NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
NOTE 1 –
ORGANIZATION AND NATURE OF BUSINESS
China Agri-Business, Inc. (“China Agri”) was incorporated in the State of Maryland on December 7, 2005. On October 31, 2006, China Agri effectuated a 2.032 to 1 forward stock split. All share and per share amounts have been retroactively adjusted to reflect the stock split.
China Agri is a holding company with no operations other than acting as a holding company for its wholly owned subsidiary, Mei Xin Agri Technology (Shaanxi) Co., Ltd. (“Meixin”), a limited liability company and a wholly-owned foreign enterprise (“WOFE”) organized under the laws of the People’s Republic of China (the “PRC”) on March 24, 2006. Meixin acts as a management company for our operating business in the PRC, Shaanxi Xin Sheng Centennial Agricultural and Technology Co., Ltd. (“Xinsheng”), a corporation formed under the laws of the PRC on April 22, 2002, in accordance with the terms of a management entrustment agreement between Meixin and Xinsheng. Meixin controls Xinsheng's business and management, and is entitled to the proceeds of Xinsheng's business and is obligated to fund Xinsheng’s operations, including any losses. China Agri and Meixin do not own any equity rights in Xinsheng.
Pursuant to a Management Entrustment Agreement dated April 18, 2006 between Meixin and Xinsheng, and a Stock Purchase Agreement dated April 22, 2006 between China Agri and Xinsheng (collectively, the “Transaction”), China Agri issued 10,950,897 shares of China Agri common stock, representing approximately 89% of the 12,278,774 shares of China Agri common stock outstanding immediately after the Transaction, to a trustee of a trust for the benefit of the Xinsheng stockholders. The Transaction was accounted for as a “reverse merger”, since the stockholders of Xinsheng owned a majority of China Agri’s common stock immediately following the Transaction. Xinsheng was deemed to be the acquirer in the reverse merger. Consequently, the assets and liabilities and the historical operations that are reflected in the financial statements prior to the Transaction are those of Xinsheng and are recorded at the historical cost basis of Xinsheng, and the consolidated financial statements after completion of the Transaction include the assets and liabilities of China Agri, Meixin, and Xinsheng (collectively, the “Company”), historical operations of Xinsheng, and operations of China Agri and Meixin from the date of the Transaction.
China Agri-Business, Inc., through its operating company in China, manufactures and sells non-toxic fertilizer, bactericide and fungicide products used for farming in the People’s Republic of China (the “PRC”). Crops grown with our products are eligible to qualify for the “AA Green Food” rating administered by the China Green Food Development Center, an agency under the jurisdiction of the Ministry of Agriculture of the PRC.
NOTE 2 -
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”).
Principles of Consolidation
The condensed consolidated financial statements include the accounts of China Agri, Meixin and Xinsheng. All significant intercompany accounts and transactions have been eliminated in consolidation.
Fair Value of Financial Instruments
The Company’s financial instruments consist of cash and cash equivalents, accounts receivable, net, accounts payable and accrued liabilities, long-term debt, and due to chief executive officer. The fair value of these financial instruments approximate their carrying amounts reported in the consolidated balance sheets due to the short term maturity of these instruments or by comparison to other instruments with similar terms.
Foreign Currency Transactions and Comprehensive Income
The functional currency of China Agri is the United States dollar. The functional currency of Xinsheng and Meixin is the RMB. The reporting currency of the Company is the United States dollar.
The assets and liabilities of Xinsheng and Meixin are translated into United States dollars at period-end exchange rates ($0.1568 and $0.1515 at September 30, 2011 and December 31, 2010, respectively). The revenues and expenses are translated into United States dollars at average exchange rates for the periods ($0.1558 and $0.1478 for the three months ended September 30, 2011 and 2010, respectively; $0.1542 and $0.1470 for the nine months ended September 30, 2011 and 2010, respectively). Resulting translation adjustments are recorded as a component of accumulated other comprehensive income within stockholders’ equity.
Transaction gains or losses arising from exchange rate fluctuation on transactions denominated in a currency other than the functional currency are included in the consolidated results of operations. There are no material foreign currency transaction gains or losses for the three and nine months ended September 30, 2011 and 2010.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States ("GAAP") requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates, and such differences may be material to the financial statements.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash on hand, cash on deposit with banks, and highly liquid debt investments with a maturity of three months or less when purchased.
Inventory
Inventory is stated at the lower of cost (first-in, first-out method) or market.
Property, Plant and Equipment, Net
Property, plant and equipment is stated at cost less accumulated depreciation. Depreciation is calculated on a straight-line basis over the estimated useful lives of the respective assets.
Intangible and Other Long-Lived Assets, Net
Intangible and other long-lived assets are stated at cost, less accumulated amortization and impairments. The intangible assets are being amortized over their expected useful economic lives ranging from 5 to 10 years.
The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may no longer be recoverable. When these events occur, the Company measures impairment by comparing the carrying value of the long-lived assets to the estimated undiscounted future cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flows is less than the carrying amount of the assets, the Company would recognize an impairment loss based on the fair value of the assets.
Sales of products are recorded when title passes to the customer, which is generally at time of shipment. The Company performs ongoing credit evaluations of its customers’ financial condition, but generally does not require collateral to support customer receivables. The credit risk is controlled through credit approvals, limits and monitoring procedures. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other factors. Accounts receivable are charged against the allowance for doubtful accounts once all collection efforts have been exhausted. The Company does not routinely permit customers to return product.
Delivery and other transportation costs are included in selling, general and administrative expenses.
Stock-Based Compensation
Stock-based compensation is accounted for at fair value in accordance with FASB Accounting Standards Codification (“ASC”) topic 718-10, Stock Compensation. In addition to requiring supplemental disclosures, FASB ASC 718 addresses the accounting for share-based payment transactions in which a company receives goods or services in exchange for (a) equity instruments of the company or (b) liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. FASB ASC 718 focuses primarily on accounting for transactions in which a company obtains employee services in share-based payment transactions.
References to the issuances of restricted stock refer to stock of a public company issued in private placement transactions to individuals who are eligible to sell all or some of their shares of restricted Common Stock pursuant to Rule 144, promulgated under the Securities Act of 1933 (“Rule 144”), subject to certain limitations. In general, pursuant to Rule 144, a stockholder who is not an affiliate and has satisfied a six-month holding period may sell all of his restricted stock without restriction, provided that the Company has current information publicly available. Rule 144 also permits, under certain circumstances, the sale of restricted stock, without any limitations, by a non-affiliate of the Company that has satisfied a one-year holding period.
Advertising
Advertising costs include advance payments to our branded stores (to be used for signage and store display and promotions). The Company expenses advertising costs as incurred in accordance with ASC 720-35, “Advertising Costs.” Advertising expenses were $108,941 and $43,241 for the three months ended September 30, 2011 and 2010, respectively. Advertising expenses were $256,925 and $137,727 for the nine months ended September 30, 2011 and 2010, respectively.
Research and Development
In accordance with ASC subtopic 730-10, “Research and Development”, the Company expenses all research and development costs as incurred. Research and development expenses for the three months ended September 30, 2011 and 2010 were $15,580 and $10,152, respectively. Research and development expenses for the nine months ended September 30, 2011 and 2010 were $18,835 and $33,185, respectively.
Segment Information
ASC 280-10 requires entity-wide disclosures about the products and services an entity provides, the countries in which it holds assets and reports revenues, and its major customers. The Company operates as a single segment currently and will evaluate additional segment disclosure requirements as it expands its operations.
Income Taxes
The Company accounts for income taxes using the asset and liability method described in ASC 740-10, the objective of which is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting and the tax bases of the Company’s assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. A valuation allowance related to deferred tax assets is recorded when it is more likely than not that some portion or all of the deferred tax assets will not be realized.
Xinsheng is governed by the Income Tax Laws of the PRC. Pursuant to the PRC relevant laws and regulations and tax law, Xinsheng is exempt from income tax.
Earnings (Loss) Per Common Share
The Company has adopted ASC 260-10, which requires presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation.
Basic earnings (loss) per common share are computed on the basis of the weighted average number of common shares outstanding during the period.
Diluted earnings (loss) per common share are computed similarly to basic earnings per common share except that it includes the dilutive securities (such as convertible notes, stock options and warrants) outstanding and potential dilution that could occur if dilutive securities were converted. Dilutive securities having an anti-dilutive effect on diluted earnings (loss) per common share are excluded from the calculation.
A reconciliation of net income (the numerator) used to compute basic and diluted earnings per common share for the three and nine months ended September 30, 2011 and 2010 follows:
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2011
|
|
|
2010
|
|
|
2011
|
|
|
2010
|
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
Net income (used to compute basic EPS)
|
|
$
|
1,807,090
|
|
|
$
|
895,984
|
|
|
$
|
4,929,363
|
|
|
$
|
1,981,013
|
|
Add back interest expense on convertible notes
|
|
|
-
|
|
|
|
3,750
|
|
|
|
-
|
|
|
|
11,250
|
|
Net income (used to compute diluted EPS)
|
|
$
|
1,807,090
|
|
|
$
|
899,734
|
|
|
$
|
4,929,363
|
|
|
$
|
1,992,263
|
|
A reconciliation of the weighted average number of common shares (the denominator) used to compute basic and diluted earnings per common share for the three and nine months ended September 30, 2011 and 2010 follows:
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2011
|
|
|
2010
|
|
|
2011
|
|
|
2010
|
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
Weighted average number of common shares outstanding
(used to compute basic EPS)
|
|
|
13,118,574
|
|
|
|
12,958,574
|
|
|
|
13,118,574
|
|
|
|
12,958,574
|
|
Assumed exercise of warrants
|
|
|
-
|
|
|
|
-
|
|
|
|
16,411
|
|
|
|
-
|
|
Weighted average number of common shares outstanding and dilutive common stock equivalents outstanding (used to compute diluted EPS)
|
|
|
13,118,574
|
|
|
|
12,958,574
|
|
|
|
13,134,985
|
|
|
|
12,958,574
|
|
The Company uses the treasury stock method to account for the dilutive effect of unexercised stock options and warrants on diluted earnings per common share. Antidilutive common shares related to stock options excluded from the computation of diluted earnings per common share were 429,240 and 0 for the three months ended September 30, 2011 and 2010, respectively, and 429,240 and 0 for the nine months ended September 30, 2011 and 2010, respectively. Antidilutive common shares related to warrants excluded from the computation of diluted earnings per common share were 618,980 and 1,378,580 for the three months ended September 30, 2011 and 2010, respectively, and 500,000 and 1,378,580 for the nine months ended September 30, 2011 and 2010, respectively.
Recently Issued Accounting Pronouncements
Certain accounting pronouncements have been issued by the FASB and other standard setting organizations which are not yet effective and have not yet been adopted by the Company. The impact on the Company’s financial position and results of operations from adoption of these standards is not expected to be material.
NOTE 3 – INTERIM FINANCIAL STATEMENTS
The unaudited condensed consolidated financial statements as of September 30, 2011 and for the three and nine months ended September 30, 2011 and 2010 have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q. In the opinion of management, the unaudited condensed consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the financial position as of September 30, 2011 and the results of operations and cash flows for the three and nine months ended September 30, 2011 and 2010. The financial data and other information disclosed in these notes to the interim financial statements related to these periods are unaudited. The results for the three and nine month periods ended September 30, 2011 is not necessarily indicative of the results to be expected for any subsequent quarter of the entire year ending December 31, 2011. The balance sheet at December 31, 2010 has been derived from the audited consolidated financial statements at that date.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the Securities and Exchange Commission’s rules and regulations. These unaudited condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto for the year ended December 31, 2010 included in our Form 10–K filed March 31, 2011.
NOTE 4 –
INVENTORY
Inventory at September 30, 2011 and December 31, 2010 consisted of:
|
|
2011
|
|
|
2010
|
|
|
|
(Unaudited)
|
|
|
|
|
Raw materials
|
|
$
|
24,940
|
|
|
$
|
45,827
|
|
Finished goods
|
|
|
7,743
|
|
|
|
37,840
|
|
Purchased fertilizers for resale in direct sales stores and branded stores
|
|
|
5,589
|
|
|
|
5,401
|
|
Other
|
|
|
2,616
|
|
|
|
2,528
|
|
Total inventory
|
|
$
|
40,888
|
|
|
$
|
91,596
|
|
NOTE 5 –
PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment, net, at September 30, 2011 and December 31, 2010 consisted of:
|
|
2011
|
|
|
2010
|
|
|
|
(Unaudited)
|
|
|
|
|
Buildings
|
|
$
|
282,269
|
|
|
$
|
272,763
|
|
Transportation equipment
|
|
|
243,649
|
|
|
|
235,446
|
|
Machinery and electronic equipment
|
|
|
380,796
|
|
|
|
367,329
|
|
Office equipment
|
|
|
3,753
|
|
|
|
3,626
|
|
|
|
|
910,467
|
|
|
|
879,164
|
|
Less accumulated depreciation
|
|
|
(348,808
|
)
|
|
|
(279,696
|
)
|
Property, plant and equipment, net
|
|
$
|
561,659
|
|
|
$
|
599,468
|
|
In August 2009, Xinsheng acquired two units in a building in Shannxi, China containing approximately 3,800 square feet of space for $261,195 (1,665,783 RMB). $135,755 (865,783 RMB) of the purchase price was paid in cash and the remaining $125,440 (800,000 RMB) was financed through two 10-year mortgages (see Note 10). For legal expediency reasons, the property and mortgages were acquired in the name of the Company’s Chairman of the Board of Directors.
In the first quarter of 2010, the Company acquired additional machinery and equipment from a vendor for $313,600 (2,000,000 RMB).
Depreciation expense was $19,032 and $18,723 for the three months ended September 30, 2011 and 2010, respectively, and $56,489 and $49,467 for the nine months ended September 30, 2011 and 2010, respectively.
NOTE 6 –
INVESTMENT IN TIENWE TECHNOLOGY INC
On July 29, 2005, Xinsheng acquired a 13.95% equity interest in Tienwe Technology Inc. (“Tienwe”), a PRC company, for $940,800 (6,000,000 RMB). To September 30, 2011, the investment was carried at cost. Tienwe shares are not quoted or traded on any securities exchange or in any recognized over-the-counter market; accordingly, it has not been practicable to estimate the fair value of the investment. Tienwe sells aerospace products to military industry customers. Since the 13.95% equity interest in Tienwe was acquired in 2005 the Company has received no return on this investment, such as distributions of income or dividends from Tienwe.
The major shareholders in Xinsheng informally determined (without a formal meeting vote) that based upon the lack of investment returns over the term of its investment and future prospects for investment returns from Tienwe, in September 2011, that the Company would informally contact the management of Tienwe seeking return of its 6,000,000 RMB ($940,800) investment. Tienwe informed the Company that Tienwe is not yet profitable because it continues to expend time and money on research and development, and orally offered to allow the Company to divest 50% of its investment in return for 3,000,000 RMB ($470,400) to be repaid within 2 months of Tienwe and the Company agreeing on those terms. The Company continues to negotiate with Tienwe regarding Xinsheng’s desire to divest itself of this investment. At September 30, 2011, the Company estimated, if negotiations are successful, that the sale of this investment might recover $627,200 (4,000,000 RMB) and accordingly, recorded a loss on investment in Tienwe Technology of $311,600 in the quarter ended September 30, 2011. Should negotiation be unsuccessful the Company may need to record an additional loss on this investment when the final agreement is reached.
NOTE 7 –
PREPAID LAND LEASE COSTS
Prepaid land lease costs at September 30, 2011 and December 31, 2010 consisted of:
|
|
2011
|
|
|
2010
|
|
|
|
(Unaudited)
|
|
|
|
|
Prepayment on November 12, 2010 of first 10 years rent pursuant to land lease (Note 16)
|
|
$
|
564,480
|
|
|
$
|
545,472
|
|
Accumulated amount recognized as rental expense
|
|
|
(49,392
|
)
|
|
|
(6,818
|
)
|
Balance
|
|
$
|
515,088
|
|
|
$
|
538,654
|
|
NOTE 8 –
INTANGIBLE ASSETS, NET
Intangible assets, net, at September 30, 2011 and December 31, 2010 consisted of:
|
|
2011
|
|
|
2010
|
|
|
|
(Unaudited)
|
|
|
|
|
Product rights
|
|
$
|
125,440
|
|
|
$
|
121,216
|
|
Patent
|
|
|
15,680
|
|
|
|
15,152
|
|
Trademark
|
|
|
2,343
|
|
|
|
2,264
|
|
Total
|
|
|
143,463
|
|
|
|
138,632
|
|
Less accumulated amortization
|
|
|
(36,007
|
)
|
|
|
(24,397
|
)
|
Net
|
|
$
|
107,456
|
|
|
$
|
114,235
|
|
In the first quarter of 2010, the Company acquired the Jiamei license, permits and product rights for $125,440 (800,000 RMB). These rights are amortized over their expected useful economic lives of 10 years.
The patent was acquired by Xinsheng in 2002 from three related parties (one of the parties was an officer, director and significant stockholder of the Company at the time of the exchange) in exchange for a total of 16.67% of the issued and outstanding shares of Xinsheng common stock. The patent (and contributed capital) at the date of the exchange on April 22, 2002 has been reflected at the transferors’ cost. The patent is for Zero-tillage Fertilizing Equipment (PRC Patent Number 330398), which is a type of seeding machine, the use of which reduces soil erosion.
At September 30, 2011, estimated amortization for the next five years and thereafter are as follows:
Year ending
September 30,
|
|
Amortization
|
|
|
|
(Unaudited)
|
|
2012
|
|
$
|
13,037
|
|
2013
|
|
|
12,600
|
|
2014
|
|
|
12,600
|
|
2015
|
|
|
12,600
|
|
2016
|
|
|
12,600
|
|
Thereafter
|
|
|
44,019
|
|
Total
|
|
$
|
107,456
|
|
NOTE 9 –
CONVERTIBLE NOTES PAYABLE, NET
On September 29, 2008, the Company completed the sale of 3% unsecured convertible notes in an aggregate principal amount of $500,000, and Series C warrants to purchase 500,000 shares of common stock, to two accredited investors. The Company received net proceeds of $431,500 after the deduction of Placement Agent commissions of $40,000, Placement Agent expense allowance of $25,000, and an escrow agent fee of $3,500.
The Notes matured two years from the date of issuance and bore interest at the rate of 3% per annum, which was payable annually in cash or in shares of common stock, subject to approval of the holder. Overdue interest was to bear interest at the rate of 15% per annum. Overdue principal was to bear interest at the rate of 8% per annum. The Notes were convertible at the option of the holder into the common stock of the Company at an initial conversion price of $0.50 per share. The conversion price was subject to adjustment upon the occurrence of stock splits, combinations, dividends and subsequent offerings.
The Series C warrants had a term of three years and were exercisable into shares of common stock at an exercise price of $1.50 per share. Upon exercise of a Series C warrant, in addition to receiving shares of common stock, each Series C warrant holder was issued a Series D warrant to purchase additional shares of common stock in an amount equal to the number of Series C warrants exercised. The Series D warrants have a term of three years and an exercise price of $2.00 per share. The exercise price of the warrants is subject to adjustment upon the occurrence of stock splits, combinations, dividends and subsequent offerings, as set forth in the warrants.
The Company had the right to prepay the Notes at 110% of the outstanding principal amount any time prior to the maturity date and upon 30 days prior written notice to the holders. The Company could call for the termination of any unexercised portion of the Series C warrants upon consummation of a subsequent offering by the Company of not less than $7,500,000 in gross proceeds and upon 30 days written notice to the holders. Upon termination of any unexercised Series C warrants, the warrant holders would not receive any Series D warrants, any shares underlying the Series C or Series D warrants, or any other securities.
In connection with the transaction, the Company agreed to prepare and file a registration statement with the Securities and Exchange Commission (the “SEC”) within 60 days following the final closing date. In addition, if the registration statement was not declared effective within 120 days from the filing date, the Company was subject to monthly cash liquidated damages payments equal to 2% of the purchase price paid by each investor, subject to a maximum of 24%. On February 13, 2009, the Company filed a registration statement on Form S-1 to register the shares underlying the convertible notes and warrants. In response to SEC comment letters, the Company filed amendments to the registration statement on Form S-1. The Company and the investors entered into agreements extending the date that the Form S-1 was required to become effective to October 30, 2009. The registration statement on Form S-1 was declared effective on November 16, 2009. The Company accrued $734 liquidated damages under the registration rights agreement payable to the investors as of November 16, 2009.
The Company recorded the $149,615 relative fair value of the warrants ($78,136 for the Series C warrants; $71,479 for the Series D warrants) and the $49,615 intrinsic value of the beneficial conversion feature as additional paid in capital.
The $149,615 fair value of the Series C and Series D warrants was calculated using a Black-Scholes option pricing model and the following assumptions: risk-free interest rate of 2.26%; expected stock price volatility of 130.69%; stock price of $0.40 per share; exercise price of $1.50 per share for the Series C warrants and $2.00 per share for the Series D warrants; and term of 3 years.
In connection with the private placement, the placement agent received warrants to purchase 80,000 shares of the Company’s common stock at an exercise price of $1.00 per share for a term of three years. The $19,920 fair value of these warrants (calculated using the same assumptions described above except for the exercise price) was charged to deferred financing costs and added to additional paid in capital. On October 9, 2009, the Company issued warrants to purchase 1,000 shares of the Company’s common stock at an exercise price of $1.00 per share for a term of three years for services rendered and waiving registration rights. The $426 fair value of these warrants (calculated using the same assumptions described above except for the exercise price) was charged to current financing cost and added to additional paid in capital. In September 2011, the Company agreed to extend the expiration date of above-mentioned warrants to September 30, 2012.
On September 29, 2010, the maturity date of the Convertible Notes, the Company repaid the Notes principal of $500,000 together with the interest accrued on the Notes in the amount of $15,000.
On December 17, 2010, the investors exercised 160,000 Series C Warrants at a price of $1.50 per share. The Company received $240,000 in cash and issued 160,000 shares of common stock and 160,000 Series D Warrants to the investors.
NOTE 10 –
LONG-TERM DEBT
Long-term debt represents mortgages payable to Xian Commerce Bank in connection with Xinsheng’s acquisition of two units in a building in August 2009 (see Note 5). The mortgages, which had a total initial balance of $125,440 (800,000 RMB), are secured by the units, bear interest at an annual rate of 6.53% and are due in monthly installments of interest and principal of approximately $1,426 (9,097 RMB) to August 6, 2019.
At September 30, 2011, maturities of the Long-term Debt for the next five years and in total are as follows:
Year ending
September 30,
|
|
Amount
|
|
|
|
(Unaudited)
|
|
2012
|
|
$
|
10,531
|
|
2013
|
|
|
11,240
|
|
2014
|
|
|
11,997
|
|
2015
|
|
|
12,805
|
|
2016
|
|
|
13,667
|
|
Thereafter
|
|
|
45,625
|
|
Total
|
|
$
|
105,865
|
|
|
|
|
|
|
Interest expense incurred on the Long-term Debt during the three months ended September 30, 2011 and 2010 was $1,723 and $1,893, respectively; and for the nine months ended September 30, 2011 and 2010 was $5,285 and $5,607, respectively.
NOTE 11 –
COMMON STOCK
On October 11, 2007, upon the completion of the public offering, China Agri sold 379,800 units at a price of $1.00 per unit to public investors. Each Unit consisted of one share of Common Stock, one warrant to purchase one share of Common Stock at $1.50 per share exercisable for three years from the date of issuance, and one warrant to purchase one share of Common Stock at $2.00 per share exercisable for three years from the date of issuance only if the $1.50 Unit Warrant was exercised.
On December 17, 2010, the Company issued 160,000 shares of its common stock to the two investors involved in our September 29, 2008 sale of $500,000 convertible notes payable (see Note 9) as a result of the investors’ exercise of 160,000 Series C warrants at $1.50 per share.
NOTE 12 –
WARRANTS AND OPTIONS
The Company has issued warrants (exercisable into shares of common stock) to investors, the underwriter of its initial public offering and placement agent as part of its sale of Series A preferred stock, public offering, and private placement of convertible notes. Changes in the warrants outstanding are as follows:
|
|
Nine Months Ended
September 30, 2011
|
|
|
Year Ended
December 31, 2010
|
|
|
|
(Unaudited)
|
|
|
|
|
Outstanding at beginning of period
|
|
|
618,980
|
|
|
|
1,378,580
|
|
Warrants issued
|
|
|
-
|
|
|
|
160,000
|
|
Warrants exercised
|
|
|
-
|
|
|
|
(160,000
|
)
|
Warrants expired
|
|
|
(340,000
|
)
|
|
|
(759,600
|
)
|
Outstanding at end of period
|
|
|
278,980
|
|
|
|
618,980
|
|
|
|
|
|
|
|
|
|
|
Exercisable at end of period
|
|
|
278,980
|
|
|
|
618,980
|
|
Warrants outstanding at September 30, 2011 consisted of:
Date Issued
|
|
Expiration Date
|
|
Number of
Warrants
|
|
|
Weighted Average
Exercise Price
|
|
October 11, 2007
|
|
October 10, 2012
|
|
|
37,980
|
|
|
$
|
1.00
|
|
September 29, 2008
|
|
September 30, 2012
|
|
|
80,000
|
|
|
|
1.00
|
|
December 17, 2010 (1)
|
|
December 17, 2013
|
|
|
160,000
|
|
|
|
2.00
|
|
October 9, 2009
|
|
October 9, 2012
|
|
|
1,000
|
|
|
|
1.00
|
|
Total (Unaudited)
|
|
|
|
|
278,980
|
|
|
$
|
1.57
|
|
(1) Represents Series D warratns.
Effective January 1, 2011, the Company decided to grant stock options to its chief financial officer and to an outside director as part of their year 2011 compensation package. The number of options and specified terms were formalized pursuant to a unanimous written consent of the Board of Directors dated May 16, 2011, whereby the Company granted 257,544 stock options to its chief financial officer and granted 171,696 stock options to an outside director. The exercise price of the options is $1.16, the market closing price at May 13, 2011. These stock options expire on May 16, 2014. The $392,755 estimated fair value of these stock options is being expensed evenly over the year ending December 31, 2011, since the actual option grant instrument provides for the services of these individuals already performed to the date of the grant and services to be performed in 2011.
The $392,755 fair value of the stock options was calculated using a Black-Scholes option pricing model and the following assumptions: risk-free interest rate of 2.00%; expected stock price volatility of 142.36%; stock price of $1.16 per share; exercise price of $1.16 per share; and term of 3 years.
As of September 30, 2011, none of the stock options had been exercised into common stock.
NOTE 13 –
RESTRICTED NET ASSETS
Relevant PRC statutory laws and regulations permit payments of dividends by Meixin and Xinsheng only out of its retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. In addition, PRC laws and regulations require that annual appropriations of 10% of after-tax income should be set aside prior to payments of dividends as a reserve fund. As a result of these PRC laws and regulations, the Company is restricted in its ability to transfer a portion of its net assets in the form of dividends, loans or advances. The restricted portion amounted to approximately $5,978,384 and $5,485,448 at September 30, 2011 and December 31, 2010, respectively.
NOTE 14 –
INCOME TAXES
Xinsheng is subject to a PRC 25% standard enterprise income tax. However, due to its agricultural industry status, the National Tax Bureau in Xi’an High-Tech Development Zone has granted Xinsheng exemptions from this tax since 2006. The Company has to apply for exemption status on an annual basis.
At September 30, 2011 and December 31, 2010, the Company had an unrecognized deferred United States income tax liability relating to undistributed earnings of Xinsheng. These earnings are considered to be permanently invested in operations outside the United States. Generally, such earnings become subject to United States income tax upon the remittance of dividends and under certain other circumstances. Determination of the amount of the unrecognized deferred United States income tax liability with respect to such earnings is not practicable.
Based on management’s present assessment, the Company has not yet determined it to be more likely than not that a deferred tax asset of approximately $388,000 ($327,000 at December 31, 2010) attributable to the future utilization of the approximately $1,109,000 net operating loss carry-forward of China Agri as of Septemper 30, 2011 will be realized. Accordingly, the Company has maintained a 100% allowance against the deferred tax asset in the financial statements at September 30, 2011. The Company will continue to review this valuation allowance and make adjustments as appropriate. The net operating loss carry-forward expires in varying amounts from year 2025 to year 2031.
Current United States income tax laws limit the amount of loss available to be offset against future taxable income when a substantial change in ownership occurs. Therefore, the amount available to offset future taxable income may be limited.
The provisions for income taxes differ from the amounts computed by applying the statutory United States federal income tax rate to income (loss) before income taxes. Reconciliations for the three and nine months ended September 30, 2011 and 2010 follow:
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2011
|
|
|
2010
|
|
|
2011
|
|
|
2010
|
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
Expected tax at 35%
|
|
$
|
632,482
|
|
|
$
|
313,594
|
|
|
$
|
1,725,277
|
|
|
$
|
693,355
|
|
Tax effect of unutilized losses of China Agri and Meixin
|
|
|
52,637
|
|
|
|
37,239
|
|
|
|
173,797
|
|
|
|
121,160
|
|
Effect of PRC income tax exemption granted to Xinsheng
|
|
|
(489,371
|
)
|
|
|
(250,596
|
)
|
|
|
(1,356,481
|
)
|
|
|
(581,796
|
)
|
Permanent difference relating to Xinsheng's earnings to be permanently invested in operations outside the United States
|
|
|
(195,748
|
)
|
|
|
(100,237
|
)
|
|
|
(542,593
|
)
|
|
|
(232,719
|
)
|
Actual provision for income taxes
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
NOTE 15 –
SEGMENT INFORMATION
The Company operates in one industry segment – the manufacturing and sale of agricultural enhancement products. Substantially all of the Company’s identifiable assets at September 30, 2011 and December 31, 2010 were located in the PRC. Net sales for the periods presented were all derived from PRC customers.
In 2008, the Company launched a new sales and marketing initiative to establish a closer relationship with farmers through agricultural cooperatives located throughout the rural areas of China. One component of this initiative is called the “Super Chain Sales Partner Program”, which involves stores branded under the name of “Xinsheng Shiji” but owned and managed by third parties. The other is called “Direct Sales Stores”. The Direct Sales Stores were controlled and managed by the Company until December 2010. In December 2010, the Company outsourced the operation and ownership of the Direct Sales Stores to subcontractors who bear the risk of operations of the stores. Since both the “super chain sales stores” and the “outsourced direct sales stores” operate under the name of “Xinsheng Shiji”, we refer to these stores as the “Xinsheng Shiji” branded stores. There are approximately 630 branded stores as of September 30, 2011. The majority of branded stores are located in Shannxi Province (local province); others are located in Hunan and Sichuan provinces. For the three and nine months ended September 30, 2011, approximately 66% and 67%, respectively, of revenue was generated from our branded and outsourced direct sales stores, and approximately 34% and 33%, respectively, from traditional sales channels.
Sales by Sales Network
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2011
|
|
|
2010
|
|
|
2011
|
|
|
2010
|
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
Branded sales stores
|
|
$
|
2,451,984
|
|
|
|
65.58
|
%
|
|
$
|
2,545,107
|
|
|
|
72.09
|
%
|
|
$
|
6,243,641
|
|
|
|
66.91
|
%
|
|
$
|
6,741,766
|
|
|
|
79.09
|
%
|
Traditional sales network
|
|
|
1,287,033
|
|
|
|
34.42
|
%
|
|
|
985,456
|
|
|
|
27.91
|
%
|
|
|
3,087,790
|
|
|
|
33.09
|
%
|
|
|
1,782,312
|
|
|
|
20.91
|
%
|
Total Sales
|
|
$
|
3,739,017
|
|
|
|
100.00
|
%
|
|
$
|
3,530,563
|
|
|
|
100.00
|
%
|
|
$
|
9,331,431
|
|
|
|
100.00
|
%
|
|
$
|
8,524,078
|
|
|
|
100.00
|
%
|
NOTE 16 –
COMMITMENTS AND CONTINGENCIES
Lease Agreements
Xinsheng leased its office space (approximately 7300 square feet) at an annual rent of 366,390 RMB ($57,450) under a lease with a three year term expiring March 31, 2011. The Company terminated this lease on October 1, 2009 after relocating to its new purchased two units in a building (see Note 5). On October 1, 2009, the Company signed a new lease with the same landlord for office space of 344 square feet at an annual rent of 12,000 RMB ($1,882). This one year lease expired on September 30, 2010. The Company did not renew the lease but with the permission of the landlord continues to use the leased premises for the same rent.
Xinsheng leases its operating and testing space (approximately 2600 square feet) at an annual rent of 38,500 RMB ($6,037) under a lease which expired March 31, 2010. The Company did not renew the lease but with the permission of the landlord continues to use the leased premises for the same rent.
On November 12, 2010, Xinsheng entered into a Land Leasing Contract with Xi’an Shishang Weiyang Investment & Management, Inc. pursuant to which the Company agreed to lease 24 mu of land (one mu is equivalent to approximately 0.165 acres) located in Zhongcha Village, Petrochemical Road, Weiyang District, Xi’an, China. Pursuant to the terms of the lease, the Company has the right to construct warehouses and processing centers on the land. The Company plans to build a warehouse and distribution center for the Company’s and other organic manufacturers’ products.
The term of the lease is twenty-one years, from November 12, 2010 through November 12, 2031. The Company is obligated to pay rent of RMB 360,000 ($56,448) per year. Rent for the first ten years totaling RMB 3,600,000 ($564,480) was paid in November 2010 pursuant to the lease, which amount is being expensed as rent expense using the straight line method over the 10 year period of the prepayment. The annual rental will increase by 12% every three years starting on November 12, 2020. Upon the expiration of the lease, the Company has a right of first refusal with regard to contract renewal.
China Agri utilizes office space provided by one of its directors at no cost.
For the three months ended September 30, 2011 and 2010, rental and related expenses for all operating leases amounted to $110,126 and $68,361, respectively. For the nine months ended September 30, 2011 and 2010, rental and related expenses for all operating leases amounted to $143,067 and $149,984, respectively.
At September 30, 2011, future minimum rental commitments (excluding the $564,480 rent prepaid for the first 10 years of the land lease described above) under all non-cancellable operating leases were:
Year Ending
September 30,
|
|
Minimum
Rent
|
|
2012
|
|
$
|
-
|
|
2013
|
|
|
-
|
|
2014
|
|
|
-
|
|
2015
|
|
|
-
|
|
2016
|
|
|
-
|
|
Thereafter
|
|
|
806,804
|
|
Total
|
|
$
|
806,804
|
|
Construction Contract
On March 21, 2011, Xinsheng entered into a contract with a general construction contractor to build a warehouse and distribution center for Xinsheng’s products on the property subject to the land lease discussed above. The estimated cost of the construction is approximately 3,000,000 RMB ($470,400). The construction will commence after receipt of approval of our plans from the local government.
Consulting Agreement
On March 31, 2010, the Company entered into an Investor and Media Relations Service Agreement with Christensen International Limited (“Christensen”). Pursuant to the agreement, Christensen was to provide investor relations services to the Company for a term of one year and the Company was to pay Christensen a total of $100,000 in fees, payable quarterly at the beginning of each quarter. The Company paid $25,000 in the second quarter of 2010 and then decided to terminate the service contract with Christensen.
Qinfeng Operation Agreement
On June 24, 2011, the Company, through its Chinese operating subsidiary, Xinsheng, acquired the right to manage and operate Shaanxi Qinfeng Agrochemical Inc. (“Qinfeng”) in Xi’an, China. Qinfeng is an agrochemical manufacturer. Currently, Qinfeng has an annual production capacity of 400 metric tons of diafenthiuron, 600 metric tons of prochloraz, and approximately 5,000 metric tons of seed coating agents and preparations.
Pursuant to the management and operating agreement with Qinfeng, the Company will manage Qinfeng’s operations from June 1, 2011 until December 31, 2013. The Company is entitled to the net profits or losses from the operations of Qinfeng during the Term. During the term, the Company has rights to use Qinfeng’s production facilities and intangible assets (i.e. trade names, trademarks, and certain licenses), to hire and dismiss employees, to file all applicable registrations with government authorities, and to coordinate with third parties in connection with technical development and production.
The Company agreed: (1) to manage Qinfeng’s assets and production lawfully; if production is unreasonably interrupted continually more than two months, Qinfeng may terminate the Agreement and hold the Company responsible for all resulting losses; (2) to be responsible for payment of all taxes and fees, except taxes relating to housing and land and pre-existing taxes and fees; (3) to be responsible for the safeguard of Qinfeng’s assets and intangible assets; (4) to be responsible for the safety of production and annual safety production inspections; (5) to be responsible for the validation and registration of fertilizer licenses; (6) to be responsible for the maintenance of current facilities and new equipment if needed; (7) to be responsible for the purchase of workers’ compensation insurance; (8) to be responsible for the payment of wages and salaries; (9) to be responsible for all civil administrative and criminal charges in connection with the operation of Qinfeng’s assets that occur during the Term.
As consideration for entering into the agreement, the Company paid Qinfeng 1,200,000 RMB (approximately $188,160) on June 14, 2011. The $188,160 was included in prepaid expenses at June 30, 2011 and is being expensed as a rental expense evenly over the six months ending December 31, 2011. From January 1, 2012 to December 31, 2013, the Company must pay an aggregate of 2,400,000 RMB each year to Qinfeng, payable in installments of 1,200,000 RMB (approximately $188,160) due within the first 15 business days of January and July of each year.
During the term of the agreement, the Company has a right of first refusal to purchase any shares of Qinfeng owned by Qinfeng’s controlling shareholder on the same terms as those offered by the third party offeror. Upon the expiration of the Agreement, if Qinfeng decides to continue to lease, transfer or sell its operations, and if the Company’s performance under the Agreement has been satisfactory, the Company has a right of first refusal on the same terms as those offered by the third party offeror.
The Qinfeng facility is not yet in operation. The Company is conducting technical tests and equipment adjustments for the products.
Potential Acquisition of Land Use Rights
On October 21, 2009, Xinsheng received an approval letter from the Bureau of Foreign Trade and Economic Cooperation of Lantian County of Xinsheng’s application to purchase land use rights in Lantian County to establish “Xinsheng Centennial Industrial Zone”. Xinsheng intends to purchase the land use rights for 66 acres for a term of 30 years. The land use rights purchase cost is expected to be approximately $4,390,400 (28,000,000 RMB). In addition, the estimated cost for relocation of local dwellers is expected to be approximately $319,872 (2,040,000 RMB). As of the filing date of this Form 10-Q, the transaction has not yet been finalized due to the delay in processing by the local government.
PRC Risks
Substantially all of the Company’s business operations are conducted in the PRC and governed by PRC laws and regulations. Meixin and Xinsheng are generally subject to laws and regulations applicable to foreign investments and foreign-owned enterprises. Because these laws and regulations are relatively new, the interpretation and enforcement of these laws and regulations involve uncertainties.
The PRC government imposes controls on the convertibility of RMB into foreign currencies and, in certain cases, the remittance of currency out of the PRC. The Company receives substantially all of its revenues in RMB, which is currently not a freely convertible currency. Under existing PRC foreign exchange regulations, payment of current account items, including profit distributions, interest payments and expenditures from the transaction, can be made in foreign currencies without prior approval from the PRC State Administration of Foreign Exchange by complying with certain procedural requirements. However, approval from appropriate governmental authorities is required where RMB is to be converted into foreign currency and remitted out of the PRC to pay capital expenses, such as the repayment of bank loans denominated in foreign currencies. The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions.
NOTE 17 –
CONCENTRATION OF CREDIT RISK
The Company maintains cash balances that are held in five banks in China. Currently, no deposit insurance system has been set up in China. Therefore, the Company will bear a risk if any of these banks become insolvent. As of September 30, 2011 and December 31, 2010, the Company’s uninsured cash balances were approximately $19,088,904 and $13,008,000 respectively.