEN PORK MARKET IN THE PRC DOES NOT GROW AS WE EXPECT, OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION MAY BE ADVERSELY AFFECTED. We believe chilled and frozen pork products have strong growth potential in the PRC and, accordingly, we have continuously increased our sales of chilled and frozen pork. If the chilled and frozen pork market in the PRC does not grow as we expect, our business may be harmed, we may need to adjust our growth strategy and our results of operation may be adversely affected. WE REQUIRE VARIOUS LICENSES AND PERMITS TO OPERATE OUR BUSINESS, AND THE LOSS OF OR FAILURE TO RENEW ANY OR ALL OF THESE LICENSES AND PERMITS COULD REQUIRE US TO SUSPEND SOME OR ALL OF OUR PRODUCTION OR DISTRIBUTION OPERATIONS. In accordance with PRC laws and regulations, we are required to maintain various licenses and permits in order to operate our business, including, without limitation, a slaughtering permit in respect of each of our chilled and frozen pork production facilities and a permit for production of industrial products in respect of each of our processed meat production facilities. We are required to comply with applicable hygiene and food safety standards in relation to our production processes. Our premises and transportation vehicles are subject to regular inspections by the regulatory authorities for compliance with applicable regulations. Failure to pass these inspections, or the loss of or failure to renew our licenses and permits, could require us to temporarily or permanently suspend some or all of our 21 production or distribution operations, which could disrupt our operations and adversely affect our revenues and profitability. OUR ABILITY TO EXPORT MAY BE RESTRICTED IF WE CANNOT MAINTAIN CURRENT LICENSES OR OBTAIN ADDITIONAL LICENSES IN OTHER COUNTRIES AND REGIONS. For the three years ended December 31, 2004, 2005 and 2006, revenue attributable to our export business as a percentage of our total revenue was approximately 9.5%, 10.2% and 8.5%, respectively. We must maintain certain licenses from applicable foreign governments in order to continue to export to those jurisdictions. In addition, we must apply for licenses from applicable foreign governments should we desire to export our products to countries with which we currently do not have business relations. We cannot assure you that we can maintain our current licenses for export or obtain licenses to export to countries with which we do not currently have business relations. The loss of any licenses or the inability to obtain new licenses to export may adversely affect the aggregate amount of our export sales and the profitability of our business. THE LOSS OF SENIOR MANAGEMENT OR KEY RESEARCH AND DEVELOPMENT PERSONNEL OR OUR INABILITY TO RECRUIT ADDITIONAL PERSONNEL MAY HARM OUR BUSINESS. We are highly dependent on our senior management to manage our business and operations and our key research and development personnel for the development of new processing technologies and food products and the enhancement of our existing products. In particular, we rely substantially on our chairman and chief executive officer, Mr. Xianfu Zhu, to manage our operations. We also depend on our key research personnel. In addition, we also rely on information technology and logistics personnel for the production, storage and shipment of our products and on marketing and sales personnel, engineers and other personnel with technical and industry knowledge to transport, market and sell our products. We do not maintain key man life insurance on any of our senior management or key personnel. The loss of any one of them, in particular Mr. Zhu, would have a material adverse effect on our business and operations. Competition for senior management and research and development personnel is intense and the pool of suitable candidates is limited. We may be unable to locate a suitable replacement for any senior management or key research and development personnel that we lose. In addition, if any member of our senior management or key research and development personnel joins a competitor or forms a competing company, they may compete with us for customers, business partners and other key professionals and staff members of our company. Although each of our senior management and key research and development personnel has signed a confidentiality and non-competition agreement in connection with his employment with us, we cannot assure you that we will be able to successfully enforce these provisions in the event of a dispute between us and any member of our senior management or key research and development personnel. We compete for qualified personnel with other food processing companies, food retailers, logistics companies and research institutions. Intense competition for these personnel could cause our compensation costs to increase significantly, which could have a material adverse effect on our results of operations. Our future success and ability to grow our business will depend in part on the continued service of these individuals and our ability to identify, hire and retain additional qualified personnel. If we are unable to attract and retain qualified employees, we may be unable to meet our business and financial goals. 22 OUR GROWTH STRATEGY MAY PROVE TO BE DISRUPTIVE AND DIVERT MANAGEMENT RESOURCES, WHICH COULD ADVERSELY AFFECT OUR EXISTING BUSINESSES. In November 2006, we leased a production facility located in Hailun City, Heilongjiang Province in the PRC. Our growth strategy includes the expansion of our manufacturing operations to include new production plants located within Henan Province. In addition, we intend to expand our network of sales offices and warehouses to additional cities in the PRC and may include acquisitions of additional products, manufacturing or production capabilities or sources of supply. The implementation of such strategy may involve large transactions and present financial, managerial and operational challenges, including diversion of management attention from existing businesses, difficulty with integrating personnel and financial and other systems, increased expenses, including compensation expenses resulting from newly-hired employees, assumption of unknown liabilities and potential disputes. We also could experience financial or other setbacks if any of our growth strategies incur problems of which we are not presently aware. WE MAY REQUIRE ADDITIONAL FINANCING IN THE FUTURE AND OUR OPERATIONS COULD BE CURTAILED IF WE ARE UNABLE TO OBTAIN REQUIRED ADDITIONAL FINANCING WHEN NEEDED. We may need to obtain additional debt or equity financing to fund future capital expenditures. Additional equity may result in dilution to the holders of our outstanding shares of capital stock. Additional debt financing may include conditions that would restrict our freedom to operate our business, such as conditions that: o limit our ability to pay dividends or require us to seek consent for the payment of dividends; o increase our vulnerability to general adverse economic and industry conditions; o require us to dedicate a portion of our cash flow from operations to payments on our debt, thereby reducing the availability of our cash flow to fund capital expenditures, working capital and other general corporate purposes; and o limit our flexibility in planning for, or reacting to, changes in our business and our industry. We cannot guarantee that we will be able to obtain any additional financing on terms that are acceptable to us, or at all. OUR OPERATIONS ARE CASH INTENSIVE AND OUR BUSINESS COULD BE ADVERSELY AFFECTED IF WE FAIL TO MAINTAIN SUFFICIENT LEVELS OF WORKING CAPITAL. We expend a significant amount of cash in our operations, principally to fund our raw material procurement. Our suppliers, in particular, suppliers of pigs, typically require payment in full within seven days after delivery, although some of our suppliers provide us with credit. In turn, we typically require our customers of chilled and frozen pork to make payment in full on delivery, although we offer some of our long-standing customers credit terms. We generally fund most of our working capital requirements out of cashflow generated from operations. If we fail to generate sufficient revenues from our sales, or if we experience difficulties collecting our accounts receivable, we may not have sufficient cashflow to fund our operating costs and our profitability could be adversely affected. 23 WE MAY BE UNABLE TO MAINTAIN OUR PROFITABILITY IN THE FACE OF A CONSOLIDATING RETAIL ENVIRONMENT IN THE PRC. We sell substantial amounts of our products to supermarkets and large retailers. The supermarket and food retail industry in the PRC has been, and is expected to continue, undergoing a trend of development and consolidation. As the retail food trade continues to consolidate and our retail customers grow larger and become more sophisticated, they may demand lower pricing and increased promotional programs. Furthermore, larger customers may be better able to operate on reduced inventories and potentially develop or increase their focus on private label products. If we fail to maintain a good relationship with our large retail customers, or maintain a wide offering of quality products, or if we lower our prices or increase promotional support of our products in response to pressure from our customers and are unable to increase the volume of our products sold, our profitability could decline. OUR OPERATING RESULTS MAY FLUCTUATE FROM PERIOD TO PERIOD AND IF WE FAIL TO MEET MARKET EXPECTATIONS FOR A PARTICULAR PERIOD, OUR SHARE PRICE MAY DECLINE. Our operating results have fluctuated from period to period and are likely to continue to fluctuate as a result of a wide range of factors, including seasonal variations in live pig supply and processed meat products consumption. For example, demand for our products in general is relatively high before the Chinese New Year in January or February each year and lower thereafter. Our production and sales of chilled and frozen pork are generally lower in the summer, due to a lower supply of live pigs. Interim reports may not be indicative of our performance for the year or our future performance, and period-to-period comparisons may not be meaningful due to a number of reasons beyond our control. We cannot assure you that our operating results will meet the expectations of market analysts or our investors. If we fail to meet their expectations, there may be a decline in our share price. WE DERIVE A SUBSTANTIAL PORTION OF OUR REVENUES FROM SALES IN THE PRC AND ANY DOWNTURN IN THE CHINESE ECONOMY COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS AND FINANCIAL CONDITION. Substantially all of our revenues are generated from sales in the PRC. We anticipate that revenues from sales of our products in the PRC will continue to represent a substantial proportion of our total revenues in the near future. Any significant decline in the condition of the PRC economy could, among other things, adversely affect consumer buying power and discourage consumption of our products, which in turn would have a material adverse effect on our revenues and profitability. WE RELY ON OUR EXCLUSIVE NETWORK OF SHOWCASE STORES, NETWORK STORES AND SUPERMARKET BRAND COUNTERS FOR THE SUCCESS OF OUR SALES AND OUR BRAND IMAGE, AND SHOULD THEY PERFORM POORLY, OUR REVENUES AND BRAND IMAGE COULD BE MATERIALLY AND ADVERSELY AFFECTED. In addition to our sales to wholesale customers, we sell our products through showcase stores, network stores and supermarket brand counters. All of these retail-based stores exclusively sell our pork products and display the Zhongpin logo on the fascia of the stores. For the years ended December 31, 2004, 2005 and 2006, these retail outlets accounted for approximately 47.0%, 48.0% and 45.0%, respectively, of our total revenue. If the sales performance of our retail-based stores deteriorates, this could adversely affect the financial results of the company. In addition, any sanitation, hygiene or food quality problems that might arise from the retail-based stores could adversely affect our brand image and lead to a loss of sales. We do not own or franchise any of the retail-based stores. 24 WE RELY ON THE PERFORMANCE OF OUR WHOLESALE RETAILER AND MASS MERCHANT CUSTOMERS FOR THE SUCCESS OF OUR SALES, AND SHOULD THEY PERFORM POORLY OR GIVE PRIORITY TO OUR COMPETITORS' PRODUCTS, OUR SALES PERFORMANCE AND BRANDING IMAGE COULD BE MATERIALLY AND ADVERSELY AFFECTED. In addition to our retail sales channel, we sell our products to supermarkets and large retailers, which in turn sell the products to end consumers. If the sales performance of our wholesale customers deteriorates, this could adversely affect the performance of our products. Furthermore, our wholesale customers also carry products which directly compete with our products for retail space and consumer purchases. There is a risk that our wholesale customers may give higher priority to products of, or form alliances with, our competitors. If our wholesale customers do not continue to purchase our products, or provide our products with similar levels of promotional support, our sales performance and brand imaging could be adversely affected. THE LOSS OF ANY OF OUR SIGNIFICANT CUSTOMERS COULD REDUCE OUR REVENUES AND OUR PROFITABILITY. Our key customers are principally supermarkets and large retailers in the PRC. For the years ended December 31, 2004, 2005 and 2006, sales to our five largest customers amounted in the aggregate to approximately $11.1 million, $15.5 million and $28.76 million, respectively, accounting for approximately 26%, 22% and 20%, respectively, of our total revenue. We have not entered into long-term supply contracts with any of these major customers. Therefore, there can be no assurance that we will maintain or improve the relationships with these customers, or that we will be able to continue to supply these customers at current levels or at all. If we cannot maintain long-term relationships with our major customers, the loss of a significant portion of our sales to them could have an adverse effect on our business, financial condition and results of operations. RECENT REGULATORY ENFORCEMENT CRACKDOWNS ON FOOD PROCESSING COMPANIES IN THE PRC COULD INCREASE OUR COMPLIANCE COSTS AND REDUCE OUR PROFITABILITY. We believe we are in compliance in all material respects with all applicable regulatory requirements of the PRC and all local jurisdictions in which we operate. However, the PRC government authorities recently have taken certain measures to maintain the PRC food market in good order and to improve the integrity of the PRC food industry, such as enforcing full compliance with industry standards and closing certain food processing companies in the PRC that did not meet regulatory standards. While the closing of competing meat processing plants that do not meet regulatory standards could increase our revenues in the long term, we may also experience increased regulatory compliance costs that could reduce our profitability. We also cannot assure you that our businesses and operations will not be affected as a result of the deteriorating reputation of the food industry in the PRC due to recent scandals regarding food products. OUR FAILURE TO COMPLY WITH INCREASINGLY STRINGENT ENVIRONMENTAL REGULATIONS AND RELATED LITIGATION COULD RESULT IN SIGNIFICANT PENALTIES, DAMAGES AND ADVERSE PUBLICITY FOR OUR BUSINESS. Our operations and properties are subject to extensive and increasingly stringent laws and regulations pertaining to, among other things, the discharge of materials into the environment and the handling and disposition of wastes (including solid and hazardous wastes) or otherwise relating to protection of the environment. Failure to comply with any laws and regulations and future changes to them may result in significant consequences to us, including civil and criminal penalties, liability for damages and negative publicity. 25 We have incurred, and will continue to incur, significant capital and operating expenditures to comply with these laws and regulations. We cannot assure you that additional environmental issues will not require currently unanticipated investigations, assessments or expenditures, or that requirements applicable to us will not be altered in ways that will require us to incur significant additional costs. OUR CONTROLLING SHAREHOLDER HAS SIGNIFICANT INFLUENCE OVER OUR MANAGEMENT AND AFFAIRS AND COULD EXERCISE THIS INFLUENCE AGAINST YOUR BEST INTERESTS. At March 15, 2007, Mr. Xianfu Zhu, our controlling shareholder, beneficially owned approximately 46.3% of our outstanding shares of common stock (33.5% including shares of common stock issuable upon conversion of our outstanding shares of Series A convertible preferred stock), and our other executive officers and directors collectively beneficially owned an additional 10.2% of our outstanding shares of common stock (7.4% including shares of common stock issuable upon conversion of our outstanding shares of Series A convertible preferred stock). As a result, pursuant to our By-laws and applicable laws and regulations, our controlling shareholder and our other executive officers and directors are able to exercise significant influence over our Company, including, but not limited to, any shareholder approvals for the election of our directors and, indirectly, the selection of our senior management, the amount of dividend payments, if any, our annual budget, increases or decreases in our share capital, new securities issuance, mergers and acquisitions and any amendments to our By-laws. Furthermore, this concentration of ownership may delay or prevent a change of control or discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of us, which could decrease the market price of our shares. DETERIORATION OF OUR PERISHABLE PRODUCTS MAY OCCUR DUE TO DELIVERY DELAYS, MALFUNCTIONING OF FREEZER FACILITIES OR POOR HANDLING DURING TRANSPORTATION, WHICH COULD ADVERSELY AFFECT OUR REVENUES AND THE GOODWILL OF OUR BUSINESS. The condition of our food products (being perishable goods) may deteriorate due to shipment or delivery delays, malfunctioning of freezer facilities or poor handling during delivery by shippers or intermediaries. We are not aware of any instances whereby we were made to compensate for delivery delays, malfunctioning of freezer facilities or poor handling during transportation. However, there is no assurance that such incidents will not occur in the future. In the event of any delivery delays, malfunctioning of freezer facilities or poor handling during transportation, we may have to make compensation payments and our reputation, business goodwill and revenue will be adversely affected. IF WE FAIL TO DEVELOP AND MAINTAIN AN EFFECTIVE SYSTEM OF INTERNAL CONTROLS, WE MAY NOT BE ABLE TO ACCURATELY REPORT OUR FINANCIAL RESULTS OR PREVENT FRAUD; AS A RESULT, CURRENT AND POTENTIAL SHAREHOLDERS COULD LOSE CONFIDENCE IN OUR FINANCIAL REPORTS, WHICH COULD HARM OUR BUSINESS AND THE TRADING PRICE OF OUR COMMON STOCK. Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate and report on our internal controls over financial reporting and have our independent registered public accounting firm annually attest to our evaluation, as well as issue their own opinion on our internal controls over financial reporting, beginning with our Annual Report on Form 10-K for the fiscal year ended December 31, 2007. We plan to prepare for compliance with Section 404 by strengthening, assessing and testing our system of internal controls to provide the basis for our report. The process of strengthening our internal controls and complying with Section 404 is expensive and time consuming, and requires significant management attention, especially given that we have only recently undertaken any efforts to comply with the requirements of Section 404. We cannot be certain that the measures we 26 will undertake will ensure that we will maintain adequate controls over our financial processes and reporting in the future. Furthermore, if we are able to rapidly grow our business, the internal controls that we will need will become more complex, and significantly more resources will be required to ensure our internal controls remain effective. Failure to implement required controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. If we or our auditors discover a material weakness in our internal controls, the disclosure of that fact, even if the weakness is quickly remedied, could diminish investors' confidence in our financial statements and harm our stock price. In addition, non-compliance with Section 404 could subject us to a variety of administrative sanctions, including the suspension of trading, ineligibility for listing on one of the Nasdaq Stock Markets or national securities exchanges, and the inability of registered broker-dealers to make a market in our common stock, which would further reduce our stock price. POSSIBLE MATERIAL MISSTATEMENTS OR OMISSIONS IN THE REGISTRATION STATEMENT OR REPORTS WE FILED UNDER THE FEDERAL SECURITIES LAWS OR OUR FAILURE TO FILE CERTAIN REPORTS UNDER THE FEDERAL SECURITIES LAWS COULD REQUIRE US TO REPURCHASE CERTAIN OUTSTANDING SHARES OF OUR COMMON STOCK OR TO PAY SUBSTANTIAL DAMAGES, EITHER OF WHICH COULD MATERIALLY AND ADVERSELY AFFECT OUR CASH FLOWS AND OUR FINANCIAL CONDITION. Prior to our acquisition of Falcon Link on January 30, 2006, we engaged in businesses unrelated to our current operations, which businesses were managed by officers and directors who are no longer employed by or affiliated with our company. In January 2004, we filed with the Securities and Exchange Commission a registration statement on Form SB-2 to register the resale of up to 85,028 shares of common stock that were beneficially owned by Richard Armstrong, our Chairman of the Board, Chief Executive Officer and Chief Financial Officer at that time, and certain other stockholders of our company, including certain members of Mr. Armstrong's immediate family. Such registration statement became effective under the Securities Act on October 21, 2004. In addition, since October 2004 we have been obligated to file with the Commission periodic reports under the Exchange Act. During the preparation of this prospectus, certain information has come to our attention that indicates there may have been from time to time certain material misstatements or omissions in our registration statement on Form SB-2 or in the reports we filed under the Exchange Act. In addition, we may have failed to timely file certain reports under the Exchange Act or amendments or supplements to our reports previously filed under the Exchange Act. Such information includes the following: o Following the change of control of our company on March 30, 2005, we failed to amend our registration statement on Form SB-2 to disclose such change of control, the change in the composition of our board of directors, the changes in our executive officers and the fact that we had ceased operations and had changed our strategic plan to position our company as an acquisition vehicle for the purchase of an operating company located in the PRC. o Following our execution of the stock purchase agreement dated as of March 15, 2005 among Richard Armstrong, Halter Capital Corporation and our company, we failed to amend our registration statement on Form SB-2 or to file a Current Report on Form 8-K disclosing that, in connection with the proposed sale by Richard Armstrong of a controlling interest in our company on March 30, 2005, (i) we had agreed to sell to Richard Armstrong, in consideration of his forgiveness of certain outstanding indebtedness owed to Mr. Armstrong and his family for loans and accrued salary, all of the assets of our company relating to our former business of supplying skilled workers and engineering professionals to businesses on a temporary basis, which sale of assets 27 would represent a sale of substantially all of our assets, and (ii) as a result of such asset sale, our company would become on March 30, 2005 a blank check company (I.E., a development stage company that has no specific business plan or has indicated its business plan is to engage in a merger or acquisition of an unidentified company or companies). o By agreeing on or about March 15, 2005 to sell all or substantially all of our assets on or about March 30, 2005, a claim may be made that on or about March 15, 2005 our company no longer had a specific business plan and became a blank check company on such date. In such event, we failed to make adequate disclosure by amendment to our registration statement on Form SB-2 or in proper filings under the Exchange Act of the change in our status. In general under U.S. federal and state securities laws, material misstatements and omissions in a prospectus may give rise to rights of rescission in favor of, or claims for damages by, persons who purchased securities pursuant to the prospectus. Claims for rescission generally provide successful claimants with the right to recover the entire purchase price of their securities plus interest from the date of purchase in exchange for surrender of their purchased shares. In general, a claim for rescission must be made by a person who purchased shares pursuant to a defective prospectus or other representation and within the applicable statute of limitations period, which, for claims made under federal law (Section 12 of the Securities Act) and most state statutes, is one year from the time the claimant discovered or reasonably should have discovered the facts giving rise to the claim, but not more than three years from the date of the event giving rise to the claim. A successful claimant for damages under federal or state law could be awarded an amount to compensate for the decrease in value of his or her shares caused by the alleged violation (including, possibly, punitive damages), together with interest, while retaining the shares. Claims under the anti-fraud provisions of the federal securities laws must generally be brought within two years of discovery, but not more than five years after occurrence. While we have not received any claims that we have violated any federal or state securities laws, and while based upon current facts known to us at this time, we do not believe that assertion of such claims by any of our current or former stockholders is probable, there can be no assurance that any such claims will not arise in the future. Should any such claims arise, we can give no assurance that the claimant in such action will not prevail. Depending upon the magnitude of any judgment that may be entered against us in any such actions, our cash flow, financial condition and prospects could be materially and adversely affected. RISKS RELATING TO OUR INDUSTRY THE PIG SLAUGHTERING AND PROCESSED MEAT INDUSTRIES IN THE PRC ARE SUBJECT TO EXTENSIVE GOVERNMENT REGULATION, WHICH IS STILL EVOLVING AND COULD ADVERSELY AFFECT OUR ABILITY TO SELL PRODUCTS IN THE PRC OR INCREASE OUR PRODUCTION COSTS. The pig slaughtering and processed meat industries in the PRC are heavily regulated by a number of governmental agencies, including primarily the Ministry of Agriculture, the Ministry of Commerce, the Ministry of Health, the General Administration of Quality Supervision, Inspection and Quarantine and the State Environmental Protection Administration. These regulatory bodies have broad discretion and authority to regulate many aspects of the pig slaughtering and processed meat industries in the PRC, including, without limitation, setting hygiene standards for production and quality standards for processed meat products. In addition, the pig slaughtering and processed meat products regulatory 28 framework in the PRC is still in the process of being developed. If the relevant regulatory authorities set standards with which we are unable to comply or which increase our production costs and hence our prices so as to render our products non-competitive, our ability to sell products in the PRC may be limited. THE PIG SLAUGHTERING AND PROCESSED MEAT INDUSTRIES IN THE PRC MAY FACE INCREASING COMPETITION FROM BOTH DOMESTIC AND FOREIGN COMPANIES, AS WELL AS INCREASING INDUSTRY CONSOLIDATION, WHICH MAY AFFECT OUR MARKET SHARE AND PROFIT MARGIN. The pig slaughtering and processed meat industries in the PRC are highly competitive. Our processed meat products are targeted at mid- to high-end consumers, a market in which we face increasing competition, particularly from foreign suppliers. In addition, the evolving government regulations in relation to the pig slaughtering industry has driven a trend of consolidation through the industry, with smaller operators unable to meet the increasing costs of regulatory compliance and therefore at a competitive disadvantage. We believe that our ability to maintain our market share and grow our operations within this landscape of changing and increasing competition is largely dependant upon our ability to distinguish our products and services. In addition, prior to the entry of the PRC into the World Trade Organization ("WTO"), high barriers to entry existed for many potential competitors in our business through the use of tariffs and restrictive import licensing and distribution practices. The admission of the PRC to the WTO has lowered some of the tariffs and other barriers to entry so we can expect that competition will increase. We cannot assure you that our current or potential competitors will not develop products of a comparable or superior quality to ours, or adapt more quickly than we do to evolving consumer preferences or market trends. In addition, our competitors in the raw meat market may merge or form alliances to achieve a scale of operations or sales network which would make it difficult for us to compete. Increased competition may also lead to price wars, counterfeit products or negative brand advertising, all of which may adversely affect our market share and profit margin. We cannot assure you that we will be able to compete effectively with our current or potential competitors. THE OUTBREAK OF ANIMAL DISEASES, INCLUDING THE RECENT OUTBREAK AFFECTING THOSE IN CONTACT WITH STREPTOCOCCUS SUIS-INFECTED PIGS IN SICHUAN PROVINCE, PRC, OR OTHER EPIDEMICS COULD ADVERSELY AFFECT OUR OPERATIONS. An occurrence of serious animal diseases, such as foot-and-mouth disease, or any outbreak of other epidemics in the PRC affecting animals or humans might result in material disruptions to our operations, material disruptions to the operations of our customers or suppliers, a decline in the supermarket or food retail industry or slowdown in economic growth in the PRC and surrounding regions, any of which could have a material adverse effect on our operations and turnover. Recently, there has been an outbreak of streptococcus suis in pigs, principally in Sichuan Province, PRC, with a large number of cases of human infection following contact with diseased pigs. Our procurement and production facilities are located in Henan Province, PRC and were not affected by the streptococcus suis infection. However, there can be no assurance that our facilities or products will not be affected by an outbreak of this disease or similar ones in the future, or that the market for pork products in the PRC will not decline as a result of fear of disease. In either case, our business, results of operations and financial condition would be adversely and materially affected. 29 CONSUMER CONCERNS REGARDING THE SAFETY AND QUALITY OF FOOD PRODUCTS OR HEALTH CONCERNS COULD ADVERSELY AFFECT SALES OF OUR PRODUCTS. Our sales performance could be adversely affected if consumers lose confidence in the safety and quality of our products. Consumers in the PRC are increasingly conscious of food safety and nutrition. Consumer concerns about, for example, the safety of pork products, or about the safety of food additives used in processed meat products, could discourage them from buying certain of our products and cause our results of operations to suffer. WE MAY BE SUBJECT TO SUBSTANTIAL LIABILITY SHOULD THE CONSUMPTION OF ANY OF OUR PRODUCTS CAUSE PERSONAL INJURY OR ILLNESS AND, UNLIKE MOST FOOD PROCESSING COMPANIES IN THE UNITED STATES, WE DO NOT MAINTAIN PRODUCT LIABILITY INSURANCE TO COVER OUR POTENTIAL LIABILITIES. The sale of food products for human consumption involves an inherent risk of injury to consumers. Such injuries may result from tampering by unauthorized third parties or product contamination or degeneration, including the presence of foreign contaminants, chemical substances or other agents or residues during the various stages of the procurement and production process. While we are subject to governmental inspections and regulations, we cannot assure you that consumption of our products will not cause a health-related illness in the future, or that we will not be subject to claims or lawsuits relating to such matters. Even if a product liability claim is unsuccessful or is not fully pursued, the negative publicity surrounding any assertions that our products caused personal injury or illness could adversely affect our reputation with customers and our corporate and brand image. Unlike most food processing companies in the United States, but in line with industry practice in the PRC, we do not maintain product liability insurance. Furthermore, our products could potentially suffer from product tampering, contamination or degeneration or be mislabeled or otherwise damaged. Under certain circumstances, we may be required to recall products. Even if a situation does not necessitate a product recall, we cannot assure you that product liability claims will not be asserted against us as a result. A product liability judgment against us or a product recall could have a material adverse effect on our revenues, profitability and business reputation. OUR PRODUCT AND COMPANY NAME MAY BE SUBJECT TO COUNTERFEITING AND/OR IMITATION, WHICH COULD HAVE AN ADVERSE IMPACT UPON OUR REPUTATION AND BRAND IMAGE, AS WELL AS LEAD TO HIGHER ADMINISTRATIVE COSTS. We regard brand positioning as the core of our competitive strategy, and intend to position our "Zhongpin" brand to create the perception and image of "health, nutrition, freshness and quality" in the minds of our customers. There have been frequent occurrences of counterfeiting and imitation of products in the PRC in the past. We cannot guarantee that counterfeiting or imitation of our products will not occur in the future or that we will be able to detect it and deal with it effectively. Any occurrence of counterfeiting or imitation could impact negatively upon our corporate and brand image, particularly if the counterfeit or imitation products cause sickness, injury or death to consumers. In addition, counterfeit or imitation products could result in a reduction in our market share, a loss of revenues or an increase in our administrative expenses in respect of detection or prosecution. RISKS RELATING TO CONDUCTING BUSINESS IN THE PRC Substantially all of our assets and operations are located in the PRC, and substantially all of our revenue is sourced from the PRC. Accordingly, our results of operations and financial position are 30 subject to a significant degree to economic, political and legal developments in the PRC, including the following risks: CHANGES IN THE POLITICAL AND ECONOMIC POLICIES OF THE PRC GOVERNMENT COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATIONS. Our business operations may be adversely affected by the political and economic environment in the PRC. The PRC has operated as a socialist state since 1949 and is controlled by the Communist Party of China. As such, the economy of the PRC differs from the economies of most developed countries in many respects, including, but not limited to: o structure o capital re-investment o government involvement o allocation of resources o level of development o control of foreign exchange o growth rate o rate of inflation In recent years, however, the government has introduced measures aimed at creating a "socialist market economy" and policies have been implemented to allow business enterprises greater autonomy in their operations. Nonetheless, a substantial portion of productive assets in the PRC is still owned by the PRC government. Changes in the political leadership of the PRC may have a significant affect on laws and policies related to the current economic reforms program, other policies affecting business and the general political, economic and social environment in the PRC, including the introduction of measures to control inflation, changes in the rate or method of taxation, the imposition of additional restrictions on currency conversion and remittances abroad, and foreign investment. Moreover, economic reforms and growth in the PRC have been more successful in certain provinces in the PRC than in others, and the continuation or increases of such disparities could affect the political or social stability in the PRC. Although we believe the economic reform and the macroeconomic measures adopted by the Chinese government have had a positive effect on the economic development in the PRC, the future direction of these economic reforms is uncertain and the uncertainty may decrease the attractiveness of our company as an investment, which may in turn materially adversely affect the price at which our stock trades. SOCIAL CONDITIONS IN THE PRC COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATIONS AS THE PRC GOVERNMENT CONTINUES TO EXERT SUBSTANTIAL INFLUENCE OVER THE MANNER IN WHICH WE MUST CONDUCT OUR BUSINESS ACTIVITIES. The PRC only recently has permitted provincial and local economic autonomy and private economic activities. The government of the PRC has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in the PRC may be adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property and other matters. We believe our operations in China are in compliance with all applicable legal and regulatory requirements. However, the central or local governments 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. Were the PRC government, or local municipalities, to limit our ability to develop, produce, import or sell our products in the PRC, or to finance and operate our business in the PRC, our business could be adversely affected. 31 RECENT REGULATORY REFORMS IN THE PRC MAY LIMIT OUR ABILITY AS AN OFFSHORE COMPANY CONTROLLED BY PRC RESIDENTS TO ACQUIRE ADDITIONAL COMPANIES OR BUSINESSES IN THE PRC, WHICH COULD HINDER OUR ABILITY TO EXPAND IN THE PRC AND ADVERSELY AFFECT OUR LONG-TERM PROFITABILITY. Our long-term business plan may include an acquisition strategy to increase the number or types of products we offer, increase our manufacturing or production capabilities, strengthen our sources of supply or broaden our geographic reach. Recent PRC regulations relating to acquisitions of PRC companies by foreign entities controlled by PRC residents may limit our ability to acquire PRC companies and adversely affect the implementation of our strategy as well as our business and prospects. On August 8, 2006, the PRC Ministry of Commerce, the State Assets Supervision and Administration of Commerce, the State Administration of Taxation, the State Administration of Industry and Commerce, the China Securities Regulatory Commission and the State Administration of Foreign Exchange jointly promulgated a new rule entitled "Provisions Regarding Mergers and Acquisitions of Domestic Enterprises by Foreign Investors" (the "M&A Rules"), which became effective on September 8, 2006, relating to acquisitions by foreign investors of businesses and entities in the PRC. The M&A Rules provide the basic framework in the PRC for the approval and registration of acquisitions of domestic enterprises in the PRC by foreign investors. In general, the M&A Rules provide that if an offshore company controlled by PRC residents intends to acquire or take control of a PRC company, such acquisition or transaction will be subject to strict examination by the relevant foreign exchange authorities. The M&A Rules also state that the approval of the relevant foreign exchange authorities is required for any sale or transfer by the PRC residents of a PRC company's assets or equity interests to foreign entities, such as us, for equity interests or assets of the foreign entities. The M&A Rules also stress the necessity of protecting national economic security in the PRC in the context of foreign acquisitions of domestic enterprises. Foreign investors must comply with comprehensive reporting requirements in connection with acquisitions of domestic companies in key industrial sectors that may affect the security of the "national economy" or in connection with acquisitions of domestic companies holding well-known trademarks or traditional brands in the PRC. Failure to comply with such reporting requirements that cause, or may cause, significant impact on national economic security may be terminated by the relevant ministries or be subject to other measures as are deemed necessary to mitigate any adverse impact. Our business operations or future strategy could be adversely affected by the interpretations of the M&A Rules. For example, if we decide to acquire a PRC company, we cannot assure you that we or the owners of such company, as the case may be, will be able to complete the necessary approvals, filings and registrations for the acquisition. This may restrict our ability to implement our acquisition strategy and adversely affect our business and prospects. THE FAILURE OF THE PRC RESIDENTS THAT CONTROL OUR COMPANY TO COMPLY WITH VARIOUS REPORTING OBLIGATIONS UNDER PRC REGULATIONS GOVERNING THE INVESTMENT BY FOREIGN ENTITIES IN DOMESTIC ENTERPRISES MAY RESTRICT OUR FOREIGN EXCHANGE ACTIVITIES AND OUR ABILITY TO RECEIVE DIVIDENDS FROM OUR SUBSIDIARIES LOCATED IN THE PRC. In the formation of Falcon Link as an offshore special purpose vehicle controlled by PRC residents, the six individual shareholders of Henan Zhongpin were required to comply with various PRC regulations governing the financing of a domestic enterprise by a foreign entity or special purpose vehicle, and each submitted a registration form with the local SAFE branch with respect to his respective 32 ownership interests in Falcon Link. Each of such shareholders is required to file an amendment to such registration if Falcon Link or our company experiences certain material events, such as changes in share capital, share transfers, mergers or acquisitions, spin-off transactions or the use of assets in the PRC to guarantee offshore obligations. While we believe our PRC stockholders are in compliance with all applicable rules and regulations governing the financing by foreign entities of domestic enterprises, the failure to comply with such rules and regulations, including compliance with the registration procedures, may result in restrictions on our PRC resident stockholders or Henan Zhongpin or may subject our PRC subsidiaries to more stringent review and approval processes, including the respect to their foreign exchange activities and their ability to remit dividends to our company and to make foreign-currency-denominated borrowings. FURTHER MOVEMENTS IN EXCHANGE RATES MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS. At present, almost all of our domestic sales are denominated in Renminbi and our export sales are denominated primarily in U.S. dollars. In addition, we incur a portion of our cost of sales in Euros, U.S. dollars and Japanese yen in the course of our purchase of imported production equipment and raw materials. Since 1994, the conversion of the Renminbi into foreign currencies has been based on rates set by the People's Bank of China, and the exchange rate for the conversion of the Renminbi to U.S. dollars had generally been stable. However, starting from July 21, 2005, the PRC government moved the Renminbi to a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. As a result, the Renminbi is no longer directly pegged to the U.S. dollar. On March 15, 2007, the exchange rate of the U.S. dollar against the Renminbi was RMB 7.742 per U.S. dollar. The exchange rate may become volatile, the Renminbi may be revalued further against the U.S. dollar or other currencies or the Renminbi may be permitted to enter into a full or limited free float, which may result in an appreciation or depreciation in the value of the Renminbi against the U.S. dollar or other currencies, any of which could have a material adverse effect on our financial condition and results of operations. GOVERNMENTAL CONTROL OF CURRENCY CONVERSION MAY AFFECT THE ABILITY OF OUR COMPANY TO OBTAIN WORKING CAPITAL FROM OUR SUBSIDIARIES LOCATED IN THE PRC AND THE VALUE OF YOUR INVESTMENT. The PRC government imposes controls on the convertibility of Renminbi into foreign currencies and, in certain cases, the remittance of currency outside of the PRC. We receive substantially all of our revenues in Renminbi. Under our current structure, our income is primarily derived from payments from Henan Zhongpin. Shortages in the availability of foreign currency may restrict the ability of Henan Zhongpin to remit sufficient foreign currency to pay dividends or other payments to us, or otherwise satisfy its foreign currency denominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from trade-related transactions, can be made in foreign currencies without prior approval from the PRC State Administration of Foreign Exchange by complying with certain procedural requirements. However, approval from appropriate government authorities is required in those cases in which Renminbi is to be converted into foreign currency and remitted out of the PRC to pay capital expenses, such as the repayment of bank loans denominated in foreign currencies. The PRC government also may at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay dividends in foreign currencies to our shareholders. 33 HENAN ZHONGPIN IS SUBJECT TO RESTRICTIONS ON MAKING PAYMENTS TO US, WHICH COULD ADVERSELY AFFECT OUR CASH FLOW AND OUR ABILITY TO PAY DIVIDENDS ON OUR CAPITAL STOCK. We are a holding company incorporated in the State of Delaware and do not have any assets or conduct any business operations other than our investment in our operating subsidiary in the PRC, Henan Zhongpin. As a result of our holding company structure, we will rely entirely on contractual payments or dividends from Henan Zhongpin for our cash flow to fund our corporate overhead and regulatory obligations. The PRC government imposes controls on the conversion of Renminbi into foreign currencies and the remittance of currencies out of the PRC. As a result, we may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency. Further, as Henan Zhongpin has in the past, and Henan Zhongpin and our other subsidiaries in the PRC may in the future, incur debt on its or their own, the instruments governing such debt may restrict such subsidiary's ability to make contractual or dividend payments to any parent corporation or other affiliated entity. If we are unable to receive all of the funds we require for our operations through contractual or dividend arrangements with our PRC subsidiaries, we may not have sufficient cash flow to fund our corporate overhead and regulatory obligations in the United States and may be unable to pay dividends on our shares of capital stock. UNCERTAINTIES WITH RESPECT TO THE PRC LEGAL SYSTEM COULD ADVERSELY AFFECT OUR ABILITY TO ENFORCE OUR LEGAL RIGHTS. We conduct our business primarily through Henan Zhongpin, our subsidiary in the PRC. Our operations in the PRC are governed by PRC laws and regulations. We are generally subject to laws and regulations applicable to foreign investments in the PRC and, in particular, laws applicable to wholly foreign-owned enterprises. The PRC legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value. Since 1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in the PRC. However, the PRC has not developed a fully-integrated legal system and recently-enacted laws and regulations may not sufficiently cover all aspects of economic activities in the PRC. In particular, because these laws and regulations are relatively new, and because of the limited volume of published decisions and their nonbinding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, the PRC legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until some time after the violation. The uncertainties regarding such regulations and policies present risks that may affect our ability to achieve our business objectives. If we are unable to enforce any legal rights we may have under our contracts or otherwise, our ability to compete with other companies in our industry could be materially and adversely affected. In addition, any litigation in the PRC may be protracted and result in substantial costs and diversion of resources and management attention. IT MAY BE DIFFICULT TO EFFECT SERVICE OF PROCESS UPON US OR OUR DIRECTORS OR SENIOR MANAGEMENT WHO LIVE IN THE PRC OR TO ENFORCE ANY JUDGMENTS OBTAINED FROM NON-PRC COURTS. Our operations are conducted and our assets are located within the PRC. In addition, all of our Directors and our senior management personnel reside in the PRC, where substantially all of their assets are located. You may experience difficulties in effecting service of process upon us, our Directors or our senior management as it may not be possible to effect such service of process outside the PRC. In addition, our PRC counsel, DeHeng Law Office, has advised us that the PRC does not have treaties with 34 the United States and many other countries providing for reciprocal recognition and enforcement of court judgments. Therefore, recognition and enforcement in the PRC of judgments of a court in the United States or certain other jurisdictions may be difficult or impossible. RISK RELATING TO AN INVESTMENT IN OUR SECURITIES WHILE CASH DIVIDENDS WERE PAID BY A DEEMED PREDECESSOR TO OUR COMPANY IN 2003 AND 2002, WE HAVE NOT PAID ANY CASH DIVIDENDS AND NO CASH DIVIDENDS WILL BE PAID IN THE FORESEEABLE FUTURE. Henan Zhongpin, a deemed predecessor to our company and our subsidiary in the PRC, paid cash dividends to its stockholders in 2002 and 2003. However, we do not anticipate paying cash dividends on our common stock in the foreseeable future and we may not have sufficient funds legally available to pay dividends. Even if the funds are legally available for distribution, we may nevertheless decide not to pay, or may be unable to pay, any dividends. We intend to retain all earnings for our company's operations. OUR COMMON STOCK IS THINLY TRADED AND YOU MAY BE UNABLE TO SELL AT OR NEAR "ASK" PRICES OR AT ALL IF YOU NEED TO SELL YOUR SHARES TO RAISE MONEY OR OTHERWISE DESIRE TO LIQUIDATE YOUR SHARES. We cannot predict the extent to which an active public market for our common stock will develop or be sustained. However, we do not rule out the possibility of applying for listing on the Nasdaq Global Market or other exchanges. Our common stock has historically been sporadically or "thinly-traded" on the "Over-the-Counter Bulletin Board," meaning that the number of persons interested in purchasing our common stock at or near bid prices at any given time may be relatively small or nonexistent. This situation is attributable to a number of factors, including the fact that we are a small company which is relatively unknown to stock analysts, stock brokers, institutional investors and others in the investment community that generate or influence sales volume, and that even if we came to the attention of such persons, they tend to be risk-adverse and would be reluctant to follow an unproven company such as ours or purchase or recommend the purchase of our shares until such time as we become more seasoned and viable. As a consequence of this lack of liquidity, the trading of relatively small quantities of shares by our stockholders may disproportionately influence the price of our common stock in either direction. The price for our shares could, for example, decline precipitously in the event a large number of shares of our common stock is sold on the market without commensurate demand, as compared to a seasoned issuer that could better absorb those sales without adverse impact on its share price. We cannot give you any assurance that a broader or more active public trading market for our common stock will develop or be sustained. PAST ACTIVITIES OF OUR COMPANY AND ITS AFFILIATES, INCLUDING OUR FORMER EXECUTIVE OFFICERS AND DIRECTORS, MAY LEAD TO FUTURE LIABILITY FOR OUR COMPANY. Prior to our acquisition of Falcon Link and its subsidiary, Henan Zhongpin, on January 30, 2006, we engaged in businesses unrelated to our current operations. In connection with such acquisition, we did not receive any indemnifications from our former controlling shareholders or management against any loss, damage or expense arising out of or based on any breach of or inaccuracy in any of their representations and warranties made regarding such acquisition, and any liabilities that may arise relating to such prior businesses may have a material adverse effect on our company. 35 THE MARKET PRICE FOR OUR STOCK MAY BE VOLATILE AND SUBJECT TO WIDE FLUCTUATIONS, WHICH MAY ADVERSELY AFFECT THE PRICE AT WHICH YOU CAN SELL OUR SHARES. The market price for our stock may be volatile and subject to wide fluctuations in response to factors including the following: o actual or anticipated fluctuations in our quarterly operations results; o changes in financial estimates by securities research analysts; o conditions in foreign or domestic meat processing or agricultural markets; o changes in the economic performance or market valuations of other meat processing companies; o announcements by us or our competitors of new products, acquisitions, strategic partnerships, joint ventures or capital commitments; o addition or departure of key personnel; o fluctuations of exchange rates between the RMB and the U.S. dollar; o intellectual property litigation; o general economic or political conditions in the PRC. In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our stock. FUTURE SALES OF SHARES OF OUR COMMON STOCK MAY DECREASE THE PRICE FOR SUCH SHARES. On January 30, 2007, the 11,250,005 shares of our common stock issued to the former stockholders of Falcon Link in our acquisition of that company on January 30, 2006, became eligible for resale by such stockholders on the open market, subject to the volume limitations and other restrictions of Rule 144. On January 31, 2007, 6,900,000 shares of our common stock issuable upon conversion of the 6,900,000 shares of our Series A convertible preferred stock also became eligible for resale on the open market, subject to the volume limitations and other restrictions of Rule 144. In addition on February 2, 2007, the Securities and Exchange Commission declared effective our registration statement on Form S-1 registering the resale from time to time in the open market of 1,500,005 shares of our common stock, including 1,001,408 shares of our common stock issuable upon conversion of our Series A convertible preferred stock. Actual sales of such shares, or the prospect of sales of such shares by the holders of such shares, may have a negative effect on the market price of the shares of our common stock. We may also register for resale additional outstanding shares of our common stock, additional shares that are issuable upon conversion of outstanding shares of our Series A convertible preferred stock or shares that are issuable upon exercise of outstanding warrants or reserved for issuance under our stock option plan. Once such shares are registered, they can be freely sold in the public market. If any of our stockholders either individually or in the aggregate cause a large number of securities to be sold in the public market, or if the market perceives that these holders intend to sell a large number of securities, 36 such sales or anticipated sales could result in a substantial reduction in the trading price of shares of our common stock and could also impede our ability to raise future capital. ITEM 1B. UNRESOLVED STAFF COMMENTS None. ITEM 2. - PROPERTIES PROPERTIES The following table sets forth certain information relating to our corporate offices and other facilities. APPROXIMATE OWNERSHIP LOCATION SQUARE FEET STATUS PRINCIPAL USES -------- ----------- --------- --------------
21 Changshe Road 23,328 Owned Corporate headquarters Changge City, Henan Province 21 Changshe Road 258,120 Owned Meat products processing plant Changge City, Henan Province South Part, Changxin Road 776,520 Owned Meat, fruit and vegetable products Changge City, Henan Province processing plant 21 Changshe Road 118,800 Owned Logistic center and warehouse Changge City, Henan Province South of National Road 311 161,740 Owned Meat products processing plant Yanling, Henan Province No. 8 North Ring Road 65,870 Leased(1) Meat products processing plant Hailun City, Heilongjiang Province
- ----------- (1) This facility is leased pursuant to a three-year lease that expires in November 2009 and provides for aggregate rental payments of 1,900,000 RMB ($251,116.75) for the first year and 2,100,000 RMB ($266,497.46) per year for the second and third years of the lease term. Each of the foregoing properties is in good condition and is occupied solely by our subsidiaries. In the opinion of management, all of our properties are adequately covered by insurance. ITEM 3. - LEGAL PROCEEDINGS Neither our company nor any of our subsidiaries is a party to any legal proceedings that, individually or in the aggregate, are material to our company as a whole. 37 ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of our security holders during the fourth quarter of our fiscal year ended December 31, 2006. 38 PART II ITEM 5. - MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Our shares began trading on the OTC Bulletin Board on January 12, 2005. Prior to that date, there was no public market for our common stock. Our common stock is traded on the OTC Bulletin Board under the symbol "ZHNP." Prior to January 30, 2006, the date on which our reverse acquisition of Falcon Link was consummated, our common stock was traded on the OTC Bulletin Board under the symbol "STGH." During the period March 30, 2005 to January 30, 2006, we operated as a public "shell" corporation with no significant revenues or assets. During such period, there was only a limited public market for our common stock and our common stock traded only sporadically on the OTC Bulletin Board. The following table contains information about the range of high and low bid prices for our common stock for each full quarterly period during the two-year period ended December 31, 2006, based upon reports of transactions on the OTC Bulletin Board. HIGH LOW FISCAL 2005 ---- --- ----------- First Quarter (commencing January 12)......... $ 3.54 $ 3.54 Second Quarter.................................. 18.03 18.03 Third Quarter................................... 123.72 18.03 Fourth Quarter.................................. 53.02 36.06 FISCAL 2006 ----------- First Quarter.................................. $ 54.79 $ 5.11 Second Quarter.................................. 8.00 5.00 Third Quarter................................... 10.00 8.00 Fourth Quarter.................................. 8.50 7.50 The source of these high and low prices was the OTC Bulletin Board. These quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not represent actual transactions. The high and low prices listed have been rounded up to the next highest two decimal places. In addition, such prices have been adjusted to give effect to the one-for-35.349 reverse stock split of all issued and outstanding shares of our common stock, which became effective on February 16, 2006. As of March 15, 2007, there were approximately 40 holders of record of our common stock. On March 15, 2007, the closing bid price of our common stock as reported by the OTC Bulletin Board was $8.25 per share. While cash dividends were paid in 2003 and 2002 by Henan Zhongpin, which is a deemed predecessor to our company and our subsidiary in the PRC, we have never paid or declared any dividend on our common stock and we do not anticipate paying cash dividends in the foreseeable future. As a result of our holding company structure, we would rely entirely on contractual or dividend payments from Henan Zhongpin for our cash flow to pay dividends on our common stock. The PRC government imposes controls on the conversion of Renminbi into foreign currencies and the remittance of currencies 39 out of the PRC, which also may affect our ability to pay cash dividends in the future. See Note 1 to our audited consolidated financial statements. The holders of our Series A convertible preferred stock are entitled to receive, when and as declared by our Board of Directors, dividends in such amounts as may be determined by our Board of Directors from time to time out of funds legally available therefor. No dividends (other than those payable solely in common stock) will be paid to the holders of our common stock until there shall have been paid or declared and set apart during that fiscal year for the holders of our Series A convertible preferred stock a dividend in an amount per share that the holders would have got for the shares of common stock issuable upon conversion of their shares of Series A convertible preferred stock. SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS On January 30, 2006, our Board of Directors and stockholders adopted and approved our 2006 Equity Incentive Plan (the "2006 Plan"). The 2006 Plan allows for awards of stock options, restricted stock grants and share appreciation rights for up to 1,800,000 shares of common stock. As of January 30, 2007, no awards had been granted under the 2006 Plan. Options granted in the future under the 2006 Plan are within the discretion of our board of directors. The following table summarizes the number of shares of our common stock authorized for issuance under our equity compensation plans. (C) NUMBER OF SECURITIES REMAINING AVAILABLE (A) FOR FUTURE NUMBER OF (B) ISSUANCE UNDER SECURITIES TO BE WEIGHTED- EQUITY ISSUED UPON AVERAGE COMPENSATION EXERCISE OF EXERCISE PRICE PLANS (EXCLUDING OUTSTANDING OF OUTSTANDING SECURITIES REFLECTED PLAN CATEGORY OPTIONS OPTIONS IN COLUMN (A)) ------------- ---------------- -------------- --------------------
Equity compensation plans approved by security holders 0 N/A 1,800,000 Equity compensation plans not N/A approved by security holders 0 0 - --------- Total 0 N/A 1,800,000 = =========
ITEM 6. - SELECTED FINANCIAL DATA The following selected consolidated income statement data for the three years ended December 31, 2004, 2005 and 2006 and the selected consolidated balance sheet data as of December 31, 2005 and 2006 have been derived from our audited consolidated financial statements included elsewhere in this Report. These consolidated financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements 40 and related notes included elsewhere in this Report. Our selected consolidated income statement data for the year ended December 31, 2002 and 2003 and our selected consolidated balance sheet data as of December 31, 2002, 2003 and 2004 have been derived from the audited financial statements of Henan Zhongpin, our deemed predecessor, which are not included in this Report. The historical results presented below are not necessarily indicative of the results that may be expected in any future period. FISCAL YEARS ENDED DECEMBER 31, 2006 2005 2004 2003 2002 ---- ---- ---- ---- ---- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
SELECTED INCOME STATEMENT DATA: Net Sales................................ $ 143,812 $ 73,400 $ 42,787 $ 29,593 $ 24,191 Gross Profit............................. 20,616 12,179 6,117 3,449 2,773 Income From Operations................... 5,788 7,484 3,058 1,736 1,403 Net Income............................... 6,359 5,914 2,768 1,536 1,053 Net Income per Common Share: Basic................................. 0.35 0.32 0.15 0.08 0.06 Diluted............................... 0.31 0.27 0.13 0.07 0.05 Cash Dividends........................... - - - 56 58 SELECTED BALANCE SHEET DATA: Property, Plant, Equipment............... $32,597 $ 10,213 $ 10,072 $ 5,805 $ 4,794 Total Assets............................. 102,222 53,254 32,167 27,528 18,180 Long-Term Debt (Less Current Maturities)............................ 1,912 2,264 4,329 7,638 5,534 Stockholders' Equity..................... 52,697 14,516 8,183 5,414 3,934
ITEM 7. - MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION Certain statements in this prospectus constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of our company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Factors that might cause such a difference include, among others, uncertainties relating to general economic and business conditions, intense competition for the acquisition of businesses, and domestic and foreign government regulations. During the period from our formation on February 4, 2003 to March 30, 2005, we were in an unrelated business that was discontinued on March 30, 2005. From March 30, 2005 to January 30, 2006, we did not generate any significant revenue, and accumulated no significant assets, as we explored various business opportunities. On January 30, 2006, in exchange for a controlling interest in our publicly-held "shell" corporation, we acquired all of the issued and outstanding capital stock of Falcon Link. This transaction is commonly referred to as a "reverse acquisition." For financial reporting purposes, Falcon Link was considered the acquirer in such transaction. As a result, our historical financial statements for all periods prior to January 30, 2006 included in this Report are those of Falcon Link. 41 OVERVIEW We are principally engaged in the meat and food processing and distribution business in the PRC. Currently, we have six processing plants located in Henan and Heilongjiang Provinces in the PRC, with a total of nine production lines. Our current total production capacity for chilled pork and frozen pork is 446 metric tons per day, based on an 8-hour working day, or approximately 160,560 metric tons on an annual basis. We also have production capacity for prepared meats of 40 metric tons per 8-hour day (or approximately 14,400 metric tons on an annual basis) and for fruits and vegetables of 35 metric tons per 8-hour day (or approximately 12,600 metric tons on an annual basis). We utilize state-of-the-art equipment in all of our abattoirs and processing facilities. On June 7, 2006, our subsidiary, Henan Zhongpin, formed a wholly-owned subsidiary, Zhumadian Zhongpin Food Limited, through which we plan to invest approximately $14 million to construct a new production facility in southern Henan Province that will be designed with a production capacity for chilled or frozen pork of 200 metric tons per 8-hour working day, or approximately 72,000 metric tons on an annual basis. We plan to put this new plant into production in the second quarter of fiscal 2007. On August 21, 2006, a new wholly-owned subsidiary, Anyang Zhongpin Food Company Limited was formed by Henan Zhongpin. Through this subsidiary, we plan to invest approximately $13.5 million to construct a new facility in northern Henan Province with a production capacity of 175 metric tons per 8-hour working day, or approximately 63,000 metric tons on an annual basis. Approximately 60% of the production capacity will be designed for the production of chilled pork and approximately 40% will be designed for the production of frozen pork. We plan to put the new plant into operation in the third quarter of fiscal 2007. We also plan to expand the production capacity for prepared meat products inside Zhongpin Industry Park, which is located in Changge City, Henan Province, by investing approximately $3.0 million to construct an additional facility at this location with additional production capacity of 30 metric tons per 8-hour working day, or approximately 10,800 metric tons on an annual basis. We expect to put this new facility into operation in the second quarter of fiscal 2007. Our products are sold under the "Zhongpin" brand name. Our customers include over 16 international or domestic fast food companies in the PRC, over 36 export-registered processing factories and over 1,531 school cafeterias, factory canteens, army posts and national departments. We also sell directly to over 2,721 retail outlets, including supermarkets, within the PRC. Since 2001, we have been one of the "leading agricultural industrial enterprises" in the PRC. During the past five years, we achieved a compound annual growth rate of 56% in terms of revenues and 57% in terms of net profits. We have established distribution networks in more than 24 provinces, including four cities with special legal status, in the North, East, South and South Midland of the PRC, and also have formed strategic partnerships with leading supermarket chains and the catering industry in the PRC. In addition, we export products to the European Union, Southeast Asia, Russia and South Africa. CRITICAL ACCOUNTING POLICIES Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and 42 judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We evaluate, on an on-going basis, our estimates for reasonableness as changes occur in our business environment. We base our estimates on experience, the use of independent third-party specialists, and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Critical accounting policies are defined as those that are reflective of significant judgments, estimates, and uncertainties, and potentially result in materially different results under different assumptions and conditions. We believe the following are our critical accounting policies: ACCOUNTS RECEIVABLE. We state accounts receivable at cost, net of allowance for doubtful accounts. Based on our past experience and current practice in the PRC, management provides for an allowance for doubtful accounts equivalent to those accounts that are not collected within one year plus 5% of receivables less than one year old. During fiscal 2006, we were successful in collecting $0.70 million, or approximately 93%, of doubtful accounts that were outstanding at December 31, 2005 for longer than one year. It is management's belief that the current bad debt allowance adequately reflects an appropriate estimate based on management's judgment. INVENTORY VALUATION. We value our pork inventories at the lower of cost, determined on a weighted average basis, and net realizable value (the estimated market price). When the carcasses are disassembled and transferred from primary processing to various manufacturing departments, we adjust the net realizable value for product specifications and further processing, which becomes the basis for calculating inventory values. In addition, substantially all inventory expenses, packaging, and supplies are valued by the weighted average method. GOODWILL AND OTHER INTANGIBLES. Our identifiable intangible assets are amortized over their useful life, unless the useful life is determined to be indefinite. The useful life of an identifiable intangible asset is based on an analysis of several factors, including contractual, regulatory or legal obligations, demand, competition and industry trends. Goodwill and indefinite-lived intangible assets are not amortized, but are tested annually for impairment. The goodwill impairment test is a two-step process. First, the fair value of each reporting unit is compared with the carrying amount of the reporting unit, including goodwill. The estimated fair value of the reporting unit is determined on the basis of discounted cash flow. If the carrying value exceeds fair value of the reporting unit, then a second step must be completed in order to determine the amount of goodwill impairment that should be recorded. In the second step, the implied fair value of the reporting unit's goodwill is determined by allocating the reporting unit's fair value to all of its assets and liabilities other than goodwill in a manner similar to a purchase price allocation. The resulting implied fair value of the goodwill that results from the application of this second step is then compared to the carrying amount of the goodwill and an impairment charge is recorded for the difference. Annual impairment testing for indefinite-lived intangible assets compares the fair value and carrying value of the intangible. The fair value of indefinite-lived intangible assets is determined on the basis of discounted cash flows. If the carrying value exceeds fair value, the indefinite-lived intangible asset is considered impaired and an impairment charge is recorded for the difference. Intangible assets that are subject to amortization are evaluated for impairment using a process similar to that used to evaluate elements of long-lived assets. 43 The assumptions used in the estimate of fair value are consistent with historical performance and the estimates and assumptions used in determining future profit plans for each reporting unit. We review product growth patterns, market share information, industry trends, changes in distribution channels, and economic indicators in determining the estimates and assumptions used to develop cash flow and profit plan assumptions. INCOME TAXES. We account for income taxes in accordance with Statement of Financial Accounting Standard No. 109, "Accounting for Income Taxes." We compute our provision for income taxes based on the statutory tax rates and tax planning opportunities available to us in the PRC. Significant judgment is required in evaluating our tax positions and determining our annual tax position. RESULTS OF OPERATIONS In fiscal 2007, we intend to continue to focus on the implementation of our strategic plan to continue the growth we have experienced in the last four years. As discussed above, in February 2006, we completed the construction of a new, fresh-chilled meat processing facility in the Zhongpin Industrial Park II, in November 2006, we added an additional processing plant by leasing a meat processing plant in Heilongjiang Province and we are currently constructing additional processing facilities in Henan Province. We also are expanding our capability in temperature-controlled, physical logistic systems. On January 31, 2006, we received gross proceeds of $27.6 million from the sale of our Series A convertible preferred stock and warrants. We expect to continue to expand our capital base, to scale up operations and to develop new markets, streamline our supply chain management, continue the development of our information technology systems, invest in training and human resources development and accelerate revenue and profit growth. In fiscal 2007, we expect the results of the pork and pork products segment of our business to remain strong. While supply is expected to be ample, live hog prices are expected to increase. We anticipate that our gross profit margin will decrease slightly during the remainder of fiscal 2007 due to the increase in the prices of raw materials. We anticipate strong demand for pork throughout the remainder of fiscal 2007. We also expect to increase our market share in the meat and meat products segment in our target markets in fiscal 2007. COMPARISON OF FISCAL YEARS ENDED DECEMBER 31, 2006 AND DECEMBER 31, 2005 REVENUE. Total revenue increased from $73.40 million for the year ended December 31, 2005 to $143.81 million for the year ended December 31, 2006, which represented an increase of $70.41 million, or approximately 96%. The increase in revenues was primarily due to increased sales in our meat and meat products segment resulting from the effects of the continued increase in the amount of branded stores sales and increased sales through food service distributors. During the year ended December 31, 2006, 621 new showcase stores, "branded" retail stores and supermarket counters were opened and we expanded our marketing and sales efforts to include 31 additional second-tier cities and 84 additional third-tier cities domestically. During the year ended December 31, 2006, revenues from sales to branded stores increased to $64.7 million, which represented an increase of $29.5 million, or approximately 84%, as compared to the year ended December 31, 2005. During the year ended December 31, 2006, revenues from sales to food service distributors increased to $28.5 million, which represented an increase of $16.2 million, or approximately 131%, as compared to the year ended December 31, 2005. During the year ended December 31, 2006, revenues from sales to restaurants and non-commercial customers increased to $38.4 44 million, which represented an increase of $20.1 million, or approximately 109%, as compared to the year ended December 31, 2005. During the year ended December 31, 2006, revenues from export sales increased to $12.2 million, which represented an increase of $4.7 million, or approximately 63%, as compared to the year ended December 31, 2005. Within these four distribution channels, the percentage of growth was highest for food service distributors. As a percentage of total sales revenue, sales to food service distributors has grown from 17% for the year ended December 31, 2005 to 20% for the year ended December 31, 2006, and sales through branded stores and super markets has decreased from 48% for the year ended December 31, 2005 to 45% for the year ended December 31, 2006. COST OF SALES. Cost of sales increased from $61.22 million for the year ended December 31, 2005 to $123.20 million for the year ended December 31, 2006, which represented an increase of $61.98 million, or approximately 101%. The increase in cost of sales was primarily due to the corresponding increase in revenues. The gross profit margin (gross profit divided by total sales revenue) decreased from 16.59% for the year ended December 31, 2005 to 14.34% for the year ended December 31, 2006. The decrease of gross profit margin was primarily due to an increase in average live hog prices for the year ended December 31, 2006 as compared to the year ended December 31, 2005. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased from $2.40 million for the year ended December 31, 2005 to $2.99 million for the year ended December 31, 2006, which represented an increase of $0.59 million, or approximately 25%. During fiscal 2006, we collected $1.34 million of outstanding accounts receivable for which bad debt allowance had been provided during fiscal 2005. Such collections reduced our general and administrative expenses by $1.34 million in fiscal 2006. As a percentage of revenues, general and administrative expenses decreased from 3.26% for the year ended December 31, 2005 to 2.08% for the year ended December 31, 2006. The increase in general and administrative expenses primarily resulted from the additional expenses we are incurring as a publicly-traded company that is reporting under the U.S. federal securities laws. During the year ended December 31, 2006, we incurred approximately $1.22 million in legal fees, accounting fees, advisory fees and consulting fees relating to such matters and in preparing to become compliant in a timely manner with our obligations under the Sarbanes-Oxley Act of 2002. PENALTY EXPENSE. During the year ended December 31, 2006, we incurred a non-recurring expense in the aggregate amount of $8.35 million as a result of payments we made in December 2006 to the holders of our Series A convertible preferred stock and related stock purchase warrants because of our failure to register in a timely manner for resale under the Securities Act of 1933, as amended, the shares of our common stock issuable upon the conversion or exercise of such securities. Such payments included cash payments in the aggregate amount of $1.04 million and our issuance of an aggregate of 379,743 shares of our common stock valued at $2.85 million, and warrants to purchase 884,799 shares of our common stock valued at $4.46 million. We do not anticipate any additional expense of this nature in fiscal 2007. OPERATING EXPENSES. Operating expenses increased from $2.30 million for the year ended December 31, 2005 to $3.49 million for the year ended December 31, 2006, which represented an increase of $1.19 million, or approximately 52%. As a percentage of revenue, operating expenses decreased from 3.13% for the year ended December 31, 2005 to 2.42% for the year ended December 31, 2006. The decrease in operating expenses as a percentage of revenue was the result of our increased total sales and operating scale. The increase in the net amount of operating expenses was primarily the result of additional transportation expenses of $0.93 million. INTEREST EXPENSE. Interest expense decreased from $1.80 million for the year ended December 31, 2005 to $1.56 million for the year ended December 31, 2006, which represented a decrease of $0.24 45 million, or approximately 13%. The decrease in interest expense was primarily a result of our having adequate cash flow from the equity private placement we consummated in the first quarter of 2006, which enabled us to repay and reduce our higher-interest-bearing bank loans. During the year ended December 31, 2006, our weighted average outstanding bank debt decreased by approximately $1.47 million, from $22.00 million for the year ended December 31, 2005 to $20.53 million for the year ended December 31, 2006. Our weighted average borrowing rate decreased from 7.99% for the year ended December 31, 2005 to 5.83% for the year ended December 31, 2006. INTEREST INCOME, ALLOWANCE INCOME, OTHER INCOME AND EXCHANGE GAIN (LOSS). Interest income, allowances income, other income and exchange gain (loss) increased from $0.66 million for the year ended December 31, 2005 to $2.71 million for the year ended December 31, 2006, which represented an increase of $2.05 million, or approximately 311%. This increase was primarily the result of an increase of $2.28 million in allowance income. The cash grant we received from the Chinese central government for our participation in research and development programs and training programs was recharacterized from a long-term liability to allowance income when the production line was completed and placed into operation during fiscal 2006. INCOME TAXES. The effective tax rate in the PRC on income generated from the sale of prepared products is 33% and there is no income tax on income generated from the sale of raw products, including raw meat products and raw fruits and vegetable products. The increase of $0.22 million in the provision for income taxes for the year ended December 31, 2006 over the year ended December 31, 2005 resulted from an increase of $0.67 million in our pre-tax net income from the sale of prepared products in fiscal 2006. COMPARISON OF FISCAL YEARS ENDED DECEMBER 31, 2005 AND DECEMBER 31, 2004 REVENUE. Total revenue increased by $30.61 million, or approximately 72%, during the year ended December 31, 2005, from $42.79 million in the year ended December 31, 2004 to $73.40 million for the year ended December 31, 2005. The increase in revenues was primarily due to increased sales in our meat and meat products segment resulting from the effects of the continued increase in the amount of branded stores sales and a widening wholesale customer base. During the year ended December 31, 2005, revenues from sales to branded stores increased to $35.23 million, which represented an increase of $15.12 million, or approximately 75%, as compared to the year ended December 31, 2004, of which $11.50 million was due to sales to new branded stores and $3.62 million was due to increased same store sales. During the year ended December 31, 2005, revenues from sales to food services distributors increased to $12.33 million, which represented an increase of $4.67 million, or approximately 61%, as compared to the year ended December 31, 2004, of which $1.40 million was due to increased sales to existing distributors and $3.27 million was due to sales to new distributors. During the year ended December 31, 2005, revenues from sales to restaurants and non-commercial customers increased to $18.35 million, which represented an increase of $7.40 million, or approximately 68%, as compared to the year ended December 31, 2004, of which $5.92 million was due to sales to new customers and $1.48 million was due to increased sales to existing customers. During the year ended December 31, 2005, revenues from export sales increased to $7.49 million, which represented an increase of $3.42 million, or approximately 84%, of which $0.69 million was due to sales to new export customers and $2.73 million was due to increased sales to existing export customers. COST OF SALES. Cost of sales increased by $24.55 million, or approximately 67%, for the year ended December 31, 2005, from $36.67 million in fiscal 2004 to $61.22 million in fiscal 2005. As a percentage of revenue, total cost of sales decreased from approximately 86% in fiscal 2004 to 46 approximately 83% in fiscal 2005. The decrease in our cost of sales as a percentage of revenue was primarily due to a lower rate of increase in raw material costs in fiscal 2005 (an increase of approximately 4%) as compared to the rate of increase in the prices of our products in fiscal 2005 (an increase of approximately 7%). GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased by $1.19 million, or approximately 98%, in the year ended December 31, 2005, from $1.21 million in fiscal 2004 to $2.40 million in fiscal 2005. As a percentage of revenues, general and administrative expenses increased from 2.84% in fiscal 2004 to 3.26% in fiscal 2005. During fiscal 2005, our bad debt allowance increased by $0.73 million due to a slowdown in collections of old accounts receivable. In addition, we incurred expenses of $0.46 million in fiscal 2005 relating to the private placement of our equity securities that we completed in January 2006. INTEREST EXPENSE. Interest expense increased by $0.59 million, or approximately 49%, in the year ended December 31, 2005, from $1.21 million in fiscal 2004 to $1.80 million in fiscal 2005, primarily due to an increase of approximately 31% in our average indebtedness. During fiscal 2005, we increased our average indebtedness by approximately $5.84 million to meet our increasing working capital requirements resulting from our significant growth in revenue. Our weighted average annual borrowing rate increased from 7.23% in fiscal 2004 to 7.99% in fiscal 2005. We have been able to secure debt financing with lower interest costs, and at September 30, 2006, our weighted average annual borrowing rate had been reduced to 6.16%. INTEREST INCOME, ALLOWANCE INCOME, OTHER INCOME AND EXCHANGE GAIN (LOSS). Interest income, allowances income, other income and exchange gain (loss) decreased by $0.36 million, or approximately 35%, in the year ended December 31, 2005, from $1.02 million in fiscal 2004 to $0.66 million in fiscal 2005, primarily due to a decrease of allowance income. During fiscal 2004, we received central or local government grants in the aggregate amount of $0.93 million for our participation in research and development programs targeted by the government. INCOME TAXES. The increase of $0.27 million in the provision for income taxes in fiscal 2005 over the prior fiscal year resulted from an increase of $0.82 million in our pre-tax income from the sale of prepared products in fiscal 2005. SEGMENT INFORMATION We operate in two business segments: pork and pork products, and vegetables and fruits. Our pork and pork products segment is involved primarily in the processing of live market hogs into fresh, frozen and processed pork products. Our pork and pork products segment markets its products domestically to our branded stores, food retailers, foodservice distributors, restaurant operators and noncommercial foodservice establishments, such as schools, hotel chains, healthcare facilities, the military and other food processors, as well as to international markets. Our vegetables and fruits segment is involved primarily in the processing of fresh vegetables and fruits. We contract with more than 120 farms in Henan Province and nearby areas to produce high-quality vegetable varieties and fruits suitable for export purposes. The proximity of the contracted farms to our operations ensures freshness from harvest to processing. We contract to grow more than 20 categories of vegetables and fruits, including asparagus, sweet corn, broccoli, mushrooms, lima beans, strawberries and capsicum. 47 The following tables set forth our revenues, sales in metric tons, operating income and production processed in metric tons by segment for the fiscal years ended December 31, 2006, 2005 and 2004 and the percentage increases for each segment between fiscal periods. SALES BY SEGMENT (U.S. DOLLARS IN MILLIONS) YEAR ENDED DECEMBER 31, PERCENTAGE ------------------- NET CHANGE CHANGE 2006 2005 2006/2005 2006/2005 ------- ------- ---------- ---------- Pork and Pork Products Chilled pork .............. $ 71.76 $ 31.50 $ 40.26 128% Frozen pork ............... 50.88 33.03 17.85 54% Prepared pork products .... 15.44 6.93 8.51 123% Vegetables and Fruits ....... 5.73 1.94 3.79 195% --------- -------- -------- Total ....................... $ 143.81 $ 73.40 $ 70.41 96% ========= ======== ======== SALES BY SEGMENT (IN METRIC TONS) YEAR ENDED DECEMBER 31, PERCENTAGE ------------------- NET CHANGE CHANGE 2006 2005 2006/2005 2006/2005 ------- ------- ---------- ---------- Pork and Pork Products Chilled pork .............. 59,284 27,546 31,738 115% Frozen pork ............... 43,785 30,011 13,774 46% Prepared pork products .... 9,838 4,747 5,091 107% Vegetables and Fruits ....... 9,504 2,681 6,823 254% --------- -------- -------- Total ............ 122,411 64,985 57,426 88% ========= ======== ======== OPERATING INCOME BY SEGMENT (U.S. DOLLARS IN MILLIONS) YEAR ENDED OPERATING MARGIN DECEMBER 31, NET YEAR ENDED ----------------- CHANGE DECEMBER 31, 2006 2005 2006/2005 2006 2005 ------- ------- ---------- ------ ------ Pork and Pork Products Chilled pork .............. $ 2.65 $ 3.31 $ (0.66) 3.69% 10.51% Frozen pork ............... 1.52 3.34 (1.82) 2.99% 10.11% Prepared pork products .... 1.26 0.60 0.66 8.16% 8.66% Vegetables and Fruits ....... 0.36 0.23 0.13 6.28% 11.86% ------- ------- ------- ---- Total ............ $ 5.79 $ 7.48 $ (1.69) 4.03% 10.19% ======= ======= ======= ==== 48 PRODUCTION BY SEGMENT (IN METRIC TONS) YEAR ENDED DECEMBER 31, PERCENTAGE ------------------- NET CHANGE CHANGE 2006 2005 2006/2005 2006/2005 ------- ------- ---------- ---------- Pork and Pork Products Chilled pork .............. 59,288 27,599 31,689 115% Frozen pork ............... 47,219 29,793 17,426 58% Prepared pork products .... 9,971 4,763 5,208 109% Vegetables and Fruits ....... 9,342 2,713 6,629 244% --------- -------- -------- Total ............ 125,820 64,868 60,952 94% ========= ======== ======== SALES BY SEGMENT (U.S. DOLLARS IN MILLIONS) YEAR ENDED DECEMBER 31, PERCENTAGE ------------------- NET CHANGE CHANGE 2005 2004 2005/2004 2005/2004 ------- ------- ---------- ---------- Pork and Pork Products Chilled pork .............. $ 31.50 $ 16.98 $ 14.52 86% Frozen pork ............... 33.03 22.28 10.75 48% Prepared pork products .... 6.93 2.54 4.39 173% Vegetables and Fruits ....... 1.94 0.99 0.95 96% --------- -------- -------- Total ............ $ 73.40 $ 42.79 $ 30.61 72% ========= ======== ======== SALES BY SEGMENT (IN METRIC TONS) YEAR ENDED DECEMBER 31, PERCENTAGE ------------------- NET CHANGE CHANGE 2005 2004 2005/2004 2005/2004 ------- ------- ---------- ---------- Pork and Pork Products Chilled pork .............. 27,546 16,046 11,500 72% Frozen pork ............... 30,011 21,116 8,895 42% Prepared pork products .... 4,747 1,751 2,996 171% Vegetables and Fruits ....... 2,681 1,525 1,156 76% --------- -------- -------- Total ............ 64,985 40,438 24,547 61% ========= ======== ======== 49 OPERATING INCOME BY SEGMENT (U.S. DOLLARS IN MILLIONS) YEAR ENDED OPERATING MARGIN DECEMBER 31, NET YEAR ENDED ----------------- CHANGE DECEMBER 31, 2005 2004 2005/2004 2005 2004 ------- ------- ---------- ------ ------ Pork and Pork Products Chilled pork .............. $ 3.31 $ 1.23 $ 2.08 10.51% 7.24% Frozen pork ............... 3.34 1.58 1.76 10.11% 7.09% Prepared pork products .... 0.60 0.21 0.39 8.66% 8.27% Vegetables and Fruits ....... 0.23 0.04 0.19 11.86% 4.04% ------- ------- ------- Total ............ $ 7.48 $ 3.06 $ 4.42 10.19% 7.15% ======= ======= ======= PRODUCTION BY SEGMENT (IN METRIC TONS) YEAR ENDED DECEMBER 31, PERCENTAGE ------------------- NET CHANGE CHANGE 2005 2004 2005/2004 2005/2004 ------- ------- ---------- ---------- Pork and Pork Products Chilled pork .............. 27,599 16,114 11,485 71% Frozen pork ............... 29,793 21,022 8,771 42% Prepared pork products .... 4,763 1,780 2,983 168% Vegetables and Fruits ....... 2,713 1,610 1,103 68% --------- -------- -------- Total ............ 64,868 40,526 24,342 60% ========= ======== ======== SALES BY SEGMENT (U.S. DOLLARS IN MILLIONS) YEAR ENDED DECEMBER 31, PERCENTAGE ------------------- NET CHANGE CHANGE 2004 2003 2004/2003 2004/2003 ------- ------- ---------- ---------- Pork and Pork Products Chilled pork .............. $ 16.98 $ 11.41 $ 5.57 49% Frozen pork ............... 22.28 16.80 5.48 33% Prepared pork products .... 2.54 0.78 1.76 226% Vegetables and Fruits ....... 0.99 0.60 0.39 65% --------- -------- -------- Total ............ $ 42.79 $ 29.59 $ 13.20 45% ========= ======== ======== 50 SALES BY SEGMENT (IN METRIC TONS) YEAR ENDED DECEMBER 31, PERCENTAGE ------------------- NET CHANGE CHANGE 2004 2003 2004/2003 2004/2003 ------- ------- ---------- ---------- Pork and Pork Products Chilled pork .............. 16,046 10,597 5,449 51% Frozen pork ............... 21,116 15,616 5,500 35% Prepared pork products .... 1,751 601 1,150 191% Vegetables and Fruits ....... 1,525 941 584 62% ------- ------- ------- Total ............ 40,438 27,755 12,683 46% ======= ======= ======= OPERATING INCOME BY SEGMENT (U.S. DOLLARS IN MILLIONS) YEAR ENDED OPERATING MARGIN DECEMBER 31, NET YEAR ENDED ----------------- CHANGE DECEMBER 31, 2004 2003 2004/2003 2004 2003 ------- ------- ---------- ------ ------ Pork and Pork Products Chilled pork .............. $ 1.23 $ 0.71 $ 0.52 7.24% 6.22% Frozen pork ............... 1.58 0.92 0.66 7.09% 5.48% Prepared pork products .... 0.21 0.05 0.16 8.27% 6.41% Vegetables and Fruits ....... 0.04 0.03 0.01 4.04% 5.00% ------- ------- ------- Total ............ $ 3.06 $ 1.71 $ 1.35 7.15% 5.78% ======= ======= ======= PRODUCTION BY SEGMENT (IN METRIC TONS) YEAR ENDED SALES DECEMBER 31, NET PERCENTAGE ------------------- CHANGE CHANGE 2004 2003 2004/2003 2004/2003 ------- ------- ---------- ---------- Pork and Pork Products Chilled pork .............. 16,114 10,607 5,507 52% Frozen pork ............... 21,022 15,687 5,335 34% Prepared pork products .... 1,780 613 1,167 190% Vegetables and Fruits ....... 1,610 1,207 403 33% --------- -------- -------- Total ............ 40,526 28,114 12,412 44% ========= ======== ======== 51 ADDITIONAL OPERATING DATA In assessing our existing operations and planning our future growth and the development of our business, management considers, among other factors, our revenue growth and growth in sales volume by market segment, as well as our sales by distribution channel and geographic market coverage. The following table sets forth our revenues by sales channel for the three years ended December 31, 2004, 2005 and 2006. SALES BY DISTRIBUTION CHANNEL (U.S. DOLLARS IN MILLIONS) YEAR ENDED DECEMBER 31, DISTRIBUTION ----------------------------------------------------------- CHANNEL 2004 2005 2006 ------- ---- ---- ----
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT ------ ------- ------ ------- ------ ------- Branded stores.............. $ 20.11 47.0% $ 35.23 48.0% $ 64.71 45.0% Food services distributors.. 7.66 17.9 12.33 16.8 28.48 19.8 Restaurants and non-commercial............ 10.95 25.6 18.35 25.0 38.40 26.7 Export...................... 4.07 9.5 7.49 10.2 12.22 8.5 ------- ------ ------ ------ ------ ------ Total.................. $ 42.79 100.0% $ 73.40 100.0% $143.81 100.0% ======= ====== ======= ===== ====== =====
The following table sets forth information with respect to the average number of products we offered, the average number of stores in our retail network and the number of provinces and cities in the PRC in which we offered and sold our products for each of the three years ended December 31, 2004, 2005 and 2006. YEAR ENDED DECEMBER 31, ------------------------------------------ 2004 2005 2006 ---- ---- ---- No. of products..................... 125 168 229 No. of retail stores................ 978 2,100 2,721 Expansion of Market Coverage No. of Provinces................. 23 24 24 No. of first-tier cities........ 23 29 29 No. of second-tier cities....... 36 44 75 No. of Third-tier cities........ 109 142 226 LIQUIDITY AND CAPITAL RESOURCES We have financed our operations over the three years ended December 31, 2006 primarily through cash from operating activities and borrowings under our lines of credit with various lending banks in the PRC. In January 2006, we completed a private placement of our Series A convertible preferred stock and common stock purchase warrants and received net proceeds of approximately $23.11 million. At December 31, 2004, 2005 and 2006 we had cash and cash equivalents of $5.20 million, $10.14 million and $21.69 million, respectively. Net cash provided by operating activities was $9.46 million in fiscal 2006, $13.08 million in fiscal 2005 and $0.61 million in fiscal 2004. Net cash provided by operating activities in fiscal 2006 was 52 primarily attributable to the net income of $6.36 million generated in fiscal 2006 and an increase of $8.25 million in accounts payable and other payables due to improved payment terms to suppliers. In addition, due to our failure to have our registration statement filed under the Securities Act of 1933, as amended, declared effective by the Securities and Exchange Commission during fiscal 2006, we accrued $8.35 million of penalty expense, of which $1.04 million was paid by cash and $7.31 million was paid by issuing shares of our common stock and warrants. Net cash used in operating activities in fiscal 2006 was primarily attributable to increases in inventories, accounts receivable and taxes payable in the amounts of $7.73 million, $3.42 million and $1.68 million, respectively. However, during fiscal 2006, management focused on reducing the average age of our accounts receivable. Our average accounts receivable turnover days decreased from approximately 42 days in fiscal 2005 to approximately 30 days in fiscal 2006. In addition, our average inventory turnover days increased from approximately 16 days in fiscal 2005 to approximately 18 days in fiscal 2006. Net cash provided by operating activities in fiscal 2005 consisted primarily of net income of $5.91 million, an increase in accounts payable and accrued liabilities of $7.14 million, and increase in taxes payable of $1.30 million and an increase in the allowance for bad debt of $1.21 million. Cash used in operating activities in fiscal 2005 was primarily due to an increase of $3.79 million in accounts receivable and other receivables. Net cash provided by operating activities in fiscal 2004 consisted primarily of net income of $2.77 million, an improvement of inventory management that generated cash inflow of $1.32 million, an improved payment term that resulted in cash inflow of $1.20 million and an increase in taxes payable of $0.92 million. Cash used in operating activities in fiscal 2004 was primarily due to an increase of $5.33 million in accounts receivable and other receivables. Net cash used in investing activities was $26.28 million in fiscal 2006, $13.23 million in fiscal 2005 and $2.54 million in fiscal 2004. In fiscal 2006, construction in progress in the amount of $21.96 million for the construction of Zhongpin Industrial Park II was completed and transferred to fixed assets. During fiscal 2006, we invested an additional $17.05 million in construction in progress and expended $1.82 million for the purchase of fixed assets. In addition, we expended $7.40 million for an investment in land use rights during fiscal 2006. During fiscal 2005, we expended $12.70 million for the construction of additional production facilities and production lines. During fiscal 2004, we expended $1.54 million for the purchase of fixed assets. Net cash provided by financing activities was $26.99 million in fiscal 2006, $4.88 million in fiscal 2005 and $0.99 million in fiscal 2004. In fiscal 2006, cash provided by financing activities included net proceeds from the issuance of Series A convertible preferred stock and common stock purchase warrants of $23.11 million and net proceeds of short-term loans of $30.08 million, and the net cash used in financing activities included the repayment of short-term indebtedness in the aggregate amount of $25.23 million, the repayment of long-term indebtedness in the amount of $0.35 million and the repayment of bank overdrafts of $0.62 million. During fiscal 2005 and 2004, we received net proceeds from short-term bank loans of $9.64 million and $2.04 million, respectively. At December 31, 2006, Henan Zhongpin had short-term bank and governmental loans in the aggregate amount of $23.99 million with a weighted average interest rate per annum of 6.26%, and lines of credit with aggregate credit availability of $83.75 million, as follows: 53 MAXIMUM CREDIT AMOUNT INTEREST BANK AVAILABILITY BORROWED RATE MATURITY DATE ---- -------------- ------------ -------- -------------
Agriculture Bank of China...... $ 23,051,212 $ 2,433,184 7.344% 09/10/2007 2,561,246 7.334% 12/25/2007 896,436 7.344% 12/29/2007 Industrial and Commercial Bank of China............... 15,367,475 1,920,934 5.85% 03/30/2007 1,920,934 5.85% 05/24/2007 1,920,934 6.12% 10/11/2007 China Construction Bank........ 11,525,606 640,311 6.417% 01/16/2007 CITIC Industrial Bank.......... 6,403,114 5,122,492 5.85% 07/16/2007 Agriculture Development Bank of China..................... 25,612,458 3,841,869 5.85% 07/03/2007 2,561,246 5.85% 07/17/2007 Bank of China.................. 10,244,983 - Shanghai Pudong Development Bank of China................ 6,403,114 - Guangdong Development Bank..... 3,841,869 - China Merchants Bank........... 5,122,492 ------------- ------------ Total................. $ 107,572,323 $ 23,819,587 ============= ============ Canadian Government Transfer Loan......................... $ 1,780,440 * 05/15/2043 Canadian Government Transfer Loan - Current portion....... $ 145,671 6.02% 05/15/2007 City Finance................... $ 131,904 0.00% None City Finance - current portion...................... $ 25,612 0.00% None
- ---------------- * 58% of the principal amount of this loan bears interest at the rate of 6.02% per annum and the remaining principal amount of this loan is interest free. All repayments are applied first to the interest-bearing portion of this loan. Of our outstanding short-term indebtedness at December 31, 2006, $3.46 million aggregate principal amount of loans was secured by our land and plants located in the PRC and $20.36 million aggregate principle amount of loans was guaranteed by our wholly-owned subsidiary, Henan Zhongpin Industry Co., Ltd. We believe our existing cash and cash equivalents, together with our available lines of credit, will be sufficient to finance our investment in new facilities, operating requirements and anticipated capital expenditures of approximately $26.0 million over the next 12 months. We may, however, determine to sell additional debt or equity securities in fiscal 2007 to raise funds for additional capital projects or strategic acquisitions that will enable us to strengthen our market position and accelerate our growth. 54 CONTRACTUAL COMMITMENTS The following table summarizes our contractual obligations at December 31, 2006 and the effect those obligations are expected to have on our liquidity and cash flow in future periods. PAYMENTS DUE BY PERIOD (IN THOUSANDS) ---------------------------------------------------- LESS THAN MORE THAN CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS ----------------------- ----- ------ --------- --------- -------
Long-Term Debt Obligations.......... $2,058 $146 $291 $291 $1,330 Capital Lease Obligations........... - - - - - Operating Lease Obligations......... 781 243 538 - - Purchase Obligations................ - - - - - Other Obligations................... - - - - - -------- ----- ----- ----- -------- Total........................ $2,839 $389 $829 $291 $1,330 ======== ===== ===== ===== ========
INFLATION AND SEASONALITY While demand for our products in general is relatively high before the Chinese New Year in January or February each year and lower thereafter, we do not believe our operations have been materially affected by inflation or seasonality. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK DISCLOSURES ABOUT MARKET RISK. We may be exposed to changes in financial market conditions in the normal course of business. Market risk generally represents the risk that losses may occur as a result of movements in interest rates and equity prices. We currently do not use financial instruments in the normal course of business that are subject to changes in financial market conditions. CURRENCY FLUCTUATIONS AND FOREIGN CURRENCY RISK. Substantially all of our operations are conducted in the PRC, with the exception of our export business and limited overseas purchases of raw materials. Most of our sales and purchases are conducted within the PRC in Renminbi, which is the official currency of the PRC. As a result, the effect of the fluctuations of exchange rates is considered minimal to our business operations. Substantially all of our revenues and expenses are denominated in Renminbi. However, we use the United States dollar for financial reporting purposes. Conversion of Renminbi into foreign currencies is regulated by the People's Bank of China through a unified floating exchange rate system. Although the PRC government has stated its intention to support the value of the Renminbi, there can be no assurance that such exchange rate will not again become volatile or that the Renminbi will not devalue significantly against the U.S. dollar. Exchange rate fluctuations may adversely affect the value, in U.S. dollar terms, of our net assets and income derived from our operations in the PRC. INTEREST RATE RISK. We do not have significant interest rate risk, as our debt obligations are primarily short-term in nature, with fixed interest rates. 55 CREDIT RISK. We have not experienced significant credit risk, as most of our customers are long-term customers with superior payment records. Our receivables are monitored regularly by our credit managers. NEW ACCOUNTING STANDARDS In March 2005, the Financial Accounting Standards Board (FASB) issued Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations," an interpretation of FASB Statement No. 143 (the Interpretation). Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" (SFAS No. 143), was issued in June 2001 and requires an entity to recognize the fair value of a liability for an asset retirement obligation in the period in which it is incurred if a reasonable estimate of fair value can be made. SFAS No. 143 applies to legal obligations associated with the retirement of a tangible long-lived asset that resulted from the acquisition, construction, development and (or) the normal operation of a long-lived asset. The associated asset costs are capitalized as part of the carrying amount of the long-lived asset. The Interpretation clarifies that the term "conditional asset retirement obligation" as used in SFAS No. 143, refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. The Interpretation requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. Uncertainty about the timing and (or) method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when sufficient information exists. SFAS No. 143 acknowledges that in some cases, sufficient information may not be available to reasonably estimate the fair value of an asset retirement obligation. The Interpretation is effective for fiscal years ending after December 15, 2005. We are currently in the process of evaluating any potential effects of the Interpretation but do not believe its adoption will have a material impact on our consolidated financial statements. In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R, "Share-Based Payment" (SFAS No. 123R), which is a revision of FASB Statement No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123). SFAS No. 123R supersedes Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and amends FASB Statement No. 95, "Statement of Cash Flows." The revision requires companies to measure and recognize compensation expense for all share-based payments to employees, including grants of employee stock options, in the financial statements based on the fair value at the date of the grant. SFAS No. 123R permits companies to adopt its requirements using either the modified prospective method or the modified retrospective method. Under the modified prospective method, compensation cost is recognized beginning with the effective date for all share-based payments granted after the effective date and for all awards granted to employees prior to the effective date of SFAS No. 123R that remain unvested on the effective date. The modified retrospective method includes the requirements of the modified prospective method, but also permits entities to restate either all prior periods presented or prior interim periods of the year of adoption for the impact of adopting this standard. We will apply the modified prospective method upon adoption. In April 2005, the Securities and Exchange Commission announced it would provide for phased-in implementation of SFAS No. 123R. As a result, SFAS No. 123R is effective for the first interim or annual reporting period of a registrant's first fiscal year beginning on or after June 15, 2005. We estimate that compensation expense related to employee stock options for fiscal 2006 is expected to be in the range of $0.5-$1.0 million. SFAS No. 123R also requires the benefits of tax deductions in excess of recognized compensation costs to be reported as financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. We believe this reclassification will not have a material impact on our consolidated statements of cash flows. 56 In December 2004, the FASB issued Statement of Financial Accounting Standards No. 151, "Inventory Costs" (SFAS No. 151). SFAS No. 151 requires abnormal amounts of inventory costs related to idle facility, freight handling and wasted material expenses to be recognized as current period charges. Additionally, SFAS No. 151 requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The standard is effective for fiscal years beginning after June 15, 2005. We believe the adoption of SFAS No. 151 will not have a material impact on our consolidated financial statements. ITEM 7A. - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK DISCLOSURES ABOUT MARKET RISK We may be exposed to changes in financial market conditions in the normal course of business. Market risk generally represents the risk that losses may occur as a result of movements in interest rates and equity prices. We currently do not use financial instruments in the normal course of business that are subject to changes in financial market conditions. CURRENCY FLUCTUATIONS AND FOREIGN CURRENCY RISK Substantially all of our operations are conducted in the PRC, with the exception of our export business and limited overseas purchases of raw materials. Most of our sales and purchases are conducted within the PRC in Chinese Renminbi, which is the official currency of the PRC. As a result, the effect of the fluctuations of exchange rates is considered minimal to our business operations. Substantially all of our revenues and expenses are denominated in Renminbi. However, we use the United States dollar for financial reporting purposes. Conversion of Renminbi into foreign currencies is regulated by the People's Bank of China through a unified floating exchange rate system. Although the PRC government has stated its intention to support the value of the Renminbi, there can be no assurance that such exchange rate will not again become volatile or that the Renminbi will not devalue significantly against the U.S. dollar. Exchange rate fluctuations may adversely affect the value, in U.S. dollar terms, of our net assets and income derived from its operations in the PRC. INTEREST RATE RISK We do not have significant interest rate risk, as our debt obligations are primarily short-term in nature, with fixed interest rates. CREDIT RISK We have not experienced significant credit risk, as most of our customers are long-term customers with superior payment records. Our receivables are monitored regularly by our credit managers. ITEM 8. - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following consolidated financial statements, notes thereto, and the related independent auditors' report contained on page F-2 to our consolidated financial statements are herein incorporated: 57 Consolidated balance sheets - December 31, 2006, 2005 and 2004 Consolidated statements of operations and comprehensive income - Years ended December 31, 2006, 2005 and 2004 Consolidated statement of changes in stockholders' equity - Years ended December 31, 2006, 2005 and 2004 Consolidated statements of cash flows - Years ended December 31, 2006, 2005 and 2004 Notes to consolidated financial statements - Years ended December 31, 2006, 2005 and 2004 ITEM 9. - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES. (a) DISCLOSURE CONTROLS AND PROCEDURES. Our management, with the participation of our chief executive officer and chief financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on such evaluation, our chief executive officer and chief financial officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act. (b) INTERNAL CONTROL OVER FINANCIAL REPORTING. There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fourth quarter of 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. ITEM 9B. OTHER INFORMATION. None. 58 PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE The information required by this Item is incorporated by reference to the information contained in our Proxy Statement for our 2007 Annual Meeting of Stockholders, which we will file with the Commission within 120 days after the end of fiscal 2006. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated by reference to the information contained in our Proxy Statement for our 2007 Annual Meeting of Stockholders, which we will file with the Commission within 120 days after the end of fiscal 2006. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information required by this Item is incorporated by reference to the information contained in our Proxy Statement for our 2007 Annual Meeting of Stockholders, which we will file with the Commission within 120 days after the end of fiscal 2006. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE The information required by this Item is incorporated by reference to the information contained in our Proxy Statement for our 2007 Annual Meeting of Stockholders, which we will file with the Commission within 120 days after the end of fiscal 2006. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES The information required by this Item is incorporated by reference to the information contained in our Proxy Statement for our 2007 Annual Meeting of Stockholders, which we will file with the Commission within 120 days after the end of fiscal 2006. 59 PART IV ITEM 15. - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a) Documents filed as part of this Report: (1) Report of Independent Registered Public Accounting Firm Financial Statements covered by the Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets as of December 31, 2006, 2005 and 2004 Consolidated Statements of Operations and Comprehensive Income for the Years ended December 31, 2006, 2005 and 2004 Consolidated Statement of Changes in Stockholders' Equity for the years ended December 31, 2006, 2005 and 2004 Consolidated statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004 Notes to Consolidated Financial Statements for the years ended December 31, 2006, 2005 and 2004 (2) Schedules for the years ended December 31, 2006, 2005 and 2004 None. (b) Exhibits: 3.1 Certificate of Incorporation of the Registrant filed February 4, 2003 with the Delaware Secretary of State, incorporated by reference to Exhibit 3.1 to our Registration Statement on Form SB-2 filed with the Securities and Exchange Commission on January 22, 2004. 3.2 Amendment to Certificate of Incorporation of the Registrant filed January 30, 2006 with the Delaware Secretary of State, incorporated by reference to Exhibit 3.2 to our Current Report on Form 8-K dated January 30, 2006. 3.3 Certificate of Designation of Series A Convertible Preferred Stock of the Registrant filed January 30, 2005 with the Delaware Secretary of State, incorporated by reference to Exhibit 3.3 to our Current Report on Form 8-K dated January 30, 2006. 3.4 Amendment to Certificate of Incorporation of the Registrant filed February 16, 2006 with the Delaware Secretary of State, incorporated by reference to Exhibit 3.1 to our Current Report on Form 8-K dated February 16, 2006. 3.5 Amendment to the Certificate of Incorporation of the Registrant filed March 20, 2007 with the Delaware Secretary of State. 3.6 Amended and Restated By-laws of the Registrant, incorporated by reference to Exhibit 3.2 to our Current Report on Form 8-K dated February 14, 2007. 60 10.1 Loan Agreements between Agricultural Bank of China, Xuchang Branch and Henan Zhongpin Food Share Co., Ltd., incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K dated January 30, 2006.* 10.2 Loan Agreement dated March 31, 2005 between CITIC Industrial Bank, Zhengzhou Branch and Henan Zhongpin Food Share Co., Ltd., incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K dated January 30, 2006.* 10.3 Loan Agreements between Shanghai Pudong Development Bank, Zhengzhou Branch and Henan Zhongpin Food Share Co., Ltd., incorporated by reference to Exhibit 10.3 to our Current Report on Form 8-K dated January 30, 2006.* 10.4 Loan Agreements between China Construction Bank, Xuchang Branch and Henan Zhongpin Food Share Co., Ltd., incorporated by reference to Exhibit 10.4 to our Current Report on Form 8-K dated January 30, 2006.* 10.5 Transfer Loan Agreement dated May 31, 2002 between Bank of Communications, Zhengzhou Branch and Henan Zhongpin Food Share Co., Ltd., incorporated by reference to Exhibit 10.5 to our Current Report on Form 8-K dated January 30, 2006.* 10.6 Equipment Purchase Agreement dated July 18, 2001 between Henan International Economic Trading Corporation (buyer), Henan Zhongpin Food Share Co., Ltd. (end user) and Berg Chilling Systems Inc.(seller), incorporated by reference to Exhibit 10.6 to our Current Report on Form 8-K dated January 30, 2006.* 10.7 Advisory Agreements dated April 07, 2005 and April 26, 2005 between Greenstone Investment & Consultants Ltd. and Henan Zhongpin Food Share Co., Ltd., incorporated by reference to Exhibit 10.7 to our Registration Statement on Form S-1 (Registration No. 333-133226) (TRANSLATED FROM MANDARIN). 10.8 Agreement on Transfer of Shares of Henan Zhongpin Food Share Co., Ltd. dated May 23, 2005 between Zhu Xianfu and Henan Zhongpin Food Co., Ltd., incorporated by reference to Exhibit 10.8 to our Current Report on Form 8-K dated January 30, 2006.* 10.9 Agreement on Transfer of Shares of Henan Zhongpin Food Share Co., Ltd. dated May 23, 2005 between Ben Baoke and Henan Zhongpin Food Co., Ltd., incorporated by reference to Exhibit 10.9 to our Current Report on Form 8-K dated January 30, 2006.* 10.10 Agreement on Transfer of Shares of Henan Zhongpin Food Share Co., Ltd. dated May 23, 2005 between Si Shuichi and Henan Zhongpin Food Co., Ltd., incorporated by reference to Exhibit 10.10 to our Current Report on Form 8-K dated January 30, 2006.* 10.11 Agreement on Transfer of Shares of Henan Zhongpin Food Share Co., Ltd. dated May 23, 2005 between Wang Qinghe and Henan Zhongpin Food Co., Ltd., 61 incorporated by reference to Exhibit 10.11 to our Current Report on Form 8-K dated January 30, 2006.* 10.12 Agreement on Transfer of Shares of Henan Zhongpin Food Share Co., Ltd. dated May 23, 2005 between Liu Chaoyang and Henan Zhongpin Food Co., Ltd., incorporated by reference to Exhibit 10.12 to our Current Report on Form 8-K dated January 30, 2006.* 10.13 Agreement on Transfer of Shares of Henan Zhongpin Food Share Co., Ltd. dated May 23, 2005 between Wang Juanjuan and Henan Zhongpin Food Co., Ltd., incorporated by reference to Exhibit 10.13 to our Current Report on Form 8-K dated January 30, 2006.* 10.14 Agreement on Trust of Share Equity of Henan Zhongpin Food Share Co., Ltd. dated May 23, 2005 between Zhu Xianfu, Ben Baoke, Si Shuichi, Wang Qinghe, Liu Chaoyang and Wang Juanjuan and Henan Zhongpin Food Co., Ltd., incorporated by reference to Exhibit 10.14 to our Current Report on Form 8-K dated January 30, 2006.* 10.15 Agreement on Transfer of Equity Interest of Henan Zhongpin Food Co., Ltd. dated August 16, 2005 between Zhu Xianfu, Ben Baoke, Si Shuichi, Wang Qinghe, Liu Chaoyang and Wang Juanjuan (Transferors) and Falcon Link Investment Ltd., incorporated by reference to Exhibit 10.15 to our Current Report on Form 8-K dated January 30, 2006.* 10.16 Securities Purchase Agreement, dated as of January 30, 2006, by and among the Registrant and the purchasers named therein, incorporated by reference to Exhibit 10.16 to our Registration Statement on Form S-1 (Registration No. 333-133226).* 10.17 Registration Rights Agreement, dated as of January 30, 2006, by and among the Registrant and the purchaser named therein, incorporated by reference to Exhibit 10.17 to our Registration Statement on Form S-1 (Registration No. 333-133226).* 10.18 Form of Warrant to purchase common stock, incorporated by reference to Exhibit 10.18 to our Current Report on Form 8-K dated January 30, 2006, incorporated by reference to Exhibit 10.18 to our Registration Statement on Form S-1 (Registration No. 333-133226). 10.19 Placement Agent Warrant Agreement, dated as of January 30, 2006, between the Registrant and TN Capital Equities, Ltd., incorporated by reference to Exhibit 10.19 to our Registration Statement on Form S-1 (Registration No. 333-133226). 10.20 Stock Purchase Agreement, dated as of March 15, 2005, among Richard Armstrong, Halter Capital Corporation and the Registrant, incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K dated March 30, 2005. 62 10.21 Share Exchange Agreement, dated as of January 30, 2006, among the Registrant, Falcon Link Investment Limited, the stockholders of the Registrant signatory thereto and as to Articles IV, VII and IX only, Kevin Halter, Jr., incorporated by reference to Exhibit 10.21 to our Registration Statement on Form S-1 (Registration No. 333-133226). 10.22 Advisory Agreement, dated as of January 30, 2006, between HFG International Limited and Falcon Link Investment Limited, incorporated by reference to Exhibit 10.22 to our Registration Statement on Form S-1 (Registration No. 333-133226). 10.23 Amendment dated as of February 21, 2006 [to Securities Purchase Agreement dated as of January 30, 2006] among the Registrant and the purchasers named therein, incorporated by reference to Exhibit 10.23 to our Registration Statement on Form S-1 (Registration No. 333-133226). 10.24 Escrow Agreement dated as of January 30, 2006 among the Registrant, Law Debenture Trust Company of New York, as escrow agent, and the stockholders of the Registrant named therein, incorporated by reference to Exhibit 10.24 to our Registration Statement on Form S-1 (Registration No. 333-133226). 10.25 Amendment to Escrow Agreement dated as of February 21, 2006 among the Registrant, Law Debenture Trust Company of New York, as escrow agent, and the stockholders of the Registrant named therein, incorporated by reference to Exhibit 10.25 to our Registration Statement on Form S-1 (Registration No. 333-133226). 10.26 Common Stock Purchase Warrant dated June 15, 2006 between the Registrant and CCG Partners LLC, incorporated by reference to Exhibit 10.26 to our Registration Statement on Form S-1 (Registration No. 333-133226). 10.27 Leasing Contract dated as of November 6, 2006 between Heilongjiang Gongzhun Meat and Food Co., Ltd. and Henan Zhongpin Food Share Co., Ltd., incorporated by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2006. 10.28 Amendment dated as of December 21, 2006 [to Registration Rights Agreement dated as of January 30, 2006] among the Registrant and the Investors named therein, incorporated by reference to Exhibit 10.28 to our Registration Statement on Form S-1 (Registration No. 333-133226). 10.29 Form of Common Stock Purchase Warrant issued in December 2006, incorporated by reference to Exhibit 10.29 to our Registration Statement on Form S-1 (Registration No. 333-133226). 14.1 Code of Business Conduct and Ethics of the Registrant, incorporated by reference to Exhibit 14.1 to our Registration Statement on Form S-1 (Registration No. 333-133226). 63 31.1 Certification of our Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of our Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of our Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of our Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.1 Business License of Henan Zhongpin Food Share Co., Ltd., dated December 16, 2003, incorporated by reference to Exhibit 99.1 to our Current Report on Form 8-K dated January 30, 2006. (TRANSLATED FROM MANDARIN) 99.2 By-Laws of Henan Zhongpin Food Share Co., Ltd., dated May 23, 2005, incorporated by reference to Exhibit 99.2 to our Current Report on Form 8-K dated January 30, 2006. (TRANSLATED FROM MANDARIN) 99.3 Governmental Approval of the Acquisition of Henan Zhongpin Food Co., Ltd. by Falcon Link Investment Limited, dated September 13, 2005, incorporated by reference to Exhibit 99.3 to our Current Report on Form 8-K dated January 30, 2006. (TRANSLATED FROM MANDARIN) 99.4 Certificate of Approval for Establishment of an Enterprise with Foreign Investment [Henan Zhongpin Food Co., Ltd.] in the People's Republic of China, dated September 15, 2005, incorporated by reference to Exhibit 99.4 to our Current Report on Form 8-K dated January 30, 2006. (TRANSLATED FROM MANDARIN) 99.5 By-Laws of Henan Zhongpin Food Co., Ltd., dated August, 2005, incorporated by reference to Exhibit 99.5 to our Current Report on Form 8-K dated January 30, 2006. (TRANSLATED FROM MANDARIN) 99.6 Certificate of Incorporation of Falcon Link Investment Limited, dated July 21, 2005, incorporated by reference to Exhibit 99.6 to our Current Report on Form 8-K dated January 30, 2006. 99.7 Memorandum of Association of Falcon Link Investment Limited, dated July 21, 2005, incorporated by reference to Exhibit 99.7 to our Registration Statement on Form S-1 (Registration No. 333-133226). 99.8 Articles of Association of Falcon Link Investment Limited, dated July 21, 2005, incorporated by reference to Exhibit 99.8 to our Registration Statement on Form S-1 (Registration No. 333-133226). 64 99.9 Business License of Henan Zhongpin Food Co., Ltd. dated May 26, 2005, incorporated by reference to Exhibit 99.9 to our Current Report on Form 8-K dated January 30, 2006. (TRANSLATED FROM MANDARIN) - ------------ * Original agreement in Mandarin, summary of key terms attached. 65 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, we have duly caused this Report to be signed on our behalf by the undersigned, thereunto duly authorized on the 23rd day of March 2007. ZHONGPIN INC. (Company) By: /s/ Xianfu Zhu ------------------------------- Xianfu Zhu Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated. SIGNATURE TITLE DATE - -------------------------- ----------------------------- --------------- /s/ Xianfu Zhu Chairman of the Board of March 23, 2007 - -------------------------- Directors and Chief Xianfu Zhu Executive Officer (Principal Executive Officer) /s/ Yuanmei Ma Chief Financial Officer March 23, 2007 - -------------------------- (Principal Financial and Yuanmei Ma Accounting Officer) /s/ Xinyu Li Director March 23, 2007 - -------------------------- Xinyu Li /s/ Yunchun Wang Director March 23, 2007 - -------------------------- Yunchun Wang 66 ZHONGPIN INC. CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004 ZHONGPIN INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE ----- Index to Consolidated Financial Statements F-1 Report of Independent Registered Public Accounting Firm F-2 Consolidated Balance Sheets F-3 Consolidated Statements of Operations and Comprehensive Income F-4 Consolidated Statement of Change in Stockholders' Equity F-5 Consolidated Statements of Cash Flows F-6 Notes to Consolidated Financial Statements F-7 F-1 Child, Van Wagoner & Bradshaw, PLLC Report of Independent Registered Public Accounting Firm To the Board of Directors Zhongpin Inc. Henan Province, People's Republic of China We have audited the consolidated balance sheets of Zhongpin Inc. (the Company) as of December 31, 2006 and 2005, and the related consolidated statements of operations and comprehensive income, stockholders' equity, and cash flows for the years ended December 31, 2006, 2005 and 2004. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. 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 audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Zhongpin Inc. as of December 31, 2006 and 2005, and the results of its operations and its cash flows for the years ended December 31, 2006, 2005 and 2004, in conformity with accounting principles generally accepted in the United States of America. /s/ Child, Van Wagoner & Bradshaw, PLLC Salt Lake City, Utah March 8, 2007 F-2 ZHONGPIN INC. CONSOLIDATED BALANCE SHEETS (US dollars) December 31, December 31, ------------- ------------ ASSETS 2006 2005 ------------- ------------ Current assets Cash and cash equivalents $ 21,692,814 $ 10,142,394 Accounts receivable and other receivables 13,471,450 10,002,918 Purchase deposits - 220,836 Prepaid expenses and deferred charges 200,436 99,009 Inventories 10,077,479 2,347,312 Tax refund receivable 1,079,002 644,232 ------------- ------------ Total current assets 46,521,181 23,456,701 Property, plant and equipment (net) 32,597,150 10,212,848 Related party receivables - 267,658 Other receivables 2,056,642 632,063 Construction in progress 12,016,823 16,931,178 Intangible assets 9,030,077 1,753,124 ------------- ------------ Total assets $102,221,873 $ 53,253,572 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Bank overdraft $ - $ 619,579 Accounts payable and other payables 20,712,794 10,278,464 Accrued liabilities 1,597,557 759,420 Short-term loans payable 23,845,198 18,995,853 Taxes payable 378,705 2,055,925 Deposits from clients 683,814 769,398 Research & development grants payable 248,572 2,436,804 Long-term loans payable - current portion 145,671 145,671 ------------- ------------ Total current liabilities 47,612,311 36,061,114 Long-term loans payable 1,912,343 2,264,448 ------------- ------------ Total liabilities 49,524,654 38,325,562 Minority interest - 411,742 Stockholders' equity Preferred stock par value $0.001; 10,000,000 authorized; 6,900,000 and 0 issued and outstanding 6,900 - Common stock par value $0.001; 25,000,000 authorized; 12,132,311 and 11,752,568 issued and outstanding 12,133 11,753 Additional paid in capital 32,538,535 2,102,933 Retained earnings 18,456,884 12,097,834 Accumulated other comprehensive income 1,682,767 303,748 ------------- ------------ Total stockholders' equity 52,697,219 14,516,268 ------------- ------------ Total liabilities and stockholders' equity $102,221,873 $ 53,253,572 ============ ============ The accompanying notes are an integral part of the consolidated financial statements F-3 ZHONGPIN INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (US dollars) Year ended DECEMBER 31, -------------------------------------------- 2006 2005 2004 ---- ---- ---- Revenues Sales revenues $143,812,212 $ 73,399,998 $ 42,787,153 Cost of sales 123,195,870 61,220,499 36,669,989 ------------ ------------ ------------ Gross profit 20,616,342 12,179,499 6,117,164 Operating expenses General and administrative expenses 2,989,158 2,395,961 1,214,365 Operating expenses 3,485,397 2,299,950 1,844,840 Liquidated damages 8,354,205 - - ------------ ------------ ------------ Total operating expenses 14,828,760 4,695,911 3,059,205 ------------ ------------ ------------ Income from operations 5,787,582 7,483,588 3,057,959 Other income (expense) Interest income 316,604 182,798 85,854 Other income 50,589 166,673 31,807 Allowances income 2,364,803 85,592 928,302 Exchange gain (loss) (21,377) 226,547 (22,554) Interest expense (1,555,671) (1,802,042) (1,208,362) ------------ ------------ ------------ Total other income (expense) 1,154,948 (1,140,432) (184,953) ------------ ------------ ------------ Net income before taxes 6,942,530 6,343,156 2,873,006 Provision for income taxes 568,433 352,880 84,541 ------------ ------------ ------------ Net income after taxes 6,374,097 5,990,276 2,788,465 Less: minority interest in gain 15,047 76,429 19,992 ------------ ------------ ------------ Net income $ 6,359,050 $ 5,913,847 $ 2,768,473 ============ ============ ============ Foreign currency translation adjustment 1,379,019 303,748 - ------------ ------------ ------------ Comprehensive income $ 7,738,069 $ 6,217,595 $ 2,768,473 ============ ============ ============ Basic earnings per common share $ 0.35 $ 0.50 $ 0.24 ------------ ------------ ------------ Diluted earnings per common share $ 0.31 $ 0.50 $ 0.24 ------------ ------------ ------------ Basic weighted average shares outstanding 11,761,932 11,752,568 11,752,568 ------------ ------------ ------------ Diluted weighted average shares outstanding 20,334,259 11,752,568 11,752,568 ------------ ------------ ------------ The accompanying notes are an integral part of the consolidated financial statements F-4 ZHONGPIN INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (US dollars) Preferred Stock Common Stock Shares Par Value Shares Par Value ------------- ------------ ------------ ------------
Balance January 1, 2004 - $ - 1 $ 1,816,425 Net income for the year - - - - ------------- ------------ ------------ ------------ Balance December 31, 2004 - - 1 1,816,425 Merger on May 20 - - - 115,942 Recapitalization on September 15 - - 9,999 (1,922,367) Net income for the year Foreign currency translation adjustment - - - - ------------- ------------ ------------ ------------ Balance December 31, 2005 - - 10,000 10,000 Items applied retroactively: Recapitalization on January 30, 2006 415,432,354 405,442 Reverse stock split on February 16, 2006 - - (403,689,786) (403,689) ------------- ------------ ------------ ------------ Restated balance December 31, 2005 - - 11,752,568 11,753 Preferred stock sold for cash 6,900,000 6,900 Cost of issuance Warrant expense Common stock issued for damages 379,743 380 Warrants issued for damages Net income for the year Foreign currency translation adjustment - - - - ------------- ------------ ------------ ------------ Balance December 31, 2006 6,900,000 $ 6,900 12,132,311 $ 12,133 ============= ============ ============ ============
Accumulated Additional Other Paid In Retained Comprehensive Capital Earnings Income Total ------------ ------------ ------------ ------------
Balance January 1, 2004 $ 182,319 $ 3,415,514 $ - $ 5,414,258 Net income for the year - 2,768,473 - 2,768,473 ------------- ------------ ----------- ------------ Balance December 31, 2004 182,319 6,183,987 - 8,182,731 Merger on May 20 115,942 Recapitalization on September 15 1,922,367 - Net income for the year 5,913,847 5,913,847 Foreign currency translation adjustment - - 303,748 303,748 ------------- ------------ ----------- ------------ Balance December 31, 2005 2,104,686 12,097,834 303,748 14,516,268 Items applied retroactively: Recapitalization on January 30, 2006 (405,442) - Reverse stock split on February 16, 2006 403,689 - - - ------------- ------------ ----------- ------------ Restated balance December 31, 2005 2,102,933 12,097,834 303,748 14,516,268 Preferred stock sold for cash 27,593,100 27,600,000 Cost of issuance (4,489,297) (4,489,297) Warrant expense 22,330 22,330 Common stock issued for damages 2,847,693 2,848,073 Warrants issued for damages 4,461,776 4,461,776 Net income for the year 6,359,050 6,359,050 Foreign currency translation adjustment - - 1,379,019 1,379,019 ------------- ------------ ----------- ------------ Balance December 31, 2006 $ 32,538,535 $ 18,456,884 $ 1,682,767 $ 52,697,219 ============= ============ =========== ============
The accompanying notes are an integral part of the consolidated financial statements F-5 ZHONGPIN INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (US dollars) Year ended DECEMBER 31, ----------------------------------------- 2006 2005 2004 ------------- ----------- -----------
Cash flows from operating activities: Net income $ 6,359,050 $ 5,913,847 $ 2,768,473 Adjustments to reconcile net income to net cash provided by (used in) operations: Minority interest 15,047 76,447 87,625 Acquisition gain 1,066 - - Depreciation 973,618 602,008 415,979 Amortization 127,449 37,431 38,144 Provision for bad debt (1,304,589) 1,214,461 267,668 Liquidated damages 7,309,848 - - Warrant expense 22,330 - - Changes in operating assets and liabilities: Accounts receivable and other receivables (3,320,865) (3,788,597) (5,327,868) Purchase deposits 220,836 (91,712) 114,890 Prepaid expense and deferred charges (101,427) (4,383) (72,836) Inventories (7,730,167) 865,583 1,323,097 Tax refunds receivable (434,770) (634,793) - Accounts payable and other payable 8,248,230 7,135,575 1,201,819 Accrued liabilities 838,137 419,194 (43,842) Taxes payable (1,677,220) 1,303,773 920,393 Deposits from clients (85,584) 35,676 (1,084,338) ------------ ----------- ----------- Net cash provided by operating activities 9,459,923 13,084,510 609,204 Cash flows from investing activities: Construction in progress (17,051,855) (12,703,414) (49,267) Additions to fixed assets (1,820,630) (527,369) (1,536,144) Purchase of intangible assets (7,404,402) - (951,436) ------------ ----------- ----------- Net cash used in investing activities (26,276,887) (13,230,783) (2,536,847) Cash flows from financing activities: Proceeds from (repayment of) bank overdraft (619,579) 610,501 - Proceeds from short-term loans 30,081,418 9,641,295 2,035,903 Repayment of short-term loans (25,232,072) Repayments of long-term loans (352,105) (5,490,645) (1,044,150) Proceeds from preferred stock 23,110,703 Capital paid in at acquisition - 117,216 - Advances to related parties - (190,476) - Investment in sub by minority holder - 190,476 - ------------ ----------- ----------- Net cash provided by financing activities 26,988,365 4,878,367 991,753 Effect of rate changes on cash 1,379,019 205,663 - ------------ ----------- ----------- Increase (decrease) in cash and cash equivalents 11,550,420 4,937,757 (935,890) Cash and cash equivalents, beginning of period 10,142,394 5,204,637 6,140,527 ------------ ----------- ----------- Cash and cash equivalents, end of period $ 21,692,814 $10,142,394 $ 5,204,637 ============ =========== =========== Supplemental disclosures of cash flow information: Cash paid for interest $ 1,554,883 $ 1,699,634 $ 1,208,362 ============ =========== =========== Cash paid for income taxes $ 323,866 $ 370,696 $ 84,541 ============ =========== ===========
The accompanying notes are an integral part of the consolidated financial statements F-6 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND NATURE OF OPERATIONS Zhongpin Inc. ("Zhongpin") was incorporated on February 4, 2003 as Strong Technical Inc. in the State of Delaware for the purpose of operating a personnel outsourcing service that provides skilled workers to industry. On March 30, 2005, an 82.4% controlling interest in our company was acquired by Halter Capital Corporation and all previous operations were discontinued. On January 30, 2006, we acquired Falcon Link Investment Limited ("Falcon") in a stock exchange by issuing 11,250,000 shares of our common stock in exchange for all of the issued and outstanding capital stock of Falcon. The acquisition transaction was accounted for as a reverse acquisition resulting in the recapitalization of Falcon. Accordingly, the historical financial statements of Falcon have been retroactively restated to give effect to the recapitalization as if it had occurred at the beginning of the first period presented. Zhongpin and its subsidiaries are collectively referred to herein as "our company," "we," "us" and "our." Falcon was incorporated in the Territory of the British Virgin Islands ("BVI") on July 21, 2005 as a holding company for the purpose of owning all of the equity interests of Henan Zhongpin Food Co., Ltd. ("HZFC"), a People's Republic of China ("PRC") company. Falcon acquired 100% ownership of HZFC by paying 20,940,000 Renminbi ("RMB") ($2,528,986) to the stockholders of HZFC, who also were the stockholders of Falcon. The transaction was accounted for as a transfer of entities under common control, wherein HZFC was the continuing entity. The historical financial statements of Falcon are essentially those of HZFC and are shown as if the transfer had taken place at the beginning of the first period presented. HZFC was established in the PRC on May 20, 2005 for the sole purpose of holding the capital stock of Henan Zhongpin Food Share Company Limited ("Food Share") and its subsidiaries. The owners of Food Share formed HZFC by investing 16,000,000 RMB ($1,932,367). HZFC acquired Food Share by paying 15,040,000 RMB ($1,816,425) to the stockholders of Food Share, who were also the stockholders of HZFC, in exchange for 100% ownership of Food Share. The transaction was accounted for as a transfer of entities under common control, wherein Food Share was the continuing entity with an increase in registered capital of 960,000 RMB ($115,942). The historical financial statements of HZFC are essentially those of Food Share shown with an increase in capital as if the transfer had taken place at the beginning of the first period presented. Food Share was incorporated in the PRC. It is headquartered in Henan Province in the PRC and its corporate office is in Changge City. Through our subsidiaries, we are principally engaged in the production of pork, pork products and vegetables, and the retail sales of pork, processed pork products, vegetables and other grocery items to customers throughout the PRC and other export countries, either directly or through our subsidiaries. On January 30, 2006, we consummated an agreement with the shareholders of Falcon whereby we issued 11,250,000 shares of our common stock in exchange for all of the issued and outstanding stock of Falcon. Immediately prior to the transaction there were 502,578 shares outstanding as compared to 11,752,578 shares outstanding immediately following the transaction. Consequently, Falcon became a wholly-owned subsidiary of our company. The transaction was accounted for as a reverse acquisition resulting in a recapitalization of Falcon, wherein Falcon's historical financial statements became those of our company, retrospectively restated to reflect the adopted capital structure of our company as if the transaction had occurred at the beginning of the first period presented. These financial statements have been adjusted to reflect such restatement. F-7 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND NATURE OF OPERATIONS (continued) In conjunction with our acquisition of Falcon, on January 31, 2006, we sold for $8.00 per unit 3.45 million units, each consisting of two shares of Series A convertible preferred stock and a five-year warrant to purchase one share of common stock at a purchase price of $5.00 per share. Each preferred share is convertible into one share of common stock. The outstanding shares of Series A convertible preferred stock are convertible into an aggregate of 6,900,000 shares of common stock and the outstanding warrants are exercisable to purchase an aggregate of 3,450,000 shares of common stock. On February 16, 2006, we amended our articles of incorporation to change our name from Strong Technical, Inc. to Zhongpin Inc. In the same amendment, we changed our authorized common stock to 25,000,000 shares with a par value of $0.001 per share and our authorized preferred stock to 10,000,000 shares with a par value of $0.001 per share. On February 16, 2006, we effected a 1:35.349 reverse split of our outstanding common stock. Immediately prior to the split, 415,442,354 common shares were outstanding as compared to 11,752,578 common shares outstanding immediately following the split. The aggregate number of shares of common stock issuable upon conversion of our outstanding shares of Series A convertible preferred stock was reduced from 243,908,100 common shares to 6,900,000 common shares, and the aggregate number of shares of our common stock issuable upon the exercise of our outstanding warrants was reduced from 121,954,050 common shares to 3,450,000 common shares. These financial statements have been adjusted to show all stock transactions using post-split amounts. In June 2006, Zhumadian Zhongpin Food Company Limited was registered with a registered capital of 5,000,000 RMB ($625,344), which is 100%-owned by Food Share. In August 2006, Anyang Zhongpin Food Company Limited was registered with a registered capital of 4,800,000 RMB ($606,927), which is 100%-owned by Food Share. In September 2006, Henan Zhongpin Fresh Food Logistics Company Limited, Deyang Zhongpin Food Company Limited and Henan Zhongpin Business Development Company Limited were registered with the registered capitals of 1,500,000 RMB ($189,665), 1,000,000 RMB ($126,443) and 5,000,000 RMB ($632,215), respectively, which are all 100%-owned by Food Share. In October 2006, Heilongjiang Zhongpin Food Company Limited was registered with a registered capital of 1,000,000 RMB ($126,406), which is 100%-owned by Food Share. Details of Food Share's subsidiaries are as follows: DOMICILE/DATE OF REGISTERED PERCENTAGE NAME INCORPORATION CAPITAL OF OWNERSHIP -------------------------- ------------------ --------------- --------------
Henan Zhongpin Industry PRC/Jan. 17, 2004 18,000,000 RMB 100.00% Company Limited ($2,173,913) Henan Zhongpin Imports and Exports PRC/Aug. 11, 2004 5,060,000 RMB 100.00% Trade Company Limited ($611,111) Zhumadian Zhongpin Food Company PRC/June 7, 2006 5,000,000 RMB 100.00% Limited ($625,344) Anyang Zhongpin Food Company PRC/Aug 21, 2006 4,800,000 RMB 100.00% Limited ($606,927)
F-8 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DOMICILE/DATE OF REGISTERED PERCENTAGE NAME INCORPORATION CAPITAL OF OWNERSHIP
Henan Zhongpin Fresh Food Logistics PRC/Sept. 14, 2006 1,500,000 RMB 100.00% Company Limited ($189,665) Deyang Zhongpin Food Company PRC/Sept. 25, 2006 1,000,000 RMB 100.00% Limited ($126,443) Henan Zhongpin Business Development PRC/Sept. 27, 2006 5,000,000 RMB 100.00% Company Limited ($632,215) Heilongjiang Zhongpin Food Company PRC/Oct. 17, 2006 1,000,000 RMB 100.00% Limited ($126,406)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The consolidated financial statements include the accounts of Zhongpin Inc. (formerly Strong Technical, Inc.), Falcon Link Investment Limited, Henan Zhongpin Food Co., Ltd., Food Share, Henan Zhongpin Industry Company Limited, Henan Zhongpin Imports and Exports Trade Company Limited, Zhumadian Zhongpin Food Company Limited, Anyang Zhongpin Food Company Limited, Henan Zhongpin Business Development Company Limited, Henan Zhongpin Fresh Food Logistics Company Limited, Deyang Zhongpin Food Company Limited and Heilongjiang Zhongpin Food Company Limited. All material intercompany accounts and transactions have been eliminated in consolidation. The consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. U.S. GAAP differs from that used in the statutory financial statements of our PRC subsidiaries, which were prepared in accordance with the relevant accounting principles and financial reporting regulations as established by the Ministry of Finance of the PRC. The Renminbi of the People's Republic of China (RMB) has been determined to be our functional currency. The balance sheets of our company and our subsidiaries were translated at year end exchange rates. Expenses were translated at moving average exchange rates in effect during the year. The effects of rate changes on assets and liabilities are recorded as accumulated other comprehensive income. FISCAL YEAR Our financial statements have been prepared using December 31 as the fiscal year end. F-9 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) MINORITY INTEREST IN SUBSIDIARIES We record minority interest expense, which reflects the minority shareholders' portion of the earnings of Henan Zhongpin Industry Company Limited and Henan Zhongpin Imports and Exports Trade Company Limited. During 2004, Henan Zhongpin Industry Company Limited increased its registered capital from 5,000,000 RMB ($603,864) to 18,000,000 RMB ($2,173,913), which required the minority holders to increase their investment by 1,560,000 RMB ($188,406), effectively increasing the minority interest shown on our balance sheet by $188,406. In November 2006, Food Share acquired the minority interest shares of Henan Zhongpin Industry Company Limited and Henan Zhongpin Imports and Exports Trade Company Limited and became the 100% owner of Henan Zhongpin Industry Company Limited and Henan Zhongpin Imports and Exports Trade Company Limited. RESTRICTIONS ON TRANSFER OF ASSETS OUT OF THE PRC Dividend payments by HZFC are limited by certain statutory regulations in the PRC. No dividends may be paid by HZFC without first receiving prior approval from the Foreign Currency Exchange Management Bureau. Dividend payments are restricted to 85% of profits, after tax. CONTROL BY PRINCIPAL STOCKHOLDERS Our directors and executive officers and their affiliates or related parties own, beneficially and in the aggregate, the majority of the voting power of the outstanding shares of our common stock. Accordingly, if our directors and executive officers and their affiliates or related parties vote their shares uniformly, they would have the ability to control the approval of most corporate actions, including increasing our authorized capital stock and the dissolution or merger of our company or the sale of our assets. START-UP COSTS In accordance with the provisions of the American Institute of Certified Public Accountants' Statement of Position (SOP) 98-5, "Reporting on the Costs of Start-up Activities," we expense all start-up and organizational costs as they are incurred. USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. SIGNIFICANT ESTIMATES Several areas require significant management estimates relating to uncertainties for which it is reasonably possible there will be a material change in the near term. The more significant areas requiring F-10 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) the use of management estimates relate to the valuation of receivables, equipment and accrued liabilities, and the useful lives for amortization and depreciation. CASH EQUIVALENTS We consider all highly-liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. ACCOUNTS RECEIVABLE Accounts receivable are stated at cost, net of allowance for doubtful accounts. Based on our experience and current practice in the PRC, management provides for an allowance for doubtful accounts equivalent to those accounts that are not collected within one year plus 5% of receivables less than one year old. INVENTORIES Inventories are stated at the lower of cost, determined on a weighted average basis, and net realizable value. Work-in-progress and finished goods are composed of direct material, direct labor and an attributable portion of manufacturing overhead. Net realizable value is the estimated selling price, in the ordinary course of business, less estimated costs to complete and dispose. LAND USE RIGHTS We adopted the provisions of Statement of Financial Accounting Standard ("SFAS") No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), effective January 1, 2002. Under SFAS 142, goodwill and indefinite lived intangible assets are not amortized, but are reviewed annually for impairment, or more frequently, if indications of possible impairment exist. We have performed the requisite annual impairment tests on intangible assets and determined that no impairment adjustments were necessary. REVENUE RECOGNITION We recognize revenue on the sales of our products as earned when the customer takes delivery of the product according to previously agreed upon pricing and delivery arrangements, and when we believe collectibility is reasonably assured. We sell primarily perishable and frozen food products. As such, any right of return is only for a few days and has been determined to be insignificant by management. Accordingly, no provision has been made for returnable goods. EARNINGS PER SHARE Basic earnings per common share ("EPS") are calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Our Series A convertible preferred stock is a participating security. Consequently, the two-class method of income allocation is used in determining net income available to common stockholders. F-11 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Diluted EPS is calculated by using the treasury stock method, assuming conversion of all potentially dilutive securities, such as stock options and warrants. Under this method, (i) exercise of options and warrants is assumed at the beginning of the period and common shares are assumed to be issued, (ii) the proceeds from exercise are assumed to be used to purchase common stock at the average market price during the period, and (iii) the incremental shares (the difference between the number of shares assumed issued and the number of shares assumed purchased) are included in the denominator of the diluted EPS computation. The numerators and denominators used in the computations of basic and diluted EPS are presented in the following table: 2006 2005 2004 ---- ---- ----
NUMERATOR FOR BASIC AND DILUTED EPS Net income (numerator for Diluted EPS) $ 6,359,050 $ 5,913,847 $ 2,768,473 ============ =========== =========== Net income allocated to preferred stock 2,225,558 - - ------------ ----------- ----------- Net income to common stockholders (Basic) $ 4,133,492 $ 5,913,847 $ 2,768,473 ============ =========== =========== DENOMINATORS FOR BASIC AND DILUTED EPS Common stock outstanding after recapitalization and 1:35.349 reverse stock split 11,761,932 11,752,568 11,752,568 ------------ ----------- ----------- DENOMINATOR FOR BASIC EPS 11,761,932 11,752,568 11,752,568 ============ =========== =========== Add: Weighted average preferred as if converted 6,332,876 - - Add: Weighted average stock warrants outstanding 2,239,451 - - DENOMINATOR FOR DILUTED EPS 20,334,259 11,752,568 11,752,568 ============ =========== =========== EPS - Basic $ 0.35 $ 0.50 $ 0.24 ------------ ----------- ----------- EPS - Diluted $ 0.31 $ 0.50 $ 0.24 ------------ ----------- -----------
SHIPPING AND HANDLING COSTS Shipping and handling amounts billed to customers in related sales transactions are included in sales revenues. Direct shipping costs are included in operating expenses, which were approximately $1,885,900, $933,300 and $755,000 for the years ended December 31, 2006, 2005 and 2004, respectively. Handling costs are included in costs of sales, which were approximately $1,232,800, $717,200 and $382,100 for the years ended December 31, 2006, 2005 and 2004, respectively. ADVERTISING COSTS Advertising costs are expensed as incurred. Advertising expenses were approximately $327,700, $225,800 and $59,400 for the years ended December 31, 2006, 2005 and 2004, respectively. F-12 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) RESEARCH AND DEVELOPMENT COSTS The PRC government has made a cash grant to our company specifically to fund research and development. We have recorded this grant as a liability titled "Research & development grants payable" on our balance sheet. Qualifying research and development costs reduce the liability while non-qualifying research and development costs are expensed as incurred. Research and development costs were approximately $1,057,100, $723,000 and 435,000 for the years ended December 31, 2006, 2005 and 2004, respectively. PROPERTY AND EQUIPMENT Impairment of long-lived assets is recognized when events or changes in circumstances indicate the carrying amount of an asset, or related groups of assets, may not be recoverable. Under the provisions of SFAS No. 144, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," we recognize an "impairment charge" when the expected net undiscounted future cash flows from an asset's use and eventual disposition are less than the asset's carrying value and the asset's carrying value exceeds its fair value. Measurement of fair value for an asset, or related group of assets, may be based on appraisals, market values of similar assets or estimated discounted future cash flows resulting from the use and ultimate disposition of the asset or assets. Expenditures for maintenance, repairs and betterments, which do not materially extend the normal useful life of an asset, are charged to operations as incurred. Upon sale or other disposition of assets, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in income. Depreciation and amortization are provided for financial reporting purposes primarily on the straight-line method over the estimated useful lives, ranging from five to 50 years. OPERATING LEASES Operating leases represent those leases under which substantially all the risks and rewards of ownership of the leased assets remain with the lessors. Rental payments under operating leases are charged to expense on the straight-line basis over the period of the relevant leases. INCOME TAXES Income tax expense is based on reported income before income taxes. Deferred income taxes reflect the effect of temporary differences between assets and liabilities that are recognized for financial reporting purposes and the amounts that are recognized for income tax purposes. In accordance with SFAS No. 109, "Accounting for Income Taxes," these deferred taxes are measured by applying currently-enacted tax laws. We recorded income tax expenses of $568,400, $352,900 and $84,500 for the years ended December 31, 2006, 2005 and 2004, respectively. F-13 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) We withhold and pay income taxes on our employees' wages, which fund the Chinese government's sponsored health and retirement programs for all of our employees. For our employees, we were obligated to make contributions to the social insurance bureau under the laws of the PRC for pension and retirement benefits. 3. BUSINESS ACQUISITIONS Food Share formed Henan Zhongpin Imports and Exports Trade Company Limited on August 11, 2004 as a joint venture with Li Jun Wei, an individual, to facilitate exporting of our goods. Initially, we owned 88.93% of Henan Zhongpin Imports and Exports Trade Company Limited. In November 2006, Food Share acquired Li Jun Wei's share interest in, and became the 100% owner of Henan Zhongpin Imports and Exports Trade Company Limited. During 2001, Zhongpin Food Share Co. Limited acquired Yanlin Meat factory and established Zhongpin Industry Company Limited as a joint venture with three individuals and owned 88% initially. In November 2006, Henan Zhongpin Food Share Co. Limited acquired the three individuals' share interest in, and became the 100% owner of Zhongpin Industry Company Limited. 4. ACCOUNTS RECEIVABLE AND OTHER RECEIVABLES We accrue an allowance for bad debts related to our receivables. The receivable and allowance balances at December 31, 2006 and 2005 were as follows: DECEMBER 31, 2006 DECEMBER 31, 2005 ----------------- ----------------- Accounts receivable $ 13,763,260 $ 10,337,838 Other receivables 2,176,858 2,013,757 Allowance for bad debts (412,026) (1,716,614) ------------- ------------- $ 15,528,092 $ 10,634,981 ============= ============= Current $ 13,471,450 $ 10,002,918 Non-current 2,056,642 632,063 ------------- ------------- $ 15,528,092 $ 10,634,981 ============= ============= Other receivables consist primarily of cash advances to suppliers to ensure preferential pricing and delivery. These advances bear no interest and are expected to be repaid in cash. Repayment is typically required to be made in less than one year. Advances that are not expected to be repaid within one year are classified as non-current. During fiscal 2006, we collected $1.34 million of outstanding accounts receivable for which bad debt allowance had been provided during fiscal 2005. Such collections reduced our general and administrative expenses by $1.34 million in fiscal 2006. F-14 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. INVENTORIES Inventories at December 31, 2006 and 2005 consisted of: December 31, 2006 December 31, 2005 ----------------- ----------------- Raw materials $ 307,202 $ 210,288 Low value consumables & packaging 401,177 147,000 Work-in-progress 487,930 290,149 Finished goods 8,881,170 1,699,875 ----------- ----------- Provision for loss of pricing - - - ----------- Net inventories $10,077,479 $ 2,347,312 =========== =========== 6. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment at cost at December 31, 2006 and 2005 consisted of: December 31, 2006 December 31, 2005 ----------------- ----------------- Machinery and equipment $12,453,177 $ 6,832,887 Furniture and office equipment 434,128 253,187 Motor vehicles 416,479 281,371 Buildings 22,584,113 5,084,728 ----------- ------------ Subtotal 35,887,897 12,452,173 Less: Acquisition gain (92,510) -- Less: accumulated depreciation (3,198,237) (2,239,325) ----------- ------------ Net property and equipment $32,597,150 $10,212,848 =========== ============ Depreciation expense $ 973,618 $ 602,008 7. INTANGIBLE ASSETS Intangible assets consist of prepaid land use rights. According to the laws of the PRC, the government owns all of the land in the PRC. Companies or individuals are authorized to possess and use the land only through land use rights granted by the PRC government. Accordingly, we paid in advance for certain land use rights. Prepaid land use rights are being amortized and recorded as lease expense using the straight-line method over the use terms of 20 to 50 years. Intangible assets at December 31, 2006 and 2005 consisted of the following: December 31, 2006 December 31, 2005 ----------------- ----------------- Land use rights $ 9,250,410 $ 1,840,937 Accumulated amortization (220,333) (87,813) ----------- ----------- $ 9,030,077 $ 1,753,124 =========== =========== Amortization expense $ 127,449 $ 37,431 F-15 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. CONSTRUCTION IN PROGRESS Construction in progress at December 31, 2006 and 2005 consisted of: Completion or Estimated Construction Project Completion Date December 31, 2006 December 31, 2005 -------------------- --------------- ----------------- -----------------
Industrial plant February 2006 $ 16,931,178 Production line for chilled pork May 2007 $9,313,544 - (in Zhumadian) Production line for chilled pork August 2007 1,161,339 (in Anyang) Land use right of Industrial Park No.4 land December 2007 970,147 Production line for prepared pork (in industrial plant) April 2007 542,493 Logistic Software July 2007 29,300 $ 12,016,823 $ 16,931,178 ============ =============
9. LOANS PAYABLE SHORT-TERM LOANS Short-term loans are due within one year. Of the $23.85 million aggregate principal amount of short-term loans at December 31, 2006, loans in the principal amount of $3.46 million were secured by our land and plants located in the PRC and loans in the aggregate principal amount of $20.36 million were guaranteed by Henan Zhongpin Industry Co., Ltd. These loans bear interest at prevailing lending rates in the PRC ranging from 5.85% to 7.34% per annum. At December 31, 2006, there was approximately $83.75 million in available unused lines of credit. LONG-TERM LOANS Our long-term loan bears interest at the rate of 6.0% per annum. The balances of loans payable at December 31, 2006 and 2005 were as follows: December 31, 2006 December 31, 2005 ----------------- ----------------- Short-Term Loans Payable $ 23,845,199 $ 18,995,853 ------------ ------------ Total Long-Term Loans Payable 2,058,014 2,410,119 ------------ ------------ $ 25,903,213 $ 21,405,972 ============ ============ F-16 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. LOANS PAYABLE (continued) Long-Term Repayment Schedule Payments due in 2007 - current portion $145,671 Payments due in 2008 145,671 Payments due in 2009 145,671 Payments due in 2010 145,671 Payments due in 2011 145,671 Payments due thereafter 1,329,659 ----------- $ 2,058,014 =========== 10. COMMITMENTS AND CONTINGENCIES LEGAL PROCEEDINGS From time to time, we have disputes that arise in the ordinary course of our business. At December 31, 2006, there was no material legal proceeding to which we were a party or to which any of our property was subject that will have a material adverse effect on our financial condition. REGISTRATION RIGHTS AGREEMENT In connection with the issuance of our Series A convertible preferred stock and warrants on January 30, 2006, we entered into a registration rights agreement with certain investors. The agreement requires us to effect the registration of our common stock issuable upon the conversion of the Series A convertible preferred stock and the exercise of the warrants. If such registration was not effected by June 29, 2006, we were required to pay the investors liquidated damages in an amount equal to 1-1/2% per month times the amount paid by the investors for the purchase of our Series A convertible preferred stock and warrants (approximately $414,000 per month) until the registration statement we filed with the Securities and Exchange Commission (the "SEC") to effect such registration was declared effective by the SEC. On June 29, 2006, such registration statement had not become effective, and in July 2006 we began to accrue a liability in the amount of $414,000 per month for this contingency because a loss was reasonably possible and a loss amount could reasonably be estimated. On December 22, 2006, we amended the registration rights agreement and agreed to pay an aggregate of $1,044,357 in cash and to issue an aggregate of 379,743 shares of our common stock to settle in full our obligations under such agreement to have the registration statement required thereunder declared effective by the SEC in an timely manner. At the same time, in order to obtain the consent of investors to remove from such registration statement certain shares of common stock underlying our stock purchase warrants, we issued to such investors warrants to purchase an aggregate of 884,799 shares of common stock with an exercise price of $5.50 per share. The total expenses related to the penalty were $1,044,357 in cash, $2,848,073 related to the shares of common stock and $4,461,775 related to the warrants. On February 2, 2007, the initial registration statement we filed pursuant to the registration rights agreement was declared effective by SEC. F-17 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. ALLOWANCES INCOME "Allowances income" consists of grants from the government of the PRC for our participation in specific programs, such as import and export, branding, and city maintenance and construction. We received allowances income for the years ended December 31, 2006, 2005 and 2004 as follows: 2006 2005 2004 ---- ---- ---- Allowances income $2,364,803 $85,592 $928,302 In addition to paying our company for our participation in ongoing programs, the PRC government has made a cash grant to our company specifically to fund research and development. We recorded this grant as a liability titled "Research & development grants payable" on our balance sheet rather than as revenue. As qualifying research and development costs are incurred, we reduce the liability rather than recording an expense. 12. FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107, "Disclosures about Fair Value of Financial Instruments" ("SFAS 107") requires entities to disclose the fair values of financial instruments except when it is not practicable to do so. Under SFAS No. 107, it is not practicable to make this disclosure when the costs of formulating the estimated values exceed the benefit when considering how meaningful the information would be to financial statement users. As a result of the difficulties presented in the valuation of the loans payable to related entities/parties because of their related party nature, estimating the fair value of these financial instruments is not considered practical. The fair values of all other assets and liabilities do not differ materially from their carrying amounts. None of the financial instruments held are derivative financial instruments and none were acquired or held for trading purposes in fiscal 2006, 2005 or 2004. 13. NEW ACCOUNTING PRONOUNCEMENTS In February 2006, the Financial Accounting Standards Board ("FASB") issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140." The statement permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips are not subject to the requirements of Statement 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends Statement 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. The Statement is effective for financial instruments acquired or issued after the beginning of the first fiscal year that begins after September 15, 2006. We expect the Statement will have no material impact on our consolidated financial statements. F-18 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. NEW ACCOUNTING PRONOUNCEMENTS (continued) In February 2006, the FASB issued Staff Position No. FAS 123(R)-4, "Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event." This position addresses the classification of options and similar instruments issued as employee compensation that allow for cash settlement upon the occurrence of a contingent event, amending paragraphs 32 and A229 of SFAS No. 123 (revised 2004), "Share-Based Payment." As we have not traditionally paid compensation through the issuance of equity securities, no impact is expected on our consolidated financial statements. In October 2005, the FASB issued Staff Position No. FAS 13-1, "Accounting for Rental Costs Incurred during a Construction Period." This position addresses the accounting for rental costs associated with operating leases that are incurred during a construction period. Management believes this position has no application to our company. In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections ("SFAS No. 154"), which replaced Accounting Principles Board Opinion No. 20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principles. It requires retrospective application to prior periods' financial statements of changes in accounting principles, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The impact on our operations will depend on future accounting pronouncements or changes in accounting principles. In March 2005, the FASB issued FASB Interpretation ("FIN") No. 47, "Accounting for Conditional Asset Retirement Obligations." FIN 47 clarifies that the term "Conditional Asset Retirement Obligation" as used in FASB Statement No. 143, "Accounting for Asset Retirement Obligations," refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Accordingly, an entity is required to recognize a liability for the fair value of a Conditional Asset Retirement Obligation if the fair value of the liability can be reasonably estimated. FIN 47 is effective no later than the end of the first fiscal year ending after December 15, 2005. Management does not believe the adoption of FIN 47 will have a material effect on our consolidated financial position, results of operations or cash flows. In November 2004, the FASB issued Statement No. 151, "Inventory Costs." SFAS No. 151 requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as current period charges and that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The statement is effective for fiscal periods beginning after June 15, 2005. We believe the application of SFAS No. 151 will have no significant impact on our consolidated financial statements. F-19 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. PREFERRED STOCK The principal terms of our Series A convertible preferred stock are as follows. DIVIDENDS. The holders of our Series A convertible preferred stock are entitled to receive, when and as declared by our board of directors, dividends in such amounts as may be determined by our board of directors from time to time out of funds legally available therefor. No dividends (other than those payable solely in common stock) will be paid to the holders of common stock until there shall have been paid or declared and set apart during that fiscal year for the holders of our Series A convertible preferred stock a dividend in an amount per share that the holders would have received for the shares of common stock issuable upon conversion of their shares of Series A convertible preferred stock. PREFERENCE ON LIQUIDATION. In the event of our merger or consolidation or the sale of all or substantially all of our assets or other liquidation of our company, holders of our Series A convertible preferred stock shall get a priority in payment over all other classes of stock. In such event, the Series A convertible preferred stock would be entitled to receive the greater of (i) the original purchase price of the Series A convertible preferred stock or (ii) the amount the holder would get if such holder converted all of such holder's Series A convertible preferred stock into common stock. VOTING. The holder of each share of Series A convertible preferred stock (i) shall be entitled to the number of votes with respect to such share equal to the number of shares of common stock into which such share of Series A convertible preferred stock could be converted on the record date for the subject vote or written consent (or, if there is no such record date, then on the date that such vote is taken or consent is effective) and (ii) shall be entitled to notice of any stockholders' meeting in accordance with our by-laws. APPOINT AND ELECT A DIRECTOR. So long as the number of shares of common stock issuable upon conversion of the outstanding shares of Series A convertible preferred stock is greater than 10% of the number of outstanding shares of common stock (on a fully diluted basis), the holders of record of the shares of Series A convertible preferred stock, exclusively and as a separate class, shall be entitled to elect one of our directors. CONVERSION RIGHT. The holders of Series A convertible preferred stock may convert each share of Series A convertible preferred stock into common stock at an initial conversion price of $4.00. The conversion price will be adjusted for stock dividends, stock splits and similar events. AUTOMATIC CONVERSION. Each share of Series A convertible preferred stock will automatically be converted into shares of common stock at the conversion price at the time in effect if (i) we consummate an underwritten public offering of our common stock giving us at least $30 million in net proceeds, (ii)(A) the closing price of our common stock equals or exceeds $10.00 (as adjusted) for the twenty (20) consecutive-trading-day period ending within two (2) days of the date on which we provide notice of such conversion as hereinafter provided and (B) either a registration statement registering for resale the shares of common stock issuable upon conversion of the Series A convertible preferred stock has been declared effective and remains effective and available for resale for the twenty (20)-day period, or Rule 144(k) under the Securities Act of 1933, as amended, is available for the resale of such shares, or (iii) by consent of at least 67% of the then-outstanding shares of Series A convertible preferred stock. F-20 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. PREFERRED STOCK (continued) PROTECTIVE PROVISIONS. So long as at least 1,750,000 shares of Series A convertible preferred stock are outstanding (subject to adjustment for stock splits, combinations and the like), the holders of a majority of the outstanding shares of Series A convertible preferred stock shall be required (in addition to any consent or approval otherwise required by law) for us to take certain actions, including (1) the liquidation, dissolution or wind up of our company, (2) the amendment, alteration or repeal of any provision of our certificate of incorporation so as to affect the rights, preferences or privileges of the Series A convertible preferred stock, (3) the creation of a new class of preferred stock or any increase in the number of shares of Series A convertible preferred stock that can be issued, or (4) the purchase or redemption, or the payment or declaration of any dividend or the making of any distribution on, any securities junior in priority to the Series A convertible preferred stock; or (5) making any change in the size of our board of directors. 15. WARRANTS In conjunction with the issuance of preferred stock discussed in Note 15, we issued warrants for the purchase of 3,450,000 shares of our common stock. Also in conjunction with the issuance of preferred stock, we issued warrants to purchase 345,000 units at an initial exercise price of $8.00 per unit. The units that may be acquired upon exercise of such warrants consist of two shares of Series A convertible preferred stock and one warrant to purchase one share of common stock at an initial exercise price per share of $5.00. These warrants, if fully exercised and converted, would require the issuance of 1,035,000 shares of common stock. On June 15, 2006, in conjunction with a one-year consulting agreement, we issued three-year warrants to purchase 100,000 shares of common stock at a price of $6.50 per share. The warrants vest monthly over a one-year period. These warrants were accounted for using the fair value method, with the expense being recognized ratably over the requisite service period of one year. Consulting expense related to the warrants amounted to $22,330 for the year ended December 31, 2006. On December 22, 2006, in conjunction with an amendment to a registration rights agreement, we issued to investors warrants to purchase 884,799 shares of common stock at a price of $5.50 per share. The warrants were accounted for using the fair value method. Penalty expense related to the warrants amounted to $4,461,775 for the year ended December 31, 2006. The following table provides certain information with respect to the above-referenced warrants outstanding at December 31, 2006: Weighted Weighted Number Average Average Life - Exercise Price Outstanding Exercise Price Years -------------- ----------- -------------- -------------- Warrants $4.00 - $6.50 5,469,799 $4.98 4.20 F-21 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15. WARRANTS (continued) The following table provides certain information with respect to warrants exercisable at December 31, 2006: Number Weighted Average Exercise Price Outstanding Exercise Price -------------- ----------- ---------------- Warrants $4.00 - $6.50 5,421,799 $4.97 The weighted average fair value at date of grant for warrants granted during 2006 was $0.38, and was estimated using the Black-Scholes option valuation model with the following assumptions: Expected life in years 3 - 5 Interest rate 4% - 4.52% Volatility 6.1% - 68.5% Dividend yield 0% 16. SEGMENT REPORTING We operate in two business segments: pork and pork products, and vegetables and fruits. Our pork and pork products segment is involved primarily in the processing of live market hogs into fresh, frozen and processed pork products. Our pork and pork products segment markets its products domestically to our branded stores and to food retailers, foodservice distributors, restaurant operators and noncommercial foodservice establishments, such as schools, hotel chains, healthcare facilities, the military and other food processors, as well as to international markets. Our vegetables and fruits segment is involved primarily in the processing of fresh vegetables and fruits. We contract with more than 120 farms in Henan Province and nearby areas to produce high-quality vegetable varieties and fruits suitable for export purposes. The proximity of the contracted farms to our operations ensures freshness from harvest to processing. We contract to grow more than 20 categories of vegetables and fruits, including asparagus, sweet corn, broccoli, mushrooms, lima beans and strawberries. F-22 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SALES BY SEGMENT (U.S. DOLLARS IN MILLIONS) YEAR ENDED DECEMBER 31, PERCENTAGE ------------------- NET CHANGE CHANGE 2006 2005 2006/2005 2006/2005 ------- ------- ---------- ---------- Pork and Pork Products Chilled Pork .............. $ 71.76 $ 31.50 $ 40.26 128% Frozen Pork ............... 50.88 33.03 17.85 54% Prepared Pork Products .... 15.44 6.93 8.51 123% Vegetables and Fruits ......... 5.73 1.94 3.79 195% ------- ------- ------- Total .............. $143.81 $ 73.40 $ 70.41 96% ======= ======= ======= 16. SEGMENT REPORTING (continued) SALES BY SEGMENT (U.S. DOLLARS IN MILLIONS) YEAR ENDED DECEMBER 31, PERCENTAGE ------------------- NET CHANGE CHANGE 2005 2004 2005/2004 2005/2004 ------- ------- ---------- ---------- Pork and Pork Products Chilled Pork .............. $ 31.50 $ 16.98 $ 14.52 86% Frozen Pork ............... 33.03 22.28 10.75 48% Prepared Pork Products .... 6.93 2.54 4.39 173% Vegetables and Fruits ......... 1.94 0.99 0.95 96% ------- ------- ------- Total .............. $ 73.40 $ 42.79 $ 30.61 72% ======= ======= ======= OPERATING INCOME BY SEGMENT (U.S. DOLLARS IN MILLIONS) YEAR ENDED OPERATING MARGIN DECEMBER 31, YEAR ENDED ----------------- CHANGE DECEMBER 31, 2006 2005 2006/2005 2006 2005 ------- ------- ---------- ------ ------ Pork and Pork Products Chilled Pork .............. $ 2.65 $ 3.31 ($ 0.66) 3.69% 10.51% Frozen Pork ............... 1.52 3.34 (1.82) 2.99% 10.11% Prepared Pork Product ..... 1.26 0.60 0.66 8.16% 8.66% Vegetables and Fruits ......... 0.36 0.23 0.13 6.28% 11.86% ------- ------- ------- Total .............. $ 5.79 $ 7.48 ($ 1.69) 4.03% 10.19% ======= ======= ======= F-23 ZHONGPIN INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 16. SEGMENT REPORTING (continued) OPERATING INCOME BY SEGMENT (U.S. DOLLARS IN MILLIONS) YEAR ENDED OPERATING MARGIN DECEMBER 31, YEAR ENDED ----------------- CHANGE DECEMBER 31, 2005 2004 2005/2004 2005 2004 ------- ------- ---------- ------ ------ Pork and Pork Products Chilled Pork .............. $ 3.31 $ 1.23 $ 2.08 10.51% 7.24% Frozen Pork ............... 3.34 1.58 1.76 10.11% 7.09% Prepared Pork Product ..... 0.60 0.21 0.39 8.66% 8.27% Vegetables and Fruits ......... 0.23 0.04 0.19 11.86% 4.04% ------- ------- ------- Total .............. $ 7.48 $ 3.06 $ 4.42 10.19% 7.15% ======= ======= ======= F-24 EX-3.5 2 c47555_ex3-5.txt EXHIBIT 3.5 CERTIFICATE OF AMENDMENT TO THE CERTIFICATE OF INCORPORATION OF ZHONGPIN INC. (Pursuant to Section 242 of the Delaware General Corporation Law) Zhongpin Inc., a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, does hereby certify as follows: 1. The name of the Corporation is Zhongpin Inc. (the "CORPORATION"). 2. That the original Certificate of Incorporation of the Corporation, as subsequently amended, was filed on February 4, 2003 (the "CERTIFICATE OF INCORPORATION"). 3. The Certificate of Incorporation of the Corporation is hereby amended by deleting Article "FOURTH" thereof and replacing it with the following: "FOURTH: The total number of shares of capital stock which the Corporation shall have authority to issue is one hundred twenty-five million (125,000,000) shares, of which one hundred million (100,000,000) shares shall be Common Stock, par value $.001 per share without cumulative voting rights and without preemptive rights, and twenty-five million (25,000,000) shares shall be Preferred Stock, par value $.001 per share. The Board of Directors of the Corporation is expressly authorized at any time, and from time to time, to provide for the issuance of shares of Preferred Stock in one or more series, with such designations, preferences and relative, participating, optional or other special rights, and qualifications, limitations, or restrictions thereof, as shall be stated and expressed in the resolution or resolutions providing for the issue thereof adopted by the Board of Directors." 4. The foregoing amendment was duly approved by the Board of Directors and recommended to be adopted by the stockholders of the Corporation in accordance with Section 242 of the Delaware General Corporation Law, and was adopted by the written consent of the stockholders of the Corporation in accordance with Section 228 of the Delaware General Corporation Law. IN WITNESS WHEREOF, the Corporation has caused this Certificate of Amendment to be executed on its behalf this 20th day of March, 2007. ZHONGPIN INC. By: /s/ Xianfu Zhu ---------------------------------- XIANFU ZHU Chief Executive Officer, Chairman EX-31.1 3 c47555_ex31-1.txt EXHIBIT 31.1 CERTIFICATION Pursuant to 18 U.S.C. 1350 (Section 302 of the Sarbanes-Oxley Act of 2002) I, Xianfu Zhu, Chief Executive Officer of ZHONGPIN INC., certify that: 1. I have reviewed this Annual Report on Form 10-K of ZHONGPIN INC.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under my supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to me by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report my conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. I have disclosed, based on my most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 23, 2007 By:/s/ Xianfu Zhu ------------------------------ Xianfu Zhu Chief Executive Officer EX-31.2 4 c47555_ex31-2.txt EXHIBIT 31.2 CERTIFICATION Pursuant to 18 U.S.C. 1350 (Section 302 of the Sarbanes-Oxley Act of 2002) I, Yuanmei Ma, Chief Financial Officer of ZHONGPIN INC., certify that: 1. I have reviewed this Annual Report on Form 10-K of ZHONGPIN INC.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under my supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to me by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report my conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. I have disclosed, based on my most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 23, 2007 By:/s/ Yuanmei Ma ------------------------------ Yuanmei Ma Chief Financial Officer EX-31.1 5 c47555_ex32-1.txt EXHIBIT 32.1 CERTIFICATION Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002) In connection with the Annual Report on Form 10-K of ZHONGPIN INC. (the "Company") for the year ended December 31, 2006, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Xianfu Zhu, as Chief Executive Officer of the Company, hereby certifies, pursuant to 18 U.S.C. ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 23, 2007 By: /s/ XIanfu Zhu ------------------------------- Xianfu Zhu Chief Executive Officer - -------------------------------------------------------------------------------- This certification accompanies each Report pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by the Company for purposes of ss.18 of the Securities Exchange Act of 1934, as amended. A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. EX-32.2 6 c47555_ex32-2.txt EXHIBIT 32.2 CERTIFICATION Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002) In connection with the Annual Report on Form 10-K of ZHONGPIN INC. (the "Company") for the year ended December 31, 2006, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Yuanmei Ma, as Chief Financial Officer of the Company, hereby certifies, pursuant to 18 U.S.C. ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 23, 2007 By: /s/ Yuanmei Ma ------------------------------ Yuanmei Ma Chief Financial Officer - -------------------------------------------------------------------------------- This certification accompanies each Report pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed filed by the Company for purposes of ss.18 of the Securities Exchange Act of 1934, as amended. A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----