ITEM 1.
|
DESCRIPTION OF BUSINESS
|
In this Annual Report, unless the context
requires otherwise, references to the “Company,” “Sino Agro,” “SIAF,” “we,” “our
company” and “us” refer to Sino Agro Food, Inc., a Nevada corporation together with its subsidiaries.
Sino Agro Food, Inc.
SIAF is an agriculture technology and
natural food holding company with principal operations in the People’s Republic of China. The Company acquires and maintains
equity stakes in a cohesive portfolio of companies that SIAF forms according to its core mission to produce, distribute, market
and sell natural, sustainable protein food and produce, primarily seafood and cattle, to the rapidly growing middle class in China.
SIAF provides financial oversight and strategic direction for each company, and for the interoperation between companies, stressing
vertical integration between the levels of the Company’s subsidiary food chain. The Company owns or licenses patents, proprietary
methods, and other intellectual properties in its areas of expertise. SIAF provides technology consulting and services to joint
venture partners to construct and operate food businesses, primarily producing wholesale fish and cattle. Further joint ventures
market and distribute the wholesale products as part of an overall “farm to plate” concept and business strategy.
Revenues by division were as follows
(in millions of U.S. dollars):
Division (on Sales of Goods)
|
|
2015
|
|
|
2016
|
|
Fisheries (CA)
|
|
$
|
85.4
|
|
|
$
|
61.4
|
|
Organic Fertilizer (HSA & SJAP)
|
|
|
164.6
|
|
|
|
155.2
|
|
Cattle (MEIJI)
|
|
|
35.3
|
|
|
|
29.8
|
|
Plantation (JHST)
|
|
|
13.7
|
|
|
|
13.3
|
|
Corporate, Marketing & Trading (SIAF)
|
|
|
37.9
|
|
|
|
72.4
|
|
Total Revenues derived on sales of goods
|
|
$
|
336.9
|
|
|
$
|
332.1
|
|
Division (on consulting & services)
|
|
2015
|
|
|
2016
|
|
CA (Fishery related developments)
|
|
$
|
88.5
|
|
|
$
|
72.2
|
|
MEIJI (Cattle farm developments)
|
|
|
0
|
|
|
|
0
|
|
SIAF (Other developments)
|
|
|
3.8
|
|
|
|
0
|
|
Total Revenues derived on consulting & services
|
|
$
|
92.3
|
|
|
$
|
72.2
|
|
History
The Company, which was formerly known
as Volcanic Gold, Inc. and A Power Agro Agriculture Development, Inc., was incorporated on October 1, 1974 in the State of Nevada.
The Company was formerly engaged in the mining and exploration business but ceased the mining and exploring business in 2005.
On 24 August 2007, the Company entered into a merger and acquisition agreement with CA, a Belize corporation and its subsidiaries
CS and CH. Effective of the same date, CA completed a reverse merger transaction with the Company.
For two years after its introduction in
China, the Company operated in the dairy segment, but sold the dairy business in December of 2009 and began to implement its five
year plan to develop its vertically integrated business operations consisting of (i) cattle fattening and production of beef products
and (ii) cultivation of fish and prawn and related products. The Company now operates as an engineering, technology and consulting
company specializing in building and operating agriculture and aquaculture farms in China.
Our principal executive office is located at
Room 3801, 38
th
Floor, Block A, China Shine Plaza, No. 9 Lin He Xi Road, Tianhe District, Guangzhou City, Guangdong
Province, PRC, 510610.
The table below provides an overview of key
events in the development of the business of the Company.
Year
|
|
Event
|
2006
|
|
·
|
Initiates agriculture and aquaculture consulting activities in China.
|
2007
|
|
·
|
Changes name from A Power Agro Agriculture Development, Inc. to Sino Agro Food, Inc.
|
|
|
·
|
Acquires the Belize holding company Capital Award. Today, Capital Award is Sino Agro Food’s subsidiary operating many of the Company’s aquaculture activities.
|
|
|
·
|
Acquires the dairy operations through a 78 percent ownership stake in ZhongXing Agriculture and Husbandry.
|
|
|
·
|
Acquires the HU Plantation through a 75 percent ownership stake in Jiang Men City Heng Sheng Tai Agriculture Development.
|
2009
|
|
·
|
Conducts a strategic review and divests the dairy business in December due to poor industry fundamentals with control of the industry concentrated in a few very large value-added manufacturers.
|
|
|
·
|
Founds Qinghai Sanjiang A Power Agriculture (“SJAP”). SJAP manufactures bioorganic fertilizer, livestock feed and develops other agriculture projects in the County of Huangyuan, in the vicinity of Xining City, Qinghai Province.
|
2010
|
|
·
|
Creates a five-year plan to develop vertically integrated businesses in primary production, distribution and marketing of beef cattle, beef products and seafood through proprietary recirculating aquaculture systems.
|
|
|
·
|
Begins construction of the Company’s first fish farm, Fish Farm 1, with targeted capacity of 1,000 metric tons per year.
|
2011
|
|
·
|
Begins construction of Prawn Farm 1 & 2, Cattle Farm 1 and Fish Farm 2.
|
|
|
·
|
Becomes a fully reporting SEC company on the OTCQB (as defined below).
|
2012
|
|
·
|
Acquires a 75 percent ownership in Fish Farm 1 and Cattle Farm 1. Advances construction of Cattle Farm 2 and Wholesale Center 1 in Guangzhou.
|
|
|
·
|
Produces 1,800 MT of seafood and raises 6,000 head of cattle.
|
2013
|
|
·
|
Closes the Zhongshan Prawn Farm agreement, targeting production of 10,000 MT of prawn p.a. in 2016/2017 and 100,000 MT in 2024.
|
|
|
·
|
SJAP awarded Dragon Head Enterprise status by the Qinghai provincial government.
|
|
|
·
|
Mr. George Yap and Mr. Nils-Erik Sandberg join SIAF’s Board of Directors, as independent directors.
|
|
|
·
|
Produces 4,700 MT of seafood and raises 15,000 head of cattle.
|
2014
|
|
·
|
SJAP’s abattoir and meat processing facilities commence operations. SJAP signs supplier and concession agreements with Tesco, PLC China for packaged meat products.
|
|
|
·
|
Advances construction of a wholesale and distribution center in Shanghai, targeting ultimate capacity of 12,000 MT of meat and 6,000 MT of seafood per annum.
|
|
|
·
|
Mr. Anthony Soh and Mr. Dan Ritchey join SIAF’s Board of Directors as independent directors.
|
|
|
·
|
Ms. Olivia Lai is hired as Chief Financial Officer.
|
|
|
·
|
Produces 5,600 MT of Seafood and raises 26,000 head of cattle during 2014.
|
2015
|
|
·
|
Sino Agro Food announces a long-term vision to become a leading sustainable aquaculture company focused on organically farmed fish and prawns.
|
|
|
·
|
Wholesale Center 2 in Shanghai initiates operations
|
|
|
·
|
Mr. Bertil Tiusanen is hired as Chief Financial Officer. Ms. Lai becomes the Company’s Chief Corporate Affairs Officer.
|
|
|
·
|
Sino Agro Food announces contemplated plan to divest its aquaculture operations and seek a separate listing on the Oslo Stock Exchange.
|
2016
|
|
·
|
Sino Agro Food was admitted to the Merkur market in Oslo.
|
|
|
·
|
The Company upgraded to OTCQX Premier from the OTCQB
®
Venture Market.
|
|
|
·
|
Mr. Bertil Tiusanen resigned as Chief Financial Officer and appointed as SVP Business Development, New Ventures Europe
|
|
|
·
|
Officer and Mr. Dan Ritchey appointed as Chief Financial Officer.
|
|
|
2016 / 2017: Sino Agro Food Inc.’s carve-out of Tri-way resulting in categorization of Tri-way as an Investor in Associate from a subsidiary status. As such, Sino Agro Food Inc.’s fully owned subsidiary namely, Capital Award Inc (CA), retains its main business activity in the sector of technology and engineering consulting and related services, and Tri-way has assumed all activity regarding aquaculture operations and the sale of all products produced by them.
|
|
|
Tri-way has purchased Master Developer and Operating licensing rights from CA for purposes of future development of aquaculture projects in China utilizing CA’s APM-indoor and ODRAS technology, and has contracted with CA to provide its turnkey contractor services for those projects in China.
|
Through December 31, 2016 on all of its
development projects, the Company has been contracted as turnkey contractor to the owners and developers of the C&S Project
Companies and acted as the master engineer, pioneering the construction and building of farms, from raw land into fully operational
facilities. The Company completes the construction and building of infrastructure including staff quarters, offices, processing
facilities, storage, and all related production facilities. The Company’s management teams are responsible for developing
all business activities into effective and efficient operations. From October 5, 2016, onward, Tri-way has assumed the role as
developer of aquaculture projects in China with CA contracted to provide turnkey contracted services for those projects.
In just a few years, Sino Agro Food has
matured into a company dedicated to the agriculture and aquaculture industry in China. The Company currently maintains operation
of its HU Plantation (see description in section 4.10 below) as well as its services in engineering consulting, specializing in
the development of two major products, namely meat derived from the rearing of beef cattle and seafood derived from the growth
of fish, prawns, eel and other marine species.
Background
After successfully developing many aquaculture
fishery farms, cattle farms and related business operations (along with sales and marketing of produce and products) in Australia
and Malaysia since 1998, SIAF’s management team introduced its business activities in China in 2006. The Company is an engineering
and consulting company that specializes in building and operating agriculture and aquaculture farms.
To accomplish this, we use our expertise
and know how in specific agriculture and aquaculture technologies. Our “A Power Re-circulating Aquaculture System,”
sometimes referred to herein as APRAS, is a patented and proven technology for indoor fish farming. We have developed modern techniques
and technologies to grow, feed and house both fish and cattle. These are engineered into the designs of, and the management systems
for, indoor and outdoor fishery and cattle farms. Our experience managing crops, and employing technologies, including hydroponic,
to work within climate and growing conditions optimizes production of organic, green and natural agricultural produce.
In all of our developments we have acted
as the master engineer, pioneering the construction and building of farms, from raw land into fully operational facilities. We
complete the construction and building of infrastructure including staff quarters, offices, processing facilities, storage, and
all related production facilities. Our management teams are responsible for developing all business activities into effective
and efficient operations.
In just a few years, SIAF has matured
into a company dedicated to the agriculture and aquaculture industry in China. We currently maintain operation of our HU Plantation
as well as our services in engineering consulting, specializing in the development of two major products, namely meat derived
from the rearing of beef cattle and seafood derived from the growth of fish, prawns, eel and other marine species.
Revenues are generated from activities
that we divide into five stand-alone business divisions or units: (1) Fishery, (2) Cattle & Beef, (3) Organic
Fertilizer, (4) HU Plantation, and (5) Marketing and Trading. This fifth and newest division, “Marketing and Trading,”
represents our strongest push to vertically integrate the Company’s operations, furthering the Company’s overall “farm
to plate” concept.
Corporate Acquisitions
On September 5, 2007, we acquired two businesses
in the People’s Republic of China (“
PRC
”):
(a) Tri-Way Industries Ltd., Hong Kong (“
TRW
”)
(formerly known as Tri-way Industries Limited), a company incorporated in Hong Kong; and
(b) Macau EIJI Co. Ltd., Macau (“
MEIJI
”)
(formerly known as Macau Eiji Company Limited), a company incorporated in Macau, and the owner of 75% equity interest in Enping
City Juntang Town Hang Sing Tai Agriculture Co. Ltd. (“
HST
”), a PRC corporate Sino Foreign joint venture.
On November 27, 2007, MEIJI and HST established
a corporate Sino Foreign joint venture, Jiangmen City Heng Sheng Tai Agriculture Development Co. Ltd, China (“
JHST
”)
(formerly known as Jiang Men City Heng Sheng Tai Agriculture Development Co. Ltd.), a company incorporated in the PRC with MEIJI
owning a 75% interest and HST owning a 25% interest. HST was dissolved in 2010.
In September 2009, we formed a 100% owned subsidiary
in Macau, A Power Agriculture Development (Macau) Ltd., China (“
APWAM
”) (formerly known as A Power Agro Agriculture
Development (Macau) Limited). APWAM presently owns 45% of a corporate Sino Foreign joint venture, Qinghai Sanjiang A Power Agriculture
Co. Ltd. (“
SJAP
”). SJAP is engaged in the business of manufacturing bioorganic fertilizer, livestock feed and
development of other agriculture projects in the County of Huangyuan, in the vicinity of the Xining City, Qinghai Province, PRC.
On February 28, 2011, TRW applied to form a
corporate joint venture, Enping City A Power Prawn Culture Development Co. Ltd., China (“
EBAPCD
”) (formerly
known as Enping City Bi Tao A Power Fishery Development Co., Limited), which is incorporated in the PRC. TRW initially owned a
25% equity interest in EBAPFD. On November 17, 2011, TRW formed Jiangmen City A Power Fishery Development Co. Ltd, China (“
JFD
”)
(formerly known as Jiang Men City A Power Fishery Development Co., Limited) in which it acquired a 25% equity interest, while withdrawing
its 25% equity interest in EBAPFD. As of December 31, 2011, we had invested $1,258,607 in JFD. JFD operates an indoor fish farm.
On January 1, 2012, we acquired an additional 25% equity interest in JFD for total cash consideration of $1,662,365. On April 1,
2012, we acquired an additional 25% equity interest in JFD for the amount of $1,702,580. We presently own a 75% equity interest
in JFD and control its board of directors. As of September 30, 2012, we had consolidated the assets and operations of JFD.
On April 15, 2011, MEIJI applied to form Enping
City A Power Beef Cattle Farm 2 Co. Ltd., China (“
EAPBCF
”) (formerly known as Enping City A Power Cattle Farm
Co., Limited), all of which we would indirectly own a 25% equity interest in as of November 17, 2011. On September 13, 2012 MEIJI
formed Jiangmen City Hang Mei Cattle Farm Development Co. Ltd., a company incorporated in the PRC (“
JHMC
”) (formerly
known as Jiang Men City Hang Mei Cattle Farm Development Co., Limited) in which it owns 75% equity interest with an investment
of $3,636,326, while withdrawing its 25% equity interest in ECF. As of September 30, 2012, we had consolidated the assets and operations
of JHMC.
Cross-Listing on the Merkur Market
On January 13, 2016, securities representing
beneficial interests in the shares of common stock of the Company, referred to as VPS Shares, began to be traded on the Oslo Børs’
Merkur Market under the symbol “SIAF-ME.” The Company’s common shares continued to trade on the OTCQB under
the symbol “SIAF.”
The Merkur Market is a multilateral trading
facility operated by Oslo Børs ASA. The Merkur Market is subject to the rules in the Norwegian Securities Trading Act and
the Securities Trading Regulations that apply to such marketplaces. These rules apply to companies admitted to trading on the
Merkur Market, as do the marketplace’s own rules, which are less comprehensive than the rules and regulations that apply
to companies listed on Oslo Børs and Oslo Axess. The Merkur Market is not a regulated market, and is therefore not subject
to the Norwegian Stock Exchange Act or to the Stock Exchange Regulations. Investors should take this into account when making
investment decisions.
Uplisting to the OTC QX Premier
On January 19, 2016, the Company’s shares
of common stock began to be traded on the OTCQX
®
Best Market in the U.S. under its existing ticker symbol “SIAF.”
The Company upgraded to OTCQX Premier from the OTCQB
®
Venture Market.
The OTCQX
®
Market is the top
tier of the U.S. over-the-counter markets operated by OTC Markets Group Inc. It is reserved for established investor-focused companies
meeting high financial and governance standards, and sponsored by professional third party advisors. SIAF has qualified to trade
on OTCQX U.S. Premier, for which eligibility standards are higher still. For comparison, as of December 31, 2015, there were 942
companies traded on the OTCQB, 425 companies traded on the OTCQX and 98 companies traded on OTCQX U.S. Premier, of which only 17
are non-bank companies.
With OTCQX admission, OTC Markets Group’s
Blue Sky Monitoring Service provides the Company with a customized daily audit of its compliance status in all 50 states. Blue
Sky compliance is mandatory for broker-dealers and registered investment advisors to solicit or recommend a security to investors.
U.S. investors can find current financial disclosure
and Real-Time Level 2 quotes for the Company on
www.otcmarkets.com
.
Emerging Growth Company
We are an “emerging growth company,”
as defined in the Jumpstart Our Business Startups Act of 2012. We will remain an emerging growth company until the earlier of
(1) the last day of the fiscal year (a) in which we have total annual gross revenue of at least $1.0 billion or (b) in
which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates
exceeded $700.0 million as of the prior June 30, and (2) the date on which we have issued more than $1.0 billion in
non-convertible debt during the prior three-year period. We refer to the Jumpstart Our Business Startups Act of 2012 herein as
the “JOBS Act” and references herein to “emerging growth company” shall have the meaning associated with
it in the JOBS Act.
As an emerging growth company, we may
take advantage of specified reduced disclosure and other requirements that are otherwise applicable generally to public companies.
These provisions include:
|
·
|
only
two years of audited consolidated financial statements in addition to any required unaudited
interim financial statements with correspondingly reduced “Management’s Discussion
and Analysis of Financial Conditions and Results of Operations” disclosure;
|
|
·
|
reduced disclosure
about our executive compensation arrangements;
|
|
·
|
no requirement that
we hold non-binding advisory notes on executive compensation or golden parachute arrangements;
and
|
|
·
|
exemption
from the auditor attestation requirement in the assessment of our internal control over
financial reporting.
|
We have taken advantage of some of these
reduced burdens, and thus the information we provide stockholders may be different from what you might receive from other public
companies in which you hold shares.
In addition, Section 107 of the JOBS Act
also provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B)
of the Securities Act for complying with new or revised accounting standards. In other words, an emerging growth company can delay
the adoption of certain accounting standards until those standards would otherwise apply to private companies. However, we are
choosing to “opt out” of such extended transition period, and as a result, we will comply with new or revised accounting
standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Section 107
of the JOBS Act provides that our decision to opt out of the extended transition period for complying with new or revised accounting
standards is irrevocable.
Reverse Split
On November 10, 2014, the board of directors
of Sino Agro Food, Inc. approved an amendment to our Articles of Incorporation to effectuate a reverse stock split (the “Reverse
Split”) of our common stock, par value $.001 per share, affecting both the authorized and issued and outstanding number of
such shares by a ratio of 1 for 9.9. The Reverse Split became effective in the State of Nevada on December 16, 2014. The Market
Effective Date of the Reverse Split was December 16, 2014, having been approved by the Financial Industry Regulatory Authority,
Inc. (“
FINRA
”) on December 15, 2014. As a result of the Reverse Split, each 9.9 shares of common stock authorized
as well as each such share issued and outstanding prior to the Reverse Split has been converted into 1 share of common stock, and
all options, warrants, and any other similar instruments convertible into, or exchangeable or exercisable for, shares of common
stock have been proportionally adjusted. All references to common stock have been retroactively restated.
Legal structure
The Company is primarily a holding company
whose operations are carried out through its subsidiaries.
The following table sets out information
about the entities in which the Company, as of the date of this Annual Report, holds (directly or indirectly) more than 10 percent
of the outstanding capital and votes.
The table below sets out a brief description
of the companies within the Company as well as the Company’s respective holdings within such companies and their domiciles.
Company
|
|
Country of incorporation
|
|
Field of activity
|
|
%
Holding
|
Sino Agro Food, Inc.
|
|
US
|
|
Engineering consulting (general types of developments), business management, trading, sales
and marketing
|
|
|
Capital Award Inc. (CA)
|
|
Belize
|
|
Engineering consulting (mainly in development of fishery), management of fishery operation,
marketing and sales of fishery produces and products
|
|
100
|
Tri-way Industries Limited (TRW)
|
|
Hong Kong
|
|
Holding company and holder of technology licenses
|
|
36.6%
|
Macau Eiji Company Limited (MEIJI)
|
|
Macau
|
|
Engineering consulting (mainly in cattle farming and vegetable farming), management service
and marketing and sales of cattle and related products
|
|
100
|
A Power Agro Agriculture Development (Macau) Limited (APWAM)
|
|
Macau
|
|
Holding company
|
|
100
|
Sino Agro Food Sweden AB (publ) (SAFS)
|
|
Sweden
|
|
Various support and service to parent company, asset management, finance, consulting and
provision of services in agriculture and aquaculture, marketing and sale of agricultural products, consultancy for business
development in China, and related business
|
|
100
|
Capital Stage Inc. (CS)
|
|
Belize
|
|
Dormant
|
|
100
|
Capital Hero Inc. (CH)
|
|
Belize
|
|
Dormant
|
|
100
|
Jiangmen City A Power Fishery Development Co. Ltd. (JFD or Fish Farm 1)
|
|
China
|
|
Growing of fish (sleepy cod species), eels (flower pattern species) and prawns
|
|
100
% owned by Triway
36.6% owned indirectly by SIAF
|
Jiangmen City Hang Mei Cattle Farm Development Co. Ltd. (JHMC or Cattle Farm 1)
|
|
China
|
|
A demonstration farm for growing cattle in a semi-tropical climate
|
|
75
|
Jiangmen City Heng Sheng Tai Agriculture Development Co. Ltd. (JHST)
|
|
China
|
|
HU plantation, immortal vegetable planning, processing and sales of produces and products
|
|
75
|
Hunan Shenghua A Power Agriculture Co. Ltd. (HSA)
|
|
China
|
|
Existing activities: manufacturing of organic fertilizer, 100% pure organic mixed fertilizer
and lake fish farming organic fertilizer. Cattle rearing.
|
|
76
|
Qinghai Sanjiang A Power Agriculture Co. Ltd. (SJAP)
|
|
China
|
|
Existing activities: manufacturing of organic fertilizer (permits valid until December 2016),
bulk and concentrated livestock feed, and rearing of cattle and cooperative farming. Slaughter and deboning of cattle and
value added processing of beef products.
|
|
45% owned by SIAF
|
Qinghai Zhong He Meat Products Co. Ltd. (QZH)
|
|
China
|
|
Cattle slaughter and deboning
|
|
100% owned by SJAP
|
In addition to the legal entities included
in the chart and table above, the Company is providing technology know-how with consulting service and turnkey contracting services
(“
C&S
”) to various Chinese owned Project Companies (“
C&S Project Company
”) which
mainly are private companies formed in China with Chinese citizens acting as legal representatives. Sino Agro Food does not have
any ownership in these C&S Project Companies. However, in consideration of the Company’s right to protect its technology
and know-how granted to the C&S Project Companies, the Company has an option to acquire equity stakes in the future SFJVC at
an agreed value equivalent to the project’s development cost. The chart below sets out the various C&S Project Companies
in which the Company is currently involved. The maximum equity stake which may be obtained in any C&S Project Company is 75%.
In addition, regarding the investment agreement
between QZH and QQI, (i) QQI enjoyed 6% annual interest on its capital contribution, but not any profit distribution; (ii) investment
period was 3 years, and (iii) SJAP shared 100% (2015: 100%) on profit or loss after 6% interest payment to QQI and
enjoyed 100% (2015: 100%) voting rights of QZH’s board and stockholders meetings.
C&S Project Company
“APNW” or “Wholesale Center 1&2”
|
Marketing, sales and distribution of seafood, beef, and related products
|
|
|
(Guangzhou City A Power NaWei Trading Co. Ltd.)
|
|
|
|
“Vigor” (Shanghai Vigour Trading Co. Ltd.)
|
Marketing, sales and distribution of seafood, beef, and related products
|
|
|
“
EAPBCF
” or “
Cattle Farm 2
”
|
|
|
|
Enping City A Power Beef Cattle Farm 2 Co. Ltd.
|
Cattle rearing
|
Triway’s Farms
Company
|
|
Field of activity
|
Aqua-farm 1 or Fish Farm 1
|
|
Grow-out mainly of fish and eels production; started in 2012
with 16 APM tanks
|
|
|
|
Aqua-Farm 2 or Prawn Farm 1
|
|
Grow-out mainly of prawns; production started in Q3 2013. Additional
production commenced with 10 additional APM tanks in Q2 2015.
|
|
|
|
Aqua-Farm 3 or “Prawn Farm 2”
|
|
Hatchery and Nursery operation of prawns; production started
from Q2 2012. Growing of prawns utilizing open-dams applying re-circulating filtration systems; production started from Q3
2013 with construction still in progress to include over 700 Mu of open RAS dams.
|
|
|
|
Aqua-Farm 4 or Prawn Farm 3
And
Aqua-farm 4 or Prawn Farm 4
|
|
Grow-out of prawns and other seafood.
Hatchery and Nursery operations of prawns and hydroponics scheduled in the future.
Production started at PF4; construction
work still in progress.
|
Business model
The Company works with Chinese investors to
form operating companies, in which Sino Agro Food retains the option to acquire equity interest. After a certain period of time
and successful operating results, the Company and the Chinese investor may form a Sino Foreign Joint Venture Company (“
SFJVC
”).
Prior to the formal naming, registration, and incorporation of an anticipated SFJVC, the Company prepays a deposit toward the consideration
of its future SFJVC stake as a percentage of the assets of the fully developed farm. Upon conversion, the prepayments become equity
capital.
The Company oversees financing and provides
interoperating strategies, encouraging vertically integrated growth. China has problems with quality assurance in primary production,
distribution and poor origin traceability, as well as low food quality. This has created a market where consumers will eventually
pay significant price premiums for “BAP (Best Aquaculture Practice) Certified” seafood with brands guaranteeing quality
and consistency.
A vertically integrated operation in a
fragmented and poorly regulated environment such as in China is the strategy that will yield the most success for the Company.
Our presence in retailing and wholesale markets generates market power and provides potential for both margin maintenance and
expansion.
Integration into fertilizer and feed production
for rearing of beef cattle together with breeding of prawn brood stock help decrease primary production operational risks as well
as helping to offset price fluctuations that sometimes occur in raw product input prices.
Sino Agro Food uses expertise and know-how
in specific agriculture and aquaculture technologies. The Company’s “A Power Re-circulating Aquaculture System”
(the “
APRAS
”) is a proven recirculating aquaculture system (“
RAS
”) technology for indoor
fish farming. Sino Agro Food has developed modern techniques and technologies to grow, feed and house both fish and cattle. These
are engineered into the designs of, and the management systems for, indoor and outdoor fishery and cattle farms. Today Sino Agro
Food is the world’s largest operator of RAS aquaculture for prawns. In all developments Sino Agro Food acts as the master
engineer, pioneering the construction and building of farms, from raw land into fully operational facilities. Sino Agro Food builds
the infrastructure including staff quarters, offices, processing facilities, storage, and all related production facilities; then,
manages developing of all business activities into effective and efficient operations. Sino Agro Food’s largest customer
represents a Company of thirty separate live seafood wholesalers at the Guangzhou wholesale markets.
The Company holds licenses for fertilizer formulas,
enzyme patents, and for indoor fish farm techniques, including a “master license” in China for “A Power Technology”
(“
APT
”), a modular land-based fish growing system and technology utilizing RAS.
Sino Agro Food partners with Chinese investors
in food projects as a turnkey project manager
The Company engages in projects as a technological
and engineering expert, partnering with local and regional investors in food related projects. Sino Agro Food generally has exclusive
marketing, sales and distribution rights for each project company. For example, MEIJI purchases all marketable cattle from Cattle
farm 2 and distributes them to wholesale markets. Up until September 30, 2016, prior to SIAF becoming an investment associate of
Tri-way (i.e. post-carve-out), CA had been purchasing all seafood produced by the fishery farms and also supplied the fishery farms
with fingerling, baby or adult fish or prawns and stock feed. Thus, while CA is no longer involved in any sales, marketing and
supplies of fishery goods being operated by Tri-way, it will continue to carry out its current contracts with other entities, as
well as developing other business ties that are interested in utilizing its services.
Generally, Sino Agro Food exercises an
option to acquire a majority equity stake in the project company once development of the operating company has matured and successful
operating results are demonstrated. Prior to acquisition, Sino Agro Food prepays a deposit toward the acquisition consideration
of the project company. Upon acquisition and conversion into a SFJVC, the pre-payments together with a cash consideration become
equity capital, with Sino Agro Food becoming a major shareholder.
Acquired project companies are operated
and managed by the management team and the Chinese investor, and overseen by Sino Agro Food.
Land
ownership in China
In China, nearly all land is owned by
the Central Government or local village collectives, which grant “usufructuary” rights (i.e., the right to use and
enjoy the derived benefits for a period of time) in the form of land use rights. This is similar to “leasehold” land
rights in the United States. Corporate entities and individuals may own the property (buildings) erected on Government land. Land
use rights may be transferred, but since they are based on agricultural contracts, and cannot be changed arbitrarily to non-agricultural
purposes.
Business overview
Introduction
Sino Agro Food is an agriculture technology
and natural food holding company with principal operations in China participating in the ongoing transformation of China’s
fragmented agrarian sector into a modern food production industry using sustainable and profitable methods. Sino Agro Food focuses
on seafood and beef production with integrated wholesale distribution. The Company acquires and maintains equity stakes in a cohesive
portfolio of companies that Sino Agro Food forms per its core mission to produce, distribute, market and sell natural, sustainable
protein food and produce, primarily seafood and cattle, to the rapidly growing middle class in China.
Sino Agro Food employs a strategy of vertical
integration from primary production through processing, distribution and marketing of high quality, organic food products in the
food value chain. China’s fast growing middle class is creating rapidly rising demand for gourmet and high-quality protein
food. The Company’s core products are live prawns, live finfish, whole beef cattle and packaged beef meat.
The Company’s operations and strategy
are executed through several subsidiaries located in China, and the Company contributes financial oversight and strategic direction
to otherwise independent management teams which employ the Company’s intellectual property and proprietary methods within
aquaculture, beef cattle rearing and production of organic fertilizer.
Sino Agro Food has enjoyed strong growth
since the Company initiated its business activities in China in 2006. During the fiscal year of 2016, the Company’s consolidated
revenues amounted to USD 343 million. The four principal factors that have enabled the growth are:
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Joint venture investment models with existing local Chinese investors in agriculture and aquaculture;
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Technological competitive advantages in recirculating aquaculture, beef rearing and livestock slaughter;
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Strong growth in Chinese consumers’ demand for quality protein food; and
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The Chinese Government’s policy to consolidate the agrarian sector and increase the efficiency of China’s food production industry.
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Sino Agro Food provides consulting and
services to several private Chinese third party companies to construct and operate primary production facilities for fish, prawn
and beef cattle, as well as wholesale marketing and distribution centers. As part of its consulting and service agreements, Sino
Agro Food has the option to acquire these operations to expand Sino Agro Food’s proprietary production and wholesaling capacity.
Revenues are generated from activities that
are divided into five stand-alone business divisions:
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(i)
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Aquaculture (CA: inclusive Technology
engineering consulting & services (Project Development division) and sales of goods)
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(ii)
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Integrated Cattle Farm (SJAP &
QHZ) and Organic Fertilizer (HSA)
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(iii)
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Cattle Farm (MEIJI: sales of goods)
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(v)
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Seafood & Meat Trading (SIAF GZ:
inclusive Technology engineering consulting & services (Project Development division)
and sales of goods and corporate affairs)
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Aquaculture
division
CA has entered and completed several CSC’s
(i.e. the Fish Farm 1 for JFD, the Prawn Farm 1 for EBAPCD and the Fish Farm 2 for Gao Aquaculture with development and construction
work still in progress for the Prawn Farm 2 at Xin Hui District and the Prawn Farm 3 and Prawn Farm 4 at San Jiao Town Zhongshan
for ZSAPP.
Prior to September 30, 2016, CA was the
sole marketing, sales and distribution agent of the APRAS fishery and prawn farms. CA had purchased all marketable fish and prawn
from the farms, and then sold them to wholesale markets. CA also supplied the farms with fingerlings, baby or adult fish or prawns,
and stock feed. CA generated revenue from the sale of seafood bought from farms that either had been Company subsidiaries or C&S
Project Companies.
However, since then, Tri-way has acquired
all of CA’s C&S relationships with its project farms (i.e. PF1, PF2, PF3 and PF4) and SIAF has reduced its controlling
interest in Triway to 36.6%, such that Tri-way, the subsidiary, is categorized as an “investment in associate” holding
of SIAF, constituted by SIAF’s deemed disposal of equity interest in the subsidiary.
Integrated
Cattle Farm division (SJAP)
Operated by SJAP, the
Integrated Cattle Farm division is the business unit of Sino Agro Food active in beef cattle rearing and value added processing
of domestic and imported beef meat. Revenue for fiscal year ended December 31, 2016 was USD 134.6 million or 49.7 percent of the
Company’s total sales of goods revenue of USD 270.8 million in the same period. Gross profit for SJAP in the fiscal year
ended December 31, 2016 was USD 33.7 million, or 56.9% percent of the Company’s total gross profit in sales of goods of
USD 59.2 million in the same period.
Within the beef cattle farm division, the Company
applies a co-operative farming model creating an intermediary supply pipeline to ramp up production at lower marginal cost to its
operations.
Generally, the Company commits to repurchasing
the cattle between 21-month to 24-month old under mutual understanding without written contract and the amount involved was immaterial.
The company accounted for the sale of cattle in accordance with ASC 605. Local farmers purchase 12 to 15-month cattle from the
Company’s cattle agent at market price. The Company had no legal obligations to repurchase all 21-month to 24-month old cattle
from local farmers at market price. However, the Company was likely to purchase those cattle at market price due to mutual understanding
reached with the local farmers. There was no special accounting procedure for the above purchase.
Our Cooperative Farming Model provides
us with an intermediary supply pipeline so we can ramp up our production at lower marginal cost to our operations, albeit on favorable
trade terms from us.
Our strategy is to identify agriculture
projects with strong growth potential linked to sales demand where small farmers lack commercial scale and expertise, and where
they benefit with our strategic alliance approach.
This provides a mutually beneficial outcome
for local small farmers who cooperate with us as an intermediary to produce the goods to supply our farms.
We also work with local governments, and
with their help we introduce and initiate Farmers Cooperatives, such as in Huangyuan County, Xining City. This concept of strategic
alliance with small hold farmers under a Cooperative Farming Model allows us to sell the cattle at the 12 to 15-month stage at
cost to farmers participating in the Cooperative.
Throughout the grow-out period between
15 and 21/24 months, these Coop farmers purchase bulk feed and other supplies from the Company (required to a) rear the cattle
and b) with feed that meets strict organic standards) on credit terms that are then offset at the time that the Company repurchases
the cattle from the farmers, and on average yields an approximate 28% to 30% yield on Gross Profit to them after accounting for
feed supply and other items sold to them throughout the grow-out period.
Sales and cost of feed as well as repurchase
and sale of cattle are each incorporated into the income statement, as well as the exchange of cattle between the Company and the
Coop farmers accounted for under inventories and deposits and prepayments on the balance sheet, as warranted.
SJAP now has twelve cattle houses, with
its smaller buildings housing a minimum of 200 head and larger cattle houses accommodating up to 350 head.
Within the Chinese agriculture market,
small farmers lack commercial scale and expertise and therefore benefit from a strategic alliance. The Company works with the local
government, soliciting their help to introduce and initiate a farmers’ co-operative, such as in the Huangyuan County, Xining
City. This concept of strategic alliance with smallholder farmers under a co-operative farming model was originated and has been
based on the following key characteristics and value enablers:
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The Company assesses the ability of the regional farmers to grow crops and pastures as its nominated contractors, using the Company’s land that is leased to the Company free of rent by the local government or using the farmer’s own land. The regional farmers use the Company’s plant and equipment for their planting and harvesting. The Company provides the farmers with supervision and associated services, seeds and organic fertilizer on credit terms, and also purchases crops and pastures from them.
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The Company also uses this regional farmers’ concept when growing cattle. The farmers are the Company’s
contractors optionally using the Company’s bulk livestock feed and concentrated livestock feed on credit terms. The Company
has the option to buy the mature cattle, which the regional farmers raise.
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Ultimately, the Company is aiming to obtain cattle that will be qualified as “organically raised cattle,” to produce organic beef products on a commercial scale.
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The key features of the co-operative farming model are set out in
the illustration below:
As of the date of this report, SJAP has
established 22 farmer co-operatives that have the capacity to fatten up to 20,000 head of cattle per year based on a 3-month turn-around
program. The cost of rearing cattle is expected to be lower as a result of concentrating efforts on manufacturing and/or selling
livestock feed. The regional farmers are contracted to grow crops and pasture for the Company using the Company’s land that
has been provided lease-free by the local Government or by using their own land, the Company’s equipment operated by its
workers for planting and harvesting, and the Company’s supervision and associated services, as well as seed and organic fertilizer.
These items are provided to them on credit, which are then charged against their account when the Company purchases the crops and
pasture grass from them in return. Regional farmers also raise cattle for potential purchase by the Company, and its bulk and concentrated
livestock feed if purchased, treated under the same credit terms and conditions described above. That is, if/when the Company purchases
the mature cattle from the regional farmers, their accounts are charged for the feed against the amount tendered.
Further information related to Beef Cattle
Rearing, including tables and charts delineating year-over-year comparatives, as well as the Company’s arrangement with cooperative
cattle farmers is provided throughout other sections in this report.
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2.
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The Organic Chain: (Organic
Beef Product and Supply Chain)
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The Company prepares its agricultural wastes
into bioorganic fertilizer.
1
Also the livestock feed
2
is prepared into bioorganic livestock feed. Bioorganic
fertilizer and the bio-organic livestock feed is sold to farmers that work on the Company’s land-use rights, which is owned
by the government and leased with a subsidy or rent free, due to the many benefits for the community. Fertilizer and livestock
feed are prepared based on the Company’s patented enzyme. The use of the enzyme is synergistic, as the production of fertilizer
and livestock feed is permissible all 12 months of the year, which is a competitive advantage.
1
Through the environmental friendly “Bacterial and Bio-organic Fertilizer Manufacturing
Technology”
2
Consists of raw material consisting of crop wastes as well as locally grown and available wild wheat plus wild wheat
sterns, wild peas with sterns and leaves, and selective pastures grown in the wild. These raw materials will be finely cut and
put through a number of aging and fermentation processes by adopting a technology and method called “Stock Feed Manufacturing
Technology,” duly licensed by TRW, a 100 percent owned subsidiary of the Company, and catalyzed by the enzyme developed
by SJAP. Thereafter, the end materials will be packed and sealed in airtight and weatherproof packaging ready for storage.
The farmers use the bioorganic fertilizer on the soil and feed the
grain to the cows together with the livestock feed. Government tests show:
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Additional average weight gain per head of fattening cattle;
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Additional fresh milk is produced;
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All feeds are much easier to digest resulting in much cleaner environment in the cattle yards and houses;
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No ill effects were recorded due to the Company’s feed;
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All cattle preferred to eat the Company’s feed and were reluctant to revert back to the consumption of their old feed after they had consumed the Company’s feed during the period.
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Through an acquired patent,
3
the
fat content of a 15 month-old cattle can be decreased from 15 kg to 5 kg, which improves the quality of the meat and its yield.
The inventor of the patent is now an equity partner in SJAP.
On February 28, 2013, SJAP completed its development
of the Concentrated Livestock Feed (“
CLF
”) manufacturing factory, and started the production and sales of CLF.
This CLF complements SJAP’s bulk livestock feed to provide the local cattle and sheep farming industry with a completed feed
formula that can cater to the rearing of cattle and sheep at various growing cycles (e.g., specially formulated mixes with efficient
nutrients for dairy cows and sheep, weaning, fattening and mature cattle and sheep). The advantage of the formulated feed combination
is that the cattle and sheep growers will realize cost savings in production knowing precisely the amount of concentrated feed
that will be needed by their livestock, thus avoiding wasted excess concentrated feed due to over feeding, which results in worthless
excess fat in mature animals. In this respect, the Chinese central government has placed an order with SJAP to reserve up to 5,000
MT of CLF annually as part of the country’s annual reserve emergency livestock feed inventory. Thus, since March 2013 onward,
SJAP has generated additional revenue generated from the sales of CLF.
SJAP sells its organic fertilizer and
bulk livestock feed mainly to its cooperative and regional farmers in addition to using it to rear its own grown cattle, but because
its geographic location is so far away from other major provinces there are high costs associated with selling its fertilizer,
bulk livestock feed and live cattle other than to local purchasers. Conversely, equivalent imports from other provinces must be
purchased at a higher cost, providing SJAP with a competitive edge. Furthermore, Qinghai Province is a region rearing millions
of cattle and sheep per year, providing an ample market for SJAP’s fertilizer and livestock feed.
In the longer term, the Company believes
that wholesale prices of SJAP’s livestock feed will maintain a steady growth rate of 5% to 10% per annum influenced mainly
by rising labor cost of the country.
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4.
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Value
Added Processing and distribution
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In 2014 the Company initiated operations
in slaughter and deboning services to farmers at its abattoir and deboning facilities. SJAP received a business permit from the
Chinese authorities on April 17, 2013, and construction commenced on April 21, 2013 on the abattoir, deboning factory, and related
packaging facility. Since it is rare and difficult to obtain a permit for an abattoir facility in China, having this facility
is expected to become a very valuable asset for the Company. To date, SJAP’s abattoir, deboning factory and packaging facilities
are fully operational.
Before the abattoir and related facilities
were operational, the Company sold mostly live cattle to or through various cattle wholesalers to existing wholesale and distribution
markets that did not require much marketing efforts and networking.
In China, beef is customarily distributed
through various tiers of established wholesalers and distributors that source their beef from various slaughter and deboning houses
located across many districts in China. Most of these wholesalers sell multiple types of frozen or freshly chilled meats (including
pork and poultry, etc.), and some slaughterhouses specialize in and solely supply beef. These wholesalers and distributors supply
beef to regional supermarket chain stores, retailing wet and frozen food markets, the catering industry, etc. Therefore, after
having established its own slaughterhouse and deboning factory, SJAP is expected to automatically become the primary supplier
of beef. As such, many existing wholesalers and distributors will source their beef supplies directly from the Company. With the
current ever increasing demands of quality beef meats due to the increase of middle class consumers, the Government’s enforcement
of food safety regulation, and of anti-smuggling and illegal imports of beef, the right opportunity exists for SJAP to market
its high-quality beef product. Therefore, the Company is confident it will successfully sell its beef meats in domestic markets.
Also, a portion was exported to South Asian countries (i.e., Malaysia, Singapore, Hong Kong, Middle East countries and Thailand
etc.) in 2014, as the Local Government encourages the Company to do.
3
T1 Enzyme Technology (T1), Patent number ZL2005 10063039.9.
In this respect, SJAP’s overall
cattle division (excluding QZH) achieved sales revenue of USD45.46 million in 2016 compared to 2015’s USD86.97 million (representing
a negative growth rate of 47.7%) and gross profit dropped to USD14.91 million from 2015’s USD18.25 million (representing
a drop of 18.3%).
The impact of China governmental change of
policy during the 2
nd
quarter of 2015 relaxing the restriction on beef imports from eleven countries (e.g., New Zealand,
Brazil, Australia, etc.), continued to affect the local cattle and beef industry throughout 2016, such that the local cattle industry
has not been able to map out any firm direction under the current volatile pricing environment. At the same time, e-commerce has
also affected sales through the traditional marketing outlets, requiring new marketing approaches, which consequently has absorbed
some of the capital previously earmarked for capital projects under construction.
Throughout 2016, the
Company’s beef operations had begun implementing certain business plans aimed at minimizing the adverse impact from those
items mentioned, namely:
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Increasing its VAP activities
by importing more beef from other countries (Australia and Brazil, etc.), however, volatile
pricing and marked competition between exporting countries attempting to gain a lion-share
of China’s fledgling beef market has made it difficult to determine export vendors
providing the best long-term guarantee on both quality and price when compared to new
exporters having just entered or just entering the market.
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Upgrading cattle herds by 2018 to Wagyu cattle,
500-day grain-fed angus and pure organically grown angus while gradually reducing its current breeds down to zero. However,
this has limitations in the mid-term, mainly due to the impact of import market prices competing with the disposal of these
breeds at break-even or slightly higher price points.
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Adding more value added processing lines (VAP),
i.e. canning division, etc., to gain more export sales apart from domestic sales. This is being viewed as potentially the
ultimate solution for SJAP’s operations due to the following factors:
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a. Quality of labor available
in the Value Added Processed goods industry is readily available at a competitive cost.
b. Land and construction cost
in Xining are still cheap when compared to other major cities in China, providing a lower cost to capital expenditures.
c. Abundance of raw materials
because of imports having helped reduce the overall cost of these items.
d. Transportation costs to deliver
value added products remain at affordable levels.
e. Consistent food safety and
quality can be maintained within a controlled environment.
f. There exists sufficient demand
for value added beef products in China as well as offshore markets that can be targeted through e-commerce websites, supermarket
chains, distribution networks, etc. resulting in capturing a healthy return on investment.
SJAP is in the process of readying itself
for an IPO, and in the interim withholding incurring additional CapEx until an equity raise provides the capital necessary to
implement its overall plan. With most work detail now completed on the Tri-way carve-out, more time will be made available to
accelerate the completion of the SJAP carve-out going forward.
Even though no assurance regarding timeline
and success in attaining a listing can be made now, updates regarding this exercise will be made available on a periodic basis
as they occur.
Organic
Fertilizer (HSA) division
The business division
Cattle Farms, or MEIJI, refers to SIAF’s cattle rearing operations in Jiangmen, Guangdong Province. Revenue for fiscal year
ended December 31, 2016 was USD 29.8 million, or 11.0 percent, of the Company’s total sales of goods revenue of USD 270.8
million in the same period. Gross profit for the Cattle Farm (MEIJI) division for the 12 months ended December 31, 2016 was USD
1.5 million, or 2.5% percent of the Company’s total gross profit on sales of goods of USD 59.2 million in the same period.
The operation in Linli District, Hunan
Province, is run by HSA, a 76% owned Chinese subsidiary. HSA conducts the following business activities, both of which are in
the development stage:
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manufacturing
and sales of organic and mixed fertilizer,
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cultivation
of pastures and crops in preparation for the establishment of beef cattle farms to rear
and grow a selective Chinese National Breed of cattle mainly for the domestic market
of China.
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By January 2013, the first organic fertilizer
production plant was established and started its production of organic fertilizer. On March 5, 2013, HSA secured the rights to
use an enzyme developed by a Hong Kong company some twenty years ago, that has been utilized by global manufacturers of organic
fertilizer. The advantage of this enzyme is that when it is applied to the organic fertilizer it can convert part of the organic
raw materials into potash and phosphate without having to add in chemically formulated potash and phosphate, such that the Company’s
end fertilizer can be qualified as pure organic fertilizer made with 100% natural organic raw materials. With this pure organic
fertilizer, HSA is able to fully explore the potential market for fish in farm lakes and thereby to attempt to align itself with
the government’s policy of encouraging lake fish farmers to use pure organic fertilizer instead of chemical fertilizers.
In addition, cost savings from avoiding the use of chemical potash and phosphate will, in management’s belief, result in
a better profit margin for the Company. Sales of pure organic fertilizer commenced at the end of Q1 2013.
HSA produced 50,000 MT of organic fertilizer
and organic mixed fertilizer in 2016. The main hardship related to selling fertilizer is the requirement to provide longer credit
terms (sometimes up to 180 days) to the Company’s end buyers because these end users normally can afford to pay for them
only after they sell their products. Therefore, the Company must assess creditworthiness of its prospective customers, and only
consider the farmers who can be deemed creditworthy, and who follow the Company’s requirements for planting their fields
and harvesting crops each year.
Development of HSA in Linli District,
Hunan Province, follows SJAP’s business model. HSA is situated in a much better growing environment than SJAP, a farming
rich province in central China. Thus, HSA benefits from cheaper logistics costs, proximity to large markets, and a more favorable
climate (milder winters and longer summers versus SJAP’s long bitterly cold winters and short summers). However, financial
support from the Government is more difficult to obtain in the Hunan Province because more entities share the Government’s
support provisions.
HSA endures both higher development costs
and longer time to construct its facilities when compared to SJAP, whose property had 40 older (yet salvageable) buildings, which
it has renovated to meet its needs.
Hunan Province is one of the biggest primary
producing provinces of China with over four million primary producers that grow rice, tea, tobacco, grapes, citrus, cotton, seedlings,
sunflowers, herb plants and many varieties of cash crops. Hunan also has a long-standing history in lake aquaculture producing
millions of tons of fish and other seafood annually.
Construction work to develop HSA’s
cattle station that began in March 2012 was completed in 2016 containing a 2,000-head capacity cattle farm built and ready for
operation. The Company cultivated 75 acres of its land, situated below the fertilizer factory, and planted crops and pasture,
such that bulk stock feed will be harvested by June 2017.
The Company’s plan for HSA is to
process cattle waste from its own cattle farm to be used as raw materials for the manufacturing of fertilizer, thus there will
be substantial saving in its cost of fertilizer manufacturing (estimated at over USD2.5 million per year based on current sales),
and with such cost of saving, HSA will be able to self-finance the development of its Yellow Cattle Program designed to eventually
produce the Yellow Cattle into one of the top quality beef cattle in Asia, aiming to reach meat quality on par with Japanese Wagyu
Cattle.
Therefore, the Company’s plan is
to merge Cattle Farms (1) & (2) with HSA sometime in 2017, at the latest, such that CF (1) & CF (2) will become breeding
stations supplying yearlings for HSA to grow into full grown cattle (up to 3 years old) that will be sold in the Chinese market.
The Yellow Cattle is very similar in body size and weight and quality to the Japanese Wagyu cattle and has distinct meat texture,
flavor and quality that are in high demand in China. In this respect, HSA’s cattle development is very different compared
to SJAP’s cattle business since HSA’s business is aimed at developing a brand of cattle strictly of Chinese origin,
whereas SJAP’s cattle business is a fully integrated model as primary producer, value added processor, canning operator,
stock-feed producer, as well as, marketer and distributor of imported beef and other commercially recognized breeds of cattle.
Cattle farms (MEIJI) division
The business division
Cattle Farms, or MEIJI, refers to SIAF’s cattle rearing operations in Jiangmen, Guangdong Province. Revenue for fiscal year
ended December 31, 2016 was USD 29.8 million, or 11.0 percent, of the Company’s total sales of goods revenue of USD 270.8
million in the same period. Gross profit for the Cattle Farm (MEIJI) division for the 12 months ended December 31, 2016 was USD
1.5 million, or 2.5% percent of the Company’s total gross profit on sales of goods of USD 59.2 million in the same period.
Currently there are two operations in
this segment, Cattle Farm 1 and Cattle Farm 2.
Cattle Farm 1:
Cattle Farm 1 was
built as a demonstration farm to show that cattle can be raised in a semi-tropical climate using the Company’s semi-grazing
and housing method. Using the Company’s semi-free growing management system, the cattle can graze in the field during the
early morning and kept indoors and out of the sun during the hot summer days. This method has proven reliable, with the growth
rate of the cattle measuring slightly higher than the cattle at SJAP (i.e., averaging around 0.28 kg per day per cattle more).
Cattle Farm 2:
Cattle
Farm 2 is a beef cattle farm situated in Guangdong Province, Guangzhou City. Cattle Farm 2 is operated by a private company formed
in China with Chinese citizens acting as its legal representative as required by Chinese law. Cattle Farm 2 is complementary to
Cattle Farm 1, having an additional 76 acres of land suitable for growing the Company’s type of pasture (a cross between
elephant grass and yellow grass) that has a very high yield rate of over 35 MT per 1/6 acre per year, and containing an average
of over 9 percent protein that is very suitable for consumption by cattle. Between the two farms, under normal seasons, they have
a capacity to produce up to 30,000 MT of pasture/year collectively that is capable to feed up to 5,000 head of cattle/year based
on the consumption rate on average of 6 MT/head.
MEIJI is the marketing
and distribution agent for all cattle farms that are and will be developed by MEIJI using its “Semi-free growing”
management systems and aromatic-feed programs and systems to grow beef cattle.
Like CA in its business model, MEIJI purchases
fully-grown cattle from Cattle Farm 1 and sells them to the cattle wholesalers. MEIJI also buys young cattle from other farmers
and sells the young stock to Cattle Farm 1. All cattle farms developed by MEIJI will utilize its “semi-free growing”
management system and aromatic-feed programs and systems to raise beef cattle.
Yellow Cattle (Beef meat) is traditionally
a high-end market in China, as it is mainly sold in higher end markets. This situation is rapidly changing, though, owing to urbanization
and rising incomes, the rising demand for such quality beef, such that we foresee that eventually, locally grown and produced
high quality beef from local breeds like the Yellow Cattle will establish its “Brand” and in turn premium prices in
China similar to how many locally bred Japanese Cattle found their market niches in Japan.
Plantation division
The business division Plantation refers to
SIAF’s produce production situated at Enping City, Guangdong Province. Revenue for 12 months ended December 31, 2016 was
USD 13.3 million or 5 percent of the Company’s total sales of goods revenue of USD 270.8 million in the same period. Gross
profit for the plantation division for the 12 months ended December 31, 2016 was USD 1.54 million, or 2.6% percent of the Company’s
total gross profit for sales of goods of USD 59.2 million in the same period.
JHST is an SFJVC that is 75 percent owned by
SIAF. Situated at Enping City, Guangdong Province, it is consolidated as a subsidiary, and is the owner and operator of a Plantation
where mainly Hylocereus Undatus, or Dragon Fruit, and cash crop vegetables, are grown.
Hylocereus Undatus is a cactus commonly referred
to as dragon fruit. JHST conducts two main operations: (i) growth and sales of flowers that are consumed as vegetables in China,
and (ii) drying and value added processing and sales of HU flower products (used in health-related soups and teas). JHST cultivates
187 acres of Hylocereus Undatus in the Guangdong Province.
HU cacti take three years to reach maturity,
though they will flower a little even in their first year, and can produce for as long as twenty years. JHST began planting in
late 2007, and by 2015 all of the plants are mature (averaging over four years). HU blooms for a very short period, sometimes only
one night, and flowers must be 20 to 25 cm long when picked before they turn from green to white. HU is a delicate crop and the
harvest season runs from July through October.
Fresh flowers are sold to regional wholesale
and retail markets due to their short shelf life. Some are dried and packed; these flowers are sold to a few major wholesalers,
who distribute them to wholesale and retail markets and export traders through the winter and spring months (from October to June)
in Guangdong Province. HU is a seasonal revenue product; more than half of JHST’s revenues are recognized in the third quarter.
No sales are made in the first quarter.
The Company originally expected that by 2014,
dried and pickled flowers would make up 96 percent of the division’s flower income as produce is diverted away from delicate
fresh flowers. In 2013, the Company planted a special selenium-rich Chinese herb (called XueYingZi, or “Immortal Vegetable”
in China and Snowsakurako in Japan) among the HU plants hoping to prolong the shelf life of the fresh flowers from 2-3 days up
to 12-14 days and increasing the sales of fresh flowers. This experimentation had not produced the desired outcome; thus, the Company
instead has processed up to 80 percent of HU as dried flowers from 2013, onward. The Company’s organic Immortal Vegetable
plants have properties that some believe induce good health. The Company has processed these into small gift packs - selling them
as organic vegetables with leaves for tea and stems for soup. Laboratory test results show that each kilo of fresh Immortal Vegetables
contains 0.58 gram of selenium, which adds value to their sales. In December 2013, the Company started trials to plant other cash
crops in between the HU plants with the aim of improving revenue covering all seasons. As of the 2015 season there were 70 Mu designated
for growing immortal vegetables on the plantation, however, due to poor market sales, was reduced to 10 Mu and instead replaced
with the growing of cash-crop vegetables (i.e. varieties such as eggplant, lady fingers, chili plants and some highly popular Chinese
vegetables, etc.) on over 500 Mu of property.
HU flowers are in greater demand than
supply can meet for several reasons; (i) In Guangdong Province, HU plants can only be grown commercially along certain districts;
there were over 40,000 acres of HU Plantation in 2005, but due to the growth of industrialization and modernization, acreage is
now less than 4,000 acres, and (ii) farm laborers are getting harder to find. With the increase of cost of wages and salaries,
the rapid rise of the land cost and the increase cost of farm developments, it is extremely difficult to start up a large HU plantation.
For these reasons the Company anticipates that prices of dried HU flowers will enjoy a steady rise at an average rate of 8 to
12 percent per year, which has been the trend since 2009. However, the biggest risk to yield is weather, as substantially wet
rainy seasons can limit the yield of any harvest.
Marketing & Trading
Division
Revenue for 12 months
ended December 31, 2016 was USD 13.3 million or 5 percent of the Company’s total sales of goods revenue of USD 270.8 million
in the same period. Gross profit for the plantation division for the 12 months ended December 31, 2016 was USD 1.54 million, or
2.6% percent of the Company’s total gross profit for sales of goods of USD 59.2 million in the same period.
The Company distributes
imported meat and seafood through two completed and operational facilities from which it has acted as turnkey project developer
to construct and manage these operations:
|
1)
|
Wholesale and distribution facilities (
“Wholesale Center 1”
) for Guangzhou City NaWei Trading Co. Ltd (
“NWT”
), an unrelated Chinese third party owned company situated at the Guangzhou City, LiWan District, New Wholesale Market.
|
|
2)
|
The Shanghai Distribution Center which was built to accommodate a capacity of 50 metric tons of meat per day and to distribute 5,000 metric tons of seafood within two years.
|
In 2013, the Company
also constructed a trading complex (the “Trading Center”) for the Import and Export at another building adjacent to
Wholesale Centers 1 and 2. The Trading Center has imported frozen and fresh chilled and live seafood (i.e., cuttlefish, squid,
prawns, salmon, crabs and eels) from Malaysia, Thailand, Russia and Madagascar and other local coastal fishing towns. The seafood
was sold to Wholesale Center 1, which distributed and sold it into various reputable food chain outlets, wholesale market stores
and supermarket chains in the Guangzhou City, Shanghai City as well as in the southern coastal towns of the Guangdong Province.
Primarily, the Company
distributes meat imported from Australia and seafood from other countries through these operations
Project Development
Division
The project developments (or Technology
engineering consulting and services) work are carried out by CA on aquaculture related projects and by SIAF on non-aquaculture
projects:
Introduction
The Project Development division earns
revenue by providing turnkey project management and engineering services today mainly within aquaculture. Project development
revenue for 12 months ended December 31, 2016 was USD 72.2 million or 21.1 percent of the Company’s total revenue of USD
342.9 million in the same period. Gross profit for project development for the 12 months ended December 31, 2016 was USD 23.7
million or 28% percent of the Company’s total gross profit of USD 84 million in the same period. All project development
activity for the year was carried out through Capital Award for the aquaculture division.
Historical events:
Historical Information
and status of CA’s consulting and engineering service are shown in the table below:
Number
|
|
Year
|
|
Name
|
|
Stage of completion
|
1
|
|
2010
|
|
Fish Farm 1 (JFD)
|
|
Completed and acquired by SIAF
|
2
|
|
2011
|
|
Fish Farm 2
|
|
Under expansion by owner
|
3
|
|
2011
|
|
Cattle Farm 1 (JHMC)
|
|
Completed and acquired by SIAF
|
4
|
|
2011
|
|
Prawn Farm 1 (EBAPCD)
|
|
Completed with hydroponic farm to go
|
5
|
|
2011
|
|
Prawn Farm 2 (ZSAPP)
|
|
Under expansion by owner
|
6
|
|
2012
|
|
Cattle Farm 2 (EAPBCF)
|
|
Completed
|
7
|
|
2012
|
|
Wholesale Center 1 - Guangzhou (APNW)
|
|
Completed
|
8
|
|
2012
|
|
Central kitchen, distribution network, signature restaurants
|
|
Completed
|
9
|
|
2013
|
|
Zhongshan New Prawn Project (ZSNP)
|
|
Under construction
|
10
|
|
2014
|
|
Wholesale Center 2 - Shanghai (APNW)
|
|
Completed
|
Together with its subsidiaries,
the Company essentially constitutes an engineering company providing services in engineering consultancy, supervision and management
on the development of agriculture and food based projects in China. These include the construction of farms (or other facilities)
as well as the development of business operations of related projects that are apply and use the Company’s principal technologies,
including the following:
|
·
|
An
indoor recirculating aquaculture system (APM-RAS) and designs for the growing of aquatic
animals (fishery indoor);
|
|
·
|
An
open-dam recirculating Aquaculture System (ODRAS) for the growing of aquatic animals
(Fishery outdoor);
|
|
·
|
Semi-free
range cattle growing systems and design for raising cattle and sheep in China tropical
climate locations, (e.g. Cattle Farm 1 at Enping district); and
|
|
·
|
Other
associated technologies.
|
CA’s standard
principal terms and conditions for its Aquaculture project development consulting and service contracts are outlined below:
|
·
|
CA
is the consulting and service provider as the turnkey contractor of the project;
|
|
·
|
The
Chinese businessmen are the clients of CA and the investors and owners of the project
company;
|
|
·
|
CA
creates and manages development schedules for the project;
|
|
·
|
CA
is responsible to build the Aquaculture project (including development of its business
operation) using the Company’s APRAS technology, systems, know-how, and management
expertise and systems for and on behalf of the developer;
|
|
·
|
The developer is responsible to pay CA for
its work, including all subcontractors and suppliers appointed by CA in a timely manner, normally a 60-day term;
|
|
·
|
Provision
clauses allow CA to appoint and to select sub-contractors and suppliers;
|
|
·
|
Clauses
allow extra work and additional work and extra cost provisions; and
|
|
·
|
Contracts
generally include i) warranty and limitation of liabilities, ii) scope of work and lists
of supplies (including all plant and equipment), iii) installation, training and commissioning
of the developments and business operation; and iv) granting to CA rights to management
of operation, and marketing and sales of the produce and products from the farm’s
operation.
|
The Company’s services are comprehensively
supportive with vertically integrated operational activities to provide service for the construction of and the business development
of the projects to joint ventures. Consulting services include research and development on mature and young animals, supply of
foundation animals (baby calves, fingerling and breeding stocks etc.), supplying designed and configured plants and equipment
to the marketing and sales of the product.
Aquaculture
Project Development
Engineering consulting
and services provide a comprehensive range of services in the field of aquaculture. These include research and development, brood
stock supply, nurturing of fish fingerlings and prawn post-larvae as well as growing of fish and prawns, engineering designs and
planning of farms and associated operations, technology and related implementation, supervision, training and conducting trials,
management of farm operation and construction, supply of plants and equipment, training of maintenance and operational services,
sales, transportation and marketing of fish and prawns, as well as financing. The Company’s management team and staff in
Guangzhou conduct the engineering and consulting work. Sino Agro Food directs the scope of work so that building subcontractors
deliver projects efficiently and cost effectively. Using locally manufactured equipment, parts and components customized to the
Company’s proprietary designs and engineering specifications, production costs for machinery and facilities are far lower
compared to foreign aquaculture systems. The Company believes that it delivered the first indoor re-circulated aquaculture prawn
farm in Asia.
From October 5,
2016, onward:
CA has granted to Tri-way
a Technology Master License for China, such that starting from October 5, 2016, all future fishery project development in China
using APM-RAS or ODRAS will be developed by Tri-way. CA has been hired by Tri-way as the Company’s turnkey contractor to
provide consultation respective of Tri-way’s operations.
CA’s aim, in addition to providing
quality service to Tri-way in China, is expecting to expand its reach to introduce and help implement its APM-RAS and ODRAS plant
and equipment and services, worldwide.
Other
Project Development
The Company has also,
acting as a turnkey project developer, built 8 restaurants with central kitchen and bakery facilities in the greater Guangzhou
area.
|
·
|
Restaurant
1, at River South District, Guangzhou. Operated since Q1 2012.
|
|
·
|
Restaurant
2, at the UU Park Complex in Tianhe District, Guangzhou. Operated since Q3 2012.
|
|
·
|
Restaurant
3, at the Sporting Complex in Tianhe District, Guangzhou. Operated since Q1 2013. The
Company stopped operating Restaurant 3 in Q3 2013 due to landlord’s failure to
provide a Fire Safety Permit.
|
|
·
|
Restaurant
4, at Harbor City Shopping Center, Guangzhou. Operated since Q3 2013.
|
|
·
|
Restaurant
5, at the center of Zhungzhen City. Operated since Q1 2014.
|
|
·
|
Restaurant
6, at the Li Wan District and next to Wholesale Center 1, Guangzhou. Operated since 2014.
|
|
·
|
Restaurant 7, at Xining City which is the 2
nd
“BULL” restaurant established in Qinghai Province operated since 2015.
|
|
·
|
Restaurant
8, at JianJiang City, JianJiang District, Guangdong Province, operated since August 2015.
|
Intellectual Property
Rights
The Company and its business are, to some
extent, dependent on patents, licenses and other intellectual property rights. As of the date of this Annual Report, the Company
holds intellectual property for fertilizer formulas, livestock feed fermenting formulas and indoor fish farm techniques. These
include an enzyme technology master license registered under a Chinese patent for the manufacturing of livestock feed and bioorganic
fertilizer, and an aromatic-feed formula technology to produce aromatic cattle, and a bacterial cellulose technology license.
On 12 November 2008, Tri-way Industries
Limited entered a Sales and Purchase of Technology Master License Agreement with the inventor of a patent, Mr Shan Dezhang, concerning
the sale and purchase of the master licence rights of a patent registered in China under the name of “Zhi Wu Jei Gan Si
Liao Chan Ye Hua Ji Qi Zhi Bei Fang Fa”, with patent number ZL200510063039.9. The patent relates to methods of processing
plant straw into animal fodder and industrialization of product of plant straw fodder. Under the agreement, Tri-way Industries
Limited is licenced to use and to licence others to use the secrets, copyrights processes and other intellectual property rights
associated with the patent in any territories in the world free from all encumbrances with all rights to the patented intellectual
property and related brand and label as provided under the laws of China. The total purchase price of the patent was USD 8,000,000,
to be paid in several installments. As Tri-way Industries Limited is not a Chinese company, relevant Chinese authorities must
under applicable Chinese law, approve the assignment. The patent assignment has not been registered. Consequently, under Chinese
law, the patent shall not take priority over the interests of third parties who are in good faith.
On 15 May 2009, Tri-way Industries Limited
(as licensor) entered into a sub-licence agreement with Qinghai Sanjiang A Power Agriculture Co. Ltd (as licensee) concerning
the sub-licensing of the above-mentioned patent (ZL200510063039.9). The licence period is 50 years, and the annual licence fee
is stipulated at USD 450,000. However, as effective patent protection for the patent is 20 years, the excess part of the term
is void under Chinese law. The contracting parties of the aforesaid sub-licence agreement have never performed the terms of the
said agreement and no payment has ever been made by the licensee to the licensor. The parties have no intention to perform the
sub-licence agreement, and the contracting parties have terminated the said agreement accordingly.
Rights to this technology have been transferred
to HSA by SIAF after SIAF obtained this, as well as other assets, in exchange for assumed liabilities of Tri-way because of the
carve-out.
On 20 June 2011, SJAP entered an agreement
with Guangzhou City Garwor Trading Company Limited, pursuant to which Guangzhou City Garwor Trading Company Limited transferred
its trademarks with registration numbers, 3713869 and 3713868, as well as a microbial patent with patent number ZL200610033295.8.
The total transfer fee for the trademarks and the patent was RMB 12 million and the transfer fee for the technology secrets was
RMB 1 million. Per the said agreement, the transfer fees shall be paid by the interest generated from the utilization of the patent.
Moreover, the said agreement stipulates that any new technology improvements of the invention shall belong to both parties, and
that any resulting profits shall be shared equally. Guangzhou City Garwor Trading Company Limited is a shareholder in the transferee
and therefore a related party. An evaluation report was not filed with the transaction. Although this is not a formal requirement
under Chinese law and the contract is valid, this may lead to the contract being challenged in the future based on unfairness.
Moreover, as the transferor, Guangzhou City Garwor Trading Company Limited, is not the owner of the trademark, the said agreement
is void under Chinese law and SJAP has therefore not obtained ownership of the trademarks. This may be corrected if SJAP enters
into an agreement with the trademark owner. If SJAP uses the trademark without prior consent of the trademark owner, this would
constitute trademark infringement. However, SJAP is intending to write off said trademark, and does not intend to use the trademark
in question.
Loans and contractual
obligations
Short-term financial debt
Name of Lender
|
|
Total
facility
|
|
Utilized
facility
|
|
Interest
Rate
|
|
Tenure
|
|
Comment
|
Da Tong
National Development Rural Bank Limited
Da Tong County, Xining City, Qinghai
Province, the P.R.C.
|
|
RMB 20,000,000 (USD 2,883,090)
|
|
RMB 20,000,000 (USD 2,883,090)
|
|
10%
|
|
July 14 ,2016 -
May 28, 2017
|
|
Issued to SJAP & QZH
Secured by land use rights and
guaranteed by third party
|
Long-term financial debt
Name of Lender
|
|
Total
facility
|
|
Utilized facility
|
|
Interest Rate
|
|
Tenure
|
|
Comment
|
China Development Bank
Beijing City, the P.R.C.
|
|
RMB 40,000,000
(USD
5,766,182)
|
|
RMB 40,000,000
(USD 5,766,182)
|
|
5.39%
|
|
December 16, 2016 –
December15, 2026
|
|
Issued to SJAP
Long-term loan
|
EuroChina Capital
Stockholm, Sweden
|
|
USD 33,000,000
|
|
USD 33,000,000
|
|
10.50%
|
|
24 August 2014 – 28 February 2020
|
|
Convertible,
Junior to all outstanding debt
|
Agricultural Development Bank of China
Credit Facilities
:
On the October 23, 2015, the Company’s
subsidiary SJAP entered three agreements regarding credit facilities with the Agricultural Development Bank of China, Huangyuan
County Branch. The agreements grant SJAP a credit of RMB 35 million, RMB 20 million and RMB 35 million, respectively, at an interest
rate of 6.40 percent. The agreements are valid for 12 and 60 months after the date of each agreement. The credit facilities are
personally guaranteed by Mr. Zhao Yilin, the general manager and legal representative of SJAP who has given personal guarantees
for the repayment of the loan sums of RMB 25 million and RMB 15 million plus interest and charges payable under the loan agreements.
Land use rights and building ownership rights with net carrying amount of USD 471,048 also secure the credit facilities. Agreements
between SJAP and the Agricultural Development Bank of China regarding credit facilities have been entered into on a yearly basis
during the last three years. As of December, 2016 SJAP repaid all loan facilities to Agriculture Development Bank of China and
entered a long term long facility (for loan amount of RMB 40,000,000 over a period of 10 years) from China Development Bank on
December 16, 2016.
Negotiable Convertible Promissory Note
(NCP Notes)
On August 29, 2015, TRW issued negotiable
promissory notes to three fund companies and one individual for $3,450,000 with SIAF acting as guarantor for repayment.
|
·
|
Issuer:
Tri-way Industries Limited (“
TRW
”)
|
|
·
|
Principal
amount: $3,450,000
|
|
·
|
Interest
rate 2.50% per month on principal amount. Interest shall be calculated on the basis of
a 30/360 day count convention
|
|
·
|
Default
interest rate 15% per month on principal amount. Interest shall be calculated on the
basis of a 30/360 day count convention
|
|
·
|
Interest
payment Accrued interest on the principal amount shall be paid by cash in arrears on
each interest payment date
|
|
·
|
Repayment
date: Repaid in full within 120 calendar days from the issue of notes
|
|
·
|
Security:
Corporate guarantee by the Company
|
|
·
|
Conversion option: Noteholder can exercise
at any time from and including the day falling 60 calendar days from the date of the notes, upon the noteholder giving not
less than 5 business days prior written notice to TRW and the Company, the principal amount shall be converted into shares
of the Company. The TRW may at their own discretion choose to settle such conversion option with newly issued shares or existing
shares, at their sole discretion. The initial conversion price is USD 12.00. In the event of a dividend, share split or consolidation
or spin-off (each a “Corporate Event”) of the Company, the conversion price shall be adjusted to provide the same
economic value to the noteholders as if such a Corporate Event did not occur.
|
Since SIAF has assumed all accrued liabilities
of Tri-way in exchange for equity holdings in the company, two NCP Notes were transferred to SIAF on September 30, 2016 amounting
to $1,013,397.00 payable on or before 31.03.2017 (includes principal and accrued interest to 31.03.2017), and the other amounting
to $669,129.00 (principal) at 5% interest, repayable on or before July 31, 2017.
EuroChina Capital Convertible Note
:
On August 29, 2014 the Company completed
the closing of a private placement financing transaction with an accredited investor, Euro China Capital AB (“
ECAB
”),
which purchased a 10.5% convertible note (the “
Note
”) in the aggregate principal amount of up to USD 33,300,000.
The Company received a total advance of USD 25 million. The Note carries an original issue discount of 25%.
Interest on the Note shall accrue on the
outstanding principal balance of the Note from August 29, 2014. Interest shall be payable quarterly on the last day of each of
March, June, September and December commencing September 30, 2014 provided, however, that the Noteholder may elect to require
the Company to issue to the Noteholder a promissory note in lieu of cash in satisfaction of any interest due and payable at such
time. Any interest payment note shall be subject to the same terms as the Note. The Note has a maturity date of February 28, 2020.
The Note is convertible, at the discretion
of the Noteholder, into shares of the Company’s common stock (i) at any time following an event of default, or (ii) for
a period of thirty (30) calendar days following October 1, 2015 and each anniversary thereof, at an initial conversion price per
share of USD 9.90, subject to adjustment for stock splits, reverse stock splits, stock dividends and other similar transactions
and subject to the terms of the Note. As long as the Note is outstanding, the Noteholder shall have a right of first refusal,
exercisable for thirty (30) calendar days after notice to the Noteholder, to make loans to the Company and its subsidiaries or
to purchase securities proposed to be offered and sold by the Company or its subsidiaries. The Company is required to promptly
give the Noteholder written notice of such proposed transaction.
The Note agreement contains regular provisions
requiring timely repayment of principal and accrued interest, payment of default interest in the event of default, default and
optional conversion and does not contain specific financial covenants. To the Company’s knowledge, the Company is in material
compliance with the terms of the Note.
Moreover, the Note provides that upon
the satisfaction of the Payee Conditions (defined as the date upon which the Noteholder shall have advanced a principal total
amount of at least USD 33,300,000 and has delivered to the Company a notification notifying the Company that the Noteholder has
formed a bondholders committee consisting of two to four persons), the Company shall not hire a new Chief Financial Officer (or
any other person that performs the functions typically performed by a Chief Financial Officer) without the prior written consent
of the Noteholder.
Except as otherwise approved by the Noteholder
in an aggregate amount not to exceed USD 5,500,000 of indebtedness and other payables currently owed to vendors and lenders, the
Company is prohibited from entering into any agreement with any vendor or lender that involves the issuance of any equity securities
as payment for any amounts owed to such vendor or lender or actually issue any such equity securities to such vendor or lender
as payment for any such amounts (“Debt settlements”) from and after the date of the Note.
Upon the Noteholder’s request, the
Company is required to use its best efforts to promptly have the Note listed through Euroclear on any exchange on which the Noteholder
may request, maintain such listing of the Note and register the Note with the United States Securities and Exchange Commission
(the “
SEC
”).
Facility
|
|
Total Facility
|
|
Utilized
facility
|
|
Unutilized
facility
|
|
Interest
rate
|
|
Maturity date
|
10.50% convertible note
|
|
MUSD 25 (following 25% discount)
|
|
USD 25 M
|
|
USD 0
|
|
10.5%
|
|
28 February 2020
|
Loan agreements
All the loan agreements set out above
under the heading “Borrowings, loans receivables and contractual obligations” in the tables above contain regular
provisions requiring timely repayment of principal amount and accrued interest, payment of default interest in the event of default,
and contain no specific financial covenants. To the Company’s knowledge, the Company is currently in compliance with the
loan agreements.
There are no provisions in the Company’s
bank borrowings and long term debts that would accelerate repayment of debt as a result of a change in credit ratings or a material
adverse change in the Company’s business. Under certain agreements, the Company has the option to retire debt prior to maturity,
either at par or at a premium over par.
Under the terms of the loan agreements
with Agricultural Development Bank of China, proposed changes in the shareholding of SJAP requires 30-days prior written notice
and prior approval from the Agricultural Development Bank of China. However, this will not be triggered by indirect changes or
changes in the shareholding of the Company.
Material Agreements
Joint Venture Agreements
The Company has two types of SFJVCs established under Chinese law:
|
·
|
Contractual Joint Ventures (“
CJV
”); and
|
|
·
|
Equity Joint Ventures (“
EJV
”).
|
Of the five Chinese joint venture project
companies, which are CJVs or EJVs, four are CJVs (JFD, JHMC, JHST, SJAP) and one is an EJV (HSA).
4
The main difference
between an EJV and a CJV is that in a CJV, the obligation of capital contribution shall be determined by the contractual parties
themselves. The proportions of capital contribution do not have to be fixed between the Chinese and foreign parties. Profit distribution
and risk sharing ratio shall also be determined by the contracting parties themselves which do not have to be the same proportions
as the parties’ capital contribution or shareholding therein. The capital contributing parties may specify their profit
and risk sharing ratio only and may or may not specify their shareholdings in the CJV. One party may make capital contribution
by way of non-monetary assets such as rights in lands, factories and machineries etc. while the other party may make capital contribution
by way of cash.
In an EJV, the shareholders
contribute capital and operate business jointly, and share profits, risks and losses in proportion to their equity contributions.
Foreign investor’s capital contribution shall not be less than 25 percent of the total registered capital.
The Company engages
in projects based on consulting and service agreements (as described under “Consulting and Services agreements” below),
whereby Sino Agro Food can choose whether the cooperation shall continue under a consulting and service agreement or be acquired
by Sino Agro Food.
Consulting
and Services Agreement
(through September 30, 2016)
Consulting and service
(“
C&S
”) agreements are important for the operation of Sino Agro Food’s subsidiaries and partners.
Only the Sino Agro Food subsidiaries SJAP and HSA do not and have not operated under C&S agreements.
Initially, agriculture
and aquaculture investors invite Sino Agro Food to act as a developer and project manager of an agribusiness or food-related project.
If the management of Sino Agro Food sees the proposal as interesting, Sino Agro Food carries out an in-depth study of the target
company including legal due diligence, business plan, budget and projected financial information. Sino Agro Food makes the decision
through a resolution of the Board of Directors. If Sino Agro Food determines to proceed, the Chinese investor forms a private
Chinese company dedicated to the project and the parties sign a C&S agreement.
Sino Agro Food acts
as the project manager providing turnkey services to the Chinese developer of the project, meaning that Sino Agro Food builds
the project using Sino Agro Food’s technology, systems, know-how, and management expertise and systems. As such, Sino Agro
Food’s expenditure in the project includes Sino Agro Food’s own administration and operational expenses provided for
and incurred in the project (charged and recorded under Sino Agro Food’s general and administrative operation expenses),
which are billed to the Chinese developer. All other development expenditures (inclusive of Sino Agro Food’s subcontractors’
and sub-suppliers’ costs and Sino Agro Food’s marked up profits) are billed to the Chinese developer who will pay
accordingly.
When the project company
initiates production Sino Agro Food acts as the sole marketer of food products and the supplier for the C&S Project Company
under the terms and conditions of the C&S agreement. Sino Agro Food acts as the selling supplier and buying wholesaler to
the company supplying items such as feed, young cattle, and RAS technological components and buys mature prawns, sleepy cod, eels
and live cattle. Sino Agro Food earns a gross profit of between 10-15 percent based on the C&S Project Company’s revenue
on this exclusivity.
4
According to the official documents of Sino Agro Food’s Chinese subsidiary JHMC,
the registered capital of such subsidiary is USD 2 million that was paid in full by year ended 31 December 2014. As of the date
of this Annual Report, MEIJI, a subsidiary of Sino Agro Food, has contributed USD 400,000 of the subscribed capital, whereas
USD 1.6 million of the subscribed capital has not been paid. Moreover, according to the official documents of Sino Agro Food’s
Chinese subsidiary HSA, the registered capital of such subsidiary is USD 2.5 million and shall be paid in full no later than 18
July 2013. As of the date of this Annual Report, MEIJI, a subsidiary of Sino Agro Food, has contributed USD 865,000 of the subscribed
capital, whereas USD 234,500 of the subscribed capital has not been paid by the Chinese owner. The aforementioned deadlines
can be re-arranged by all the promoters. If no new deadline is agreed upon, failure by MEIJI to make full payment may lead to
the other promoters making full payment of the capital contribution on MEIJI’s behalf and requesting MEIJI to compensate
for their payment and losses.
The C&S Project
Company will remain wholly-owned by the Chinese developer until Sino Agro Food exercise the acquisition option and subsequently
converts the company into an SFJVC where the Chinese investor remains as a minority shareholder. The acquisition price is normally
determined in accordance with the book value of the Chinese company as of the acquisition date. Consideration will normally consist
partly of cash and partly of project loans owed by the Chinese investor, which offset and decrease the purchase proceeds in the
corresponding amount. Generally, the agreements that Sino Agro Food has entered into governing the formation of the unincorporated
companies into SFJVCs do not regulate the maturity date for the formation of SFJVC. The date for the formation of the SFJVC is
generally left to the discretion of the Company, based on the development and profitability of the relevant project.
As of the date of this
Annual Report, Sino Agro Food has entered into ten C&S agreements. A portion of the C&S agreements contain an acquisition
premium clause, in which the accumulated C&S project development fees billed by Sino Agro Food will be paid in addition to
the equity book value at the time of acquisition. In the event that either of the investors decides to sell all or part of its
equity in the SFJVC to any third party, a portion of the agreements require the selling investor to obtain prior consent of the
other investor before such sale and to grant the right of first refusal to the other investor on the like terms for the intended
sale.
As of October 5, 2016,
when Tri-way became the developer and operator of all fishery C&S Projects formerly under SIAF, CA’s new role is one
of turnkey operator appointed by and working on behalf of Tri-way.
Land
leases
Private ownership of land is not permitted
in China. Therefore, Sino Agro Food leases land that is either collectively owned land or state owned land, through land use rights.
Corporate entities and individuals may own the property (buildings) erected on the land.
Land use rights may be transferred, but
they are based on agricultural contracts and cannot be changed arbitrarily to non-agricultural purposes. The lease term varies
from 27 to 60 years. There are certain uncertainties (e.g., lease term may not exceed 30 years and all transfers have not yet
been registered correctly) in respect of certain leased land due to the fact that not all requirements have been fulfilled or
not yet registered. However, the Company believes it is protected against these uncertainties through its agreements with the
relevant local Chinese partners and relevant registration processes have been initiated. The Company’s subsidiary HSA has
acquired land use rights for state owned land located in OuChi Village, FengHuo Town, LinLi County, Hunan Province. However, HSA
has not obtained a land use right certificate for such land, which therefore, for the time being, cannot be lawfully mortgaged
or transferred. Moreover, the Company’s subsidiary CA has entered into a Rural Land Management Rights Sub-Sales Agreement
for the acquisition of the contractual operating and use rights of 202 mu of collective owned land located in Da San Dui Wei You
Nan Village, Shenwan Town, Zhongshan City for a period of 30 years. However, the transfer procedures for the land in question
have not been completed. CA is not an enterprise registered in mainland China and therefore, according to Chinese law, cannot
acquire the contractual operating and use rights of collective owned land. The Company is currently negotiating with Beijing Hengxintianyi
Investment Guarantee Co. Ltd. to designate a subsidiary of the Company in China for the purpose of entering into a new Rural Land
Management Rights Sub-Sales Agreement.
Currently, the Company has leased the
following lots of land:
Owner
|
|
Location
|
|
Hectares
|
|
Date
Acquired
|
|
Tenure
|
|
Cost,
USD
|
|
Monthly
amortization
|
|
Nature
of
ownership
|
|
Zoning
type
|
HSA
|
|
Ouchi Village, Fenghuo Town, Linli County
|
|
12.92
|
|
5 April 2011
|
|
43
|
|
242,703
|
|
470
|
|
Lease
|
|
Agriculture
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
HSA
|
|
Ouchi Village, Fenghuo Town, Linli County
|
|
3.34
|
|
24 May 2011
|
|
40
|
|
376,489
|
|
789
|
|
Land use right
|
|
Industrial
|
JHST or HU Plantation
|
|
Yane Village, Liangxi Town, Enping City
|
|
3.33
|
|
10 Aug 2007
|
|
60
|
|
1,064,501
|
|
1,478
|
|
Management right
|
|
Agriculture
|
JHST or HU Plantation
|
|
Nandu Village of Yane Village, Liangxi Town, Enping City
|
|
11.24
|
|
14 March 2007
|
|
60
|
|
1,037,273
|
|
1,441
|
|
Management right
|
|
Agriculture
|
JHST or HU Plantation
|
|
Nandu Village of Yane
|
|
24.57
|
|
14 March 2007
|
|
60
|
|
2,267,363
|
|
3,149
|
|
Management right
|
|
Agriculture
|
JHST or HU Plantation
|
|
Village, Liangxi Town, Enping City
|
|
22.13
|
|
12 Sept 2007
|
|
60
|
|
2,041,949
|
|
2,836
|
|
Management right
|
|
Agriculture
|
JHST or HU Plantation
|
|
Jishilu Village of Dawan
Village, Juntang Town,
Enping City
|
|
11.66
|
|
12 Sept 2007
|
|
60
|
|
960,416
|
|
1,334
|
|
Management right
|
|
Agriculture
|
JHST or HU Plantation
|
|
Liankai Village of Niujiang Town, Enping
|
|
12.89
|
|
1 Jan 2008
|
|
60
|
|
821,445
|
|
1,141
|
|
Management right
|
|
Agriculture
|
JHST or HU Plantation
|
|
Nandu Village of Yane Village, Liangxi Town, Enping City
|
|
16.67
|
|
1 Nov 2011
|
|
26
|
|
5,716,764
|
|
18,323
|
|
Management right
|
|
Agriculture
|
JHST or HU Plantation
|
|
Shangchong Village of
Yane Village, Liangxi Town, Enping
City
|
|
4.57
|
|
1 Nov 2011
|
|
26
|
|
1,466,393
|
|
5,020
|
|
Management right
|
|
Agriculture
|
JHMC or Cattle Farm 1
|
|
Xiaoban Village of Yane
Village, Liangxi Town,
Enping City
|
|
16.67
|
|
1 April 2011
|
|
20
|
|
5,082,136
|
|
21,176
|
|
Management right
|
|
Agriculture
|
SJAP
|
|
Chengguan Town of
Huangyuan County,
Xining City, Qinghai Province
|
|
8.54
|
|
1 Nov 2011
|
|
40
|
|
527,234
|
|
1,098
|
|
Land use right & building ownership
|
|
Commercial
|
JHST or HU Plantation
|
|
Niu Jiang Town,
Liangxi Town, Enping City
|
|
2.54
|
|
4 March 2013
|
|
10
|
|
489,904
|
|
4,083
|
|
Management right (lease)
|
|
Agriculture
|
License
Rights
Through the past 10 years (from 2007 to
present) the Company has improved and modified the Recirculating Aquaculture System (RAS) originally pioneered in Germany into
a unique system designed for indoor systems referred to as A Power Module (“APM indoor”) and an outdoor module called
open dam RAS (“ODRAS”). We provide two types of licenses under this technology namely, a Developer License permitting
a fishery project license to utilize the technology in its design of the APM–indoor or ODRAS farms, and an Operator license
permitting the use of APM-indoor or ODRAS technology at their respective farms. Each license is granted a 50-year term per assigned
module unit for a one-time fee of $50,000 per license, that is a $50,000 fee for rights to the Developer license and a $50,000
fee for rights to the Operator license for 50 years per developed module.
On 12 November 2008, the Company’s
subsidiary TRW entered into an agreement with the inventor of a patent, Mr. Shan Dezhang, concerning the sale and purchase of
the master license rights of a patent registered in China with patent number ZL200510063039.9.
On 15 May 2009, TRW (as licensor) entered
a sub-license agreement with SJAP (as licensee) concerning the sub-licensing of the above-mentioned patent (ZL200510063039.9).
For further information on the aforementioned agreements, please refer to the section entitled “Intellectual Property Rights”
above.
Carve-outs
The Company has announced that it has
begun the first of three or four contemplated divestitures. The Company is currently exploring various opportunities for reorganizing
or restructuring some of its current assets into new companies by means of mergers and / or acquisitions with the aim to establish
higher independent fair market values for said companies (or respective related assets) by either listing each of said companies
on a suitable stock exchange or selling them in a receptive market (or to a receptive buyer). The first carve-out (Tri-way) is
comprised of aquaculture operations. The new company holds one single share class and shall conform to corporate governance standards
assigned by the Hong Kong Securities and Futures Commission as well as the potential Stock Exchange targeted for its listing.
The Company’s aquaculture operations, namely the C&S Project farms are as follows:
|
·
|
Jiang
Men City A Power Fishery Development Co., Ltd. (Fish Farm 1);
|
|
·
|
Enping
City Bi Tao A Power Prawn Culture Development Co., Ltd. (Prawn Farm 1);
|
|
·
|
Zhongshan
A Power Prawn Culture Farms Development Co., Ltd. (Prawn Farm 2), and;
|
|
·
|
Zhongshan
New Prawn Project (ZSNPP) Phase 1 as well as an opportunity to acquire additional phases
of the project as development continues. The ZSNPP is targeted to reach an annual production
capacity of at least 200,000 metric tons over the long term.
|
Establishing the proposed new company
would in management’s view expedite several strategic objectives:
|
·
|
Simplify
the structure of the Company by creating a rapidly growing, profitable aquaculture company
focused on the production of seafood with unique expansion potential;
|
|
·
|
Create
a company with an independent board of directors, a shareholder nomination committee,
a single share class, a separate management team and auditors, dedicated reporting and
investor relations functions;
|
|
·
|
Expose
the new company to institutional investors with in-depth knowledge and high appreciation
of aquaculture businesses. Facilitate funding to increase ownership in existing aquaculture
facilities, and;
|
|
·
|
Create
an independent company to secure funding for the future development of additional stages
at the significant Zhongshan New Prawn.
|
Because of the carve-out, Tri-way, as
of October 5, 2016, is now categorized under SIAF as an investor in associate status from its original categorization as a SIAF
subsidiary. Prior to the carve-out, Tri-way had assumed 100% holdings in JFD (previously, a 75% owned subsidiary) on August 16,
2016. Subsequently, Tri-way has merged / acquired in exchange for equity, all C&S farm projects and their respective assets.
Industry Overview
This section discusses the industry in
which the Company operates. Certain of the information in this section relating to market environment, market developments, growth
rates, market trends, industry trends, competition and similar information are estimates based on data compiled by professional
organizations, consultants and analysts, in addition to market data from other external and publicly available sources.
Economic outlook in China
China’s economy is at present second
only to that of the United States, having overtaken Japan’s role as number two in 2010.
5
The OECD expects that
China’s real GDP will grow by 6.9 percent in 2016.
6
The IMF expects that China will be the world’s largest
economy in 2017 with 18.3 percent of the world economy. The strong growth in China has delivered major improvements in living standards
and poverty has been reduced dramatically.
7
Based on the World Bank’s classification, China recently graduated
from lower to upper middle-income status. A growing emphasis on improving access to health and education as well as high investment
in infrastructure have helped spread the benefits of growth nationally including in rural areas, where incomes have enjoyed consistently
strong gains.
Agriculture
in China
China is the world’s largest agricultural
economy. It is the leading producer of many agricultural commodities such as pork, horticultural products, rice and cotton and
also the largest consumer of many agricultural products, such as pork, rice and soybeans. While China generally has been successful
in meeting its rapidly rising demand for food and grains by increasing domestic production, it has emerged as a leading global
importer of several agricultural commodities, including cotton, soybeans, vegetable oils, and animal hides. As its domestic agricultural
production, has grown, China has also become the largest exporter in global markets for several horticultural products, including
mandarin oranges, apples, apple juice, garlic and other vegetables.
China’s increasingly important position
in global agricultural markets followed decades of gradual growth in domestic food production and consumption. After the introduction
of market-based reforms in 1978 that included the elimination of the collective production system and relaxation of government
direction over certain farmer production and marketing decisions, Chinese agricultural output grew significantly. Between 1978
and 2008, China almost doubled its production of grains (rice, wheat and corn) and quadrupled its production of meats; the production
of fruit and milk was about 30 times greater in 2008 than in 1978. During these three decades, population growth of about 1 percent
annually, coupled with annual per capita income growth of 8 percent, fueled a significant increase in demand for more and higher-value
agricultural products, especially by China’s large and growing middle class. China’s rapid growth in food consumption
was largely met by domestic production growth, enabling it to remain self-sufficient in most major commodities.
5
The World Bank: China 2030, Building a Modern, Harmonious, and Creative Society (pages
3, 376-377), 2013
6
OECD Economic Outlook No. 92 (database)/OECD economic surveys: China 2013.
7
The World Bank; China 2030, Building a Modern, Harmonious, and Creative Society, 2013 (pages 3, 376-377)
About 40 percent of China’s population
of 1.3 billion is employed in the agricultural sector, and agriculture contributes about 11 percent to China’s GDP.
8
China’s support for agriculture
China’s government support for agriculture
is low compared to that of developed countries, such as the United States and European Union, but in line with that of other rapidly
growing economies, according to USITC. As measured by the OECD’s PSE,
9
the amount of support provided to Chinese
farmers was low (and sometimes negative) during the 1990’s, but gradually rose during the period 2008-2010. Compared with
other countries at a similar level of development, including Brazil, Mexico, Russia, and South Africa, China’s support for
farmers falls in the middle of the range. China’s PSE reflects changes in the central government’s policy priorities
from grain self-sufficiency and low consumer prices toward a stronger focus on raising farm household incomes, according to USITC.
Government support to China’s agricultural sector indicates that Chinese policymakers are placing a renewed emphasis on the
rural economy. Indirect support, in the form of general services, is very high relative to similar support programs in other countries,
due largely to investments in agricultural infrastructure. General services include modern research and extension services, food
safety agencies, and agricultural price information services, most of which provide benefits to producers and consumers throughout
the economy. Compared with direct payments to farmers, general services support is less production-distorting to the sector.
Agricultural
consumption
China is a major global consumer of agricultural
products. It consumes one-third of the world’s rice, one-fourth of all corn, and half of all pork and cotton, and it is
the largest consumer of oilseeds and most edible oils. The traditional Chinese diet centers around staple foods (mainly grains
and starches), which account for nearly half of the daily caloric intake. Average Chinese per capita consumption recently stabilized
at approximately 3,000 calories per day, one of the highest levels among Asian countries.
Chinese food consumption is influenced
by factors such as population size and demographics, income, food prices, and general preferences. Per capita income growth and
urbanization are the two factors most responsible for altering recent consumption patterns in China. Rising income translates
into higher per capita food consumption, while increasing urbanization is driving diversification of food choices because of greater
availability and choice offered through increasingly diverse sales outlets.
Chinese consumers generally fall into
one of three categories: rural consumers; urban low-income consumers; or urban high-income consumers. Although urban high-income
consumers can afford to buy more and better-quality food, the ubiquity of food outlets in cities means that nearly every urban
resident, regardless of income, has available an increasingly diverse food selection. Compared to rural diets, urban diets contain
less grain and more non-staple items, including processed and convenience foods. Rural migrants to cities tend to adopt the urban
diet.
Expenditure
on food
Food is the largest class of household
expenditure for all Chinese income groups; even housing takes a smaller share of average household income, according to USITC.
As income rises, the absolute amount of food expenditure increases, although the share of income spent on food falls. Urban residents
spend substantially more on food than their rural counterparts, according to USITC. Higher incomes lead to an increase in both
the quantity and quality of food demanded. However, while demand for higher quantities of food appears to level off in the top
income households, demand for higher-quality foods continues to rise with income.
Spending on food consumed outside the
home is on the rise. In 2003, about 18 percent of urban household food expenditures and over 11 percent of rural household food
expenditures were made outside the home. In 2008, the average per capita annual expenditure on dining out was USD 127 among urban
residents, up 26 percent from a year earlier. Per capita expenditures on food consumed away from home vary among regions, with
Shanghai spending the most (USD 300) and Tibet the least (USD 84). Most such expenditures are made in restaurants, both independent
establishments and fast-food chains. Although consumption away from the household is increasing, most foods are still eaten at
home. The exception is meat, with about half of all meat consumed outside the home.
Food
preferences
Along with more varied consumption, higher
incomes are leading to changing food preferences, including the demand for better quality and safer foods. Food preferences determine
where urban Chinese purchase their foods, whether it be at local “wet markets”, urban supermarkets, or restaurants.
Chinese value the diversity in food products that different shopping outlets offer. In the future, analysts predict that further
income growth and urbanization will continue to increase demand for a variety of higher quality foods, according to USITC.
8
USITC: China’s Agricultural Trade: Competitive Conditions and Effects on U.S.
Exports, March 2011 pages 1-1 and 1-8
9
OECD: PSE is defined as the estimated monetary value of transfers from consumers and taxpayers to farmers, expressed
as a percentage of gross farm receipts (defined as the value of total farm production at farmgate prices), plus budgetary support.
Like that of other countries at similar
stages of development, the traditional Chinese diet comprises mostly grains and other starches. Consumption of non-staple, higher-value
foods such as meat, dairy, fruits, vegetables, and processed food has grown significantly in the past three decades; 30 percent
of the food currently consumed in China has been processed in some way, according to USITC.
China’s per capita expenditures
for animal proteins for 2008 averaged USD 184, up from USD 137 in the previous year. The Chinese consume about four times as much
pork as poultry, the second most popular animal protein. Pork consumption has been encouraged by improved cold storage distribution,
as the product can be transported greater distances to reach more customers. Pork consumption levels are also high due to government
support programs, including purchasing pork for reserves and occasionally subsidizing pork purchases for low-income consumers.
The
market for aquatic products and aquaculture in China
The information in this section regarding
aquatic and aquaculture, including graphs, is taken from the USDA’s GAIN Report Number: CH12073 per 12/28/2012 unless otherwise
stated.
10
Total
Aquatic Products Production
China has the world’s largest aquatic
production and its market share of the world’s fish production has risen from 7 percent in 1961 to 37 percent by 2012. China
alone accounted for 62.3 percent of the aquaculture production in the world by volume in 2012. Aquaculture represents more than
70 percent of the total fish production in China. Total 2012 aquatic production in China increased 7.5 percent to reach 58.9 million
tons, compared to the 54.8 million tons in 2011, per the FAO.
11
10
Definition of terms: China’s definition of aquatic products includes both cultured (farm-raised) and wild caught
products; aquatic products include fish, shrimp/prawn/crab, shellfish, algae, and other. Aquatic catch production is total volume
of both fresh and seawater wild caught aquatic products; Aquaculture production is the total volume of both fresh and seawater
cultured (farmed) aquatic products. This report will use Chinese terminology to maintain consistency between Chinese statistics
and product categories. Total aquatic trade statistics below do not include fishmeal.
11
Food Outlook, October 2014, FAO.
Fish production accounts for 59 percent
of the total aquatic production, followed by shellfish and crustaceans at 22.6 percent and 10 percent, respectively. Fish production
is, per the USDA, expected to continue its upward growth trend to reach 34.5 million tons in 2012, up from 33 million tons in
2011 and 31.3 million tons in 2010.
In 2011, Shandong, Guangdong, Fujian and
Zhejiang provinces profited from favorable coastal locations and abundant freshwater resources/facilities to rank as the top four
aquatic production areas. In terms of freshwater cultured production, Hubei, Guangdong, and Jiangsu provinces are the largest
producers.
Aquaculture
China remains the world largest aquaculture
producer with total cultured aquatic production accounting for about 70 percent of the world total in recent years. Total aquaculture
production is increasing steadily and world aquaculture reached 90.4 million tons, with 66.6 million tons of food fish and 23.8
million tons of aquatic algae in 2012. Unconfirmed numbers state that world food fish aquaculture production rose 5.8 percent
to 70.5 million tons in 2013. China alone accounted for 43.5 million tons of food fish and 13.5 of aquatic algae in 2013. China
has had a CAGR of 5.5 percent in aquaculture production from the year 2000 through 2012.
Total aquatic products in China amounted
to 59.1 million tons, where seawater aquatic products represented 30.3 million tons or 51.34 percent and freshwater aquatic products
amounted to 28,743,000 tons or 48.66 percent of the total production. Fish is the most produced product and accounts for almost
61 percent of the total production, followed by shrimp, prawn and crab and shellfish. The majority of the production is in the
region Shandong, Guangdong, Fujian, Zhejiang and Jiangsu. These five regions represented more than 55 percent of the total production
of aquatic products in China. All regions are located nearby water and fish and other aquatic products is a common source of protein
for the inhabitants in these regions.
12
Aquatic
consumption
As China’s processing and distribution
systems become more developed and consumers rising affluence increases, their interest in a more diversified and nutritious diet,
seafood consumption is on the increase. According to the National Statistics Bureau, the per capita consumption of aquatic products
was 14.62 kg per urban dweller and 5.36 kg per rural inhabitant in 2011. Per capita consumption is expected to increase steadily,
with strong growth potential in the rural sector.
The per capita consumption of aquatic
products is highest in coastal regions, for example in Shanghai and Guangdong, (where aquatic products have been a traditional
source of protein) and locations with relatively high disposable income.
Per the National Bureau of Statistics
of China the overall price level of aquatic products increased 3.9 percent in July 2014 compared to the same month in 2013.
13
Exports
and imports
China is by far the largest exporter of
aquatic products in the world, with total exports amounting to USD 19.6 billion in 2013 compared to Norway that is the second
largest exporter in the world with exports amounting to USD 10.4 billion.
China has now become the third largest importer
of aquatic products, behind only the United States and Japan. Total import of aquatic products in 2013 amounted to USD 8.0 billion.
The increase in the import levels in China is mainly a result of outsourcing. China’s processors import raw material from
all major regions, including South and North America and Europe, for re-processing and re-export. However, this growth also reflects
China’s surging domestic demand of species not available from local sources.
12
China Statistical Yearbook 2013
13
Consumer Prices for July 2014, National Bureau of Statistics of China.
Recirculating Aquaculture Systems
Recirculating aquaculture systems (“
RAS
”)
is a technology that enables the same water to be reused within the same tank, and operates through filtering this water, at a
high frequency, making it an efficient and environmentally friendly method to operate water tanks. The advantages of RAS include
improved productivity, lower labor requirements and lower mortality rate of the animals. Historically, the Chinese population are
used to fresh aquatic products and prefer locally produced food if they can be assured of food quality and safety. Studies show
that consumers overall are willing to pay an average premium of 3.9 percent for Closed Containment Aquaculture (“
CCA
”)
compared to conventional farming methods such as sea water farming.
14
The market for meat in China
China is by far the world’s largest producer
and consumer of meat which includes pork, poultry and beef. Historically, this situation did not have a large impact on the rest
of the world, as China, for the most part, maintained self-sufficiency in meat. However, since 2007 the situation has changed dramatically.
China has gradually turned into a net importer of meats.
World meat production was around 308.5 million
tons in 2013.
15
China’s meat production reached 86.05 million tons in 2013. China’s total meat production
was more than double of any other country in the world, where total meat production in the United States amounted to 42.80 million
tons in 2013.
With strong economic growth, China’s
urbanization has occurred at a faster pace than commonly expected. By the end of 2011, the urban population for the first time
exceeded the rural population, reaching 51.3 percent of the total population. If rural migrants working in urban areas are included,
the population working and living in urban areas accounted for about 70 percent of the total population. Urbanization and rising
purchasing power has led to a dietary pattern change switching from the consumption of traditional food grain products to an increase
in consumption of meat.
16
The change in consumer preferences, meaning higher priced red meat representing a major part
of Chinese consumers’ main protein source, partly derives from the perception that consumption of red meat is equal to higher
status than consumption of poultry or pork.
17
There are several other specific market drivers
which underpin the increase in demand for red meat. One driver is the improved living standard in China which stimulates the growth
of beef markets since beef often sells at a much higher price and traditionally has been more expensive than what most people can
afford. Another is the fact that Chinese people’s dietary structure is becoming more diversified and reasonable, bringing
larger amount of beef consumption since beef has nutritional benefits. Lastly, a gradual lowering of import taxes is likely to
support sufficient supply of cattle.
The strong rise in feed grain prices in the
past five years is now moving substantially through the market chain and is being reflected in higher meat prices except for poultry
where adjustments have been made. On the contrary, world meat consumption continues to grow at one of the highest rates among major
agricultural commodities. Thus, developing countries can expect an increase in meat imports despite strong meat prices, driven
by population and income growth with high elasticity of demand. Equally so, strong prices will result in sustained export earnings,
which will encourage large meat exporting countries to invest in international meat markets. When breaking the expected increase
of demand down by region it is evident that the Asia and Pacific region is projected to stand for the largest increase in demand
by far.
18
Market drivers
The improvement of living standard stimulates
the growth of beef markets:
Traditionally, Chinese people eat pork and
chicken to satisfy their desire for meat. This is largely due to the much higher price of beef which goes beyond normal people’s
affordable level. With the improvement of living standards, Chinese people have begun the upgrade of their consumption of meat,
and began to eat more beef.
Chinese people’s dietary structure becomes
more diversified and reasonable, bringing larger amount of beef consumption:
At present, Chinese people are changing
their diet patterns to higher and richer nutrition. From a nutritional perspective, beef not only contains high unsaturated fatty
acids and high protein, it also has low fat and lots of nutrition, which makes it perfect for the healthy diet. Thus, in the future,
beef is expected to replace some parts of the market shares in pork, chicken and other meats.
19
14
Review of Recirculation Aquaculture System Technologies and their Commercial Application, Stirling Aquaculture, Institute
of Aquaculture.
15
Food Outlook Global Market Analysis, FAO, October 2014
16
China’s growing appetite for meats: Implications for World meat trade. A Multi-Client Study, April 2012.
17
China and Hong Kong: Food Opportunities for Maine, Maine International Trade Center, March 2012.
18
Meat - OECD-FAO Agricultural Outlook 2012-2021
19
Frost & Sullivan: China’s beef market has great growth potential.
The
market for fertilizer in China
Sales of fertilizers are expected to be
supported by healthy expansion of agricultural activities as the amount of sown areas continues to grow and rural income levels
rise. Farmers will continue to register steadily increasing incomes, the result of growing crop prices and government subsidies
designed to supplement their revenues and reduce their material costs. Subsidies aimed directly at cutting the cost of fertilizers
is expected to encourage additional use. In addition, rising crop prices have encouraged farmers to invest in fertilizers to further
boost crop yields. Advances will also be driven by increases in the acreage of sown land dedicated to growing cash crops. However,
increasing demand for organic food and improved understanding of the correct application of fertilizers is expected to prevent
demand from rising at a faster pace.
In value terms, fertilizer demand is expected
to grow 6.0 percent per year to RMB 548 billion, outpacing gains in volume terms. Faster value growth will be driven by strong
demand for higher value multi-nutrient fertilizers. In addition, advances will be supported by continued growth in fertilizer
prices as the cost of natural gas, oil, coal, and other raw materials continues to increase.
Demand for fertilizer nutrients in China
is projected to grow 4.4 percent annually through 2015 to 98.1 million metric tons. Nutrient demand will be stimulated by increasing
use of higher nutrient level products as income levels grow in rural areas in China. In addition, government efforts to promote
multi-nutrient fertilizers will also support gains in fertilizer nutrient demand. Accounting for more than three-fourths of total
fertilizer demand in 2010, single-nutrient fertilizers will remain the larger product type through 2015, despite a relatively
low growth rate of 2.1 percent per year. Sales of single nutrient fertilizers will continue to be supported by their relatively
low prices.
The size, growth and composition of fertilizer
demand in the six regions that make up China vary considerably. The Central-South and Central-East will remain the two largest
regional fertilizer markets. Due to the comparatively high income levels in the Central-South and Central-East
-
which enable residents to afford more expensive food items
-
demand for cash crops
such as fruits and vegetables will rise in these regions, which in turn will fuel demand for fertilizer. Sales in the Northeast
and Northwest regions will outpace the average through 2015, benefiting from the Great Western Development Strategy, the Northeast
Revitalization Policy, and increasing income levels for farmers.
20
In 2006, the central government started
a program intended to partially compensate farmers for price increases in fuel, fertilizer and other agricultural inputs. In the
case of fertilizers, government support is part of several separate programs targeting fertilizer producers, with cost reductions
being passed along to farmers purchasing the input. By 2009, fuel and fertilizer subsidies totaled USD 10.5 billion.
21
Market
for fruits and vegetables in China
The information in this section regarding
the market for fruit in China is taken from the International Trade Center report “Overview of the markets for selected
tropical fruits and vegetables in China” unless otherwise stated.
China is the biggest producer of fruit
in the world, with a total of approximately 10,734,259 hectares of fruit planting area and a fruit output of approximately 192,202,000
tons as of 2008, according to the National Bureau of Statistics of the PRC. The per capita annual fruit consumption in China as
of 2008 amounted 149 kilograms per capita, well above the global average of 69.09 kilograms per capita, according to FAO. In 2009,
China exported 5,255,000 tons of fruit, an 8.5 percent year-on-year increase compared to the previous year, equivalent to a value
USD 3.83 billion according to China Customs. The Chinese import of fruit in 2009 amounted to 2,309,000 tons, valued to USD 1.63
billion, a 37.0 percent increase year-on-year compared to 2008. This led to a fruit trade surplus of USD 2.2 billion, approximately
a 27.6 percent decrease compared to 2008 according the Ministry of Agriculture of the PRC.
The global tropical fruit output, where
the dragon fruit (Hylocereus Undatus) is included, reached roughly 82,700,000 tons in 2008 according to FAO. The output was led
by mango, followed by pineapple, guava and avocado. According to the Ministry of Agriculture of the PRC, tropical fruit accounted
for approximately 25 percent of the total fruit planting area in China in 2009, equivalent to roughly 2,500,000 hectares providing
a total output of more than 20,000,000 tons. The research adds that an additional 17,500,000 hectares spread over China is suitable
for planting tropical fruits.
The most commonly consumed tropical fruits
in China are pineapple, mango, banana, litchi, coconut, longan and cashew. However, demand for, e.g., mangosteen, star fruit,
durian and dragon fruit is quickly growing among the population in the first and second tier cities. The China Fruit Marketing
Association estimates that the consumption of tropical fruits accounts for roughly 10 percent of all the fruit in China, equivalent
to approximately 19,000,000 tons. Analysts estimate that about 80 percent of the tropical fruit in China is consumed fresh, contrary
to canned or processed fruit.
20
Fertilizers in China, Industry Study with Forecasts for 2015 & 2020, Freedonia Group; June 2012
21
USITC: China’s Agricultural Trade: Competitive Conditions and Effects on U.S. Exports, March 2011
Consumer
trends
Consumers in the northern and central
parts of China generally prefer more sweet tasting fruit, preferably tropical fruits. In the southern regions of China however,
the population consumes a broader range of fruits. Overall in China, consumers have started to consume more fruit with distinctive
smells, for example durian and jackfruit. During recent years there has been a significant increase in consumption of more expensive
fruit, such as durian, mangosteen and jackfruit thanks to the increasing standard of living of the population as well as the increased
availability of such imported fruits.
The most commonly consumed imported fruits
in China include kiwi, durian, mangosteen, grapes, cherries and dragon fruit. Generally, the Chinese population prefers to consume
fresh fruit; so when domestic, fresh fruit is available during summer, consumption of the fresher and cheaper domestic fruit increases.
In winter, when domestic products cannot be harvested or sold, the import of fruits, and especially tropical fruits, increases
immensely.
Organic fruits are mostly sold domestically
in China and have become increasingly popular in the market; however, the supply is still relatively small and the price is still
more expensive (approximately RMB 1-2 more expensive per kg).
GOVERNMENT REGULATION
Regulation of M&A
and Overseas Listings
On August 8,
2006, six PRC regulatory agencies, including the Ministry of Commerce (the “
MOFCOM
”), the State Assets Supervision
and Administration Commission, the State Administration of Taxation (“
SAT
”), the State Administration of Industry
and Commerce (the “
SAIC
”), the China Securities Regulatory Commission (“
CSRC
”), and the State
Administration of Foreign Exchange (the “
SAFE
”), jointly issued the
Regulations on Mergers and Acquisitions
of Domestic Enterprises by Foreign Investors
(the “
M&A Rule
”), which became effective on September 8, 2006
and was amended on June 22, 2009. The M&A Rule includes provisions that purport to require that an offshore special purpose
vehicle formed for purposes of the overseas listing of equity interests in PRC companies and controlled directly or indirectly
by PRC companies or individuals obtain the approval of the CSRC prior to the listing and trading of such special purpose vehicle’s
securities on an overseas stock exchange.
On September 21,
2006, the CSRC published on its official Website procedures regarding its approval of overseas listings by special purpose vehicles.
The CSRC approval procedures require the filing of a number of documents with the CSRC. The application of this new PRC regulation
remains unclear, with no consensus currently existing among leading PRC law firms regarding the scope of the applicability of the
CSRC approval requirement.
The M&A Rules
also establish procedures and requirements that could make some acquisitions of Chinese companies by foreign investors more time-consuming
and complex, including requirements in some instances that the MOFCOM be notified in advance of any change-of-control transaction
in which a foreign investor takes control of a Chinese domestic enterprise.
In February 2011,
the General Office of the State Council promulgated a
Notice on Establishing the Security Review System for Mergers and
Acquisitions of Domestic Enterprises by Foreign Investors
(“
Circular 6
”), which established a security
review system for mergers and acquisitions of domestic enterprises by foreign investors. Under Circular 6, a security review is
required for mergers and acquisitions by foreign investors having “national defense and security” concerns and mergers
and acquisitions by which foreign investors may acquire “de facto control” of domestic enterprises with “national
security” concerns. In August 2011, the MOFCOM promulgated the
Rules on Implementation of Security Review System
(the
“
MOFCOM Security Review Rules
”), to replace the
Interim Provisions of the Ministry of Commerce
on Matters Relating to the Implementation of the Security Review System for Mergers and Acquisitions of Domestic Enterprises by
Foreign Investors
promulgated by the MOFCOM in March 2011. The MOFCOM Security Review Rules, which came into effect on
September 1, 2011, provide that the MOFCOM will look into the substance and actual impact of a transaction and prohibit foreign
investors from bypassing the security review requirement by structuring transactions through proxies, trusts, indirect investments,
leases, loans, control through contractual arrangements or offshore transactions.
Regulation of Foreign Currency Exchange
and Dividend Distribution
The principal regulations
governing foreign currency exchange in China are the
Foreign Exchange Administration Regulations
(the “
FX
Regulations
”), which were last amended in August 2008. Under the FX Regulations, the RMB is freely convertible for current
account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions,
but not for capital account items, such as direct investments, loans, repatriation of investments and investments in securities
outside of China, unless the prior approval of the SAFE is obtained and prior registration with the SAFE is made. On August 29,
2008, the SAFE issued a notice, Circular 142
,
regulating the conversion by a foreign-invested company of foreign currency
into RMB by restricting how the converted RMB may be used. Circular 142 requires that the registered capital of a foreign-invested
company settled in RMB converted from foreign currencies may only be used for purposes within the business scope approved by the
applicable governmental authority and may not be used for equity investments within the PRC. In addition, the SAFE increased its
oversight of the flow and use of the registered capital of a foreign-invested company settled in RMB converted from foreign currencies.
The use of such RMB capital may not be changed without the SAFE’s approval, and may not in any case be used to repay RMB
loans if the proceeds of such loans have not been used. Violations of Circular 142 will result in severe penalties, such as heavy
fines. As a result, Circular 142 may significantly limit our ability to transfer cash or other assets from Sino Agro Food, Inc.
and/or our other non-PRC subsidiaries into our subsidiaries in the PRC, which may adversely affect our business expansion and we
may not be able to convert the net proceeds into RMB to invest in or acquire any other PRC companies, or establish other variable
interest entities (“
VIEs
”) in the PRC.
Dividends paid
by a PRC subsidiary to its overseas shareholder are deemed income of the shareholder and are taxable in the PRC. Pursuant to
the
Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996)
, foreign-invested enterprises in the PRC
may purchase or remit foreign currency, subject to a cap approved by the SAFE, for settlement of current account transactions
without the approval of the SAFE. Foreign currency transactions under the capital account are still subject to limitations and
require approvals from, or registration with, the SAFE and other relevant PRC governmental authorities.
In October 2005,
the SAFE promulgated
the Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Corporate Financing
and Roundtrip Investment through Offshore Special Purpose Vehicles
(“
Circular 75
”). Under Circular
75, which was issued by SAFE effective November 1, 2005, prior registration with the local SAFE branch is required for PRC
residents to establish or to control an offshore company for the purposes of financing that offshore company with assets or equity
interests in an onshore enterprise located in the PRC. An amendment to the registration or filing with the local SAFE branch by
such PRC resident is also required for the injection of equity interests or assets of an onshore enterprise in the offshore company
or overseas funds raised by such offshore company, or any other material change involving a change in the capital of the offshore
company. Moreover, Circular 75 applies retroactively. As a result, PRC residents who, prior to November 1, 2005, had established
or acquired control of offshore companies that had made onshore investments in the PRC prior to were required to complete the
relevant registration procedures with the local SAFE branch by March 31, 2006.
Since May 2007,
the SAFE has issued a series of guidance to its local branches with respect to the operational process for the SAFE registration
under Circular 75. The guidance provides more specific and stringent supervision of the registration required by Circular 75.
For example, the guidance imposes obligations on onshore subsidiaries of an offshore entity to make true and accurate statements
to the local SAFE authorities regarding any shareholder or beneficial owner of the offshore entity who is a PRC citizen or resident.
Untrue statements by the onshore subsidiaries will lead to potential liability for the subsidiaries and, in some instances, for
their legal representatives and other related individuals.
Under the relevant
rules, failure to comply with the registration procedures set forth in Circular 75 may result in restrictions being imposed on
the foreign exchange activities of the relevant onshore company, including increases in its registered capital, payment of dividends
and other distributions to its offshore parent or affiliate and capital inflows from the offshore entity, and may also subject
relevant PRC residents to penalties under PRC foreign exchange administration regulations. PRC residents who control our company
from time to time are required to register with the SAFE in connection with their investments in us.
On December 25,
2006, the People’s Bank of China (the “
PBOC
”) issued the
Administration Measures on Individual
Foreign Exchange Control
and related
Implementation Rules
were issued by the SAFE on January 5,
2007. Both became effective on February 1, 2007. Under these regulations, all foreign exchange transactions involving an
employee share incentive plan, share option plan, or similar plan participated in by onshore individuals may be conducted only
with approval from the SAFE or its authorized branch. Under the
Notice of Issues Related to the Foreign Exchange Administration
for Domestic Individuals Participating in Stock Incentive Plan of Overseas Listed Company
(“
Offshore Share Incentives
Rules
”), which was issued by the SAFE on February 15, 2012, PRC citizens who are granted share options, restricted
share units or restricted shares by an overseas publicly listed company are required to register with the SAFE or its authorized
branch and to comply with a series of other requirements. If we, or the PRC employees of ours who hold options, restricted share
units or restricted shares fail to comply with these registration or other procedural requirements, we, and/or such employees
may be subject to fines and other legal sanctions.
The principal
regulations governing distribution of dividends of foreign holding companies include the
Foreign Investment Enterprise
Law
(1986), which was amended in October 2000, and the
Administrative Rules under the Foreign Investment Enterprise
Law
(2001). Under these regulations, foreign investment enterprises in China may pay dividends only out of their accumulated
profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, foreign investment enterprises
in China are required to allocate at least 10% of their accumulated profits each year, if any, to fund certain reserve funds unless
these reserves have reached 50% of the registered capital of the enterprises. These reserves are not distributable as cash dividends.
Laws and Regulations Related to
Employment and Labor Protection
On June 29,
2007, the National People’s Congress promulgated the
Employment Contract Law of PRC
(“
Employment
Contract Law
”), which became effective as of January 1, 2008, and was amended on December 28, 2012. The Employment
Contract Law requires employers to provide written contracts to their employees, restricts the use of temporary workers and aims
to give employees long-term job security.
Pursuant to the
Employment Contract Law, employment contracts lawfully concluded prior to the implementation of the Employment Contract Law and
continuing as of the date of its implementation shall continue to be performed. Where an employment relationship was established
prior to the implementation of the Employment Contract Law but no written employment contract was concluded, a contract must be
concluded within one month after its implementation.
On September 18,
2008, the State Council promulgated the
Implementing Regulations for the PRC Employment Contract Law
which came
into effect immediately. These regulations interpret and supplement the provisions of the Employment Contract Law
.
As of December
31, 2015, we had entered written employment contracts with three of our employees.
Income Tax
On March 16, 2007, the National People’s
Congress approved and promulgated the Enterprise Income Tax Law (the “
EIT Law
”). On December 6, 2007,
the State Council approved the Implementing Rules. Both the EIT Law and its Implementing Rules became effective on January 1,
2008. Under the EIT Law and the Implementing Rules, which superseded the previous Income Tax Law, the enterprise income tax rate
for both domestic companies and foreign invested enterprises is unified at 25%. On December 26, 2007, the State Council promulgated
the Circular on Implementation of Enterprise Tax Transition Preferential Policy, or the Preferential Policy Circular. The EIT
Law, its Implementing Rules and the Preferential Policy Circular provide a five-year transitional period for certain entities
that had enjoyed a favorable income tax rate of less than 25% under the previous Income Tax Law and were established before March 16,
2007, during which period the applicable enterprises income tax rate shall gradually increase to 25%.
On April 14, 2008, the Administration
Measures for Recognition of High and New Technology Enterprises, or the Recognition Measures, were jointly promulgated by the
Ministry of Science and Technology, the Ministry of Finance, and the SAT, which sets out the standards and process for granting
the high and new technology enterprises status. According to the EIT Law and its Implementing Rules as well as the Recognition
Measures, enterprises which have been granted the high and new technology enterprises status shall enjoy a favorable income tax
rate of 15%. The new EIT Law and its Implementation Rules also provide that “software enterprises” enjoy a two-year
income tax exemption starting from the first profit making year, followed by a reduced tax rate of 12.5% for the subsequent three
years.
The EIT Law also provides that an enterprise
established under the laws of a foreign country or region but whose “de facto management body” is in the PRC be treated
as a resident enterprise for PRC tax purposes and consequently be subject to the PRC income tax at the rate of 25% for its global
income. The Implementing Rules merely defines the location of the “de facto management body” as “the place
where the exercising, in substance, of the overall management and control of the production and business operation, personnel,
accounting, properties, etc., of a non-PRC company is located.” The SAT issued the Circular regarding the Determination
of Chinese-Controlled Offshore Incorporated Enterprises as PRC Tax Resident Enterprises on the Basis of De Facto Management Bodies,
or Circular 82, on April 22, 2009. Circular 82 provides certain specific criteria for determining whether the “de facto
management body” of a Chinese-controlled offshore-incorporated enterprise is located in China. The SAT issued the Bulletin
regarding the Administrative Measures on the Income Tax of Chinese-Controlled Offshore Incorporated Resident Enterprises (Interim)
on July 27, 2011, which became effective on September 1, 2011, providing more guidance on the implementation of Circular
82. This bulletin clarifies matters including resident status determination, post-determination administration and competent tax
authorities. Although both Circular 82 and the bulletin only apply to offshore enterprises controlled by PRC enterprises, not
companies like us, the determining criteria set forth in Circular 82 and the bulletin may reflect the SAT’s general position
on how the “de facto management body” test should be applied in determining the tax resident status of offshore enterprises,
regardless of whether they are controlled by PRC enterprises or individuals. Based on a review of surrounding facts and circumstances,
the Company does not believe that it is likely that its operations outside of the PRC should be considered a resident enterprise
for PRC tax purposes. However, due to limited guidance and implementation history of the EIT Law, should the Company be treated
as a resident enterprise for PRC tax purposes, the Company will be subject to PRC tax on worldwide income at a uniform tax rate
of 25% retroactive to January 1, 2008.
The EIT Law also imposes a withholding
income tax of 10% on dividends distributed by a Foreign Invested Enterprise (an “
FIE
”) to its immediate holding
company outside of China if such immediate holding company is considered a non-resident enterprise without any establishment or
place within China or if the received dividends have no connection with the establishment or place of such immediate holding company
within China, unless such immediate holding company’s jurisdiction of incorporation has a tax treaty with China that provides
for a different withholding arrangement. Such withholding income tax was exempted under the previous law. The State of Nevada,
where the Company is incorporated, does not have such tax treaty with China. The SAT further promulgated a circular, or Circular
601, on October 27, 2009, which provides that the tax treaty benefits will be denied to “conduit” or shell companies
without business substance and that a beneficial ownership analysis will be used based on a “substance-over-form”
principle to determine whether to grant the tax treaty benefits. Most our subsidiaries in China are directly held by our non-Chinese
subsidiaries. If we are regarded as a non-resident enterprise and our non-Chinese subsidiaries are regarded as resident enterprises,
then our non-Chinese subsidiaries may be required to pay a 10% withholding tax on any dividends payable to us. If our non-Chinese
subsidiaries are regarded as non-resident enterprises, then our PRC subsidiaries may be required to pay a 5% withholding tax for
any dividends payable to our non-Chinese subsidiaries, however, it is still unclear at this stage whether Circular 601 applies
to dividends from our PRC subsidiaries paid to our non-Chinese subsidiaries, and if our non-Chinese subsidiaries were not considered
as “beneficial owners” of any dividends from their PRC subsidiaries, whether the dividends payable to our non-Chinese
subsidiaries would be subject to withholding tax at a rate of 10%.
The EIT Law and its Implementation Rules have
tried to scrutinize transactions between related parties. Pursuant to the EIT Law and its Implementation Rules, the tax authorities
may impose mandatory adjustment on tax due to the extent a related party transaction is not in line with arm’s-length principle
or was entered with a purpose to reduce, avoid or delay the payment of tax. On January 8, 2009, the SAT issued the Implementation
Measures for Special Tax Adjustments (Trial), which clarifies the definition of “related party” and sets forth the
tax-filing disclosure and documentation requirements, the selection and application of transfer pricing methods, and transfer
pricing investigation and assessment procedures.
On December 10, 2009, the SAT issued
a circular on Strengthening the Administration of Enterprise Income Tax Collection on Income Derived from Equity Transfer by Non-resident
Enterprise, or Circular 698. Pursuant to Circular 698, non-resident enterprises should declare any direct transfer of equity interest
of PRC resident enterprises and pay taxes in accordance with the EIT Law and relevant laws and regulations. For an indirect transfer,
if the effective tax rate for the transferor (a non-PRC-resident enterprise) is lower than 12.5% under the law of the jurisdiction
of the direct transferred target, the transferor is required to submit relevant transaction materials to PRC tax authorities for
review. If such indirect transfer is determined by PRC tax authorities to be a transaction without any reasonable business purpose
other than for tax avoidance, the gains derived from such transfer will be subject to PRC income tax.
In addition to the above, after the EIT
Law and its Implementing Rules were promulgated, the SAT released several regulations to stipulate more details for carrying
out the EIT Law and its Implementing Rules. These regulations include:
|
•
|
Notice of the State Administration
of Taxation on the Issues Concerning the Administration of Enterprise Income Tax Deduction
and Exemption (2008);
|
|
•
|
Notice of the State Administration
of Taxation on Strengthening the Withholding of Enterprise Income Tax on Non-resident
Enterprises’ Interest Income Sourcing from China (2008);
|
|
•
|
Notice of the State Administration
of Taxation on Several Issues Concerning the Recognition of Incomes Subject to the Enterprise
Income Tax (2008);
|
|
•
|
Opinion of the State Administration
of Taxation on Strengthening the Administration of Enterprise Income Tax (2008);
|
|
•
|
Notice of the Ministry of Finance
and State Administration of Taxation on Several Preferential Policies in Respect of Enterprise
Income Tax (2008);
|
|
•
|
Interim Measures for the Administration
of Collection of Enterprise Income Tax on the Basis of Consolidation of Trans-regional
Business Operations (2008);
|
|
•
|
Several Issues Concerning the
Enterprise Income Tax Treatment on Enterprise Reorganization (2009);
|
|
•
|
Circular of the State Council
on Printing and Distributing Policies for Further Encouraging the Development of the
Software Industry and the Integrated Circuit Industry (2011); and
|
|
•
|
Circular on Income Tax Policies
for Further Encouraging the Development of Software Industry and Integrated Circuit Industry
(2012).
|
Investing in our common stock involves
a high degree of risk. You should carefully consider each of the following risks and all other information in this Annual Report
before deciding to invest in our common stock. If any of these risks actually occur, our business, financial condition, results
of operations, and our future growth prospects would suffer. Under these circumstances, the share price and value of our common
stock could decline and you could lose all or part of your investment. The risks and uncertainties described in this Annual Report
are the only material risks and uncertainties that we presently know to be facing our company.
This Annual Report contains forward-looking
statements. Forward-looking statements anticipate future events or future financial performance. This Annual Report also
contains market data related to our business and industry. This market data includes projections that are based on a number
of assumptions. If these assumptions turn out to be incorrect, actual results may differ from projections based on them. As
a result, our markets may not grow at the rates projected by these data, or at all. The failure of these markets to grow
at these projected rates may have a material adverse effect on our business, results of operations, financial condition and the
market price of our common stock.
Currently, we conduct our business
operations in the People’s Republic of China. As China’s economy and its laws, regulations and policies may and do
differ from those found in the West, and change continually, we face certain risks that are summarized in this section.
Risks Related to Our Company
The Tri-way carve-out has resulted
in increasing dependence on a few major customers.
After the Tri-way carve-out, the number
of direct major customers associated with SIAF subsidiaries has been reduced, with the concentration of major customers now handled
through the Corporate Division via its main distribution agent, Shanghai Vigor Trading Co. Ltd. (“Vigor”), such that
a loss of business with Vigor will have an adverse effect on SIAF’s Corporate Division operational performance. The Corporate
Division accounted for 52.77% of consolidated revenues during the fiscal year ended December 31, 2016.
We may be unable to maintain an
effective system of internal control over financial reporting, and as a result we may be unable to accurately report our financial
results.
Our reporting obligations as a public
company place a significant strain on our management, operational and financial resources and systems. If we fail to maintain
an effective system of internal control over financial reporting, we could experience delays or inaccuracies in reporting our
financial information, or non-compliance with SEC reporting and other regulatory requirements. This could subject us to regulatory
scrutiny and result in a loss of public confidence in our management, which could, among other things, cause our stock price to
drop.
Because we will require additional
financing to expand our vertically integrated operations according to our business plan and growth strategy, our failure to obtain
necessary financing will impair our growth strategy; in addition, the risks of vertical integration are significant.
As of December 31, 2016, we had net working
capital of $297,338,248, including cash and cash equivalents of $2,576,058. Our capital requirements to accomplish our planned
vertically integrated development and growth plan of our business are significant.
In most developed countries, risks of
agriculture operations are shared to a certain degree by different sectors in the industry. For example:
·
|
Research and development are often initiated and supported by government departments;
|
·
|
Primary producers are mainly concerned with the growing risks of the produce;
|
·
|
Marketing companies assume the risks of marketing the produce;
|
·
|
Trading houses sell the produce and assume the credit risks of the sales; and
|
·
|
Logistics companies assume the risks of transporting the produce.
|
However, as a vertically integrated operator,
we must assume all the above-mentioned risks. China is a developing country; compared to other developed nations, its agriculture
industry is not modern. Thus, management believes that it is essential for us to develop our business operation in a vertically
integrated manner so that we can achieve reasonable profit margins for our products. We believe that the multiple layers of profits
generated through vertical integration may compensate to some degree for the variety of risks that we face through the multiple
operations; however, the overall risks are much greater. At the same time, our five-year plan for vertically integrated developments
is not fully completed, and the remaining developments may require significant capital expenditures and management resources.
Failure to implement these vertically integrated developments could hurt our ability to manage our growth and our financial position.
To accomplish the objectives discussed
above and to execute our business strategy, we need access to capital on appropriate terms. We currently have no commitments with
any third party to obtain such additional financing and we cannot assure you that we will be able to obtain the requisite additional
financing on any terms and, if we can raise additional funds, it may be necessary for us to sell our securities at a price which
is at a significant discount from the market price and on other terms which may be disadvantageous to us. About any such financing,
we may be required to provide registration rights to the investors and pay damages to the investors if the registration statement
is not filed or declared effective by specified dates. The price and terms of any financing which would be available to us could
result in both the issuance of a significant number of shares and significant downward pressure on our stock price. We cannot
assure you that our business objectives, particularly over the longer term, will be met on a timely basis, if at all. Consequently,
we may be unable to meet fixed obligations and expenses that will be generated in the operation of our business, whether as presently
in existence or as proposed. Any failure to obtain requisite financing on acceptable terms could have material and adverse effect
on our business, financial condition and prospects.
No assurance of successful expansion
of operations.
Our significant increase in the scope
and the scale of our operations, including the hiring of additional personnel, has resulted in significantly higher operating
expenses. We anticipate that our operating expenses will continue to increase. Expansion of our operations may also make significant
demands on our management, finances and other resources. Our ability to manage the anticipated future growth, should it occur,
will depend upon a significant expansion of our accounting and other internal management systems and the implementation and subsequent
improvement of a variety of systems, procedures and controls. We cannot assure that significant problems in these areas will not
occur. Failure to expand these areas and implement and improve such systems, procedures and controls in an efficient manner at
a pace consistent with our business could have a material adverse effect on our business, financial condition and results of operations.
We cannot assure that attempts to expand our marketing, sales, manufacturing and customer support efforts will succeed or generate
additional sales or profits in any future period. As a result of the expansion of our operations and the anticipated increase
in our operating expenses, along with the difficulty in forecasting revenue levels, we expect to continue to experience significant
fluctuations in its results of operations.
We may be unable to successfully
expand our production capacity, which could result in material delays, quality issues, increased costs and loss of business opportunities,
which may negatively impact our product margins and profitability
.
Part of our future growth strategy is
to increase our production capacity to meet increasing demand for our goods. Assuming we obtain sufficient funding to increase
our production capacity, any projects to increase such capacity may not be constructed on the anticipated timetable or within
budget. We may also experience quality control issues as we implement any production upgrades. Any material delay in completing
these projects, or any substantial cost increases or quality issues about these projects could materially delay our ability to
bring our products to market and adversely affect our business, reduce our revenue, income and available cash, all of which could
harm our financial condition.
Our business and operations are
growing rapidly. If we fail to effectively manage our growth, our business and operating results could be harmed
.
We have experienced, and may continue
to experience, rapid growth in our operations. This has placed, and may continue to place, significant demands on our management,
operational and financial infrastructure. If we do not manage our growth effectively, the quality of our products and services
could suffer, which could negatively affect our operating results. To effectively manage our growth, we must continue to improve
our operational, financial and management controls and reporting systems and procedures. These systems improvements may require
significant capital expenditures and management resources. Failure to implement these improvements could hurt our ability to manage
our growth and our financial position.
If the Chinese government were to
change its presently favorable policy toward the agriculture industry, we would no longer enjoy our present tax-related privileges,
which would materially and adversely impact our sales performance, margins, and net profit and our costs structure.
As producers, active in the agriculture
industry, our subsidiaries are presently exempt from income tax and enjoy various incentive grants and subsidies given by the
Chinese government. If the Chinese government were to change its presently favorable policy toward the agriculture industry, we
would no longer enjoy our present tax-related privileges, which would materially and adversely impact our sales performance, margins,
and net profit and our costs structure. We have experienced, and may continue to experience, quick changes of policies by the
Chinese government. If we do not effectively and efficiently manage our growth on time due to lack of capital, we could suffer
adversely from the consequences of any such policy changes.
Our intellectual property rights
are valuable, and any inability to adequately protect, or uncertainty regarding validity, enforceability or scope of them could
undermine our competitive position and reduce the value of our products, services and brand, and litigation to protect our intellectual
property rights may be costly.
We attempt to strengthen and differentiate
our product portfolio by developing new and innovative products and product improvements. As a result, our patents, trademarks,
trade secrets, copyrights and other intellectual property rights are important assets to us. Various events outside of our control
pose a threat to our intellectual property rights as well as to our products and services. For example, effective intellectual
property protection may not be available in China and other countries in which our products are sold. Also, although we have registered
our trademark in China, our efforts to protect our proprietary rights may not be sufficient or effective. Any significant impairment
of our intellectual property rights could harm our business or our ability to compete and hurt our results of operation. Also,
protecting our intellectual property rights is costly and time consuming. Policing unauthorized use of our proprietary technology
can be difficult and expensive. Litigation might be necessary to protect our intellectual property rights. But due to the relative
unpredictability of the Chinese legal system and potential difficulties to enforce a court’s judgment in China, there is
no guarantee that litigation would result in a favorable outcome. Furthermore, any such litigation may be costly and may divert
our management’s attention from our core business. An adverse determination in any lawsuit involving our intellectual property
is likely to jeopardize our business prospects and reputation. Although we are not aware of any of such litigation, we have no
insurance coverage against the litigation costs so we would be forced to bear all litigation costs if we cannot recover them from
other parties. All foregoing factors could harm our business, financial condition, and results of operations. Any unauthorized
use of our intellectual property could make it more expensive for us to do business and harm our operating results.
We may be exposed to infringement
or misappropriation claims by third parties, which, if determined against us, could adversely affect our business and subject
us to significant liability to third parties.
Our success mainly depends on our ability
to use and develop our technology and product designs without infringing upon the intellectual property rights of third parties.
We may be subject to litigation involving claims of patent infringement or violations of other intellectual property rights of
third parties. Holders of patents and other intellectual property rights potentially relevant to our product offerings may be
unknown to us, which may make it difficult for us to acquire a license on commercially acceptable terms. There may also be technologies
licensed to us and that we rely upon that are subject to infringement or other corresponding allegations or claims by third parties
which may damage our ability to rely on such technologies. In addition, although we endeavor to ensure that companies that work
with us possess appropriate intellectual property rights or licenses, we cannot fully avoid the risks of intellectual property
rights infringement created by suppliers of components used in our products or by companies we work with in cooperative research
and development activities. Our current or potential competitors may have obtained or may obtain patents that will prevent, limit
or interfere with our ability to make, use or sell our products. The defense of intellectual property claims, including patent
infringement suits, and related legal and administrative proceedings can be both costly and time consuming, and may significantly
divert the efforts and resources of our technical personnel and management. These factors could effectively prevent us from
pursuing some or all of our business operations and result in our customers or potential customers deferring, canceling or limiting
their purchase or use of our products, which may have a material adverse effect on our business, financial condition and results
of operations.
We rely on highly skilled personnel
and the continuing efforts of our executive officers and, if we are unable to retain, motivate or hire qualified personnel, our
business may be severely disrupted.
Our performance largely depends on the
talents, knowledge, skills, know-how and efforts of highly skilled individuals and in particular, the expertise held by our chief
executive officer, Solomon Lee. His absence, were it to occur, could impact development and implementation of our projects and
businesses. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled
personnel for all areas of our organization. Our continued ability to compete effectively depends on our ability to attract new
technology developers and to retain and motivate our existing contractors. If one or more of our executive officers are unable
or unwilling to continue in their present positions, we may not be able to replace them readily, if at all. Therefore, our business
may be severely disrupted, and we may incur additional expenses to recruit and retain new officers. In addition, if any of our
executives joins a competitor or forms a competing company, we may lose some customers.
Our financial and operating performance
may be adversely affected by epidemics, adverse weather conditions, natural disasters and other catastrophes.
Our financial and operating performance
may be affected adversely by epidemics, bad weather conditions, natural disasters and other catastrophes. For example, in early
2003, several economies in Asia, including China, were affected by the outbreak of severe acute respiratory syndrome, or SARS.
In May-June 2003, many businesses in China were closed by the PRC government, to prevent transmission of SARS. Our business
could be materially and adversely affected by the effects of H1N1 flu (swine flu), avian flu, SARS, or other epidemics or outbreaks.
In April 2009, an outbreak of H1N1 flu first occurred in Mexico and quickly spread to other countries, including the U.S. and
China. In the last decade, China has suffered health epidemics related to such outbreaks. Any prolonged occurrence or recurrence
of H1N1 flu (swine flu), avian flu, SARS or other adverse public health developments in China may have a material adverse effect
on our business and operations. These health epidemics could result in severe travel restrictions and closures that would
restrict our ability to ship our products. Potential outbreaks could also lead to temporary closure of our manufacturing facilities,
our suppliers’ facilities and/or our end-user customers’ facilities, leading to reduced production, delayed or cancelled
orders, and decrease in demand for our products. Any future health epidemic or outbreaks that could disrupt our operations and/or
restrict our shipping abilities may have a material adverse effect on our business and results of operations.
We do not expect to encounter any epidemics
in our aquaculture fishery farms in districts of the Guangdong Province or cattle farms in Huangyuan District of the Qinghai Province.
However, in the event of epidemics, we expect that our marine animals and our cattle will be quarantined until a sanitary certificate
for clean bill of health is obtained, before any of our products will be sold. In an extreme situation where our products would
fail to obtain the sanitary certificate, they will be destroyed subject to the direction of the Inspection Authorities of the
Agriculture Department of China. There is compensation granted by the Chinese government for the destruction of our products but
only for a fraction of our cost of production; as such the Company, will bear virtually all losses under such circumstances.
Furthermore, the 2008 Sichuan earthquake
also had a negative impact on many businesses in that region. Losses caused by epidemics, adverse weather conditions, natural
disasters and other catastrophes, including SARS, avian flu, swine flu, earthquakes or typhoons, will adversely affect our operations.
If we make any acquisitions, they
may disrupt or have a negative impact on our business.
Although we have no present plans for
any specific acquisitions, if we make acquisitions, we could have difficulty integrating the acquired companies’ personnel
and operations with our own. In addition, the key personnel of the acquired business may not be willing to work for us. We cannot
predict the effect expansion may have on our core business. Regardless of whether we are successful in acquiring, the negotiations
could disrupt our ongoing business, distract our management and employees and increase our expenses. In addition to the risks
described above, acquisitions are accompanied by several inherent risks, including, without limitation, the following:
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difficulty of integrating acquired products, services or operations;
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potential disruption of the ongoing businesses and distraction of our management and the management
of acquired companies;
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difficulty of incorporating acquired rights or products into our existing business;
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difficulties in disposing of the excess or idle facilities of an acquired company or business
and expenses in maintaining such facilities;
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difficulties in maintaining uniform standards, controls, procedures and policies;
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potential impairment of relationships with employees and customers because of any integration
of new management personnel;
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potential inability or failure to achieve additional sales and enhance our customer base through
cross-marketing of the products to new and existing customers;
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effect of any government regulations which relate to the business acquired;
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potential unknown liabilities associated with acquired businesses or product lines, or the
need to spend significant amounts to retool, reposition or modify the marketing and sales of acquired products or the defense
of any litigation, whether or not successful, resulting from actions of the acquired company prior to our acquisition.
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Our business could be severely impaired
if and to the extent that we are unable to succeed in addressing any of these risks or other problems encountered in connection
with these acquisitions, many of which cannot be presently identified, these risks and problems could disrupt our ongoing business,
distract our management and employees, increase our expenses and adversely affect our results of operations.
We face significant competition,
including changes in pricing.
The markets for our products are both
competitive and price sensitive. Many competitors have significant financial, operations, sales and marketing resources, plus
experience in research and development, and compete with us by offering lower prices. Competitors could develop new technologies
that compete with our products to achieve a lower unit price. If a competitor develops lower cost superior technology or cost-effective
alternatives to our products and services, our business could be seriously harmed.
The markets for some of our products are
also subject to specific competitive risks because these markets are highly price competitive. Our competitors have competed in
the past by lowering prices on certain products. If they do so again, we may be forced to respond by lowering our prices. This
would reduce sales revenues and increase losses. Failure to anticipate and respond to price competition may also impact sales
and aggravate losses.
Many of our competitors are larger
and have greater financial and other resources than we do.
Our products compete and will compete
with similar if not identical products produced by our competitors. These competitive products could be marketed by well-established,
successful companies that possess greater financial, marketing, distribution personnel, and other resources than we do. Using
said resources, these companies can implement extensive advertising and promotional campaigns, both generally and in response
to specific marketing efforts by competitors. They can introduce new products to new markets more rapidly. In certain instances,
competitors with greater financial resources may be able to enter a market in direct competition with us, offering attractive
marketing tools to encourage the sale of products that compete with our products or present cost features that consumers may find
attractive.
Risks Related to our Industry
Our agricultural assets are situated
in three provinces in China and crop disease, severe weather, natural disasters and other conditions affecting the environment,
including the effects of climate change, could result in substantial losses and weaken our financial condition.
Our agricultural operations are situated
in Qinghai Province, Hunan and Guangdong Province. Qinghai Province in particular is subject to occasional periods of drought.
Crops require water in different quantities at different times during the growth cycle. The limited water resource at any given
point can adversely impact production. In Qinghai, our cropping and pasture land presently comprises over 5,000 acres, an area
too big and too costly to afford drip irrigation systems for our crops. In Hunan, the district of Linli where we have over 300
acres of crop and pasture land may from time to time be subject to flooding that could affect our agriculture production. In Enping,
Guangdong, our HU Plants are very susceptible to dry and wet seasonal variation that could also affect our agriculture production.
Crop disease, severe weather conditions,
such as floods, droughts, windstorms and hurricanes, and natural disasters, may adversely affect our supply of one or more products,
reduce our sales volumes, increase our unit production costs or prevent or impair our ability to ship products as planned. Since
a significant portion of our costs are fixed and contracted in advance of each operating year, volume declines due to production
interruptions or other factors could result in increases in unit production costs, which could result in substantial losses and
weaken our financial condition. We may experience crop disease, insect infestation, severe weather and other adverse environmental
conditions from time to time.
Severe weather conditions may occur with
higher frequency or may be less predictable in the future because of climate change.
An occurrence of such an event might result
in material disruptions to our operations, to the operations of our customers or suppliers, resulting in a decline in the agriculture
industry. There can be no assurance that our facilities or products will not be affected by any such occurrence in the future,
which occurrence may lead to adverse conditions to our operations and financial results.
Prices of agricultural products
are subject to supply and demand, a market condition which is not predictable.
Because our agricultural products are
commodities, we are not able to predict with certainty what price we will receive for our products. Additionally, the growth cycle
of such products in many instances dictates when such products must be marketed to achieve the maximum profitability. Excessive
supplies tend to cause severe price competition and lower prices throughout the industry affected. Conversely, shortages may drive
the prices higher. Shortages often result from adverse growing conditions which can reduce the availability of the agricultural
products affected. Since multiple variables can affect supply and demand, we cannot accurately predict or control from year to
year what prices, either favorable or unfavorable, it will receive from the market.
In addition, public perceptions regarding
the quality, safety or health risks associated with particular food products could reduce demand and prices for some of our products.
To the extent that consumer preferences evolve away from products that we produce for health or other reasons, and we are unable
to modify our products or to develop products that satisfy new consumer preferences, there will be a decreased demand for our
products. However, even if market prices are unfavorable, some of our agricultural products which are ready to be, or have been,
harvested must be brought to market promptly. A decrease in the selling price received for our products due to the factors described
above could have a material adverse effect on our business, results of operations and financial condition.
We could realize losses and suffer
liquidity problems due to declines in sales prices for our agriculture products.
Sales prices for agricultural products
are difficult to predict. It is possible that sales prices for our products will decline in the future, and sales prices for other
agricultural products may also decline. In recent years, there has been increasing consolidation among food retailers, wholesalers
and distributors. A significant portion of our costs is fixed, so that fluctuations in the sales prices have an immediate impact
on our profitability. Our profitability is also affected by our production costs, which may increase due to factors beyond our
control.
We are subject to the risk of product
contamination and product liability claims.
The sales of our products may involve
the risk of injury to consumers. Such injuries may result from tampering by unauthorized personnel, product contamination or spoilage,
including the presence of foreign objects, substances, chemicals, or residues introduced during the growing, packing, storage,
handling or transportation phases. While we are subject to governmental inspection and regulations and believe, our facilities
comply in all material respects with all applicable laws and regulations, including internal product safety policies, we cannot
be sure that consumption of our products will not cause a health-related illness in the future or that we will not be subject
to claims or lawsuits relating to such matters. Even if a product liability claim is unsuccessful, the negative publicity surrounding
any assertion that our products caused illness or injury could adversely affect our reputation with existing and potential customers
and our brand image. We do not maintain product liability insurance.
We may not be successful in the
implementation of our new technologies and new products, and our new products may not be widely accepted.
Our new technologies such as our drip
irrigation system for precision agriculture or the introduction, testing and promotion of new agricultural varieties, must be
able to adapt to local conditions. The term “drip irrigation” refers to a system whereby the exact amount of water
is supplied to the plants’ roots at the correct moment. On the one hand, there exists the failure risk due to not being
suitable for the local environment and market conditions; on the other hand, there are risks of loss of competitive advantages
due to the rising of producing similar products enterprises and other enterprises that follow to produce the similar products.
We are a holding company whose subsidiaries
are given certain degree of independence and our failure to integrate our subsidiaries may adversely affect our financial condition
.
Per the specific characteristics of agricultural
production in China, we have given our subsidiary companies and their farms a certain degree of independency in decision-making.
On one hand, this independency increases the sense of ownership at all levels, on the other hand it has also increased the difficulty
of the integration of operation and management, which has resulted in increased difficulty of management integration. In the event,
we are not able to successfully manage our subsidiaries this will result in operating difficulties and have a negative impact
on our business.
One or more distributors could engage
in activities that harm our brand and our business.
Our products are sold primarily through
distributors, who are responsible for ensuring that our products have the appropriate licenses to be sold to farmers in their
provinces, and are stored at the correct temperature to ensure freshness and meet shelf life terms. If distributors do not obtain
the appropriate licenses, their sales of our products in those provinces may be illegal, and we may be subject to government sanctions,
including confiscation of illegal revenues and a fine of between two and three times the amount of such illegal revenues. Unlicensed
sales in a province may also cause a delay for our other distributors in receiving a license from the authorities for their provinces,
which could further adversely impact our sales. In addition, distributors may sell our products under another brand licensed in
a province if our product is not licensed there. If our products are sold under another brand, the purchasers will not be aware
of our brand name, and we will be unable to cross-market other seed varieties or other products as effectively to these purchasers.
Moreover, our ability to provide appropriate customer service to these purchasers will be negatively affected, and we may be unable
to develop our local knowledge of the needs of these purchasers and their environment. Furthermore, if any of our distributors
sell inferior seeds produced by other companies under our brand name, our brand and reputation could be harmed, which could make
marketing of our branded seeds more difficult. As of the date of this Annual Report, we are not aware of the occurrence of any
of the potential violations by our distributors described above.
The PRC agricultural market is highly
competitive and our growth and results of operations may be adversely affected if we are unable to compete effectively.
The agricultural market in China is highly
fragmented, largely regional and highly competitive, and we expect competition to increase and intensify within the sector. We
face significant competition in our lines of business. Many of our competitors have greater financial, research and development
and other resources than we have. Competition may also develop from consolidation within our industry in China or the privatization
of producers that are currently operated by local governments in China. Our competitors may be better positioned to take advantage
of industry consolidation and acquisition opportunities than we are. The reform and restructuring of state-owned equity in enterprises
involved primarily in producing sectors will likely lead to the reallocation of market share in the agriculture industry, and
our competitors may increase their market share by participating in the restructuring of state-owned agriculture companies. Such
privatization would likely result in increased numbers of market participants with more efficient and commercially viable business
models. As competition intensifies, our margins may be compressed by more competitive pricing and we may lose our market share
and experience a reduction in our revenues and profit.
We may not possess all of the licenses
required to operate our business, or we may fail to maintain the licenses we currently hold. This could subject us to fines and
other penalties, which could materially adversely affect our results of operations
.
We are required to hold a variety of permits
and licenses to conduct business in China. We may not possess all the permits and licenses required for each of our business segments.
In addition, the approvals, permits or licenses required by governmental agencies may change without substantial notice, and we
could fail to obtain the approvals, permits or licenses required to expand our business. If we fail to obtain or to maintain such
permits or licenses, or if renewals are granted with onerous conditions, we could be subject to fines and other penalties and
be limited in the number or the quality of the products that we could offer. Thus, our business, results of operations and financial
condition could be materially and adversely affected.
Risks Related to Doing Business in
China
Under PRC law, we are required to
obtain and retain permits and business licenses, and our failure to do so would adversely impact our ability to conduct business
in China.
We hold various permits, business licenses,
and approvals authorizing our operations and activities, which are subject to periodic review and reassessment by the Chinese
authorities. Standards of compliance necessary to pass such reviews change from time to time and differ from jurisdiction to jurisdiction,
leading to a degree of uncertainty. If renewals, or new permits, business licenses or approvals required by existing or new facility
activity, are not granted or are delayed, or if existing permits, business licenses or approvals are revoked or substantially
modified, we may not be able to continue to operate our facilities which would have a material adverse effect on our operations.
If new standards are applied to renewals or new applications, it could prove costly for us to meet these new standards.
The PRC economic cycle may negatively
impact our operating results.
We believe that the rapid growth of the
PRC economy before 2008 generally led to higher levels of inflation. We believe that the PRC economy has more recently experienced
a decrease in its growth rate. We believe that several factors have contributed to this deceleration, including appreciation of
the RMB, the currency of China, which has adversely affected China’s exports. In addition, we believe the deceleration has
been exacerbated by the recent global crisis in the financial services and credit markets, which has resulted in significant volatility
and dislocation in the global capital markets. It is uncertain how long the global crisis in the financial services and credit
markets will continue and the significance of the adverse impact it may have on the global economy in general or the Chinese economy
in particular. Slowing economic growth in China could result in weakening growth and demand for our products, which could reduce
our revenues and income. In the event of a recovery in the PRC, renewed high growth levels may again lead to inflation. The government’s
attempts to control inflation may adversely affect the business climate and growth of private enterprise. In addition, our profitability
may be adversely affected if prices for our products rise at a rate that is insufficient to compensate for the rise in inflation.
Currency fluctuations and restrictions
on currency exchange may adversely affect our business, including limiting our ability to convert Chinese Renminbi (RMB) into
foreign currencies and, if the RMB were to decline in value, reducing our revenue in U.S. dollar terms.
The exchange rate of the RMB is currently
managed by the Chinese government. On July 21, 2005, the People’s Bank of China, with the authorization of the State Council
of the PRC, announced that the RMB exchange rate would no longer be pegged to the U.S. Dollar and would float based on market
supply and demand regarding a basket of currencies. Per public reports, the governor of the People’s Bank has stated that
the basket is composed mainly of the U.S. Dollar, the European Union Euro, the Japanese Yen and the South Korean Won. Also, considered,
but playing smaller roles, are the currencies of Singapore, the United Kingdom, Malaysia, Russia, Australia, Canada and Thailand.
The weight of each currency within the basket has not been announced.
The initial adjustment of the RMB exchange
rate was an approximate 2% revaluation from an exchange rate of 8.28 RMB per U.S. Dollar to 8.11 RMB per U.S. Dollar. The People’s
Bank announced that the daily trading price of the U.S. Dollar against the RMB in the inter-bank foreign exchange market would
float within a band of 0.3% around the central parity published by the People’s Bank, while trading prices of non-U.S. Dollar
currencies against the RMB would be allowed to move within a certain band announced by the People’s Bank. The People’s
Bank has stated that it will adjust the RMB exchange rate band when necessary per market developments as well as the economic
and financial situation. In a later announcement published on May 18, 2007, the band was extended to 0.5%. Since July 2008, the
RMB has traded at 6.83 RMB per U.S. Dollar. Recent reports indicate an upward revaluation in the value of the RMB against the
U.S. Dollar may be allowed. The People’s Bank announced on June 19, 2010 its intention to allow the RMB to move more freely
against the basket of currencies, which increases the possibility of sharp fluctuations in the value of the RMB soon and thus
the unpredictability associated with the RMB exchange rate.
Despite this change in its exchange rate
regime, the Chinese government continues to manage the valuation of the RMB. The value of our common stock will be indirectly
affected by the foreign exchange rate between the U.S. dollar and the RMB. Appreciation or depreciation in the value of the RMB
relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying
change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any
dividend we issue that will be exchanged into U.S. dollars, as well as earnings from, and the value of, any U.S. dollar-denominated
investments we make in the future.
The income statements of our operations
are translated into U.S. dollars at the average exchange rates in each applicable period. To the extent the U.S. dollar strengthens
against foreign currencies, the translation of these foreign currencies denominated transactions results in reduced revenue, operating
expenses and net income for our international operations. Similarly, to the extent the U.S. dollar weakens against foreign currencies,
the translation of these foreign currency denominated transactions results in increased revenue, operating expenses and net income
for our international operations. We are also exposed to foreign exchange rate fluctuations as we convert the financial statements
of our foreign subsidiaries into U.S. dollars in consolidation. If there is a change in foreign currency exchange rates, the conversion
of the foreign subsidiaries’ financial statements into U.S. dollars will lead to a translation gain or loss, which is recorded
as a component of other comprehensive income. In addition, we have certain assets and liabilities that are denominated in currencies
other than the relevant entity’s functional currency. Changes in the functional currency value of these assets and liabilities
create fluctuations that will lead to a transaction gain or loss.
Very limited hedging transactions are
available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions.
While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited,
and we may not be able to successfully hedge our exposure. In addition, our foreign currency exchange losses may be magnified
by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.
Uncertainties with respect to the
PRC legal system could adversely affect us and we may have limited legal recourse under PRC law if disputes arise under our contracts
with third parties
.
Since 1979, we believe PRC legislation
and regulations have significantly enhanced protections afforded to various forms of foreign investments in China. However, China
has not developed a fully integrated legal system and recently enacted laws and regulations may not sufficiently cover all aspects
of economic activities in China. Because these laws and regulations are relatively new, the interpretation and enforcement of
these laws and regulations involve uncertainties. In addition, the PRC legal system is based in part on government policies and
internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result,
sometimes we may not be aware of our violation of these policies and rules until sometime after violation.
The Chinese government has enacted laws
and regulations dealing with matters such as corporate organization and governance, foreign investment, commerce, taxation and
trade. However, their experience in implementing, interpreting and enforcing these laws and regulations is limited, and our ability
to enforce commercial claims or to resolve commercial disputes is unpredictable. The resolution of these matters may be subject
to the exercise of considerable discretion by agencies of the Chinese government, and forces unrelated to the legal merits of
a particular matter or dispute may influence their determination. Any rights we may have to specific performance, or to seek an
injunction under PRC law, in either of these cases, are severely limited, and without a means of recourse by virtue of the
Chinese legal system, we may be unable to prevent these situations from occurring. The occurrence of any such events could have
a material adverse effect on our business, financial condition and results of operations.
Under the PRC EIT Law, we may be
classified as a “resident enterprise” of the PRC. Such classification could result in tax consequences to the Company
or our non-PRC resident shareholders.
On March 16, 2007, the National People’s
Congress approved and promulgated a new tax law, the PRC Enterprise Income Tax Law, or “
EIT Law
,” which
took effect on January 1, 2008. Under the EIT Law, enterprises are classified as resident enterprises and non-resident enterprises.
An enterprise established outside of China with “de facto management bodies” within China is considered a “resident
enterprise,” meaning that it can be treated in a manner like a Chinese enterprise for enterprise income tax purposes. The
implementing rules of the EIT Law define “de facto management bodies” as a managing body that in practice exercises
“substantial and overall management and control over the production and operations, personnel, accounting, and properties”
of the enterprise; however, it remains unclear whether the PRC tax authorities would deem our managing body as being located within
China. Due to the short history of the EIT Law and lack of applicable legal precedents, the PRC tax authorities determine the
PRC tax resident treatment of a foreign company on a case-by-case basis.
If the PRC tax authorities determine that
we are a “resident enterprise” for PRC enterprise income tax purposes, a number of PRC tax consequences could follow.
First, we could be subject to the enterprise income tax at a rate of 25 percent on our worldwide taxable income, as well as PRC
enterprise income tax reporting obligations. Second, under the EIT Law and its implementing rules, dividends paid between “qualified
resident enterprises” are exempt from enterprise income tax. Thus, if we are treated as a PRC “qualified resident
enterprise,” all dividends paid from our Chinese subsidiaries to us would be exempt from PRC tax.
Finally, the new “resident enterprise”
classification could result in a situation in which a 10% PRC tax is imposed on dividends we pay to our non-PRC stockholders that
are not PRC tax “resident enterprises” and gains derived by hem from transferring our common stock, if such income
is considered PRC-sourced income by the relevant PRC authorities. In such event, we may be required to withhold a 10% PRC tax
on any dividends paid to non-PRC resident stockholders. Our non-PRC resident stockholders also may be responsible for paying PRC
tax at a rate of 10% on any gain realized from the sale or transfer of our common stock in certain circumstances. We would not,
however, have an obligation to withhold PRC tax with respect to such gain.
Moreover, the SAT released Circular Guoshuihan
No. 698 (“
Circular 698
”) on December 15, 2009 that reinforces the taxation of non-listed equity transfers by
non-resident enterprises through overseas holding vehicles. Circular 698 addresses indirect share transfers as well as other issues.
Circular 698 is retroactively effective from January 1, 2008. According to Circular 698, where a foreigner (non-PRC resident)
who indirectly holds shares in a PRC resident enterprise through a non-PRC offshore holding company indirectly transfers equity
interests in a PRC resident enterprise by selling the shares of the offshore holding company, and the latter is located in a country
or jurisdiction where the effective tax burden is less than 12.5 percent or where the offshore income of his, her, or its residents
is not taxable, the foreign investor is required to provide the PRC tax authority in charge of that PRC resident enterprise with
certain relevant information within 30 days of the transfer. The tax authorities in charge will evaluate the offshore transaction
for tax purposes. In the event that the tax authorities determine that such transfer is abusing forms of business organization
and a reasonable commercial purpose for the offshore holding company other than the avoidance of PRC income tax liability is lacking,
the PRC tax authorities will be able to re-assess the nature of the equity transfer under the doctrine of substance over form.
A reasonable commercial purpose may be established when the overall international (including U.S.) offshore structure is set up
to comply with the requirements of supervising authorities of international (including U.S.) capital markets. If the SAT’s
challenge of a transfer is successful, it may deny the existence of the offshore holding company that is used for tax planning
purposes and subject the seller to PRC tax on the capital gain from such transfer. Since Circular 698 has a relatively short history,
there is uncertainty as to its application. We (or a foreign investor) may become at risk of being taxed under Circular 698 and
may be required to expend valuable resources to comply with Circular 698 or to establish that we (or such foreign investor) should
not be taxed under Circular 698, which could have a material adverse effect on our financial condition and results of operations
(or such foreign investor’s investment in us).
If any such PRC taxes apply, a non-PRC
resident stockholder may be entitled to a reduced rate of PRC taxes under an applicable income tax treaty and/or a foreign tax
credit against such stockholder’s domestic income tax liability (subject to applicable conditions and limitations). Prospective
investors are encouraged to consult with their own tax advisors regarding the applicability of any such taxes, the effects of
any applicable income tax treaties, and any available foreign tax credits.
Failure to comply with PRC regulations
relating to the establishment of offshore special purpose companies by PRC residents may materially adversely affect us.
In October 2005, the SAFE issued the Notice
on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose Companies by Residents
inside China, generally referred to as Circular 75. The policy announced in this notice required PRC residents to register with
the relevant SAFE branch before establishing or acquiring control over an offshore special purpose company, or SPV, for the purpose
of engaging in an equity financing outside of China on the strength of domestic PRC assets originally held by those residents.
Failure to comply with the requirements of Circular 75 and any of its internal implementing guidelines as applied by SAFE
in accordance with Notice 106 may result in fines and other penalties under PRC laws for evasion of applicable foreign exchange
restrictions. Any such failure could also result in the SPV’s affiliates being impeded or prevented from distributing their
profits and the proceeds from any reduction in capital, share transfer or liquidation to the SPV, or from engaging in other transfers
of funds into or out of China.
We requested our shareholders who are
PRC residents to make the necessary applications, filings and amendments as required under Circular 75 and other related rules.
We attempt to comply, and attempt to ensure that our shareholders who are subject to these rules comply, with the relevant requirements.
However, we cannot provide any assurances that our shareholders who are PRC residents will comply with our request to make any
applicable registrations, and nor can we provide any assurances that our shareholders who are PRC residents will be able to obtain
such applicable registration or comply with other requirements required by Circular 75 or other related rules or that, if
challenged by government agencies, the structure of our organization fully complies with all applicable registrations or approvals
required by Circular 75. Moreover, because of uncertainty over how Circular 75 will be interpreted and implemented, and how or
whether SAFE will apply it to us, we cannot predict how it will affect our business operations or future strategies. Failure by
such PRC resident shareholders or future PRC resident shareholders to comply with Circular 75 or other related rules, if SAFE
requires it, could subject these PRC resident shareholders to fines or legal sanctions, restrict our overseas or cross-border
investment activities, limit our subsidiaries’ ability to make distributions or pay dividends, or affect our ownership structure,
which could adversely affect our business and prospects.
Adverse changes in political and
economic policies of the Chinese government could have a material adverse effect on the overall economic growth of China, which
could reduce the demand for our products and materially and adversely affect our competitive position.
Our business, financial condition, results
of operations and prospects are affected significantly by economic, political and legal developments in China. The Chinese economy
differs from the economies of most developed countries in many respects, including:
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the amount of government involvement;
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the level of development;
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the growth rate;
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the control of foreign exchange; and
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the allocation of resources.
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While the Chinese economy has grown significantly
in the past 20 years, we believe the growth has been uneven, both geographically and among various sectors of the economy. The
Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. We believe
some measures benefit the overall Chinese economy, but may also have a negative effect on us. For example, our financial condition
and results of operations may be adversely affected by government control over capital investments or changes in tax regulations
that are applicable to us.
The Chinese economy has been transitioning
from a planned economy to a more market-oriented economy. Although in recent years the Chinese government has implemented measures
emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the
establishment of sound corporate governance in business enterprises, a substantial portion of the productive assets in China is
still owned by the Chinese government. The Chinese government also exercises significant control over Chinese economic growth
through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy
and providing preferential treatment to industries or companies.
Contract drafting, interpretation
and enforcement in China involve significant uncertainty.
We have entered numerous contracts governed
by PRC law, many of which are material to our business. As compared with contracts in the United States, contracts governed by
PRC law tend to contain less detail and to not be as comprehensive in defining contracting parties’ rights and obligations.
As a result, contracts in China are more vulnerable to disputes and legal challenges. In addition, contract interpretation and
enforcement in China is not as developed as in the United States, and the result of any contract dispute is subject to significant
uncertainties. Therefore, we cannot assure you that we will not be subject to disputes under our material contracts, and if such
disputes arise, we cannot assure you that we will prevail.
The application of PRC regulations
relating to the overseas listing of PRC domestic companies is uncertain, and we may be subject to penalties for failing to request
approval of the PRC authorities prior to listing our shares in the U.S.
As mentioned above, on August 8, 2006,
six PRC government agencies, i.e., MOFCOM, the SAIC, the CSRC, SAFE, the State-Owned Assets Supervision and Administration Commission
(“
SASAC
”) and SAT, jointly issued the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign
Investors (the “
New M&A Rules
”), which became effective on September 8, 2006. The New M&A Rules purport,
among other things, to require offshore “special purpose vehicles” that are (1) formed for the purpose of overseas
listing of the equity interests of PRC companies via acquisition and (2) are controlled directly or indirectly by PRC companies
and/or PRC individuals, to obtain the approval of the CSRC prior to the listing and trading of their securities on overseas stock
exchanges. On September 21, 2006, pursuant to the New M&A Rules and other PRC Laws, the CSRC published on its official website
relevant guidance with respect to the listing and trading of PRC domestic enterprises’ securities on overseas stock exchanges
(the “Related Clarifications”), including a list of application materials regarding the listing on overseas stock
exchanges by special purpose vehicles. We were and are not required to obtain the approval of CSRC under the new M&A Rules
about this transaction because we were and are not a special purpose vehicle formed or controlled by PRC individuals.
However, there are substantial uncertainties
regarding the interpretation, application and enforcement of these rules, and CSRC has yet to promulgate any written provisions
or formally to declare or state whether the overseas listing of a PRC-related company structured like ours is subject to
the approval of CSRC. Any violation of these rules could result in fines and other penalties on our operations in China, restrictions
or limitations on remitting dividends outside of China, and other forms of sanctions that may cause a material and adverse effect
to our business, operations and financial conditions.
The New M&A Rules also established
additional procedures and requirements that are expected to make merger and acquisition activities by foreign investors more time-consuming
and complex, including requirements in some instances that the MOFCOM be notified in advance of any change-of-control transaction
in which a foreign investor takes control of a PRC domestic enterprise that owns well-known trademarks or China’s traditional
brands. We may grow our business in part by acquiring other businesses. Complying with the requirements of the New M&A Rules
in completing this type of transaction could be time-consuming, and any required approval processes, including CSRC approval,
may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain
our market share.
We may face regulatory uncertainties
that could restrict our ability to issue equity compensation to our directors and employees and other parties who are PRC citizens
or residents under PRC law. The grant of stock options under any incentive plan that we adopt in the future would require registration
with SAFE.
On April 6, 2007, SAFE issued the “Operating
Procedures for Administration of Domestic Individuals Participating in the Employee Stock Ownership Plan or Stock Option Plan
of An Overseas Listed Company,” also known as “Circular 78”. It is not clear whether Circular 78 covers all
forms of equity compensation plans or only those that provide for the grant of stock options. For any equity compensation plan,
which is so covered and is adopted by a non-PRC listed company after April 6, 2007, Circular 78 requires all participants who
are PRC citizens to register with, and obtain the approval of, SAFE prior to their participation in any such plan. In addition,
Circular 78 also requires PRC citizens to register with SAFE and make the necessary applications and filings if they participate
in an overseas listed company’s covered equity compensation plan prior to April 6, 2007. As of the date of this filing,
we have not adopted any incentive plans, but may do so in the future. Any such plan may grant equity compensation, including,
but not limited to, stock options, to our PRC employees and/or directors. The grant of any equity compensation under such a plan
to a PRC citizen, however, may under Circular 78 require the PRC citizen to register with and obtain approval of SAFE. We believe
that the registration and approval requirements contemplated in Circular 78 will be burdensome and time consuming. If it is determined
that our such a plan, or any equity compensation grant under such a plan, is subject to Circular 78, failure to comply with such
provisions of Circular 78 may subject us and any recipients thereof to fines and legal sanctions and prevent us from being able
to grant equity compensation to our PRC employees and/or directors. In that case, our ability to compensate our employees
and directors through equity compensation would be hindered and/or prevented.
Capital outflow policies in the
PRC may hamper our ability to remit income to the United States.
The PRC has adopted currency and capital
transfer regulations. These regulations may require that we comply with complex regulations for the movement of capital and as
a result we may not be able to remit all income earned and proceeds received in connection with our operations or from the sale
of our operating subsidiary to the U.S. or to our stockholders.
Our operations and assets in the
PRC are subject to significant political and economic uncertainties.
Government policies are subject to rapid
change and the government of the PRC may adopt policies that have the effect of hindering private economic activity and greater
economic decentralization. There is no assurance that the government of China will not significantly alter its policies from
time to time without notice in a manner with reduces or eliminates any benefits from its present policies of economic reform.
In addition, a substantial portion of productive assets in China remains government-owned. For instance, all lands are state or
rural collective economic organizations owned and leased to business entities or individuals through governmental grants of the
land use rights. The grant process is typically based on government policies at the time of the grant, which could be lengthy
and complex. This process may adversely affect our business. The government of China also exercises significant control over China’s
economic growth through the allocation of resources, controlling payment of foreign currency and providing preferential treatment
to industries or companies. Uncertainties may arise as a result of changing governmental policies and measures. In addition, changes
in laws and regulations, or their interpretation, or the imposition of confiscatory taxation, restrictions on currency conversion,
imports and sources of supply, devaluations of currency, the nationalization or other expropriation of private enterprises, as
well as adverse changes in the political, economic or social conditions in China, could have a material adverse effect on
our business, results of operations and financial condition.
Our use of the allocated land may
be subject to challenges in the future.
All land use rights that we own are land
use rights relating to allocated land. The local governmental authorities have granted such land use rights to us for free use
or at a discounted levy rate given our contribution to the development of the local economy. However, pursuant to the Catalogue
on Allocated Land issued by the Ministry of Land Resources of the PRC (the “
Catalogue
”), the land use rights
for allocated land may only be granted to those specific projects which follow the Catalogue, subject to the approval of the competent
governmental authorities. We, as a privately owned agricultural producer, may not be qualified to be granted such land use rights
for allocated land per the Catalogue. Consequently, our use of such land may be subject to challenge in the future, and the legal
consequences could include the confiscation of such land by the governmental authorities or a demand that we pay a market price
for purchasing the land use rights for such land and converting the allocated land use right to a granted land use right.
Because Chinese law governs almost
all of our material agreements, we may not be able to enforce our legal rights within China or elsewhere, which could result in
a significant loss of business, business opportunities, or capital.
Chinese law governs almost all of our
material agreements. We cannot assure you that we will be able to enforce any of our material agreements or that remedies will
be available outside of China. The system of laws and the enforcement of existing laws in China may not be as certain in implementation
and interpretation as in the United States. Our inability to enforce or obtain a remedy under any of our current or future agreements
could result in a significant loss of business, business opportunities or capital. It will be extremely difficult to acquire jurisdiction
and enforce liabilities against our officers, directors and assets based in China.
Substantially all our assets will be in
the PRC and all of our officers and our present directors reside outside of the United States. Thus, it may not be possible for
United States investors to enforce their legal rights, to effect service of process upon our directors or officers or to enforce
judgments of United States courts predicated upon civil liabilities and criminal penalties of our directors and officers under
federal securities laws. Moreover, we have been advised that China does not have treaties providing for the reciprocal recognition
and enforcement of judgments of courts with the United States. Further, it is unclear if extradition treaties now in effect between
the United States and China would permit effective enforcement of criminal penalties of the federal securities laws.
We do not have insurance coverage.
We currently do not purchase property
insurance for our properties, including raw materials, semi-manufactured goods, manufactured goods, buildings and machinery equipment,
livestock, and we currently do not carry any product liability or other similar insurance, nor do we have business liability or
business disruption insurance coverage for our operations in the PR. There is no insurance covering risks incurred through seasonal
variation consequences. In this respect, we as an engineering based company have qualified personnel and staffs to manage and
to limited the happenings of these relevant risk factors; however, there is no guarantee that accidents will not happen, and if
they happen, the consequences may have a material adverse effect on our business, financial condition and results of operations.
Because our cash and cash equivalent
are held in banks that do not provide capital guarantee insurance, the failure of any bank in which we deposit our funds could
affect our ability to continue in business.
Banks and other financial institutions
in the PRC do not provide insurance for funds held on deposit. A significant portion of our assets are in the form of cash deposited
with banks in the PRC, and in the event of bank failure, we may not have access to, or may lose entirely, our funds on deposit.
Depending upon the amount of cash we maintain in a bank that fails, our inability to have access to such cash deposits could impair
our operations, and, if we are not able to access funds to pay our suppliers, employees and other creditors, we may be unable
to continue in business.
Failure to comply with the United
States Foreign Corrupt Practices Act could subject us to penalties and other adverse consequences.
We are subject to the United States Foreign
Corrupt Practices Act, which generally prohibits United States companies from engaging in bribery or other prohibited payments
to foreign officials for obtaining or retaining business. Foreign companies, including some that may compete with us, are not
subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time
to time in the PRC. We cannot assure you that our employees or other agents will not engage in such conduct for which we might
be held responsible. If our employees or agents are found to have engaged in such practices, we could suffer severe penalties
and other consequences that may have a material adverse effect on our business, financial condition and results of operations.
Labor laws in the PRC may adversely
affect our results of operations.
On June 29, 2007, the PRC government promulgated
a new labor law, namely, the Labor Contract Law of the PRC, or the New Labor Contract Law, which became effective on January 1,
2008. The New Labor Contract Law imposes greater liabilities on employers and significantly affects the cost of an employer’s
decision to reduce its workforce. Further, it requires that certain terminations be based upon seniority and not merit. In the
event, we decide to significantly change or decrease our workforce, the New Labor Contract Law could adversely affect our ability
to effect such changes in a manner that is most advantageous to our business or in a timely and cost-effective manner, thus materially
and adversely affecting our financial condition and results of operations.
Your ability to bring an action
against us or against our directors and officers, or to enforce a judgment against us or them, will be limited because we conduct
substantially all of our operations in the PRC and because the majority of our directors and officers reside outside of the United
States.
We are a Nevada holding company and substantially
all of our assets are located outside of the United States. Substantially all current operations are conducted in the PRC. In
addition, all but one of our directors and officers are nationals and residents of countries other than the United States. Substantial
portions of the assets of these persons are located outside the United States. Thus, it may be difficult to effect service
of process within the United States upon these persons. It may also be difficult to enforce in U.S. courts judgments on the civil
liability provisions of the U.S. federal securities laws against us and our officers and directors, none of whom are residents
in the United States and the substantial majority of whose assets are located outside of the United States. It is also uncertain
whether the courts of the PRC would recognize or enforce judgments of U.S. courts. Our PRC legal counsel has advised us that the
recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. Courts in the PRC may recognize
and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based on treaties between the
PRC and the country where the judgment is made or on reciprocity between jurisdictions. The PRC does not have any treaties or
other arrangements that provide for the reciprocal recognition and enforcement of foreign judgments with the United States. In
addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors
and officers if they decide that the judgment violates basic principles of PRC law or national sovereignty, security or the
public interest. It is uncertain whether a PRC court would enforce a judgment rendered by a court in the United States.
Risks Related to Ownership of our Common
Stock
Volatility in our common stock price
may subject us to securities litigation.
Stock markets, in general, have experienced
in recent months, and continue to experience, significant price and volume volatility, and the market price of our common stock
may continue to be subject to similar market fluctuations unrelated to our operating performance or prospects. This increased
volatility, coupled with depressed economic conditions, could continue to have a depressing effect on the market price of our
common stock. The following factors, many of which are beyond our control, may influence our stock price:
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the
status of our growth strategy including the building of our new production line with
any proceeds we may be able to raise in the future;
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announcements
of technological or competitive developments;
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regulatory developments
in the PRC affecting us, our customers or our competitors;
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announcements
regarding patent or other intellectual property litigation or the issuance of patents
to us or our competitors or updates with respect to the enforceability of patents or
other intellectual property rights generally in the PRC or internationally;
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actual or anticipated
fluctuations in our quarterly operating results;
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changes in financial
estimates by securities research analysts;
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changes in the
economic performance or market valuations of our competitors;
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additions or
departures of our executive officers;
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release or expiration
of lock-up or other transfer restrictions on our outstanding common stock; and
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sales or perceived
sales of additional shares of our common stock.
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In addition, the securities markets have,
from time to time, experienced significant price and volume fluctuations that are not related to the operating performance of
companies. Any of these factors could result in large and sudden changes in the volume and trading price of our common stock and
could cause our stockholders to incur substantial losses. In the past, following periods of volatility in the market price of
a company’s securities, stockholders have often instituted securities class action litigation against that company. If we
were involved in a class action suit or other securities litigation, it would divert the attention of our senior management, require
us to incur significant expense and, whether adversely determined, have a material adverse effect on our business, financial condition,
results of operations and prospects.
One of our directors and officers
controls a majority of our common stock and his interests may not align with the interests of our other stockholders.
Solomon Lee, our chairman, chief executive
officer and president, controls our company and beneficially holds more than 50.1% of the voting rights vested our issued and
outstanding common stock. This significant concentration of share ownership may adversely affect the trading price of our common
stock because investors often perceive a disadvantage in owning shares in a company with one or several controlling stockholders.
Furthermore, our directors and officers, as a Company, can significantly influence or control the outcome of all matters requiring
stockholder approval, including the election of directors and approval of significant corporate transactions, such as mergers,
consolidations or the sale of substantially all of our assets. This concentration of ownership may have the effect of delaying
or preventing a change in control of our company that could deprive our stockholders of an opportunity to receive a premium for
their shares as part of a sale of our company and might reduce the price of our common stock. In addition, without the consent
of Mr. Lee, we could be prevented from entering transactions that could be beneficial to us. Mr. Lee may cause us to take actions
that are opposed by other stockholders as his interests may differ from those of other stockholders.
Future issuances of capital stock
may depress the trading price of our common stock.
Any issuance of shares of our common stock
(or common stock equivalents) after the date hereof could dilute the interests of our existing stockholders and could substantially
decrease the trading price of our common stock. We may issue additional shares of our common stock in the future for several reasons,
including financing our operations and business strategy (including about acquisitions, strategic collaborations or other transactions).
Sales of a substantial number of
shares of our common stock in the public market could depress the market price of our common stock, and impair our ability to
raise capital through the sale of additional equity securities. We cannot predict the effect that future sales of our common stock
or other equity-related securities would have on the market price of our common stock.
We believe that the price of our shares
in the OTC QX markets is adversely affected by the current stigma associated with Chinese companies quoted or listed publicly
in the United States.
Although we managed to maintain our liquidity
to a certain degree, our share price has suffered. Many Chinese companies suffer from this stigma, which tends to affect both
market prices and liquidity, and our company is no exception. Reasons with varying degrees of legitimacy explain this stigma,
including but not limited to: (i) investors’ experience of losses suffered during investing in other Chinese companies,
(ii) the difficulty some Chinese companies have had in preparing auditable financial statements, and (iii) the difficulty in enforcing
US judgments in foreign courts generally. These have contributed to a negative perception by some US investors regarding all Chinese
companies publicly traded on US markets. Regardless of the reasons for this perception, if it continues over a sustained period
our market prices may continue to trade below net tangible asset value per share. This would increase risk that our shareholders
could lose the funds they invested in our company. It could also impact our ability to maintain our growth plan on schedule, which
would adversely affect our business and financial condition.
The issuance of any of our equity
securities pursuant any equity compensation plan we may adopt may dilute the value of existing stockholders and may affect the
market price of our stock.
In the future, we may issue to our officers,
directors, employees and/or other people’s equity based compensation under any equity compensation plan we may adopt to
provide motivation and compensation to our officers, employees and key independent consultants. The award of any such incentives
could result in an immediate and potentially substantial dilution to our existing stockholders and could result in a decline in
the value of our stock price. The exercise of these options and the sale of the underlying shares of common stock and the sale
of stock issued pursuant to stock grants may have an adverse effect upon the price of our stock. In addition, if the holders of
outstanding convertible securities convert such securities into common stock, you will suffer further dilution.
The requirements of being a public
company may strain our resources, divert management’s attention and affect our ability to attract and retain qualified board
members.
We are a public company and subject to
the reporting requirements of the Securities Exchange Act of 1934, as amended, and the Sarbanes-Oxley Act of 2002. The Exchange
Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and financial
condition. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures
and internal controls for financial reporting. For example, Section 404 of the Sarbanes-Oxley Act requires that our management
report on the effectiveness of our internal controls structure and procedures for financial reporting. Section 404 compliance
may divert internal resources and will take a significant amount of time and effort to complete. If we fail to maintain compliance
under Section 404, or if in the future management determines that our internal control over financial reporting are not effective
as defined under Section 404, we could be subject to sanctions or investigations by the NASDAQ Stock Market should we in
the future be listed on this market, the SEC, or other regulatory authorities. Furthermore, investor perceptions of our company
may suffer, and this could cause a decline in the market price of our common stock. Any failure of our internal controls could
have a material adverse effect on our stated results of operations and harm our reputation. If we are unable to implement these
changes effectively or efficiently, it could harm our operations, financial reporting or financial results and could result in
an adverse opinion on internal controls from our independent auditors. We may need to hire several additional employees with public
accounting and disclosure experience to meet our ongoing obligations as a public company, particularly if we become fully subject
to Section 404 and its auditor attestation requirements, which will increase costs. Our management team and other personnel will
need to devote a substantial amount of time to new compliance initiatives and to meeting the obligations that are associated with
being a public company, which may divert attention from other business concerns, which could have a material adverse effect on
our business, financial condition and results of operations.
Our shares of common stock may be
thinly traded, so you may be unable to sell at or near ask prices or at all.
We cannot predict the extent to which
an active public market for our common stock will develop or be sustained. Our common stock is currently traded on the OTC QX
where the shares have historically been thinly traded, meaning that the number of persons interested in purchasing our common
stock at or near bid prices at any given time may be relatively small or non-existent.
This situation may be attributable to
a number of factors, including the fact that we are a small company that is relatively unknown to stock analysts, stock brokers,
institutional investors and others in the investment community who generate or influence sales volume, and that even if we came
to the attention of such persons, they tend to be risk averse and would be reluctant to follow an unproven company such as ours
or purchase or recommend the purchase of our shares until such time as we have become more seasoned and viable. Therefore, there
may be periods of several days, weeks or months when trading activity in our shares is minimal or non-existent, as compared to
a seasoned issuer which has a large and steady volume of trading activity that will generally support continuous sales without
an adverse effect on share price. We cannot assure you that a broader or more active public trading market for our common stock
will develop or be sustained, or that current trading levels will be sustained or not diminish.
We may become involved in securities
class action litigation that could divert management’s attention and harm our business.
The stock market in general, and the shares
of early stage companies have experienced extreme price and volume fluctuations. These fluctuations have often been unrelated
or disproportionate to the operating performance of the companies involved. If these fluctuations occur in the future, the market
price of our shares could fall regardless of our operating performance. In the past, following periods of volatility in the market
price of a company’s securities, securities class action litigation has often been brought against that company. If the
market price or volume of our shares suffers extreme fluctuations, then we may become involved in this type of litigation, which
would be expensive and divert management’s attention and resources from managing our business.
As a public company, we may also from
time to time make forward-looking statements about future operating results and provide some financial guidance to the public
markets. Our management has limited experience as a management team in a public company and as a result projections may not be
made timely or set at expected performance levels and could materially affect the price of our shares. Any failure to meet published
forward-looking statements that adversely affect the stock price could result in losses to investors, stockholder lawsuits or
other litigation, sanctions or restrictions issued by the SEC.
Securities analysts may elect not
to report on our common stock or may issue negative reports that adversely affect the stock price.
At this time, to our knowledge no securities
analysts provide research coverage of our common stock, and securities analysts may not elect not to provide such coverage in
the future. It may remain difficult for our company, with its small market capitalization, to attract independent financial analysts
that will cover our common stock. If securities analysts do not cover our common stock, the lack of research coverage may adversely
affect the stock’s actual and potential market price. The trading market for our common stock may be affected in part by
the research and reports that industry or financial analysts publish about our business. If one or more analysts elect to cover
our company and then downgrade the stock, the stock price would likely decline rapidly. If one or more of these analysts cease
coverage of our company, we could lose visibility in the market, which, in turn, could cause our stock price to decline. This
could have a negative effect on the market price of our common stock.