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OINK > SEC Filings for OINK > Form 10-Q on 13-Nov-2013All Recent SEC Filings

Show all filings for TIANLI AGRITECH, INC.

Form 10-Q for TIANLI AGRITECH, INC.


13-Nov-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our Company's financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and the related notes included elsewhere in this report and with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2012. This discussion contains forward-looking statements that involve risks and uncertainties. Actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements.

Overview

Our Company is in the business of breeding, raising, and selling hogs in the Wuhan City area of the PRC, and from September 2011 to June 2012 was party to agreements that provided it with the ability to sell finished pork products through selected retail channels. We control Fengze, pursuant to a series of control agreements between Fengze, its shareholders and our wholly owned subsidiary, WFOE. Fengze mainly produces and sells hogs for breeding stock and slaughter. As of December 31, 2012, Fengze owned and operated ten commercial farms in the Wuhan City area and one commercial farm in Enshi Autonomous Prefecture, Hubei Province. Fengze's tenth farm was acquired in December 2010 and its eleventh farm was acquired in May 2011. In addition, Fengzi owns a majority of Tianzhili which operates in Enshi Autonomous Prefecture ("Enshi"). Tianzhili mainly raises and sell black hogs in conjunction with local hog farmers in Enshi. In addition, it will distribute black hogs to pork wholesalers in Wuhan, Beijing, and Tianjin.

In the last two years, our business has grown as a result of the increases in production at those of our farms that were not previously operating to maximum capacity and the commencement of our black hog sales activities described below.

In an effort to significantly increase the scale of our operations, in 2011we concluded a series of agreements (the "Exclusivity Agreements") with the Animal Husbandry and Veterinary Bureau of Enshi Tujia and Miao Autonomous Prefecture of Hubei Province, the Animal Husbandry and Veterinary Bureau of Xianfeng County of Hubei Province, the Xuwang Hog Farming Professional Cooperatives of Xianfeng County, and the Qiming Hog Farming Professional Cooperatives of Xianfeng County, whereby we were granted the exclusive right to breed and sell Enshi black hogs in Enshi Autonomous Prefecture in Hubei Province. Enshi black hog is one of the oldest hog species with a lineage that can be traced back to the year 1611. Enshi black hog originated in the Enshi Tujia and Miao Autonomous Prefecture in Hubei Province and the meat of the Enshi Black Hog is considered by many Chinese to be superior to that of many other breeds. The agreements also call for the joint development, funding and operation of local cooperatives in Enshi Autonomous Prefecture, Hubei Province whereby the Company, the relevant governmental agencies and the cooperatives will assist participating farmers to breed and raise Enshi black hogs which will be purchased by the Company for resale as meat hogs or retained or sold as breeders at the Company's discretion. By entering into these arrangements, we hope to be able to develop a widely recognized brand of black hog meat and to profit from the sale of black hogs grown by independent farmers as well as those grown by us. If successfully implemented, this program should allow us to profit from the black hogs grown by the participating farmers who will be obligated to purchase feed, vaccines and other supplies from us and then sell us their hogs at a price which is comparable to the costs at which we currently grow our own hogs.

Because black hog meat is generally considered by many Chinese to be superior to that of many other breeds, black hog meat generally sells for more than standard hog meat. The Company originally estimated that the price of Enshi black hog meat could be approximately 15% above the price of typical lean pork meat. However, since 2011, the weakened economy in China, an increased rate of inflation in the cost of feed, and reduced pork retail prices have negatively impacted the price of black hog meat. The Company now believes that black hog meat is likely to sell approximately 5% above the price of typical lean pork meat.

The Exclusivity Agreements envision that we will work with the Animal Husbandry and Veterinary Bureaus of Xianfeng County and Enshi Tujia and Miao Autonomous Prefecture, respectively, to develop a regional breeding and distribution program whereby local farmers will be trained and supervised by us, the relevant governmental agencies and their cooperatives in raising a breed of black hogs genetically developed and monitored by us with the approval of the local government agency. We will work with all of the farmers participating in the program to ensure that the quality of the breed is maintained and to develop standardized programs for the feed and care of the hogs. As part of this effort, we will develop an appropriate feed mix, which the farmers will purchase from us. To be eligible to participate in the program we initially required that farmers would need to be able to maintain no less than 6 sows or produce at least 100 black hogs per year. By the end of the second quarter of 2013 we had funded and completed the construction of 798 farms for local farmers. We currently plan to try to enroll local farmers in our black hog program by selling them breeder hogs and working with them to ensure that the quality of the breed is maintained. Although we will sell breeder hogs and feed to these farmers and train and supervise them to maintain the quality of the breed we will no longer fund construction of facilities for their use. Our goal is to achieve a production capacity ranging from 30,000 hogs to 50,000 black hogs during 2013 with a long run target of an annual capacity of 1 million hogs. Achievement of any of the program's goals and the need for financing are dependent upon the participation, cooperation and skills of local farmers which are currently being evaluated. The agreements are generally for a period of ten years.


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As noted above, we should benefit from this program in a number of ways, principally by reselling the black hogs purchased from the participating farmers and by providing the farmers with necessary supplies. The price at which black hog meat sells is currently 5% above the price of white hog meat We believe that at this price we will have the ability to operate this program profitably.

We believe that because this program offers many advantages to the participating farmers and the local governments, the number of farmers wanting to join the program will be significant ensuring the success of the program and will result in a significant increase in the volume of pork we sell. Enshi Autonomous prefecture is a relatively poor area of China. By joining this program participating farmers will benefit from our expertise in breeding and caring for hogs, and will be producing a breed which is generally considered superior to the meat of standard hogs. To develop our strain of black hog we will apply internationally recognized advanced molecular breeding strategies. The project will be supported by the Animal Husbandry Research Institution of Hubei, which has significant experience in hog breeding research. Moreover, the Enshi Autonomous Prefecture government has determined to emphasize hog farming in China's current five-year development plan (2011-2015), which should cause it to cooperate with us to make the project a success. Significantly, the local governments have agreed that we are the only company with which it will undertake a project such as this.

In addition to the advantages of this program, we believe that some of the risks typical to hog farming will be minimized. For example, because individual farms will be relatively small and decentralized, and under strict supervision to employ disease control methods we determine appropriate, the risk of disease should be lower than on traditional farms, Further, if a farm were to develop a problem, it should not spread since the farms are decentralized in the Prefecture's mountainous region. In addition, because of the emphasis being placed on this project by the local government, we anticipate a high level of cooperation from the farmers who are being given the opportunity to profit from what is otherwise communal land.

We have agreed to contribute to the financial needs of the project in various ways and the local governments have agreed to provide us and the participating farmers with various subsidies, incentives and insurance. The precise demands upon us will depend upon the rate at which the project grows which, in turn, will be impacted by the availability of financing that may be necessary to modernize and support the participating farmers. Given the long term of this project, it is likely that there will be continued negotiation of various issues that arise during the life of the project.

In the second quarter of 2013, through one of our subsidiaries, Hubei Tianzhili Breeder Hog Co., Ltd., we started to sell our "Tianli-Xiduhei" black hogs in Beijing, Tianjin, and Wuhan. Our black hogs and processed black hog products are currently being sold by us in counters we control within four supermarkets, including Zhongbai Chain Store, WuShangMart, Xinyijia Supermarket, and Hubei Laonongmin. We own and operate 11 black hog counters in facilities owned by these chains where we directly sell our products to the public. In addition to sales through these retailers, we also sell our black hogs to a Beijing pork wholesaler which has introduced our "Tianli-Xiduhei" black hogs in Beijing.

On October 2013, we entered into one-year agreements to provide three hotels and five restaurants in Wuhan City with balck hog products. We believe that associating with these upscale hotels and restaurants will enable us to promote the quality of our Tianli-Xiduhei brand of black hog meat.

Closure of 8th Farm

On November 6, 2013, the Animal Husbandry and Veterinary Bureau of Caidian District, Wuhan City, directed us to close our farm located in the Caidian District. We were advised that all agricultural and manufacturing activity in the area of Dacha Lake in the Caidian District is being ordered to close as part of the government's effort to restore the lake to its natural condition. Our farm in the Caidian District (our "8th farm") was established in 2005. The farm is situated on approximately 13.18 acres of land and has 24 buildings dedicated to hog rearing, an administration building and housing for the Company's employees that regularly work at the farm. The 8th farm had approximately 1,018 breeding sows and in the first nine months of 2013, we sold 9,546 hogs that were born on the 8th farm.

We are currently petitioning the Animal Husbandry and Veterinary Bureau of Caidian District to be allowed to operate the 8th farm into 2014 to allow for an orderly transfer of the breeding stock to other farms and for an orderly liquidation of the remaining livestock to enable us to minimize the adverse impact of the closure. We are also inspecting the livestock, equipment and supplies located on the 8th farm to determine what should be transferred to other farms, what should be sold and the best method of disposing of the livestock, equipment and supplies we determine to sell.


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Principal Factors Affecting our Results of Operations

Revenues

We derive the bulk of our revenues from the sale of hogs to other hog farms for breeding purposes, to brokers who sell our hogs both to other hog farms for breeding purposes and to slaughterhouses, and directly to slaughterhouses. We breed and raise hogs that are eventually sold as either breeder or market hogs which will be sold to slaughter houses for conversion into pork products. Some of the hogs are bred and raised for the purpose of sale as market hogs, while others become market hogs because customers do not select them as breeder hogs. Also very few boars are required for breeding purposes, as compared with sows. As approximately half of a litter will be males, most of these males will be sold as market hogs. The average sales price for a breeder is significantly higher than that of a market hog, and since breeder hogs are sold at a younger age than market hogs and usually weigh about 110 pounds at the date they are sold, as compared to the average weight of about 220 pounds for a market hog on sale date, the direct cost of feeding and otherwise raising a breeder hog is less than a market hog. Thus the gross margin for breeder hogs is substantially higher than that of market hogs. Consequently, the Company has focused its operations to emphasize sales represented by breeder hogs, and its success in so doing has been a major contribution to its operating profit.

We receive various subsidies from the government for operating our farms. Some of these subsidies are non-recurring, such as the payment we receive when we reach specified annual production capacities, or for the acquisition of certain operating equipment. Others, such as subsidies for breeder hog insurance, are ongoing so long as we qualify. Of course, there is no assurance the government will continue any of its policies for granting subsidies.

Commencing in the third quarter of 2011, we began to derive revenue from retail sales of pork products through a collaborative arrangement with a third party. In August 2011, Fengze and such party entered into an agreement whereby we received the right to sell processed pork products at retail under the brand name "Tianli An Puluo" in greater Wuhan City. This collaborative agreement was canceled in June 2012.

In the second quarter of 2013, we resumed retail operations by entering distribution agreements with two supermarkets in Wuhan City. In accordance with the agreements, we established retail operations within existing supermarkets. In these outlets, we sell our pork products under our brand name, Tianli-Xiduhei(TM). The owners of the supermarkets are responsible for collection of all retail sales made by us and they remit to us the revenues they collect on our behalf, less any fees due from us pursuant to our agreements.

During the third quarter of 2013, through one of our subsidiaries, Hubei Tianzhili Breeder Hog Co., Ltd., we expanded our supermarket sales operations to another two supermarket systems in Wuhan City. We now own and operate a total of 11 counters where we sell our black hog products directly to the public. These counters are located in supermarkets operated by Zhongbai Chain Store, WuShangMart, Xinyijia Supermarket, and Wuhan Xinchen Supermarket. In addition to sales through these retailers, we also sell our black hogs to a Beijing pork wholesaler which has introduced our "Tianli-Xiduhei" black hogs in Beijing.

On October 2013, we entered into one-year agreements to provide three hotels and five restaurants in Wuhan City with balck hog products. We believe that associating with these upscale hotels and restaurants will enable us to promote the quality of our Tianli-Xiduhei brand of black hog meat.

Factors Affecting Revenues and Profitability

The following factors, among others, affect the revenues and profitability that we derive from our operations. For other factors affecting our revenues, see "Risk Factors-Risks Related to Our Business," included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2012, filed on March 14, 2013.

Consumer demand for pork products. Consumer demand for pork products is closely linked to the performance of the general Chinese economy and is sensitive to business and personal discretionary spending levels.

Declines in consumer demand may occur as a result of adverse general economic conditions. Lower consumer confidence and changes in consumer preferences for pork as compared with other meats can lower the revenues and profitability of our operations. As a result, changes in consumer demand and general business cycles can subject our revenues to volatility.

Revenues resulting from the sale of breeder hogs. A significant amount of our revenues and operating margin result from the sales of young breeder hogs for use by other hog farmers. Because these breeder hogs command a price significantly higher than market hogs, and are sold at a younger age, thus incurring less feed and related finishing expenses, the profitability of the sale of a breeder hog is higher than that for the sale of a market hog. A significant reduction in the proportion of our sales that are breeder hogs would very likely significantly reduce our overall profit margin.

Government action in our industry. Because pork occupies such a central role in the Chinese diet, the government has occasionally taken action to prevent the price of pork from dropping below specified levels and has provided subsidies to companies engaged in hog farming. We benefit from this protection, and we could be harmed if the government terminated such practices. In addition, the government has taken actions to prevent the spread of diseases among livestock, including mandatory culls of affected animals. These actions have occasionally resulted in relative shortages, which tend to lead to higher prices for healthy animals, and could result in a reduction of our stock, thus reducing revenues and profit. Likewise it is possible that the government could implement some form of price controls that could adversely impact our ability to price our products so as to recover increases in costs such as feed.


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Competition and subsidies. While the hog farming industry in Hubei province and the Wuhan City area includes a large number of farms, many of those farms are smaller farms that sell relatively few hogs per year. We believe the incentives being given to farms that reach specified annual production capacities are likely to result in a consolidation of the industry. Our ability to increase our production capacity and thus to qualify for these incentives for our operations allows us to receive non-recurrent benefits from these subsidies, as well as to benefit from increased economies of scale in our operations.

Epidemic outbreaks. The outbreak of animal diseases could adversely affect our revenues. An occurrence of serious animal diseases, such as foot-and-mouth disease, or any outbreak of other epidemics in the PRC affecting animals or humans might result in material disruptions to our sales.

Taxes. We believe that the provisions of the PRC's Enterprise Income Tax law currently provide our hog breeding operations with an exemption from PRC income taxes, VAT taxes and business service taxes. If this understanding is incorrect or if the law or interpretations of the law change, this could significantly impact the Company's net operating results.

Contractual arrangements with Fengze. We conduct substantially all of our operations, and generate substantially all of our revenues, through contractual arrangements with Fengze that provide us with effective control over Fengze. We depend on Fengze to hold and maintain contracts with our customers. Fengze owns substantially all of our intellectual property, facilities and other assets relating to the operation of our business, and employs the personnel for substantially all of our business. Neither Tianli, nor HCS nor WFOE has any ownership interest in Fengze. Although WFOE's contractual arrangements with Fengze are valid, binding and enforceable under current PRC laws and regulations, these contractual arrangements may not be as effective in providing the Company with control over Fengze as direct ownership of Fengze.

Costs and Expenses

We primarily incur the following costs and expenses:

Costs of goods sold. In raising hogs for sale, we incur a number of costs that represent the costs of goods sold. We must purchase hog feed, premix components, medicines and other supplies to grow our hogs and keep them healthy. In addition to these items, cost of goods sold includes expenses such as the amortization of the sows (referred to as biological assets), farm employee wages, water, electricity, equipment depreciation expense, maintenance expense, quarantine expense, equipment costs, insurance expense, and sewage charges.

General and administrative expenses. General and administrative expenses consist primarily of compensation expense for our corporate staff, professional fees (including consulting, audit and legal fees), communication costs, research and development costs, gasoline, welfare expenses, education expenses, travel and business hospitality expenses, land rent, and other office administrative and related expenses.

Sales and marketing costs. Sales and marketing costs include salaries, wages, and promotion expenses.

Factors Affecting Expenses

Supplies and commodity prices. The largest component of our expenses relates to the price of materials required to breed and raise hogs for sale. Specifically, while we ordinarily breed our own hogs, we periodically purchase breeding stock to continue to improve our genetic breeding pool. Similarly, the prices of corn and soybean husks in China are important to our operations, because corn and soybean husks are the primary component of the hogs' diet. To the extent the prices of these materials vary, our cost of goods will fluctuate, and we may not be able to recover these higher costs by higher prices for our products. For this reason, we may be affected by droughts, floods, crop diseases and the like, which tend to make feed scarcer and thus more expensive.


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Transition to public company. As we are now a public company, our administrative costs have increased materially, including audit, legal, travel to the United States, investor relations and advisor costs as well as the need to comply with detailed reporting requirements.

Number of customers. The more customers we have, the greater the likelihood that related selling expenses, travel expenses and other similar costs will increase. Before 2012, we sold substantially all of our hogs to a relatively small number of customers. Beginning in the second quarter of 2013, we started to expand our operations into retail in connection with our efforts to develop brand name black hog products. This expansion will allow us to sell our hogs not just to the distributors but also directly to the public, increasing our profit margin. In connection with this effort we are likely to engage in promotional activities which will increase our expenses.

Number of farms. We have acquired or constructed a number of hog farms in the last several years. As we operate more farms, our administrative expenses tend to increase in dollars terms.

Retail expenses. As we pursue a strategy of providing our branded product to retail outlets, we expect that we will face additional costs such as promotion and advertising expenses to establish our brand image and retail recognition.

In connection with the Enshi Black Hog program described above, we have agreed to incur various costs and contribute various amounts to cover the costs of different aspects of the program. Since 2011, we have signed 7 joint development agreements, generally for periods of 10 years, with 7 local cooperatives in Enshi Autonomous Prefecture, Hubei Province whereby the Company, the relevant governmental agencies, and the cooperatives will assist participating farmers to breed and raise Enshi black hogs which will be purchased by us for resale as meat hogs or retained or sold as breeders at our discretion. Under these agreements, we provided funding to local independent farmers to construct small-scale hog rearing facilities on which the farmers will grow black hogs for sale to us. Pursuant to these joint development agreements, title to these small-scale hog rearing facilities belongs to us and the local cooperatives (and the individual farmers) have the right to use them. As of September 30, 2013, we have purchased $12.78 million of hog rearing facilities and equipment that has been completed and is operational and included in plant and equipment.

Comparison of the Results of Operations for the Three Months Ended September 30, 2013 and 2012

All amounts, other than percentages, are in U.S. dollars

                                   For Three Months Ended September
                                                 30,                                     Percentage of
                                       2013               2012          Net Change          Change
Sales                              $  8,728,050       $   6,574,673     $ 2,153,377           32.75%
Cost of goods sold                    7,824,400           5,953,024       1,871,376           31.44%
Gross profit                            903,650             621,649         282,001           45.36%
Selling, general and
administrative expenses                 672,574           1,621,856        (949,282 )        (58.53%)
Income (loss) from operations           231,076          (1,000,207 )     1,231,283         (123.10%)
Interest expense, net                   (69,738 )          (115,429 )        45,691          (39.58%)
Subsidy income                            8,634                   -           8,634            n/a
Other income (expense)                    3,483              (9,570 )        13,053         (136.39%)
Net other expense                       (57,621 )          (124,999 )        67,378          (53.90%)
Income (loss) before income
taxes                                   173,455          (1,125,206 )     1,298,661         (115.42%)
Income taxes                                  -                   -               -             -
Net income (loss) from
continuing operations                   173,455          (1,125,206 )     1,298,661         (115.42%)
Discontinued operations:
Gain from operations of
discontinued component, net of
taxes                                         -                   -               -             -
Net income (loss)                  $    173,455       $  (1,125,206 )   $ 1,298,661         (115.42%)


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The tables below illustrate the sales of breeder hogs, market hogs, and processed pork products for the quarters ended September 30, 2013 and 2012.

                               Sales by Products
                                                       Three Months Ended September 30,
                                            2013                                              2012
                        No. of Hogs        Average                        No. of Hogs        Average
                           Sold           Price/Hog          Sales           Sold           Price/Hog          Sales
Breeder Hogs                  7,605     $         282     $ 2,144,008           6,405     $         289     $ 1,848,223
Market Hogs - regular
hogs                         23,951               216       5,170,802          23,297               203       4,726,450
Market Hogs - black
hogs                          5,323               230       1,225,019               -                 -               -
Market hogs for
processed pork
products                        737               255         188,221               -                 -               -

Total                        37,616     $         232     $ 8,728,050          29,702     $         221     $ 6,574,673

Revenues. Our revenues increased by $2,153,377 or approximately 32.75% for the three months ended September 30, 2013 as compared to the three months ended September 30, 2012. This increase was mainly caused by increases in the number . . .

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