UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2013
or
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from ___________ to _____________
Commission File Number: 000-53529
TANKE BIOSCIENCES CORPORATION
(Exact name of registrant as specified in its charter)
Nevada | 26-3853855 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
Room 2801, East Tower of Hui Hao Building, No. 519 Machang Road Pearl River New City, Guangzhou, P. R. China | 510627 |
(Address of principal executive offices) | (Zip Code) |
+86 (20) 3885-9025
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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 o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | o | Accelerated filer | o | |
Non-accelerated filer | o | (Do not check if a smaller reporting company) | Smaller reporting company | x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
As of November 14, 2013, there were 13,324,083 outstanding shares of common stock of the registrant, par value $.001 per share.
TANKE BIOSCIENCES CORPORATION
TABLE OF CONTENTS
PART I—FINANCIAL INFORMATION | ||
Item 1. | Financial Statements (unaudited). | 3 |
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. | 19 |
Item 3. | Quantitative and Qualitative Disclosures About Market Risk. | 28 |
Item 4. | Controls and Procedures. | 29 |
PART II—OTHER INFORMATION | ||
Item 1. | Legal Proceedings. | 29 |
Item 1A. | Risk Factors. | 29 |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. | 29 |
Item 3. | Defaults Upon Senior Securities. | 30 |
Item 4. | Mine Safety Disclosures. | 30 |
Item 5. | Other Information. | 30 |
Item 6. | Exhibits. | 30 |
Signatures | 31 |
2
PART I—FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited).
TANKE BIOSCIENCES CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, | December 31, | |||||||
2013 | 2012 | |||||||
(Unaudited) | ||||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 5,053,700 | $ | 6,168,754 | ||||
Restricted cash | - | 231,838 | ||||||
Accounts receivable, net | 2,760,884 | 1,986,663 | ||||||
Inventories, net | 1,649,230 | 1,414,600 | ||||||
Loans to customer and supplier | 2,963,158 | 2,892,868 | ||||||
Other receivables | 738,730 | 483,884 | ||||||
Prepayments | 6,472,651 | 9,029,524 | ||||||
Other current assets | 30,050 | 132,746 | ||||||
Deferred tax assets | 27,775 | 27,042 | ||||||
Total current assets | 19,696,178 | 22,367,919 | ||||||
Property, plant and equipment, net | 6,339,399 | 4,813,232 | ||||||
Construction in progress | 1,627,652 | 295,248 | ||||||
Intangible asset, net | 1,146,189 | 1,238,025 | ||||||
Other non-current assets | - | 134,736 | ||||||
Total assets | $ | 28,809,418 | $ | 28,849,160 | ||||
LIABILITIES AND EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 640,777 | $ | 646,649 | ||||
Advance from customers | 99,410 | 128,321 | ||||||
Other payables and accrued liabilities | 901,797 | 942,793 | ||||||
Income tax payable | 1,944,216 | 1,842,139 | ||||||
Convertible notes, net | 7,509,232 | 7,267,677 | ||||||
Current portion of long-term borrowings | 1,139,676 | 1,268,106 | ||||||
Total current liabilities | 12,235,108 | 12,095,685 | ||||||
Advance from government grant | 129,990 | 37,948 | ||||||
Long-term borrowings | 732,649 | 792,567 | ||||||
Total liabilities | $ | 13,097,747 | $ | 12,926,200 | ||||
Commitments and contingencies | ||||||||
EQUITY | ||||||||
Common stock, $0.001 par value, 50,000,000 shares authorized, 13,324,083 issued and outstanding as of September 30, 2013 and December 31, 2012 | 13,324 | 13,324 | ||||||
Additional paid-in capital | 12,220,181 | 12,220,181 | ||||||
Retained earnings | 1,625,488 | 2,485,736 | ||||||
Statutory reserve | 373,406 | 373,406 | ||||||
Accumulated other comprehensive income | 1,323,686 | 658,870 | ||||||
Total Tanke Biosciences Corporation stockholders' equity | 15,556,085 | 15,751,517 | ||||||
Non-controlling interest | 155,586 | 171,443 | ||||||
Total Equity | 15,711,671 | 15,922,960 | ||||||
Total Liabilities and Equity | $ | 28,809,418 | $ | 28,849,160 | ||||
See accompanying notes to the unaudited condensed consolidated financial statements |
3
TANKE BIOSCIENCES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS) INCOME
(UNAUDITED)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Net sales | $ | 6,041,004 | $ | 9,906,581 | $ | 16,276,861 | $ | 21,878,509 | ||||||||
Costs of sales | (4,349,594 | ) | (6,521,478 | ) | (11,097,572 | ) | (14,165,652 | ) | ||||||||
Gross profit | 1,691,410 | 3,385,103 | 5,179,289 | 7,712,857 | ||||||||||||
Selling expenses | (796,302 | ) | (611,880 | ) | (2,078,771 | ) | (1,706,112 | ) | ||||||||
Administrative expenses | (1,358,109 | ) | (574,092 | ) | (3,337,168 | ) | (1,795,328 | ) | ||||||||
Depreciation and amortization | (67,337 | ) | (16,642 | ) | (183,891 | ) | (43,071 | ) | ||||||||
(Loss) income from operations | (530,338 | ) | 2,182,489 | (420,541 | ) | 4,168,346 | ||||||||||
Other (expense) income | (3,125 | ) | - | 40,210 | - | |||||||||||
Interest income | 147,037 | 23,573 | 173,183 | 193,026 | ||||||||||||
Interest credit (expense) | 46,575 | (316,422 | ) | (207,860 | ) | (1,058,291 | ) | |||||||||
Amortization of discount on notes | - | (698,495 | ) | (402,394 | ) | (2,080,301 | ) | |||||||||
(Loss) income before income taxes | (339,851 | ) | 1,191,145 | (817,402 | ) | 1,222,780 | ||||||||||
Income tax benefit (expense) | 26,907 | (222,513 | ) | (58,704 | ) | (652,711 | ) | |||||||||
Net (loss) income | $ | (312,944 | ) | $ | 968,632 | $ | (876,106 | ) | $ | 570,069 | ||||||
Net loss attributable to non-controlling interest | (10,860 | ) | - | (15,857 | ) | - | ||||||||||
Net (loss) income attributable to Tanke Biosciences Corporation | $ | (302,084 | ) | $ | 968,632 | $ | (860,249 | ) | $ | 570,069 | ||||||
Net (loss) income | $ | (312,944 | ) | $ | 968,632 | $ | (876,106 | ) | $ | 570,069 | ||||||
Other comprehensive income (loss), net of tax: | ||||||||||||||||
Foreign currency translation adjustments | 152,227 | (101,883 | ) | 664,816 | 109,074 | |||||||||||
Comprehensive (loss) income | $ | (160,717 | ) | $ | 866,749 | $ | (211,290 | ) | $ | 679,143 | ||||||
Comprehensive loss attributable to non-controlling interest | (1,944 | ) | - | (3,464 | ) | - | ||||||||||
Comprehensive (loss) income attributable to Tanke Biosciences Corporation | $ | (158,773 | ) | $ | 866,749 | $ | (207,826 | ) | $ | 679,143 | ||||||
(Loss) income per common share: | ||||||||||||||||
Basic and diluted | $ | (0.02 | ) | $ | 0.07 | $ | (0.07 | ) | $ | 0.04 | ||||||
Weighted average number of common shares used in computation | ||||||||||||||||
Basic and diluted | 13,324,083 | 13,324,083 | 13,324,083 | 13,324,083 | ||||||||||||
See accompanying notes to the unaudited condensed consolidated financial statements |
4
TANKE BIOSCIENCES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended | ||||||||
September 30, | ||||||||
2013 | 2012 | |||||||
Operating activities: | ||||||||
Net (loss) income | $ | (876,106 | ) | $ | 570,069 | |||
Adjustments to reconcile net (loss) income to net cash | ||||||||
provided by operating activities: | ||||||||
Depreciation and amortization | 629,399 | 404,123 | ||||||
Amortization of discount on convertible notes payable | 402,394 | 2,080,301 | ||||||
Amortization of capitalized offering costs | 115,688 | 598,088 | ||||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable | (567,906 | ) | (357,893 | ) | ||||
Inventories | (235,767 | ) | (450,057 | ) | ||||
Note receivables and payables - related parties | - | 239,476 | ||||||
Other receivables | (184,756 | ) | (143,925 | ) | ||||
Deferred tax asset | (733 | ) | (285 | ) | ||||
Prepayments | 1,853,659 | 388,393 | ||||||
Other current assets | (12,992 | ) | (23,047 | ) | ||||
Other non-current assets | 134,736 | 206,567 | ||||||
Advance from government grant | 92,042 | (168,561 | ) | |||||
Accounts payable | (5,872 | ) | (202,827 | ) | ||||
Other payables and accrued liabilities | (40,996 | ) | 159,035 | |||||
Income tax payable | 102,077 | 529,394 | ||||||
Advance from customer | (28,911 | ) | - | |||||
Net cash provided by operating activities | 1,375,956 | 3,828,851 | ||||||
Investing activities: | ||||||||
Increase in loans to customer and supplier | - | (363,325 | ) | |||||
Purchase of property and equipment | (2,433,181 | ) | (799,922 | ) | ||||
Purchase of intangible assets | (39,888 | ) | (477,661 | ) | ||||
Net cash used in investing activities | (2,473,069 | ) | (1,640,908 | ) | ||||
Financing activities: | ||||||||
Change in restricted cash | 231,838 | 168,161 | ||||||
Payment on convertible notes | (160,839 | ) | - | |||||
Proceeds from long-term borrowings | 964,800 | 878,123 | ||||||
Principal payments for long-term borrowings | (1,206,000 | ) | - | |||||
Net cash (used in) provided by financing activities | (170,201 | ) | 1,046,284 | |||||
Effect of exchange rate fluctuations on cash and cash equivalents | 152,260 | 109,074 | ||||||
Net (decrease) increase in cash | (1,115,054 | ) | 3,343,301 | |||||
Cash and cash equivalents, beginning of period | 6,168,754 | 7,700,156 | ||||||
Cash and cash equivalents, end of period | $ | 5,053,700 | $ | 11,043,457 | ||||
Supplemental disclosures of cash flow information: | ||||||||
Cash paid for interest | $ | 162,539 | $ | 306,803 | ||||
Cash paid for income taxes | $ | 7,151 | $ | 278,225 | ||||
See accompaning notes to the unaudited condensed consolidated financial statements |
5
TANKE BIOSCIENCES CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND PRINCIPAL ACTIVITIES
In these unaudited condensed consolidated financial statements, unless the context requires otherwise, the terms “we”, “our”, “us” and the “Company” refer to Tanke Biosciences Corporation, a Nevada corporation formerly known as Greyhound Commissary, Inc. (“Greyhound”), as well as our direct and indirect subsidiaries, and our principal operating business, Guangzhou Tanke Industry Co., Ltd. (“Guangzhou Tanke”), a company organized under the laws of the People’s Republic of China (“China” or the “PRC”), which we control via a series of variable interest entity contractual agreements (the “VIE Agreements”).
We conduct our business through our subsidiaries, principally our wholly-owned subsidiary China Flying Development Limited (“China Flying”), a Hong Kong incorporated company, and its wholly-owned subsidiary Guangzhou Kanghui Agricultural Technology Co., Ltd. (“Kanghui Agricultural” or the “WFOE”), a wholly foreign owned enterprise incorporated as a limited liability company under the laws of the PRC. The Company operates and controls Guangzhou Tanke through the VIE Agreements. On January 3, 2011, Guangzhou Tanke entered into a series of agreements with Kanghui Agricultural, pursuant to which Kanghui Agricultural effectively assumed management of the business activities of Guangzhou Tanke. Kanghui Agricultural is entitled to approximately 100% of the net income of Guangzhou Tanke and is able to direct Guangzhou Tanke’s actions.
On January 3, 2011, Guangzhou Tanke entered into a series of agreements with Kanghui Agricultural, pursuant to which Kanghui Agricultural effectively assumed management of the business activities of Guangzhou Tanke. Kanghui Agricultural is entitled to approximately 100% of the net income of Guangzhou Tanke and is able to direct Guangzhou Tanke’s actions.
As Tanke Biosciences has complete control over Guangzhou Tanke, all assets presented on the balance sheet of Guangzhou Tanke are available to settle obligations of Tanke Biosciences. Furthermore, there are no liabilities on the balance sheets of Guangzhou Tanke that do not have recourse against the assets of Tanke Biosciences. As Guangzhou Tanke is our sole operating entity, nearly all operating assets and liabilities on our balance sheet are those of Guangzhou Tanke.
“RMB” and “Renminbi” refer to the legal currency of China and “$”, “US dollar” and “US$” refer to the legal currency of the United States.
Through Guangzhou Tanke, we are one of the leading animal nutrition and innovative feed additive providers in China. Our products are different from traditional artificial feed additives in that they are environmentally-friendly, they are designed to optimize the growth and health of livestock such as pigs, poultry, and cattle, as well as farmed fish.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Preparation
The Company’s unaudited condensed consolidated financial statements as of September 30, 2013 and for the three and nine months ended September 30, 2013 and 2012 have been stated in US dollars and prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial statements and with instructions to Form 10-Q pursuant to the rules and regulations of Securities and Exchange Act of 1934, as amended (the “Exchange Act”) and Rule 8-03 of Regulation S-X under the Exchange Act. In the opinion of our management, we have included all adjustments (consisting only of normal recurring adjustments) considered necessary in order to make the financial statements not misleading. Operating results for the three and nine months ended September 30, 2013 are not indicative of the results that may be expected for the fiscal year ending December 31, 2013. The condensed consolidated balance sheet information as of December 31, 2012 was derived from the audited consolidated financial statements included in the Form 10-K for year ended December 31, 2012. These unaudited condensed financial statements and related notes should be read in conjunction with our audited annual financial statements for the year ended December 31, 2012 included in our Form 10-K filed with the Securities and Exchange Commission on April 15, 2013.
6
Basis of consolidation
These unaudited condensed consolidated financial statements include the financial statements of the Company, its subsidiaries and Guangzhou Tanke (the “Group''). All inter-company balances and transactions within the Group have been eliminated.
Use of Estimates
In preparing these unaudited condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. These accounts and estimates include, but are not limited to, the collectability of loans to customer and supplier, the valuation of prepayments, the valuation of the amount due from related parties, the net realizable value of inventories, the estimation of useful lives of property and equipment and intangible assets, and the value of warrants. Actual results could differ from those estimates.
Concentrations of Credit Risk
Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents, restricted cash, accounts receivable and amounts due from related parties. The Company places its cash with financial institutions with high-credit ratings and quality. The Company maintains bank accounts in the PRC, Hong Kong and the United States. In addition, the Company conducts periodic reviews of the related party financial conditions and payment practices. The Company has not experienced losses related to these concentrations in the past.
Concentrations of Customers and Suppliers
Substantially all of the Company’s revenue is generated from buyers in mainland China. All the Company’s suppliers are located in mainland China.
For the nine months ended September 30 in both 2013 and 2012, we had no customers that accounted for more than 10% of our consolidated revenues. For the nine months ended September 30, 2013, the three largest customers accounted for 6.2%, 5.5% and 5.3% of consolidated revenues.
For the nine months ended September 30, 2013, we had three suppliers that accounted for 12.6%, 10.7%, and 10.5% of our total raw material purchase. For the nine months ended September 30, 2012, the three largest suppliers accounted for 16.1%, 15.2% and 14.5% of our total raw material purchase.
Cash and Cash Equivalents |
The Company considers all highly liquid investments with initial maturities of three months or less to be cash equivalents. |
Trade and Other Receivables |
The Company periodically assesses its accounts receivable for collectability on a specific identification basis. If collectability of an account becomes unlikely, an allowance is recorded for that doubtful account. Once collection efforts have been exhausted, the account receivable is written off against the allowance. The Company does not require collateral for trade or other accounts receivable. |
7
Inventories |
Inventories are stated at the lower of cost or net realizable value. Cost is determined using the weighted average method. The cost of inventories includes the purchase cost and other costs incurred in bringing the inventories to their present location and condition. Net realizable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and the estimated costs necessary to make the sale. |
As of September 30, 2013 and December 31, 2012, the Company’s provision for slow-moving or defective inventories amounted to $43,099 and $41,962, respectively. |
Prepayments
Prepayments mainly represent cash paid in advance to suppliers for purchases of raw materials. During the past two years, as cost of raw materials continued to rise, it has become a common practice in our industry to secure supplies of raw material and to lock in prices by entering into year-long agreements with major suppliers and prepay projected usage. In anticipation of installation of a new manufacturing facility and launch of a new product category of premix additives in 2013, we have increased our prepayments substantially since the 4th quarter of 2012. During the first nine months of 2013, only 28% of the prepayments were used due to two reasons: (1) Decline in sales because of overall market condition led to slower consumption of raw materials. (2) Kanghui Agricultural, the raw material trading company and WFOE, began taking on more procurement and reselling to other operating subsidiaries. The prepayments were made mainly by the other operating companies such as Guangzhou Tanke Bio-Tech Co., Ltd. (“Tanke Bio-Tech”), a subsidiary of the Company, in 2012 and cannot be used by Kanghui Agricultural. In the fourth quarter of 2013, we will continue to analyze each supplier’s prepayment balances and have projections for 2014 usage. We will collect excess amounts and sign new 2014 prepayment purchase agreements with suppliers, primarily through Kanghui Agricultural and Tanke Bio-Tech. We obtained either formally or informally intelligence of our suppliers’ financial condition and continuously monitor their financial status. Based on our experience, we anticipate that the prepayments are fully realizable and any unused amounts are fully collectible.
Property, Plant and Equipment |
Property and equipment are stated at cost less accumulated depreciation. Cost represents the purchase price of the asset and other costs incurred to bring the asset into its existing use. |
Depreciation of property and equipment is calculated using the straight-line method over their estimated useful lives. The estimated useful lives are as follows: |
Buildings | 15-20 years |
Plant and machinery | 3-20 years |
Motor vehicle | 10 years |
Office equipment | 3-10 years |
Expenditures for additions, major renewals and betterments are capitalized and expenditures for maintenance and repairs are charged to expense as incurred. |
Upon sale or disposition, the applicable amounts of asset cost and accumulated depreciation are removed from the accounts and the net amount less the proceeds from disposal is charged or credited to income. |
Intangible Asset |
The intangible asset primarily represented two land use rights and internally developed production technology, and they are recorded at cost less accumulated amortization. According to the laws of China, land in the PRC is owned by the government. The government grants the users a land use right to use the land. The land use rights for Huadu facility and Qingyuan facility granted to the Company are being amortized using the straight-line method over the lease term of land use right of fifty years and the expected useful life of twenty years, respectively. |
8
During the second quarter of 2012, we acquired from an agriculture research institute the exclusive right to commercialize a new production technology and manufacturing process. We began amortization of the intangible asset from the third quarter of 2012 over a useful life of three years.
Impairment of Long-lived Assets |
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company recognizes impairment of long-lived assets in the event that the net book values of such assets exceed the future undiscounted cash flows attributable to such assets. There were no impairments of long-lived assets for the periods presented. |
Statutory Reserves
In accordance with the relevant laws and regulations of the PRC and the articles of associations of Guangzhou Tanke, Guangzhou Tanke is required to allocate 10% of its net income reported in the PRC statutory accounts, after offsetting any prior years’ losses, to statutory reserve, on an annual basis. When the balance of such reserve reaches 50% of the respective registered capital of the subsidiaries, any further allocation is optional.
As of September 30, 2013 and December 31, 2012, the statutory reserves of Guangzhou Tanke already reached 50% of the registered capital of the subsidiary and, as a result, the Company did not allocate additional amounts to its statutory reserves.
The statutory surplus reserves can be used to offset prior years’ losses, if any, and may be converted into registered capital, provided that the remaining balances of the reserve after such conversion is not less than 25% of registered capital. The statutory surplus reserve is non-distributable.
Revenue Recognition |
The Company recognizes revenue in accordance with Accounting Standards Codification (“ASC”) 605-10, Revenue Recognition, and SEC Staff Accounting Bulletin No.104. Pursuant to these pronouncements, revenue is recognized when all of the following criteria are met:
● Persuasive evidence of an arrangement exists; |
● Delivery has occurred or services have been rendered; |
● The seller's price to the buyer is fixed or determinable; and |
● Collectability is reasonably assured. |
The Company’s revenue is mainly generated through the wholesale and retail sale of livestock feed including organic trace mineral additives, functional regulation additives, herbal medicinal additives and raw materials. Before the Company recognizes revenue on these product sales, written purchase orders and contracts are received in advance of all shipments of goods to customers. For sales within the Company’s own province, delivery is made by Company employees. Such delivery occurs on the same day as shipment. For delivery outside the province, shipment is made through a separate logistics company that assumes the risk of loss. Revenue is recognized upon shipment of goods to the customers. The Company typically does not incur bad debt losses because this type of loss is deducted from the salesperson’s compensation, thereby mitigating a portion of the loss to the Company. Therefore, collectability is reasonably assured. |
Revenue is presented net of sales returns, which are generally not significant. However, the Company continually performs analyses of returns and records a provision at the time of sale if necessary. As of September 30, 2013 and December 31, 2012, it was determined that potential returns and allowances were not material so the Company did not record a provision for returns. The Company reviews this estimate regularly and adjusts it if conditions change. |
For technical service provided to third parties, revenue is recognized when the service is rendered.
9
Cost of Goods Sold |
Cost of revenue consists primarily of material cost, labor cost, rent of land allocated to production, overhead associated with the manufacturing process and directly related expenses. |
Research and Development Costs |
Research and development costs are charged to expense as incurred and are included in operating expenses after partially offset by grants from government sponsored projects.
Value Added Tax |
In accordance with the relevant tax laws in the PRC, VAT is levied on the invoiced value of sales and is payable by the purchaser. The Company is required to remit the VAT it collects to the tax authority, but may deduct the VAT it has paid on eligible purchases. The difference between the amounts collected and paid is presented as VAT recoverable or payable balance on the balance sheet. |
Income Taxes
The Company uses the asset and liability method of accounting for income taxes pursuant to ASC 740, ”Income Tax”. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and loss carry forwards and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. As of the end of September 30, 2013, an income tax liability of $1,944,216 was accrued based on an ongoing discussion among the local tax authority, the city government officials of Huadu, and Guangzhou Tanke, concerning income taxes owed during the years from 2009 to 2012. We believe the amount accrued should be sufficient to cover all late taxes plus any potential interest and penalty. Management believes that there are no uncertain tax positions requiring accrual or disclosure in accordance with ASC 740-10, Income Taxes. |
Comprehensive Income (Loss) |
Comprehensive income (loss) is defined to include all changes in equity except those resulting from net income or loss, investments by owners and distributions to owners. The Company’s only component of other comprehensive income (loss) is the foreign currency translation adjustment. |
Earnings per share (EPS)
Earnings per share is calculated in accordance with ASC 260-10 which requires the Company to calculate net income (loss) per share based on basic and diluted net income (loss) per share, as defined. Basic EPS excludes dilution and is computed by dividing net income (loss) by the weighted average number of shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Warrants and convertible notes were not included in the diluted EPS calculation because their impact was anti-dilutive as the market value of the Company’s common stock is below the conversion and exercise prices.
10
Commitments and Contingencies
Liabilities for loss contingencies arising from claims, assessments, litigation, fines, penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated.
Foreign Currency Translation
The Company, its subsidiaries and Variable Interest Entity (“VIE”) maintain financial statements in the functional currency of each entity. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency at rates of exchange prevailing at the balance sheet dates. Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transaction. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income (loss) for the respective periods.
The financial statements of each entity are prepared using the functional currency, and have been translated into United States dollars (“US$” or “$”). Assets and liabilities are translated at the exchange rates at the balance sheet dates and revenue and expenses are translated at the average exchange rates for the period. Stockholders’ equity is translated at historical exchange rates. Any translation adjustments are included as a foreign exchange adjustment in other comprehensive income, a component of stockholders’ equity.
RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into US$ at the rates used in translation.
Financial Instruments
The carrying amounts of cash and cash equivalents, restricted cash, accounts receivable, due to/from related parties, notes payable, other payable and accrued liabilities and income tax payable approximate their fair values due to the short-term nature of these items. The carrying amounts of long-term borrowings approximate the fair value based on the Company’s expected borrowing rate for debt with similar remaining maturities and comparable risk.
Convertible notes are not carried at fair value due to the discounts for warrants and the beneficial conversion feature. As the interest on these notes approximates market interest, the fair value is their face value of $7,509,232.
It is management’s opinion that the Company is not exposed to significant interest, price or credit risks arising from these financial instruments.
Recent Accounting Updates
Management does not believe that any recently issued, but not yet effective accounting pronouncements would have a material impact on the accompanying financial statements.
11
3. INVENTORIES, NET
Inventories as of September 30, 2013 and December 31, 2012 consisted of the following:
September 30, | December 31, | |||||||
2013 | 2012 | |||||||
(Unaudited) | ||||||||
Raw materials | $ | 1,163,886 | $ | 636,319 | ||||
Finished goods | 325,688 | 576,509 | ||||||
Work in pogress | 150,577 | 210,625 | ||||||
Packaging material | 52,178 | 33,109 | ||||||
Less: Inventory allowance | (43,099 | ) | (41,962 | ) | ||||
$ | 1,649,230 | $ | 1,414,600 |
4. ACCOUNTS RECEIVABLE, NET
Accounts receivable as of September 30, 2013 and December 31, 2012 consisted of the following:
September 30, | December 31, | |||||||
2013 | 2012 | |||||||
(Unaudited) | ||||||||
Account receivables | $ | 3,106,720 | $ | 2,323,370 | ||||
Less: Allowance for doubtful accounts | (345,836 | ) | (336,707 | ) | ||||
$ | 2,760,884 | $ | 1,986,663 | |||||
5. OTHER RECEIVABLES AND LOANS TO CUSTOMER AND SUPPLIER
Other receivables consisted of the following:
September 30, | December 31, | |||||||
2013 | 2012 | |||||||
(Unaudited) | ||||||||
Deposit and others | $ | 37,406 | $ | 30,401 | ||||
Business advance to staff | 134,178 | 166,451 | ||||||
Business advance to directors | 567,146 | 287,032 | ||||||
$ | 738,730 | $ | 483,884 |
Advance to staff and directors represented advance payments made to directors for business development activities and to staff for business travel purposes. These outstanding amounts are expected to be utilized within a year.
12
The following is a summary of outstanding loans to customers and suppliers.
September 30, | December 31, | |||||||
2013 | 2012 | |||||||
(Unaudited) | ||||||||
Loans to customer and supplier | $ | 2,963,158 | $ | 2,892,868 |
Loans to customer and supplier represent 8% interest bearing notes to one of the Company’s customers and one supplier, both of which were issued in December 2011. Additional amounts were advanced in first quarter of 2012 based on the same terms. The amounts are expected to be repaid within a year of December 31, 2012. The customer is a longtime customer of ours in the aquaculture business, and has been our business partner in other projects. There is no concern of the collectability of the loans based on our assessment of their financial condition, and they have been making the required interest payments. The interest payments for the first six months of 2013 were collected in August 2013. We are in the process of collecting the loan principals in the fourth quarter of 2013 and it is likely that new loan of reduced amount for the customer will be issued for another 12 months.
6. PREPAYMENTS AND OTHER CURRENT ASSETS
In order to secure key raw materials and supplies and to lock in rising purchase prices, the Company paid substantial amounts of cash in advance on purchase orders. Before contracts were signed and the following year’s projected purchases were prepaid, we evaluated these suppliers’ financial position and business condition. We only make prepayment arrangements with companies that are reputable in our industry and have strong financial position. Due to growth expectation in the second half year of 2013 and new product launches that require significant amount of raw materials, and the threat of inflation and material shortages, we increased substantially our prepayments to secure supply of raw materials in 2013. Prepayment balance declined substantially in the quarter ended September 30, 2013 after increased purchase of raw materials, usage of RMB 2,000,000 (approximately US$325,600) of prepayment for R&D, and usage of RMB 5,000,000 (approximately US$814,000) for construction in progress. Further reduction on prepayments is expected in the upcoming quarter as we will carefully evaluate the need for raw material prepayments in 2014 and negotiate new contracts with suppliers.
September 30, | December 31, | |||||||
2013 | 2012 | |||||||
(Unaudited) | ||||||||
Prepayments to suppliers | $ | 6,472,651 | $ | 9,029,524 |
Other current assets as of September 30, 2013 and December 31, 2012 consisted of the following:
September 30, | December 31, | |||||||
2013 | 2012 | |||||||
(Unaudited) | ||||||||
Deferred expenses | $ | 30,050 | $ | 16,221 | ||||
Other current assets | - | 837 | ||||||
Offering costs, net | - | 115,688 | ||||||
$ | 30,050 | $ | 132,746 |
13
7. PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment as of September 30, 2013 and December 31, 2012 consisted of the following:
September 30, | December 31, | |||||||
2013 | 2012 | |||||||
(Unaudited) | ||||||||
Buildings and leasehold improvements | $ | 5,874,394 | $ | 4,596,527 | ||||
Plant and equipment | 2,087,773 | 1,365,043 | ||||||
Motor vehicles | 181,569 | 168,984 | ||||||
Office equipment | 351,529 | 340,870 | ||||||
Total property, plant and equipment | 8,495,265 | 6,471,424 | ||||||
Less: accumulated depreciation | (2,155,866 | ) | (1,658,192 | ) | ||||
Property, plant and equipment, net | $ | 6,339,399 | $ | 4,813,232 |
The Company has buildings on the site it occupies, including factory buildings. Due to the lack of a Land Use Right Certificate, the Company is unable to apply for the Property Ownership Certificate for the buildings. However, as the buildings are in use, the Company depreciates them over their expected useful lives.
We recorded depreciation expense of $193,616 and $497,674 for the three and nine months ended September 30, 2013 and we recorded depreciation expense of $118,746 and $363,310 for the three and nine months ended September 30, 2012.
Depreciation expense of $175,694 and $445,508 for the three and nine months ended September 30, 2013 were charged to cost of inventory or cost of sales as production cost.
8. INTANGIBLE ASSET, NET
The intangible asset as of September 30, 2013 and December 31, 2012 consisted of the following:
September 30, | December 31, | |||||||
2013 | 2012 | |||||||
(Unaudited) | ||||||||
Deposit for land use right | $ | 1,248,434 | $ | 1,215,480 | ||||
New production technology, net | 488,433 | 475,540 | ||||||
Other | 7,689 | 1,330 | ||||||
1,744,556 | 1,692,350 | |||||||
Less: accumulated amortization | (598,367 | ) | (454,325 | ) | ||||
Intangible assets, net | $ | 1,146,189 | $ | 1,238,025 |
On November 21, 2003, the Company applied to the Government of Huaqiao Town, Huadu District, Guangzhou, for the land use right of No. 2 Industry Area of Huaqiao Town (i.e., Laohutou Lot, Wangongtang) covering an area of around 430,000 square feet. The Company has not obtained the land use right certificate as of November 13, 2013.
On October 22, 2010, the Company applied to the Administration Committee of Qingyuan Huaqiao Industrial District for the land use right covering an area of around 60 mu (approximately 9.9 acres). The Company has not obtained the land use right certificate as of November 13, 2013.
The Company has been amortizing the land use right at Huadu facility. The amortization of the land use right for the Qingyuan facility began in the third quarter of 2013 when construction of the new manufacturing facility started.
We recorded amortization expense of $49,415 and $131,725 for the three and nine months ended September 30, 2013 and we recorded amortization expense of $39,530 and $40,813 for the three and nine months ended September 30, 2012.
14
9. OTHER PAYABLES AND ACCRUED LIABILITIES
Other payables and accrued liabilities as of September 30, 2013 and December 31, 2012 consisted of the following:
September 30, | December 31, | |||||||
2013 | 2012 | |||||||
(Unaudited) | ||||||||
Other payables | $ | 115,762 | $ | 22,930 | ||||
Staff welfare payable | 69,541 | 68,578 | ||||||
Accrued payroll | 172,342 | 306,174 | ||||||
Value added tax payable | 62,391 | 62,401 | ||||||
Registration rights penalties | 460,206 | 460,206 | ||||||
Other tax payable | 21,555 | 22,504 | ||||||
$ | 901,797 | $ | 942,793 |
Other payables represent loans from third parties, which are interest free, unsecured and repayable on demand. Registration rights penalties are associated with the registration rights agreement. (See Note 10)
10. CONVERTIBLE NOTES PAYABLE
On February 9, 2011, the Company entered into a Securities Purchase Agreement with individual investors relating to a private placement transaction by the Company (the “Private Placement”) of 6,669,627 units. Each unit consisted of a $1.15 principal amount 8% Senior Convertible Note (the “Notes”) and a Common Stock Purchase Warrant (the “Warrants”) to purchase one share of the Company’s common stock at an exercise price of $1.40 per share.
As a result of the Private Placement, the Company sold $7,670,071 worth of Notes convertible into 6,669,627 shares of common stock. The Notes are payable 24 months from February 9, 2011 with an interest rate of 8% per annum payable semiannually in arrears. The Company placed in escrow an amount of the proceeds of the Private Placement equal to one semi-annual interest payment on the Notes to secure prompt interest payments. Until such time as 75% of the Notes are converted into shares of Common Stock, if such escrow is depleted in order to make interest payments, the Company will replenish such escrow amount. At the option of the holder, the Notes may be converted into Common Stock at a price of $1.15 per share, which is subject to customary weighted average and stock based anti-dilution protection. The issuance of the Notes was not registered under the Securities Act as such issuance was exempt from registration under Section 4(2) of the Securities Act of 1933 (“Securities Act”) and Regulation D.
The Notes contain customary events of default and affirmative and negative covenants of the Company, including negative covenants which restrict the Company’s ability to do the following (among other things) without the consent of the investors: (i) incur, or permit to exist, any indebtedness for borrowed money in excess of (A) US$3,000,000 during the twelve (12) month period beginning on February 9, 2011, or (B) US$5,000,000 during the two-year period beginning on February 9, 2011 and ending on February 9, 2013 (the maturity date of the Notes), except in the ordinary course of the Company’s business; (ii) lend or advance money, credit or property to or invest in (by capital contribution, loan, purchase or otherwise) any person or entity in excess of US$1,000,000 except: (A) investments in United States Government obligations, certificates of deposit of any banking institution with combined capital and surplus of at least $200,000,000; (B) accounts receivable arising out of sales in the ordinary course of business; and (C) inter-company loans between and among the Company and its subsidiaries; (iii) pay dividends or make any other distribution on shares of the capital stock of the Company; (iv) create, assume or permit to exist, any lien on any of the Company’s property or assets now owned or hereafter acquired, subject to existing liens and certain exceptions; (v) assume guarantees, subject to certain exceptions; (vi) engage in “sale-leaseback” transactions, subject to certain exceptions; (vii) make capital expenditures in excess of US$5,000,000 in any fiscal year, subject to certain exceptions; and (viii) materially alter the Company’s business.
15
In connection with the issuance of the Notes, we entered into a Registration Rights Agreement (the “Registration Rights Agreement”) with the investors which sets forth the rights of the investors to have the shares of common stock underlying the Notes and Warrants registered with the SEC for public resale. Pursuant to the Registration Rights Agreement, we agreed to file, no later than April 11, 2011, a registration statement to register the shares underlying the Notes and the Warrants and to have such registration statement effective no later than September 18, 2011. If the registration statement was not filed by April 11, 2011 (the “Filing Failure”), was not effective by September 18, 2011 (the “Effectiveness Failure”) or if, after the effective date, sales of securities included in the registration statement cannot be made (including, without limitation, because of a failure to keep the registration statement effective, to disclose such information as is necessary for sales to be made pursuant to the registration statement, to register a sufficient number of shares of Common Stock or to maintain the listing of the Common Stock) (a “Maintenance Failure”) then, as liquidated damages (and in complete satisfaction and to the exclusion of any claims or remedies inuring to any holder of the securities) the Company is required to pay an amount in cash equal to 1% of the aggregate purchase price paid by the Investors on each of the following dates: (i) 20 days following the date of a Filing Failure; (ii) 30 days following the initial day of a Maintenance Failure; (iii) on every thirtieth day thereafter (pro-rated for periods totaling less than thirty days) until such failure is cured; (iv) on every thirtieth day after the day of an Effectiveness Failure and thereafter (pro rated for periods totaling less than thirty days) until such Effectiveness Failure is cured; (v) on every thirtieth day after the initial day of a Maintenance Failure and thereafter (pro rated for periods totaling less than thirty days) until such Maintenance Failure is cured. The payments to be made by the Company are limited to a maximum of 6% of the aggregate amount paid by the Investors ($460,204). The registration statement was not declared effective by December 31, 2011, as such an Effectiveness Failure occurred and the Company accrued the full $460,204. The Company will continue to assess the likelihood of payments under this arrangement.
The warrants issued as a component of the units were valued using the Black-Scholes method using the following assumptions: (1) life of warrants of 3 years, (2) annualized volatility of 100%, (3) fair value of stock as of grant date of $1.15, (4) exercise price of $1.40, (5) annual dividend rate of 0%, and (6) discount rate of 1.34%. Such calculation resulted in a warrant value of $4,470,536.
The proceeds of the Private Placement offering were allocated to the Notes and warrants based on their relative fair values on a weighted average basis, with the resulting allocated value of the warrants of $2,824,350 being classified to additional paid in capital. Such discount to the Notes is being amortized over their expected life.
The beneficial conversion feature associated with the issuance of the above Notes, amounted to $2,824,350, which has also been recorded as a discount to the convertible notes payable and is being amortized over the life of the Notes. As of September 30, 2013, the discount to the convertible notes was fully amortized. The Notes do not contain any embedded derivatives which require liability classification.
As of February 10, 2013, the Company was in default on the Notes due to failure to pay the investors in full the $7,670,071 principal and accrued interest on February 9, 2013. Subsequently, the Company has released $229,018 from investor relations escrow to pay the accrued interest of $68,178 and principal of $160,839 to investors. The Company and the investor representative reached an Amendment to Promissory Notes (“Amendment”) on August 23, 2013 (see Form 8-K filed by Company on August 29, 2013) and developed a repayment schedule of the remaining principle balance over the next two years. No interest was to be accrued if the Company makes the payments on time. However, the first repayment of $1 million due on September 30 was delayed due to practical difficulty of conversion RMB funds to U.S. Dollars due to China’s foreign exchange control. The Company is in oral discussions with Euro-Pacific Capital, Inc, the investor representatives, to determine a revised repayment schedule.
16
According to the Amendment, if the Company fails to make the agreed payment and does not cure within 45 days, interest on the then outstanding principal balance shall accrue at 8% per annum retroactively from the then missed payment date. The interest is approximately $50,000 per month. In addition, another 500,000 shares shall be immediately issued to Note holders.
According to the Amendment, if the Company fails to make the first payment of $1,000,000 on or before September 30, 2013, the registration delay payments in $460, 206 shall become due immediately. The Company has fully accrued such payable as of September 30, 2013.
As required by the Amendment, the Company has released 500,000 make-good shares to Note holders by September 30, 2013. At the request of the investor representative, such shares have not been transferred to Note holders’ individual accounts due to a review for acceptability.
As of September 30, 2013, the book value of the Notes amounted to $7,509,232. There is no further unamortized discount remaining as of September 30, 2013.
11. INCOME TAX
Guangzhou Tanke, is a P.R.C “domestic enterprise” that is registered and operated in Guangzhou, the PRC. The provision for income tax expense for the three and nine months ended September 30, 2013 and 2012 consists of the following components:
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Current provision | ||||||||||||||||
PRC | $ | (26,730 | ) | $ | 222,513 | $ | 59,437 | $ | 652,711 | |||||||
Deferred provision | ||||||||||||||||
PRC | (177 | ) | - | (733 | ) | - | ||||||||||
$ | (26,907 | ) | $ | 222,513 | $ | 58,704 | $ | 652,711 |
As of September 30, 2013 and December 31, 2012, the income tax payable for the Company amounted to $1,944,216 and $1,842,139, respectively. All of the Company’s net operating loss carry forward was fully reserved.
Significant components of the Company’s deferred tax asset are as follows.
September 30, | December 31, | |||||||
2013 | 2012 | |||||||
Allowance for doubtful accounts in China | $ | 63,036 | $ | 61,373 | ||||
Net operating loss carryforward | 3,131,483 | 2,995,201 | ||||||
Share based payment | 1,122,287 | 1,047,130 | ||||||
Valuation allowance | (4,289,031 | ) | (4,076,661 | ) | ||||
Net deferred tax asset | $ | 27,775 | $ | 27,042 |
12. LONG-TERM BORROWINGS
The details of the Company’s long-term borrowings are as follows:
September 30, | December 31, | |||||||
2013 | 2012 | |||||||
(Unaudited) | ||||||||
Bank loans bearing interest at 7.36% and 6.15% per annum, maturing on June 20, 2014 and March 19, 2015. | $ | 1,872,325 | $ | 2,060,673 | ||||
Less: Current portion | 1,139,676 | 1,268,106 | ||||||
$ | 732,649 | $ | 792,567 |
17
The loans are uncollateralized and consist of $1,275,120 (RMB 8,000,000) and $956,340 (RMB 6,000,000), bearing interest of 7.36% and 6.15% per annum, maturing on June 20, 2014 and March 19, 2015, respectively. Interest is calculated and paid on the 20th of each month. Principal payments are made on a quarterly basis on the $1,275,120 loan and on a semi-annual basis on the $956,340 loan.
13. GOVERNMENT GRANT
The government grant liability represents an advance from the Chinese government for research and development projects. The Company has recorded the grants received as a government grant liability, and ratably recognizes the amount as a reduction of research and development expense when the related research and development activities are performed. As of September 30, 2013 and December 31, 2012, government grant balances are $129,990 and $37,948, respectively.
14. COMMITMENTS AND CONTINGENCIES
The Company has entered into a construction contract with Ganzhou Huifeng Construction Company, Ltd. for the construction of the new Qingyuan production plant. The total fee is RMB 16,500,000 (approximately $2,670,000) and RMB 8,000,000 (approximately $1,302,000) was paid as of September 30, 2013.
15. SEGMENT INFORMATION
The Company operates in four segments: organic trace mineral additives, functional regulation additives, herbal medicinal additives and other revenues. Management oversees each of these operations separately.
Property, equipment and other assets are shared and not tracked separately by segment. Administrative expenses are also not tracked by segment. Following is a breakdown of revenue, costs of sales and gross profit by segment.
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Segment revenues | ||||||||||||||||
Organic Trace Mineral Additives | $ | 4,730,319 | $ | 8,865,570 | $ | 12,918,273 | $ | 18,763,853 | ||||||||
Functional Regulation Additives | 613,130 | 733,785 | 1,608,503 | 2,480,324 | ||||||||||||
Herbal Medicinal Additives | 309,042 | 94,271 | 716,833 | 191,110 | ||||||||||||
Other | 388,513 | 212,955 | 1,033,252 | 443,222 | ||||||||||||
6,041,004 | 9,906,581 | $ | 16,276,861 | $ | 21,878,509 | |||||||||||
Segment costs of sales | ||||||||||||||||
Organic Trace Mineral Additives | 3,398,918 | $ | 5,744,163 | $ | 8,825,886 | $ | 11,895,318 | |||||||||
Functional Regulation Additives | 433,492 | 509,057 | 1,067,802 | 1,668,369 | ||||||||||||
Herbal Medicinal Additives | 267,971 | 72,291 | 593,206 | 187,535 | ||||||||||||
Other | 249,213 | 195,967 | 610,678 | 414,430 | ||||||||||||
4,349,594 | 6,521,478 | $ | 11,097,572 | $ | 14,165,652 | |||||||||||
Segment gross profit | ||||||||||||||||
Organic Trace Mineral Additives | 1,331,401 | 3,121,407 | $ | 4,092,387 | $ | 6,868,535 | ||||||||||
Functional Regulation Additives | 179,638 | 224,728 | 540,701 | 811,955 | ||||||||||||
Herbal Medicinal Additives | 41,071 | 21,980 | 123,627 | 3,575 | ||||||||||||
Other | 139,300 | 16,988 | 422,574 | 28,792 | ||||||||||||
1,691,410 | 3,385,103 | $ | 5,179,289 | $ | 7,712,857 |
18
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis should be read in conjunction with our financial statements and the related notes. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, such as its plans, objectives, expectations and intentions. Its actual results and the timing of certain events could differ materially from those anticipated in these forward-looking statements. As used in this section, the terms “we”, “our”, “us” and the “Company” refer to the Company, our direct and indirect subsidiaries and Guangzhou Tanke, our principal operating business.
Overview
We are one of the leading animal nutrition and feed additive providers in China. In 2001, we were certified as a high-tech company by the Guangzhou City Commission of Science and Technology as recognition for new agricultural technologies developed by us. Our products optimize the growth and health of livestock such as pigs and cattle, as well as farmed fish, and seek to capitalize on China’s growing demand for safe and reasonably priced food. Feed additives are utilized in China at a rate of less than half of that in the United States and Europe. We have a significant growth opportunity as Chinese farmers and ranchers choose to include a greater amount of increasingly sophisticated additive to their feed.
We have more than 130 employees, with 40 engaged in sale or sales-related activities. Our headquarters and manufacturing facilities of 34,000 square-meters are located in the capital city of Guangzhou, in Guangdong province. We currently produce 26 branded feed additives, with each brand available in seven different mixes that correspond to different stages of an animal’s life cycle.
Our major products respond to most key market categories within China’s animal feed additive industry including: Organic Trace Mineral Additives, which account for approximately 79% of our revenue, Functional Regulation Additives, which account for approximately 10% of our revenue, and Herbal Medicinal Additives, which account for approximately 4% of our revenue. Our extensive distribution network reaches China’s top ten feed producers and the 500 largest animal farming operations. We currently market 26 different brands of feed additives at various price points to meet the demands of existing and prospective customers. Each brand product line has seven different mixes that correspond to the different growth stages of an animal’s life cycle. While the majority of our sales are domestic, international sales, mainly in Southeast Asia, Latin American and other developing countries, currently account for approximately 3.2% of our total sales.
In 2013, we have several new products in the pipeline, with the designed feature of improving health and enhancing growth in pigs, chicken, cattle, and seafood. We have launched a new plant-based antioxidant additive in the first half of this year and introduced a number of premixture products during the third quarter and we expect a few more to come in the fourth quarter of 2013.
Critical Accounting Policies
While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements, we believe that the following accounting policies are the most critical to aid you in fully understanding and evaluating this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Basis of Preparation
The Company’s unaudited condensed consolidated financial statements have been stated in US dollars and prepared in accordance with accounting principles generally accepted in the United States of America ("US GAAP") and have been consistently applied.
19
Basis of Consolidation
These unaudited condensed consolidated financial statements include the financial statements of the Company, its subsidiaries and its VIE Guangzhou Tanke (the “Group''). All significant inter-company balances and transactions within the Group have been eliminated.
Use of Estimates
In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. These accounts and estimates include, but are not limited to, the collectability of loans to customer and supplier, the valuation of prepayments, the valuation of the amount due from related parties, the net realizable value of inventories, the estimation of useful lives of property and equipment and intangible assets, and the value of warrants. Actual results could differ from those estimates.
Revenue Recognition
The Company recognizes revenue in accordance with Accounting Standards Codification (“ASC”) 605-10, Revenue Recognition, and SEC Staff Accounting Bulletin No. 104. Pursuant to these pronouncements, revenue is recognized when all of the following criteria are met:
● Persuasive evidence of an arrangement exists;
● Delivery has occurred or services have been rendered;
● The seller's price to the buyer is fixed or determinable; and
● Collectability is reasonably assured.
The Company’s revenue is generated through the wholesale and retail sale of livestock feed additives, including organic trace mineral additives, functional regulation additives, herbal medicinal additives and raw materials. Before the Company recognizes revenue on these product sales, written purchase orders and contracts are received in advance of all shipments of goods to customers. For sales within the Company’s own province, delivery is made by Company employees. Such delivery occurs on the same day as shipment. For delivery outside the province, shipment is made through a separate logistics company that assumes the risk of loss. Revenue is recognized upon shipment of goods to the customers. The Company typically does not incur bad debt losses because this type of loss is deducted from the salesperson’s compensation, thereby mitigating the loss to the Company. Therefore, collectability is reasonably assured.
Revenue is presented net of sales returns, which are not significant. However, the Company continually performs analyses of returns and records a provision at the time of sale if necessary. As of September 30, 2013, it was determined that potential returns and allowances were not material so the Company did not record a provision for returns. The Company revisits this estimate regularly and adjusts it if conditions change.
For technical service provided to third parties, revenue is recognized when the service is rendered.
Research and Development Costs
Research and development costs are charged as expense when incurred and included in operating expenses.
Foreign Currency Translation
The Company and its subsidiaries maintain financial statements in the functional currency of each entity. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency at rates of exchange prevailing at the balance sheet dates. Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transaction. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income for the respective periods.
20
The financial statements of each entity are prepared using the functional currency, and have been translated into United States dollars (“US$” or “$”). Assets and liabilities are translated at the exchange rates at the balance sheet dates and revenue and expenses are translated at the average exchange rates for the period. Equity is translated at historical exchange rates. Any translation adjustments are included as a foreign exchange adjustment in accumulated other comprehensive income, a component of equity.
RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into US$ at the rates used in translation.
Results of Operations for the Three Months Ended September 30, 2013 as Compared to the Three Months Ended September 30, 2012
The following is a comparison of our net sales, costs of sales and gross profit by segment for the three months ended September 30, 2013 and 2012.
Revenue and Costs of Sales
The Company operates in four segments: (1) Organic Trace Mineral Additives, (2) Functional Regulation Additives, (3) Herbal Medicinal Additives and (4) Other. Management tracks each of these segments separately. The Company evaluates the performance of its operating segments based on segment revenue and gross profit, and management uses aggregate segment gross profit as a measure for the overall performance of the business. The Company believes that aggregate segment gross profit helps to evaluate changes in the gross profit of the Company’s various offerings separate from factors other than product offerings that affect net income.
Three Months Ended | ||||||||||||||||
September 30, | ||||||||||||||||
2013 | 2012 | $ Change | % Change | |||||||||||||
Segment revenues | ||||||||||||||||
Organic Trace Mineral Additives | $ | 4,730,319 | $ | 8,865,570 | $ | (4,135,251 | ) | (46.6 | %) | |||||||
Functional Regulation Additives | 613,130 | 733,785 | (120,655 | ) | (16.4 | %) | ||||||||||
Herbal Medicinal Additives | 309,042 | 94,271 | 214,771 | 227.8 | % | |||||||||||
Other | 388,513 | 212,955 | 175,558 | 82.4 | % | |||||||||||
$ | 6,041,004 | $ | 9,906,581 | $ | (3,865,577 | ) | (39.0 | %) | ||||||||
Segment costs of sales | ||||||||||||||||
Organic Trace Mineral Additives | $ | 3,398,918 | $ | 5,744,163 | $ | (2,345,245 | ) | (40.8 | %) | |||||||
Functional Regulation Additives | 433,492 | 509,057 | (75,565 | ) | (14.8 | %) | ||||||||||
Herbal Medicinal Additives | 267,971 | 72,291 | 195,680 | 270.7 | % | |||||||||||
Other | 249,213 | 195,967 | 53,246 | 27.2 | % | |||||||||||
$ | 4,349,594 | $ | 6,521,478 | $ | (2,171,884 | ) | (33.3 | %) | ||||||||
Segment gross profit | ||||||||||||||||
Organic Trace Mineral Additives | $ | 1,331,401 | $ | 3,121,407 | $ | (1,790,006 | ) | (57.3 | %) | |||||||
Functional Regulation Additives | 179,638 | 224,728 | (45,090 | ) | (20.1 | %) | ||||||||||
Herbal Medicinal Additives | 41,071 | 21,980 | 19,091 | 86.9 | % | |||||||||||
Other | 139,300 | 16,988 | 122,312 | 720.0 | % | |||||||||||
$ | 1,691,410 | $ | 3,385,103 | $ | (1,693,693 | ) | (50.0 | %) |
Organic Trace Mineral Additives
Organic Trace Mineral Additives constitute the largest and fastest growing area of our business. We are one of China’s largest domestic providers of organic trace mineral additives, specializing in the development and production of chelated organic trace mineral additives. Our current trace mineral manufacturing facility is the largest chelating facilities in China and has the capacity to produce approximately 350 metric tons of organic trace minerals per week.
21
Although sales had rebounded slightly in the third quarter of 2013 after the devastation caused by Bird Flu H7N9 to the China poultry industry in the second quarter of 2013, Organic Trace Mineral Additive revenue still decreased by $4,135,251, or 46.6%, as compared to the third quarter of 2012, the strongest quarter in the year. It will take at least six to nine months for the business to return to normal. Poultry farms were still losing money due to the massive disposition of live chicken at the heat of the Bird Flu. Organic Trace Mineral Additives accounted for approximately 78% of our revenues for the three months ended September 30, 2013 as compared to 89% for the three months ended September 30, 2012. Our gross profit percentage for the Organic Trace Mineral Additives sales amounted to 28.1% and 35.2% for the quarters ended September 30, 2013 and 2012, respectively. The decrease in gross profit percentage in 2013 was primarily due to severe pricing pressure caused by reduced demand and higher production cost from reduced volume.
Functional Regulation Additives
Functional Regulation Additives are widely used to enhance the properties of other products, improve feed efficiency and stimulate the rapid maturation of the immune system. We currently produce two types of functional regulation additives: feed acidifiers and flavor enhancers. Feed acidifiers are used to prevent microbial degradation of raw materials or finished feeds and maintain the quality of feed. Flavor enhancers are used to improve feed palatability, enhance animal appetite and stimulate saliva, gastric and pancreatic juices and other digestive juice secretion, gastrointestinal motility and ultimately feed consumption, and yield from production animals.
Revenue from Functional Regulation Additives for the quarter ended September 30, 2013 decreased by $120,655, or 16.4%, as compared to the third quarter of 2012, due to overall decline of business in the livestock farming industry. Compared to the second quarter of 2013, sales of Functional Regulation Additives actually grew 22.9% after introduction of new products and selling more to livestock farming operators instead of mainly to feed producers.
Herbal Medicinal Additives
Herbal Feed Additives utilize traditional Chinese medicine theory to improve an animal’s digestion and appetite and regulate the yin and yang balance of an animal’s health. Herbal medicines come from plants, plant extracts, fungal and bee products, minerals, shells and certain animal parts. Compared to synthetic antibiotics or inorganic chemicals, these naturally-derived products are less toxic, residue free and thought to be ideal feed additives in food animal production.
Revenue from Herbal Feed Additives for the quarter ended September 30, 2013 increased by $214,771, or 227.8%, as compared to the quarter ended September 30, 2012. The revenue from herbal medicinal additives increased as a result of the Company’s introduction of a new plant-based antioxidant additive in 2013.
Other
Other revenue mainly consists of buying and then reselling raw materials. In the second quarter of 2013, Kanghui Agricultural Technology Co., Ltd. (“Kanghui Agricultural” or “WFOE”), our wholly owned subsidiary, began generating revenues from its technical consulting services to a customer in Shanghai. Other revenues increased by $175,558 during the quarter ended September 30, 2013 compared to 2012.
22
Operating Expenses and Other Income / Expenses
The following table reconciles aggregate segment gross profit to net income for the three months ended September 30, 2013 and 2012.
Three Months Ended | ||||||||||||||||
September 30, | ||||||||||||||||
2013 | 2012 | $ Change | % Change | |||||||||||||
Gross profit | $ | 1,691,410 | $ | 3,385,103 | $ | (1,693,693 | ) | (50.0 | %) | |||||||
Selling expenses | (796,302 | ) | (611,880 | ) | 184,422 | 30.1 | % | |||||||||
Administrative expenses | (1,358,109 | ) | (574,092 | ) | 784,017 | 136.6 | % | |||||||||
Depreciation and amortization | (67,337 | ) | (16,642 | ) | 50,695 | 304.6 | % | |||||||||
Income (loss) from operations | (530,338 | ) | 2,182,489 | (2,712,827 | ) | 124.3 | % | |||||||||
Other income/ (expense) | (3,125 | ) | - | (3,125 | ) | (100.0 | %) | |||||||||
Interest income | 147,037 | 23,573 | 123,464 | 523.8 | % | |||||||||||
Interest expense | 46,575 | (316,422 | ) | (362,997 | ) | (114.7 | %) | |||||||||
Amortization of discount on notes | - | (698,495 | ) | (698,495 | ) | (100.0 | %) | |||||||||
Income (loss) before income taxes | (339,851 | ) | 1,191,145 | (1,530,996 | ) | 128.5 | % | |||||||||
Income tax expense | 26,907 | (222,513 | ) | (249,420 | ) | (112.1 | %) | |||||||||
Net income (loss) | $ | (312,944 | ) | $ | 968,632 | $ | (1,281,576 | ) | 132.3 | % |
Selling, General and Administrative Expenses
Selling expenses for the three months ended September 30, 2013 increased by $184,422, or 30.1%, as compared to 2012. This increase was in line with our planned expansion of sales activities, especially in the end-user market, despite the unexpected decline in overall revenues as a result of the H7N9 plague.
General and administrative expenses for the three months ended September 30, 2013 increased by $784,017, or 136.6%, as compared to 2012. The increase in general and administrative expenses is primarily due to R&D expenses increasing by approximately $576,000 due to increase in product development projects and a delay in applying for government subsidies in 2013.
Other Income/Expenses
Interest income for the three months ended September 30, 2013 increased by $123,464 as compared to the same period of September 30, 2012 due to receipt of the six months interest from loans receivable to a customer and a supplier in the third quarter of 2013.
Interest expense for the three months ended September 30, 2013 decreased by $362,997 due to government subsidy for loan interest received in the third quarter.
The expense associated with the amortization of discounts on our convertible notes payable for the quarter ended September 30, 2013 amounted to $0 as compared to $698,495 in 2012. The discounts were amortized through February 9, 2013. As a result, there was no amortization in the third quarter of 2013 as compared to a full quarter during the same period in 2012.
Income Tax Expense
Our income tax expense decreased by $249,420 for the three months ended September 30, 2013 as compared to 2012. The decrease was attributable to a decrease in taxable income during the quarter.
Pursuant to Section 26 of the Inland Revenue Ordinance (“IRO”), the governing statute of Hong Kong taxation, any dividend income received by any entity subject to IRO would not be taxable in Hong Kong. Furthermore, foreign (non-Hong Kong) investment income that is repatriated to Hong Kong is not subject to Hong Kong profits (income) tax.
23
Results of Operations for the Nine Months Ended September 30, 2013 as Compared to the Nine Months Ended September 30, 2012
The following is a comparison of our revenue, costs of sales and gross profit by segment for the nine months ended September 30, 2013 and 2012.
Revenue and Costs of Sales
The Company operates in four segments: (1) Organic Trace Mineral Additives, (2) Functional Regulation Additives, (3) Herbal Medicinal Additives and (4) Other. Management tracks each of these segments separately. The Company evaluates the performance of its operating segments based on segment revenue and gross profit, and management uses aggregate segment gross profit as a measure for the overall performance of the business. The Company believes that aggregate segment gross profit helps to evaluate changes in the gross profit of the Company’s various offerings separate from factors other than product offerings that affect net income.
Nine Months Ended | ||||||||||||||||
September 30, | ||||||||||||||||
2013 | 2012 | $ Change | % Change | |||||||||||||
Segment revenues | ||||||||||||||||
Organic Trace Mineral Additives | $ | 12,918,273 | $ | 18,763,853 | $ | (5,845,580 | ) | (31.2 | %) | |||||||
Functional Regulation Additives | 1,608,503 | 2,480,324 | (871,821 | ) | (35.1 | %) | ||||||||||
Herbal Medicinal Additives | 716,833 | 191,110 | 525,723 | 275.1 | % | |||||||||||
Other | 1,033,252 | 443,222 | 590,030 | 133.1 | % | |||||||||||
$ | 16,276,861 | $ | 21,878,509 | $ | (5,601,648 | ) | (25.6 | %) | ||||||||
Segment costs of sales | ||||||||||||||||
Organic Trace Mineral Additives | $ | 8,825,886 | $ | 11,895,318 | $ | (3,069,432 | ) | (25.8 | %) | |||||||
Functional Regulation Additives | 1,067,802 | 1,668,369 | (600,567 | ) | (36.0 | %) | ||||||||||
Herbal Medicinal Additives | 593,206 | 187,535 | 405,671 | 216.3 | % | |||||||||||
Other | 610,678 | 414,430 | 196,248 | 47.4 | % | |||||||||||
$ | 11,097,572 | $ | 14,165,652 | $ | (3,068,080 | ) | (21.7 | %) | ||||||||
Segment gross profit | ||||||||||||||||
Organic Trace Mineral Additives | $ | 4,092,387 | $ | 6,868,535 | $ | (2,776,148 | ) | (40.4 | %) | |||||||
Functional Regulation Additives | 540,701 | 811,955 | (271,254 | ) | (33.4 | %) | ||||||||||
Herbal Medicinal Additives | 123,627 | 3,575 | 120,052 | 3358.1 | % | |||||||||||
Other | 422,574 | 28,792 | 393,782 | 1367.7 | % | |||||||||||
$ | 5,179,289 | $ | 7,712,857 | $ | (2,533,568 | ) | (32.8 | %) |
Organic Trace Mineral Additives
Organic Trace Mineral Additives constitute the largest and fastest growing area of our business. We are one of China’s largest domestic providers of organic trace mineral additives, specializing in the development and production of chelated organic trace mineral additives. Our current trace mineral manufacturing facility is the largest chelating facilities in China and has the capacity to produce approximately 350 metric tons of organic trace minerals per week.
24
Revenue from Organic Trace Mineral Additives for the nine months ended September 30, 2013 decreased by $5,845,580, or 31.2%, as compared to 2012. As mentioned above, the Organic Trace Mineral Additives revenues were negatively impacted by Bird Flu H7N9 attacks to the China poultry industry during the second quarter and the effects lingered through the third quarter. As a result of this decrease, in 2013, the Organic Trace Mineral Additives revenue accounted for approximately 79% of our revenues for the nine months ended September 30, 2013 as compared to 86% for the nine months ended September 30, 2012. Our gross profit percentage for the organic trace mineral additive sales amounted to 25.1% and 31.4% for the nine months ended September 30, 2013 and 2012, respectively. The decrease in gross profit percentage in 2013 was primarily due to pricing pressure in the market and increased unit production cost as volume declined.
Functional Regulation Additives
Functional Regulation Additives are widely used to enhance the properties of other products, improve feed efficiency and stimulate the rapid maturation of the immune system. We currently produce two types of functional regulation additives: feed acidifiers and flavor enhancers. Feed acidifiers are used to prevent microbial degradation of raw materials or finished feeds and maintain the quality of feed. Flavor enhancers are used to improve feed palatability, enhance animal appetite and stimulate saliva, gastric and pancreatic juices and other digestive juice secretion, gastrointestinal motility and ultimately feed consumption, and yield from production animals.
Revenue from Functional Regulation Additives for the nine months ended September 30, 2013 decreased by $871,821, or 35.1%, as compared to 2012. The decrease in sales was primarily due to the shift of emphasis away from this segment by management during the first half of 2013 and the last half of 2012.
Herbal Medicinal Additives
Herbal Feed Additives utilize traditional Chinese medicine theory to improve an animal’s digestion and appetite and regulate the yin and yang balance of an animal’s health. Herbal medicines come from plants, plant extracts, fungal and bee products, minerals, shells and certain animal parts. Compared to synthetic antibiotics or inorganic chemicals, these naturally-derived products are less toxic, residue free and thought to be ideal feed additives in food animal production.
Revenue from Herbal Feed Additives for the nine months ended September 30, 2013 increased by $525,723, or 275.1%, as compared to the nine months ended September 30, 2012. The revenue from herbal medicinal additives increased as a result of the Company’s introduction of a new plant-based antioxidant product in 2013.
Other
Other revenue mainly consists of buying and then reselling raw materials. However, in the second quarter of 2013, Kanghui Agricultural began providing technical consulting services to a customer in Shanghai. Other revenues increased by $590,030 during the nine months ended September 30, 2013 as compared to 2012.
25
Operating Expenses and Other Income / Expenses
The following table reconciles aggregate segment gross profit to net income for the nine months ended September 30, 2013 and 2012.
Nine Months Ended | ||||||||||||||||
September 30, | ||||||||||||||||
2013 | 2012 | $ Change | % Change | |||||||||||||
Gross profit | $ | 5,179,289 | $ | 7,712,857 | $ | (2,533,568 | ) | (32.8 | %) | |||||||
Selling expenses | (2,078,771 | ) | (1,706,112 | ) | 372,659 | 21.8 | % | |||||||||
Administrative expenses | (3,337,168 | ) | (1,795,328 | ) | 1,541,840 | 85.9 | % | |||||||||
Depreciation and amortization | (183,891 | ) | (43,071 | ) | 140,820 | 326.9 | % | |||||||||
Income (loss) from operations | (420,541 | ) | 4,168,346 | (4,588,887 | ) | 110.1 | % | |||||||||
Other income | 40,210 | - | 40,210 | 100.0 | % | |||||||||||
Interest income | 173,183 | 193,026 | (19,843 | ) | (10.3 | %) | ||||||||||
Interest expense | (207,860 | ) | (1,058,291 | ) | (850,431 | ) | (80.4 | %) | ||||||||
Amortization of discount on notes | (402,394 | ) | (2,080,301 | ) | (1,677,907 | ) | (80.7 | %) | ||||||||
Income (loss) before income taxes | (817,402 | ) | 1,222,780 | (2,040,182 | ) | 166.8 | % | |||||||||
Income tax expense | (58,704 | ) | (652,711 | ) | (594,007 | ) | (91.0 | %) | ||||||||
Net income (loss) | $ | (876,106 | ) | $ | 570,069 | $ | (1,446,175 | ) | 253.7 | % |
Selling, General and Administrative Expenses
Selling expenses for the nine months ended September 30, 2013 increased by $372,659, or 21.8%, as compared to 2012. Despite an unexpected decline in sales in 2013, an increased emphasis in sales operations is part of our growth strategy.
General and administrative expenses for the nine months ended September 30, 2013 increased by $1,541,840, or 62.1%, as compared to 2012. R&D expenses increased by approximately $1,342,000 in the first nine months in 2013 due to increased product development projects and a delay in application for government subsidies.
Other Income/Expenses
Interest income for the nine months ended September 30, 2013 decreased by $19,843 as compared to the nine months ended September 30, 2012. The decrease was primarily due to lower interest income generated from lower cash balance in bank accounts.
Interest expense for the nine months ended September 30, 2013 decreased by $850,431 as compared to 2012. The primary reason for this decrease was due to lower amortization of capitalized offering costs recorded in 2013. These offering costs were fully amortized as of February 9, 2013. As a result, there was only approximately one month of amortization recorded during the nine months ended September 30, 2013. During 2012, we had a full nine months worth of amortization in these offering costs.
The expense associated with the amortization of discounts on our convertible notes payable for the nine months ended September 30, 2013 amounted to $402,394 as compared to $2,080,301 in 2012. The discounts were amortized through February 9, 2013. As a result, we only had approximately one month of amortization during the nine months ended September 30, 2013 as compared to a full nine months during the same period in 2012.
Income Tax Expense
Our income tax expense decreased by $594,007 for the nine months ended September 30, 2013 as compared to 2012. The decrease was attributable to a decrease in taxable income during the period.
Pursuant to Section 26 of the Inland Revenue Ordinance (“IRO”), the governing statute of Hong Kong taxation, any dividend income received by any entity subject to IRO would not be taxable in Hong Kong. Furthermore, foreign (non-Hong Kong) investment income that is repatriated to Hong Kong is not subject to Hong Kong profits (income) tax.
26
Liquidity and Capital Resources
As of September 30, 2013 and 2012 we had cash balances of $5,053,700 and $11,043,457, respectively. The following table provides detailed information about our net cash flow for all financial statement periods presented in this report. To date, we have financed our operations primarily by cash from operations, issuance of convertible notes and capital contribution by our stockholders.
The following table sets forth a summary of our cash flows for the periods indicated.
Nine Months Ended | ||||||||||||||||
September 30, | $ | % | ||||||||||||||
2013 | 2012 | Change | Change | |||||||||||||
Net cash provided by operating activities | $ | 1,375,956 | $ | 3,828,851 | $ | (2,452,895 | ) | (64.1 | %) | |||||||
Net cash used in investing activities | (2,473,069 | ) | (1,640,908 | ) | (832,161 | ) | 50.7 | % | ||||||||
Net cash provided by (used in) financing activities | (170,201 | ) | 1,046,284 | (1,216,485 | ) | (116.3 | %) | |||||||||
Effect of foreign currency conversion on cash | 152,260 | 109,074 | 43,186 | 39.6 | % | |||||||||||
Net (decrease) increase in cash | $ | (1,115,054 | ) | $ | 3,343,301 | $ | (4,458,355 | ) | (133.4 | %) |
Operating Activities
Net cash provided by operating activities was $1,375,956 for the nine months ended September 30, 2013 compared to cash provided of $3,828,851 for the nine months ended September 30, 2012. We had net losses of $876,106 during the nine months ended September 30, 2013, and a significant amount of our expenses were non-cash related such as $629,399 for depreciation and amortization of fixed and intangible assets, $402,394 for the amortization of the discounts recorded on our convertible notes payable, as well as $115,688 of offering cost amortization. In addition, we had a decrease in prepayments for raw materials of $1,853,659. As a result, we generated positive cash flows from operations of $1,375,956 during the nine months ended September 30, 2013.
During the same period in 2012, we had net income of $570,069, after deduction of non-cash expenses of $404,123 for depreciation and amortization, $2,080,301 for the amortization of the discounts on the convertible notes payable, as well as $598,088 in capitalized offering cost amortization. As a result of these non-cash expenses, we generated positive cash flows from operations of $3,828,851 during the nine months ended September 30, 2012.
Investing Activities
Net cash used in investing activities was $2,473,069 for the nine months ended September 30, 2013, which represented spending related to the purchase of property and equipment, along with $39,888 for the purchase of intangible assets. Net cash used in investing activities during the nine months ended September 30, 2012 was $1,640,908, which was the result of an increase in loans to customers and suppliers of $363,325, spending for the purchase of property and equipment of $799,922 and the purchase of intangible assets of $477,661.
Financing Activities
Net cash used in financing activities was $170,201 for the nine months ended September 30, 2013 primarily due to principal payments made on long-term borrowings of $1,206,000 and payments of convertible notes of $160,839, offset by $231,838 in restricted cash becoming unrestricted and proceeds from additional borrowings of $964,800. During the nine months ended September 30, 2012, we had net cash provided by financing activities of $1,046,284, resulting primarily from increase in bank borrowings and changes in restricted cash balances.
27
We have historically funded our operation primarily through cash generated from operations as well as the private placement completed in 2011. Over the next twelve months, we intend to pursue organic and acquisitive growth and increase our market share in mainland China. We believe that our cash on hand and cash flow from operations will meet our present operating cash needs for the next 12 months. However, we will require additional cash resources to meet the cash requirements of our planned long-term growth.
Additionally, we may require additional cash resources due to changed business conditions, implementation of our strategy to ramp up our marketing efforts and increase brand awareness, or acquisitions we may decide to pursue. If our own financial resources are insufficient to satisfy our capital requirements, we may seek to sell additional equity, securities, convertible notes or warrants in the future.
Effect of Changes in the Foreign Exchange Rate
Upon translation of the Company’s financial statements into US Dollars for the purpose of financial reporting in the United States, the exchange rate between the Chinese Renminbi and the US Dollar can have an impact on the amount of reported cash on hand.
However all of the Company’s revenue is generated in China, and currently over 90% of its cost is within China. As a result, from an operational standpoint, a change in the exchange rate has relatively little impact on the Company. Such change is not expected to affect the Company’s liquidity in any significant way.
Economy and Inflation
Inflation and changing prices have not had a material effect on our business and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future.
We have not experienced any significant cancellation in orders due to the downturn in the economy. Furthermore, we have also had only a small number of customer-requested delays in delivery or production.
Off Balance Sheet Arrangements
We do not have any off balance sheet arrangements that have, or are reasonably likely to have a current or future effect on our financial statements.
Seasonality
Our operating results and operating cash flows historically have not been subject to significant seasonal variations. However, sales around Chinese New Year are typically comparatively lower than other months. This pattern may change as a result of new market opportunities or new product introduction.
Recent Accounting Pronouncements
See Note 2 of the accompanying consolidated financial statements for a description of recent accounting pronouncements. We do not anticipate that the adoption of these recent accounting pronouncements will have a material impact on our financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We are a smaller reporting company and therefore, we are not required to provide information required by this Item of Form 10-Q.
28
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) that are designed to ensure that information required to be disclosed in our reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time period specified in the SEC’s rules and forms, and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.
As required by Rule 13a-15(b) under the Exchange Act, we have evaluated, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this quarterly report.
Due to the material weaknesses identified by management and described in the Company’s 2012 annual report that have continued to exist during the quarter covered by this report, management concluded that the Company’s disclosure controls and procedures were not effective as of September 30, 2013.
1) | There are no documented policies and procedures on the monitoring of cash transactions (including cash received from customers and cash payments to vendors and suppliers) to ensure that they are accurately recorded, timely analyzed and reconciled to supporting documentation. |
2) | There are no documented policies and procedures on the monitoring of transactions that are processed via personal bank accounts (including cash received from customers and cash payments to vendors and suppliers) to ensure that they are properly reviewed and authorized, accurately recorded and reconciled to supporting contracts or agreements. |
A material weakness is a control deficiency, or combination of control deficiencies such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. Our management has discussed the material weaknesses described above with our board of directors.
Changes in Internal Control over Financial Reporting
There were no changes to our internal control over financial reporting during the period ended September 30, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
The nature of our business exposes us to the potential for legal proceedings related to labor and employment, personal injury, property damage, and environmental matters. Although the ultimate outcome of any legal matter cannot be predicted with certainty, based on present information, including our assessment of the merits of each particular claim, as well as our current reserves and insurance coverage, we do not expect that any known legal proceeding will in the foreseeable future have a material adverse impact on our financial condition or the results of our operations.
Factors that could cause our actual results to differ materially from those in this report are any of the risks described in our Annual Report on Form 10-K for the year ended December 31, 2012 filed with the SEC. Any of these factors could result in a significant or material adverse effect on our results of operations or financial condition. Additional risk factors not presently known to us or that we currently deem immaterial may also impair our business or results of operations.
As of the date of this report, except as provided below, there have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2012 filed with the SEC.
We are in default on the 8% Senior Convertible Note and its amendment to the investors in 2011 private placement.
We have significant commitments and obligations. As of February 10, 2013, the Company is in default under the terms of the 8% Senior Convertible Notes (the “Notes,” described in Note 10 to the Financial Statements included in Part I Item 1 of this report) issued to certain accredited investors in the 2011 private placement (the “Investors”). The default is the result of the Company’s failure to pay to the Investors approximately $7.67 million in principal plus accrued interest due and payable on February 9, 2013 under the terms of the Notes. Subsequently, the Company has released $229,018 from investor relations escrow to pay the accrued interest of $68,178 and principal of $160,839 to the Investors. The Company has outstanding principal balance of approximately $7.5 million.
On August 23, 2013, the Company entered into an amendment to the Notes (the “Amendment”) with Euro Pacific Capital, Inc. (the “Investor Representative”) which extends the repayment of principals under the Notes. As of September 30, 2013, the Company is in default under the terms of the Amendment as a result of the Company’s failure to pay to the Investors $1 million principal amount prior to September 30, 2013.
As a result of the Company’s failure to pay the $1 million principal amount under the Amendment as of September 30, 2013, the outstanding principal balance of approximately $7.5 million once again becomes due immediately and payable notwithstanding the Amendment and the Investors may exercise any other remedies the Investors may have under the transaction documents, at law or in equity. Additionally, the full amount of $460,206 of the Holders Registration Delay Payment (as defined in the Registration Rights Agreement among the parties dated as of the same date as the Notes) becomes due immediately and payable notwithstanding the waiver. As such failure has not been cured within 45 days, then (i) interest is deemed to have accrued on the entire unpaid principal balance retroactively from the then missed payment due date and interest shall continue to accrue thereafter until the unpaid principal balance and all accrued interest thereon has been paid in full. The interest on the then outstanding principal balance shall accrue at the rate of eight percent (8%) per annum, and (ii) the remaining 500,000 shares in escrow shall be immediately issued to the Holders.
The Company continues to be in default under the terms of the Amendment. The Company is in discussion with the Investor Representative to determine a revised repayment schedule while the Investors reserve all of their rights under the Notes and the Amendment. There can be no assurances as to the outcome of such discussions.
If the Investors demand payment under the Notes and the Amendment, we will not have sufficient resources to make the required payments. We do not have sufficient resources to meet our obligations under the Notes and the Amendment unless we are able to raise substantial additional financing on acceptable terms or secure funds from new or existing partners. We cannot assure that financing will be available on favorable terms or at all. Additionally, these conditions may increase the cost to raise capital. If additional capital is raised through the sale of equity or convertible debt securities, the issuance of such securities would result in dilution to our existing stockholders.
While we are trying to access possible way to repay the Notes, there can be no assurance, however, that our plan will be successful. If the Company fails to raise additional capital or obtain substantial cash inflows from existing or new partners, or if the Investors demand payment under the terms of the Notes and the Amendment, the Company could be forced to cease operations. Any of the foregoing events would have a material adverse effect on our business and on the value of our stockholders’ investments in our common stock.
None.
29
None.
Not applicable.
On November 1, 2013, our Board of Directors appointed Mr. Guixiong Qiu as our interim Chief Financial Officer, effective immediately. Mr. Qiu also serves as our Chief Executive Officer and Chairman of the Board of Directors since February 2010. While Mr. Qiu is serving as our interim Chief Financial Officer, we are working diligently seeking for a qualified candidate who is experienced in U.S. GAAP for the position of Chief Financial Officer.
Exhibit No. | Description | |
31.1 | Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 * | |
32.1 | Certification of Principal Executive Officer and Principal Financial Officer of the Company, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ** | |
101.INS | XBRL Instance Document † | |
101.SCH | XBRL Taxonomy Extension Schema Document † | |
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document † | |
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document † | |
101.LAB | XBRL Taxonomy Extension Label Linkbase Document † | |
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document † | |
* | Filed herewith. | |
** | In accordance with SEC Release 33-8238, Exhibits 32.1 is furnished and not filed. | |
† | Furnished herewith. XBRL (eXtensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections. |
30
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, there unto duly authorized.
TANKE BIOSCIENCES CORPORATION | |||
Date: November 14, 2013 | By: | /s/ Guixiong Qiu | |
Guixiong Qiu | |||
Chief Executive Officer and Interim Chief Financial Officer |
31