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CMFO > SEC Filings for CMFO > Form 10-Q on 10-Nov-2011All Recent SEC Filings

Show all filings for CHINA MARINE FOOD GROUP LTD

Form 10-Q for CHINA MARINE FOOD GROUP LTD


10-Nov-2011

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

The following review concerns the nine months ended September 30, 2011 and 2010, which should be read in conjunction with the financial statements and notes thereto presented in the Form 10-Q.

Forward Looking Statements

The information in this discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements involve risks and uncertainties, including statements regarding our capital needs, business strategy and expectations. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as "may", "will", "should", "expect", "plan", "intend", "anticipate", "believe", "estimate", "predict", "potential" or "continue", the negative of such terms or other comparable terminology. Actual events or results may differ materially. We disclaim any obligation to publicly update these statements, or disclose any difference between its actual results and those reflected in these statements. The information constitutes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

OVERVIEW

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

Reverse acquisition and private placement

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


Pursuant to the Share Exchange Agreement, the former shareholders of Ocean Technology exchanged 100% of their outstanding capital stock in Ocean Technology for approximately 15,624,034 shares of our common stock, or approximately 93.15% of our outstanding shares of common stock after the share exchange. In connection with the share exchange, a majority of our shareholders of record as of November 16, 2007 approved a resolution by our Board of Directors to change our name from New Paradigm Productions, Inc. to China Marine Food Group Limited ("China Marine"). The name change became effective on January 9, 2008 upon the filing of a Certificate of Amendment to our Amended Articles of Incorporation with the State of Nevada on the twentieth day following the mailing of a Definitive Information Statement to our shareholders.

Concurrently with the closing of the reverse acquisition on November 17, 2007, we completed a private placement of our securities to certain accredited investors who subscribed for units consisting of one share of common stock and a warrant to purchase one-fifth of one share of our common stock. The investors subscribed for aggregate of 6,199,441 shares of our common stock and warrants to purchase an aggregate of 1,239,888 shares of our common stock at $3.214 per unit. The units were offered and sold pursuant to exemptions from registration under the Securities Act, including without limitation, Regulation D and Regulation S promulgated under the Securities Act. Each warrant issued to the investors had a term of three years and was exercisable at any time for a price equal to $4.1782 in cash or on a cashless exercise basis. All unexercised warrants expired in November 2010.

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

Sales

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

Our two other subsidiaries, Rixiang and Jixiang are property holding companies. These two companies operate to manage our land use rights and properties, including our production plant, cold storage facility, office tower and staff dormitory. All rental income, which is relatively immaterial, compared to our principal revenues from sale of processed seafood products, beverage products and trading of marine catch, is recognized as "Other Income" in our financial statements. In particular, Mingxiang and Rixiang are responsible for the rental income related to the collection on the 31 and 6 shop spaces, respectively, at our factory in the Dabao Industrial Zone. The rental contracts are based on a one-year lease term.

Our dried processed seafood products include dried prawns, dried squids, dried file fish, roasted prawns, shredded roasted squids, roasted squids, roasted file fish and other seafood items. Our dried processed seafood is predominantly sold under our registered trademark, the "Mingxiang" brand name. Our brand name has been awarded the "Fujian Famous Brand" award by the Fujian Commerce Authority. Our dried processed seafood products are mainly sold to distributors in Fujian and Zhejiang provinces, who in turn distribute them to major supermarkets and retailers throughout these provinces.

The raw materials for our processed seafood products are solely purchased from independent fishermen in nearby markets for further processing. In respect of the sales of marine catch, we simply buy the marine catch from the suppliers and then sell to the customers on a direct basis. The marine catch is predominantly sold to distributors in Liaoning, Fujian and Shandong provinces, some of whom directly export the marine catch to South Korea and Taiwan, and overseas customers in the Philippines.

On January 1, 2010, Mingxiang exercised its option to acquire 80% of the registered capital stock (the "Shares") of Xianghe pursuant to the terms of a share purchase agreement dated January 1, 2010. Xianghe is a Fujian-based manufacturer of the branded Hi-Power algae-based soft drinks. Hi-Power was developed by the Yellow Sea Fisheries Research Institute at Chinese Academy of Fishery Sciences in coordination with the founder, Qiu. Hi-Power is marketed as a high-protein content drink, low in calories and fat, which provides the consumers a combination of immune system benefits, improved digestion and reductions in hyperglycemia and hypertension. Hi-Power's target market focuses on health-conscious consumers in China's fast-growing beverage market. Xianghe has a network of distributors in Fujian and Zhejiang which sell Hi-Power to retail food stores, restaurants, food supply dealers and the hospitality industry.


Sales of our processed seafood products accounted for approximately 46.7% and 70.0% of our total sales in the third quarter of 2011 and 2010, respectively. Sales of our algae-based beverage products accounted for approximately 27.3% and 29.7% of our total sales in the third quarter of 2011 and 2010, respectively. Trading of marine catch accounted for approximately 26.0% and 0.3% in the third quarter of 2011 and 2010, respectively. We expect the sales of our algae-based beverage products will remain strong in the coming years given our continuous expansion into untapped areas and contribution over the related sales and marketing campaigns since our acquisition at the beginning of 2010.

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

Factors that can affect our sales are as follows:

The level of sales is dependent on the supply of raw materials on a timely basis. Raw material costs accounted for approximately 73.0% and 75.3% of our total cost of revenue of processed seafood products in the third quarter of 2011 and 2010, respectively. The availability of these raw materials could be affected by a large number of factors, including, inter alia, the availability of fish stock, weather conditions, water contamination, government policies and regulations where such fishing is carried out, the stability of supplies from fishermen and pressure from environmental or animal rights groups.

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

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

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

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

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

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

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

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

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

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


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

Production facilities and employees

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

As at September 30, 2011, we employed 918 employees.

Seasonality

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

NEW BUSINESS DEVELOPMENT

Acquisition of land for development of cold storage facilities

On November 6, 2009, we won the auction for the purchase of the 40-year use right of a land in Shishi City, Fujian. Covering an area of 8,691.4 square meters, the land is located next to the fishing port and our production facilities in the same city. The purchase price for the land use right is $2.3 million which has been fully paid as of December 31, 2009.

In September, 2010, we began to build cold storage facilities on the land with a capacity of approximately 20,000 tons, to take advantage of its proximity to the port where we obtain fresh marine catch to be processed into seafood products. We are financing the total estimated $26.3 million in land use rights and construction costs from funds generated by operations and the facilities are expected to be operational by the end of 2011. Subsequent to full settlement of the land cost, a formal agreement with the local land and resources department was executed on December 30, 2009. We have paid approximately $20.1 million in relation to the construction costs as at September 30, 2011 and the total estimated construction costs are approximately $24.0 million.

We entered into an agreement with a third party contractor in 2010 to build the cold storage facilities, and a supplementary agreement in September 2011 in relation to the additional gross areas, machineries and equipment required for the facility.

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

RESULTS OF OPERATIONS

We derive our sales from the sales of processed seafood products, marine catch
and algae-based beverage products, the breakdown of our sales and gross profit
by product, as well as by geographical location of our customers for the three
and nine months ended September 30, 2011 and 2010 are set out below:

Breakdown of our past performance by principal products and geographical region

Sales by product

                                      Three months ended September 30,                   Nine months ended September 30,
                                  2011                     2010                     2011                     2010
                                US$'000         %        US$'000         %        US$'000         %        US$'000         %

Processed seafood products        14,441        46.7       15,855        70.0       47,733        59.9       51,748        74.0
Marine catch                       8,033        26.0           72         0.3        8,109        10.2          823         1.2
Algae-based beverage products      8,444        27.3        6,735        29.7       23,802        29.9       17,299        24.8
Total                             30,918       100.0       22,662       100.0       79,644       100.0       69,870       100.0


Sales by geographical region

                                                     Three months ended September 30, 2011
                        Processed seafood                                       Algae-based
                             products              Marine catch (3)          beverage products               Total
                       US$'000          %         US$'000         %         US$'000          %        US$'000         %
PRC
Shandong                   1,324         9.2             -           -              -           -        1,324         4.3
Zhejiang                   5,839        40.4             -           -          1,838        21.8        7,677        24.8
Fujian                     6,636        46.0             -           -          6,606        78.2       13,242        42.8
Guangdong/ Shenzhen          642         4.4             -           -              -           -          642         2.1
Jiangsu/ Shanghai              -           -             -           -              -           -            -           -
Sichuan/ Chongqing             -           -             -           -              -           -            -           -
Others                         -           -         8,033       100.0              -           -        8,033        26.0
Total PRC (1)             14,441       100.0         8,033       100.0          8,444       100.0       30,918       100.0
Asia (2)                       -           -             -           -              -           -            -           -
Total                     14,441       100.0         8,033       100.0          8,444       100.0       30,918       100.0



                                                       Three months ended September 30, 2010
                        Processed seafood                                          Algae-based
                             products                Marine catch (3)           beverage products               Total
                       US$'000          %         US$'000           %          US$'000          %        US$'000         %
PRC
Shandong                   1,385         8.7             -              -              -           -        1,385         6.1
Zhejiang                   7,053        44.5             -              -              -           -        7,053        31.1
Fujian                     5,024        31.7             1            1.4          6,373        94.6       11,398        50.3
Guangdong/ Shenzhen        1,031         6.5             -              -            156         2.3        1,187         5.3
Jiangsu/ Shanghai            968         6.1             -              -            206         3.1        1,174         5.2
Sichuan/ Chongqing           394         2.5             -              -              -           -          394         1.7
Others                         -           -             -              -              -           -            -           -
Total PRC (1)             15,855       100.0             1            1.4          6,735       100.0       22,591        99.7
Asia (2)                       -           -            71           98.6              -           -           71         0.3
Total                     15,855       100.0            72          100.0          6,735       100.0       22,662       100.0


                                                                Nine months ended September 30, 2011
                                 Processed seafood                                         Algae-based
                                      products               Marine catch (3)           beverage products               Total
                                US$'000          %         US$'000          %          US$'000          %        US$'000         %
PRC
Shandong                            4,122         8.6              -            -              -           -        4,122         5.2
Zhejiang                           20,135        42.2              -            -          2,807        11.8       22,942        28.8
Fujian                             20,200        42.3              -            -         20,995        88.2       41,195        51.7
Guangdong/ Shenzhen                 2,182         4.6              -            -              -           -        2,182         2.7
Jiangsu/ Shanghai                   1,090         2.3              -            -              -           -        1,090         1.4
Sichuan/ Chongqing                      -           -              -            -              -           -            -           -
Others                                  4         0.0          8,033         99.1              -           -        8,037        10.1
Total PRC (1)                      47,733       100.0         8, 033         99.1         23,802       100.0       79,568        99.9
Asia (2)                                -           -             76          0.9              -           -           76         0.1
Total                              47,733       100.0          8,109       100. 0         23,802       100.0       79,644       100.0



                                                                Nine months ended September 30, 2010
                                  Processed seafood                                        Algae-based
                                       products               Marine catch (3)          beverage products               Total
                                 US$'000          %        US$'000           %         US$'000          %        US$'000         %
PRC
Shandong                             4,092         7.9            -             -              -           -        4,092         5.9
Zhejiang                            22,680        43.8            -             -            140         0.8       22,820        32.6
Fujian                              16,692        32.3          352          42.8         15,609        90.2       32,653        46.7
Guangdong/ Shenzhen                  3,736         7.2            -             -          1,042         6.0        4,778         6.8
Jiangsu/ Shanghai                    2,955         5.7            -             -            460         2.7        3,415         4.9
Sichuan/ Chongqing                   1,592         3.1            -             -              -           -        1,592         2.3
Others                                   1         0.0            -             -             48         0.3           49         0.1
Total PRC (1)                       51,748       100.0          352          42.8         17,299       100.0       69,399        99.3
Asia (2)                                 -           -          471          57.2              -           -          471         0.7
Total                               51,748       100.0          823         100.0         17,299       100.0       69,870       100.0

Notes:

(1) Sales to PRC include sales to local PRC distributors who in turn sell our products to Taiwan. Such sales amounted to $nil and $0.4 million for the nine months ended September 30, 2011 and 2010, respectively.

(2) Sales to Asia mainly relate to exports to the Philippines.

(3) Marine catch sales are deemed as opportunistic trading of fresh seafood in blocks and therefore the sales volume could be fluctuated significantly quarter over quarter.


Three months ended September 30, 2011 compared to three months ended September 30, 2010, and
Nine months ended September 30, 2011 compared to nine months ended September 30, 2010

Sales

Our revenue increased by approximately $8.2 million or 36.4% from $22.7 million for the three months ended September 30, 2010 to $30.9 million for the same period ended September 30, 2011. The increase in revenue was mainly due to the increase in sales of marine catch and the newly acquired algae-based beverage business, partially offset by the softness in sales of our processed seafood products as a result of consumers' perception of food safety in relation to the nuclear radiation leaks in Japan earlier this year. Sales of our processed seafood products decreased by $1.4 million or 8.9% year over year to $14.4 million, whereas sales of algae-based beverage products increased by $1.7 million or 25.4% to $8.4 million for the same periods under review. Sales of marine catch accounted for approximately $8.0 million for the three months ended September 30, 2011 compared to less than $0.1 million for the same period last year.

Similarly, our revenue during the nine months ended September 30, 2011 increased to $79.6 million by approximately $9.8 million or 14.0% compared to $69.9 million we realized during the nine months ended September 30, 2010. Sales of our processed seafood products decreased by $4.0 million or 7.8% to $47.7 million, whereas sales of algae-based beverage products increased by $6.5 million or 37.6% to $23.8 million. Sales of our marine catch segment increased by $7.3 million to $8.1 million for the same periods under review.

The processed seafood products operations continued to grow significantly during the first quarter of 2011 as our products continue to gain market acceptance, particularly in Zhejiang and Fujian provinces. As a result of consumers' perception of food safety in relation to the nuclear radiation leaks in Japan earlier this year, sales of processed seafood products declined in the second and third quarters of 2011 compared to the same period in 2010. However, we believe that our sales have stabilized as of September 30, 2011. While we are confident that the seafood we use to produce our processed seafood products are safe, it is unclear how long it will take for consumer confidence in seafood products to normalize.

This is the second year for our recognition of sales of our algae-based beverage products since the acquisition on January 1, 2010. We have reorganized the distribution network of our beverage segment and reduced our coverage solely to Fujian province during 2010. After gaining experience in Fujian last year, we expanded our distribution into Zhejiang province in the second quarter of this year. Given our continuous contribution to the related sales and marketing campaigns and our expansion plan into more untapped areas, we expect the sales of our beverage segment to remain strong in the coming years. Accordingly, the number of sales staff has increased significantly since January 1, 2010 from 23 to 159, as of September 30, 2011.

Having recognized that the processed seafood and algae-based beverage products segments have significant growth potential and attractive profit margin, we will continue to focus our resources on these two segments.

Cost of revenue

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

                                      Three months ended September 30,                   Nine months ended September 30,
                                  2011                     2010                     2011                     2010
                                US$'000         %        US$'000         %        US$'000         %        US$'000         %

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