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CMFO > SEC Filings for CMFO > Form 10-Q on 14-Aug-2013All Recent SEC Filings

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Form 10-Q for CHINA MARINE FOOD GROUP LTD


14-Aug-2013

Quarterly Report


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

The following review concerns the six months ended June 30, 2013 and 2012, 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") and Shishi Huabao Mingxiang Foods Co., Ltd. ("Mingxiang"), Shishi Xianghe Food Science and Technology Co., Ltd. ("Xianghe"), 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 trading of marine catch and ices. 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.

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 an 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, each unit consisting of one share of common stock and a warrant to purchase one-fifth of one share of our common stock. Each warrant issued to the investors had a term of three years and all unexercised warrants expired in November 2010.

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 and ices. 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.

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 Dabao Industrial Zone. A majority of these rental contracts are based on a one-year lease term and only one rental contract is based on a four-year lease term.


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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. The raw materials for our processed seafood products are solely purchased from independent fishermen in nearby markets for further processing. Our dried processed seafood is predominantly sold under our registered trademark, the "Mingxiang" brand name. Our brand name has been awarded the "China Well-Known Trademark" and the "Fujian Famous Brand" award by the State Administration for Industry and Commerce and the Fujian Commerce Authority, respectively. Our dried processed seafood products are mainly sold to distributors in Fujian and Zhejiang provinces, as well other nearby provinces, who in turn distribute them to major supermarkets and retailers throughout these provinces.

For marine catch, we buy the marine catch from the suppliers and then sell to either trading companies or distributors on a direct basis as opportunistic purchases and sales according to the seasonality of respective seafood species. The marine catch is predominantly sold to distributors in Liaoning, Fujian and Shandong provinces, and overseas customers in the Philippines. The completion of the new cold storage facility in July 2012 helps to improve our capacity for conducting marine catch trading business in Fujian and also reduce storage and freezing costs, as storage and freezing services were formerly leased. The facility is currently providing ice making services to the port area, but the corresponding income is relatively immaterial compared to the revenues generated from trading of marine catch.

Our branded "Hi-Power" algae-based drink 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 35.8% and 17.4% of our total sales in the second quarter of 2013 and 2012, respectively. Trading of our marine catch accounted for approximately 33.6% and 62.5% of our total sales in the second quarter of 2013 and 2012, respectively. Sales of our algae-based beverage products accounted for approximately 30.6% and 20.1% of our total sales in the second quarter of 2013 and 2012, respectively. We expect the sales of our algae-based beverage products will continue to grow 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 78.0% and 73.2% of our total cost of revenue of processed seafood products in the second quarter of 2013 and 2012, 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.


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? 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, including leakage of radioactive water. 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 and algae-based beverage products as a result of consumers' perception of food safety in relation to the nuclear radiation leaks in Japan.

? In May 2011, inspectors of the government of Taiwan detected dangerous levels of industrial plasticizers in sports drinks and soft drinks, used to substitute for palm oil as clouding agents in drinks, with levels far in excess of the daily allowed intake. One plasticizer, known as DEHP, is a possible carcinogen, and thought capable of wreaking havoc with children's reproductive organs. Since then, the plasticizers have been found in a range of foods and drinks. China, Hong Kong, South Korea and the Philippines have recalled beverage bottles suspected of contamination imported from Taiwan. The beverage products sector in the East Asia region was adversely affected by the food scandal, and new legislation with higher food safety standard of beverage products may be implemented in the PRC. The DEHP crisis may affect our beverage products business as a result of any failure to comply with the new standard or adverse changes in the beverage products sector.

? Our ability to maintain existing accreditations such as HACCP, ISO9001:2008, 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 ability to expand our drink business through marketing campaigns and penetration into new areas.

? 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, in the 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 June 30, 2013, we employed 395 employees.


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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 the Chinese New Year and lower during summer time. Sales for our algae-based beverage products are expected to be higher before the Chinese New Year and during the summer. Since the production will cease during the Chinese New Year holidays and it takes several months to resume demand from our distributors back to normal level, sales in the first quarter of the fiscal year are usually lower than that in the prior quarter.

NEW BUSINESS DEVELOPMENT

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. In September 2010, we entered into an agreement with a third party contractor 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 financed the total $27.3 million in land use rights and construction costs from funds generated by operations. The facilities commenced operations in July 2012. Accordingly, we transferred approximately $25.0 million of construction in progress to property, plant and equipment after commencement of operations.

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 are currently utilizing certain cold storage spaces and freezing for our own products, which do not only help to reduce storage costs but also are expected to improve margins for our current seafood segments as a result of bulk purchases at favorable prices. We are not currently providing cold storage or freezing services to third parties and only generating de minims revenues from ice making services, but we intend to increase sales of these services to third parties should we have sufficient capacity in excess of the needs for our own products.

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 six months ended June 30, 2013 and 2012 are set out below:

Breakdown of our past performance by principal products and geographical region

Sales by product

                            Three months ended June 30,                        Six months ended June 30,
                     2013                     2012                     2013                     2012
                   US$'000         %        US$'000         %        US$'000         %        US$'000         %

Processed
seafood products      9,799        35.8       10,657        17.4       21,461        44.0       20,560        26.9
Marine catch          9,125        33.6       38,334        62.5        9,381        19.2       38,334        50.2
Algae-based
beverage
products              8,363        30.6       12,293        20.1       17,930        36.8       17,474        22.9
Total                27,287       100.0       61,284       100.0       48,772       100.0       76,368       100.0


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Sales by geographical region

                                                               Three months ended June 30, 2013
                                                                                        Algae-based beverage
                         Processed seafood products             Marine catch                  products                      Total
                         US$'000                %           US$'000         %         US$'000              %         US$'000         %
PRC
Shandong                      1,063                10.8            -           -             -                 -        1,063         3.9
Zhejiang                      3,992                40.8            -           -         4,541              54.3        8,533        31.3
Fujian                        4,330                44.2        9,125       100.0         3,822              45.7       17,277        63.3
Guangdong/ Shenzhen             414                 4.2            -           -             -                 -          414         1.5
Others                            -                   -            -           -             -                 -            -           -
Total PRC                     9,799               100.0        9,125       100.0         8,363             100.0       27,287       100.0
Asia                              -                   -            -           -             -                 -            -           -
Total                         9,799               100.0        9,125       100.0         8,363             100.0       27,287       100.0



                                                                Three months ended June 30, 2012
                         Processed seafood products             Marine catch         Algae-based beverage products            Total
                         US$'000                %           US$'000         %         US$'000              %           US$'000         %
PRC
Shandong                         855                8.0       14,842        38.7             -                   -       15,697        25.6
Zhejiang                       3,628               34.1            -           -         1,816                14.8        5,444         8.9
Fujian                         5,586               52.4          156         0.4        10,477                85.2       16,219        26.4
Guangdong/ Shenzhen              588                5.5            -           -             -                   -          588         1.0
Others (1)                         -                  -       22,290        58.2             -                   -       22,290        36.4
Total PRC                     10,657              100.0       37,288        97.3        12,293               100.0       60,238        98.3
Asia (2)                           -                  -        1,046         2.7             -                   -        1,046         1.7
Total                         10,657              100.0       38,334       100.0        12,293               100.0       61,284       100.0



                                                                 Six months ended June 30, 2013
                         Processed seafood products             Marine catch         Algae-based beverage products            Total
                         US$'000                %           US$'000         %         US$'000              %           US$'000         %
PRC
Shandong                       2,286               10.6            -           -             -                   -        2,286         4.7
Zhejiang                       8,471               39.5            -           -         9,130                50.9       17,601        36.1
Fujian                         9,854               45.9        9,381       100.0         8,800                49.1       28,035        57.5
Guangdong/ Shenzhen              850                4.0            -           -             -                   -          850         1.7
Others                             -                  -            -           -             -                   -            -           -
Total PRC                     21,461              100.0        9,381       100.0        17,930               100.0       48,772       100.0
Asia                               -                  -            -           -             -                   -            -           -
Total                         21,461              100.0        9,381       100.0        17,930               100.0       48,772       100.0


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                                                                 Six months ended June 30, 2012
                         Processed seafood products             Marine catch         Algae-based beverage products            Total
                         US$'000                %           US$'000         %         US$'000              %           US$'000         %
PRC
Shandong                       1,734                8.4       14,842        38.7             -                   -       16,576        21.7
Zhejiang                       7,375               35.9            -           -         3,117                17.8       10,492        13.7
Fujian                        10,343               50.3          156         0.4        14,357                82.2       24,856        32.5
Guangdong/ Shenzhen            1,108                5.4            -           -             -                   -        1,108         1.5
Others (1)                         -                  -       22,290        58.2             -                   -       22,290        29.2
Total PRC                     20,560              100.0       37,288        97.3        17,474               100.0       75,322        98.6
Asia (2)                           -                  -        1,046         2.7             -                   -        1,046         1.4
Total                         20,560              100.0       38,334       100.0        17,474               100.0       76,368       100.0

(1) Sales to PRC Others mainly relate to the trading of marine catch transacted in Liaoning province.

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

Three months ended June 30, 2013 compared to three months ended June 30, 2012, and six months ended June 30, 2013 compared to six months ended June 30, 2012

Sales

Our revenue decreased by approximately $34.0 million or 55.5% from $61.3 million for the three months ended June 30, 2012 to $27.3 million for the same period ended June 30, 2013. The decrease in revenue was attributed to the decrease in sales of our processed seafood products, marine catch and algae-based beverage products. Sales of our processed seafood products decreased by $0.9 million or 8.1% year over year to $9.8 million, whereas sales of algae-based beverage products decreased by $3.9 million or 32.0% to $8.4 million for the same periods under review. Our marine catch segment realized sales of $9.1 million for the three months ended June 30, 2013, compared to $38.3 million for the same period under review.

Our revenue during the six months ended June 30, 2013 decreased to $48.8 million by approximately $27.6 million or 36.1% compared to $76.4 million we realized during the six months ended June 30, 2012. Sales of our processed seafood products increased by $0.9 million or 4.4%, whereas sales of our marine catch segment decreased by $29.0 million. Sales of our algae-based beverage products increased by $0.5 million or 2.6% to $17.9 million during the six months ended June 30, 2013.

As a result of consumers' perception of seafood safety in relation to the nuclear radiation leaks in Japan which occurred in March 2011, sales of processed seafood products have been significantly and adversely affected since the second quarter of 2011. During the year 2012 and through the first quarter of 2013, sales of our seafood products have largely recovered to pre-earthquake levels. While we are confident that the seafood we use to produce our processed seafood products is safe, it is unclear how long it will take for consumer confidence in seafood products to normalize. The decrease in sales of our processed seafood products for the second quarter of 2013 year over year was mainly attributable to soften product demand and weak purchasing power in the domestic market.


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Calendar year ended December 31, 2013 is the fourth year in which we recognize sales of our algae-based beverage products since the acquisition of Xianghe on January 1, 2010. In 2010, our distribution network for the beverage segment was mainly Fujian province. After gaining experience in Fujian, we expanded our distribution into Zhejiang province in the second quarter of 2011. The growth from Fujian and Zhejiang was adversely affected by the public concern over the plasticizer contamination in the beverage industry, as well as the lower-than-expected temperatures in the southern regions of China during the summer of 2011. Sales of our algae-based beverage products in 2012 and the three months ended March 31, 2013 recovered significantly as a result of our continuous contribution to the related sales and marketing campaigns. The decrease in sales of our algae-based beverage products for the second quarter of 2013 year over year was mainly attributable to soften product demand and weak purchasing power in the domestic market. However, given our expansion plan into additional untapped areas of the domestic market and our increased marketing expenditures, 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 52, as of June 30, 2013.

Trading of marine catch is deemed as opportunistic purchases and sales of frozen seafood materials and therefore the sales volume fluctuates significantly from period to period. We intend to buy marine catch in blocks from suppliers when their supplies are high and sell the stocks to customers when market prices go up. Usually the inventory cycle will be less than a year. Though the profit margin from the trading segment is relatively lower compared to that of both processed seafood and algae-based beverage products, the trading segment is a good source of revenue and profit given our expertise in the seafood industry, plenty of storage space and surplus cash in hand.

Cost of revenue

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

                            Three months ended June 30,                        Six months ended June 30,
                     2013                     2012                     2013                     2012
                   US$'000         %        US$'000         %        US$'000         %        US$'000         %

Processed
seafood products      7,358        35.6        7,631        14.6       15,476        44.4       14,902        23.7
Marine catch          8,139        39.7       37,086        70.9        8,417        24.2       37,086        59.1
Algae-based
beverage
products              5,105        24.7        7,592        14.5       10,949        31.4       10,806        17.2
Total                20,602       100.0       52,309       100.0       34,842       100.0       62,794       100.0

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