ITEM 1. BUSINESS
Overview of Our Business
We are an integrated food manufacturing company headquartered in Shandong Province, China. We develop, manufacture and sell the following types of food products:
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Chestnut products;
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Convenience foods (including ready-to-cook, or RTC, foods, ready-to-eat, or RTE, foods; and
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Frozen food products.
We conduct our production activities in China. Our products are sold in Chinese domestic markets as well as exported to foreign countries and regions such as Japan, South Korea and Europe. We derive most of our revenues from sales in China, Japan and South Korea. In 2017, our primary strategy is to continue building our brand recognition in China through consistent marketing efforts towards supermarkets, wholesalers, and significant customers, enhancing the cooperation with other manufacturers and factories and enhancing the turnover for our existing chestnut, convenience and frozen food products. In addition, we are working to develop new products and new sales channels. We currently have limited sales and marketing activity in the United States, although our long-term plan is to significantly expand our activities there.
Recent Developments
The Company has discovered errors in the timing of revenues recognized during the year ended December 31, 2015. The Company recognizes revenue upon shipping of products to its customers where title of the goods passes upon departure from the Company’s facilities; however, in certain instances, contractual terms dictate that the customers are afforded seven days after the receipt of goods at their premises to inspect the goods for defects or spoilage and notify the Company. If the Company is not contacted within those seven days, the Company’s obligation to the customer are considered fully discharged and revenue should be recognized. Given the timing of these seven days, the Company believes that certain sales transactions have been erroneously recognized during the year ended December 31, 2015. The Company has rectified this error and the impact of the Company’s financial position and result of operations
On December 22, 2016, the Company entered into a Share Exchange Agreement with Shengrong Environmental Protection Holding Company Limited, a business company incorporated in the British Virgin Islands with limited liability (“Shengrong”), and each of Shengrong’s shareholders (collectively, the “Sellers”), pursuant to which, among other things and subject to the terms and conditions contained therein, the Company agreed to effect an acquisition of Shengrong and its subsidiaries, including Hubei Shengrong Environmental Protection Energy-Saving and Technology Co. Ltd., a registered company in Hubei China by acquiring from the Sellers all outstanding equity interests of Shengrong. However, such agreement was terminated and abandoned in June 2017.
Revenues from sales in the China domestic market decreased by approximately $79.2 million, or approximately 46.05%, in 2016. The reasons for the decrease in revenues in China decreased are:
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Shandong Lorain was required to move its production lines to our factory in Junan Hongrun according to a new city zoning plan, so that Shandong Lorain’s land can be used for other urban use. Shandong Lorain started this relocation process in July 2016 and finished this process in December 2016. During the relocation process, we were unable to produce our products with full capacity. As a result, the revenue from sales of chestnuts food products by Shandong Lorain was $30.4 million and $54.3 million in 2016 and in 2015, respectively, decreasing by approximately 44%.
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The domestic sale of our chestnuts has decreased due to increased prices of chestnut in Luotian, Hubei, our main chestnut supply region, because of flooding. As a result, the sales revenue of Luotian Lorain was deceased by 44.9% in 2016.
We liquidated our French operations in 2016 following an investigation with respect to the origin of canned chestnuts sold by Conserverie Minerve (“Minerve”, a former subsidiary of Athena) issued Centre Technique Conservation of Produits Agricoles (“CTCPA”), an industry trade association for canned, preserved and dehydrated food products in France. CTCPA stated that only chestnuts based on the European or Japanese cultivars can be used in canned chestnut products sold in France according to CTCPA policies and that canned chestnut products must also have received certification from the International Featured Standards (“IFS”), a qualified third party certification agency in Europe that certifies food products, especially for retail industry.
As a result of such liquidation, our exports have decreased substantially due to weak demand in the international market. Revenue from sales in international markets decreased by approximately $29.1 million, or approximately 67.12% . We mainly relied on Athena, our French subsidiary, to sell our products in European market. But since we suffered a significant loss from the result of investigation of CTCPA during 2015 and 2016, we decided to shut down the operation of Athena. As a result, the export amount of chestnuts to Europe markets decreased markedly by 95.40% in 2016.
Revenues from sales of convenience food decreased by approximately 65.0% in 2016 due to increasing market competition. Since 2015, more competitors entered the convenience food industry that develop more types of products. Our current products have not met customers’ demand in the most recent year due to our failure to invest in research and development. In addition, we have faced significant competition from Chinese online ordering platforms since 2015, which platforms offer convenient and efficient meals directly from restaurants. In addition, Dongguan Lorain ceased operations in October 2016 due to its high cost of environmental compliance, the overlap of products and market with Luotian Lorain, both of which focus on the southern market of China, and poor performance of sales revenue.
Revenues from sales of our frozen food products decreased by 10.9% compared with that in 2015. The decrease is mainly due to the fact that the sales amount declined, because of the relocation of Shandong Lorain, one of our frozen food producing and sales company, discussed above.
Our general and administrative expenses increased approximately $35.1 million, or 620.0%, to $ 40.8 million in 2016 from $5.7 million in 2015. The increase mainly due to the bad debt including $35,590,795 unrecovered trade receivables and other receivables that management determined cannot be recovered, which accounted for 87.2% of total general and administrative expenses in 2016, respectively. In 2016, the credit terms for many of our domestic customers was between 30 and 60 days; international customers are typically extended 90 days credit. Our cash flow suffered while waiting for such payments. Many of our direct clients, such as supermarkets and restaurants, did not make payments promptly due to poor sales. In addition, third party distributors’ ability to collect accounts receivable was worsened due to the bad sales performance and such distributors’ inability to collect receivables from their own clients. Other receivables that become bad debt include (i) raw materials we paid for but the suppliers did not provide the raw materials ordered by us and refused to refund the advance payment, or we did not agree on the quality of the raw materials and (ii) advance payments made by our procurement department for raw materials, and such salesmen left the company before we could confirm that the goods had been warehoused. Most of the aforementioned receivables were incurred after 2014, and under accounting principles we determined that 2016 was a suitable time to increase the ratio of provision for bad debts exceeding half a year to 50% and to 100% for over one year.
Organizational Structure
ALN is a Nevada corporation that was incorporated on February 4, 1986 and was formerly known as “Millennium Quest, Inc.” Effective November 12, 2009, ALN reincorporated in Nevada from Delaware.
ALN owns 100% of ILH. ILH wholly owns two Chinese operating subsidiaries, Luotian Lorain and Junan Hongrun, directly. Junan Hongrun, in turn, owns 100% and 51% of Dongguan Lorain and Athena respectively. In addition, together with Junan Hongrun, ILH wholly owns Beijing Lorain, Shandong Greenpia, and owns approximately 80% of Shandong Lorain (Shandong Economic Development Investment Co. Ltd. owns approximately 20%). We sometimes refer to our six Chinese operating subsidiaries and the Athena Group throughout this annual report on Form 10-K as the Lorain Group Companies. Below is an organizational chart of ALN, ILH and the Lorain Group Companies:
* Athena is a holding company which holds majority of the capital and the voting shares of Conserverie Minerve, a company organized under French law. Conserverie Minerve specializes in the processing and sale of chestnut and prepared foods products in Europe. Conserverie Minerve operates its businesses through the following, direct and indirect, wholly owned subsidiaries:
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Sojafrais, a company organized under French law;
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SCI SIAM, a real estate company organized under French law;
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SCI GIU LONG, a real estate company organized under French law; and
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CACOVIN, a company organized under Portuguese law.
On June 6, 2015, Athena approved the merger of its wholly owned subsidiary Conserverie Minerve into Athena. Athena assumed all contracts, rights, assets and liabilities of Conserverie Minerve after the merger. Athena was a holding company with no operations and its only asset was the equity of Conserverie Minerve. On August 8, 2015, the merger was completed. In April 2016, Athena ceased operations as discussed above.
Products
Our products are categorized into the following three segments:
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Chestnut products,
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Convenience food products, and
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Frozen food products.
We produced 214 products in 2016, including 1 new product in frozen food products. We also discontinued 25 products in 2016 in the convenience a foods products.
Chestnut Products
We have developed brand equity for our chestnut products in China, Japan and South Korea over the past 18 years. We produced 60 high value-added processed chestnut products in 2016. In 2016 and 2015, this segment contributed 57% and 53.6% of our total revenues, respectively.
Our best selling products in 2016 included our frozen chestnuts. The majority of our chestnut products are natural and do not contain chemical additives.
The chestnut, in contrast to many other tree nuts, contains small quantities of oil and is very high in complex carbohydrates. This makes them useful for a wider food range than other common nuts. Chestnuts are commonly steamed, boiled, sugar stir-fried, roasted or added into dishes or desserts as an ingredient.
We position our chestnut products as middle to high end products. We differentiate our chestnut products based on production process, high quality raw materials inputs, flavor, size and method of packaging. For instance, some of our chestnut products that are sold in Japan are packaged in plastic bags or tin cans, each considered a different product. Similarly, some of our chestnut products are processed with hot water or cold water, each considered a different product.
Chestnut season in China lasts from September to January. We purchase and produce raw chestnuts during these months and store them in our refrigerated storage facilities throughout the year. Once we obtain a purchase order during the rest of the year, we remove the chestnuts from storage, process them and ship them within one day of production.
Convenience Foods
Our convenience food products are characterized as follows:
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Ready-to-cook, or RTC, food products,
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Ready-to-eat, or RTE, food products, and
These products are intended to meet the current demands of our customers for safe, wholesome and tasty foods that are easily prepared.
RTCs can be served after a few easy cooking procedures. Typically, when preparing a RTC, customers need only to heat the food in a microwave or boil it for several minutes before eating. Our best-selling RTCs in 2016 were French fries.
RTEs can be served without any cooking. Our best-selling RTEs in 2016 were various bean products and various fried vegetables.
We produced 92 convenience food products in 2016. In 2016 and 2015, this segment contributed 20.3% and 25.3%, respectively, of our total revenues.
Frozen Food Products
We produce a variety of frozen foods, mostly frozen vegetables and frozen fruits. We produced 62 frozen food products in 2016. Our best-selling frozen food products in 2016 was sweet corn products.
Our frozen food business allows us to mitigate the significant production seasonality of chestnut products and to increase the utilization rate of our production capacity. Through our sales network, we are seeking to further penetrate into domestic and overseas market for our frozen food segment as it may not only raise our spare production capacity without additional heavy capital investment, but also boost our brand equity as we are selected to be the provider for international fast food giants. The frozen foods accounted for in our total revenue increased from 21.0% in 2016 to 22.7% in 2015. Gross margins in this segment are lower than the margins for chestnut products and convenience foods.
Our Manufacturing Facilities
General
We currently manufacture our products in four facilities in China, two of which are located in Junan County, Shandong Province, one in Luotian County, Hubei Province, and one in Miyun County, Beijing. As described above, in 2016, we ceased operations in France, Dongguang and Shandong.
The following table indicates the year that operations commenced at each of the facilities and the size of the facilities.
Production Lines
We currently manufacture our products using 29 production lines. Except Chinese doughnuts production lines, each production line is used to produce between 10 and 50 products. We currently run four types of product lines:
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Deep-freezing lines, which are used to freeze raw materials for year-round production and to produce frozen food;
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Canning lines, which are used to produce canned products, including chestnut products;
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Convenience food lines, which are used for producing RTCs and RTEs, all of which have nitrogen preservation capacity; and
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Chinese doughnuts lines, which are used to produce Chinese doughnut products.
The production process for our chestnut products initially involves sorting and cleaning the raw chestnuts purchased during the chestnut season. We then store the raw chestnuts in our refrigerated storage facilities throughout the year. Once we obtain a purchase order, we remove the chestnuts from storage and process them by steaming, decladding and deep-freezing the chestnuts, depending on the particular product. We then package and ship the processed chestnuts within one day of production.
The production process of our convenience products generally involves various steps, including soaking, boiling, coating, drying, deep freezing, packing, sealing and sterilizing.
The following table shows the number and types of production lines, the types of products produced and the production capacity at each facility:
* Shandong Lorain relocated its convenience food product line, completed in December 2016, to Junan Hongrun due to the local government land seizures requirement.
We allocate our production lines based upon the location of our facilities to take advantage of efficiencies in the transportation of required raw materials. For example, Junan Hongrun and Shandong Lorain, which manufacture primarily chestnut and frozen products, are located in Shandong Province, which is China’s largest supplier of fresh products by volume. Shandong Province is also a major chestnut producing region.
Our production lines and facilities have all been designed to meet the standards and requirements of our largest customers in South Korea and Japan, with Japan being our top overseas markets in value term.
We employ advanced methods of quality control and have obtained various certifications for many of our products, packages and processes, including ISO 9000 or ISO 9001 certification for certain of our chestnut and frozen vegetable products, BRC certification for certain of our frozen fruit and vegetable products and HACCP certification for certain of our frozen vegetable, fruit and chestnut products and our bottom-open chestnuts. We believe that our quality controls and standards of products distinguish us from other manufacturers in both domestic and international markets.
With limited exception, we operate our production lines year round. In the past, when our production was focused almost exclusively on chestnuts, we experienced seasonal underutilization of our product lines. However, our current facilities have multiple-function designs allowing us to use our production lines for our convenience and frozen products when we are not producing chestnuts at full capacity. Consequently, as we have increased our processed and convenience food offerings over the last several years, we have generally been able to run our production lines at increasing efficiency.
We believe our facilities are adequate for our current levels of production. We anticipate, however, that we may require additional facilities and/or product lines as our business grows. We are exploring the possibility of alliances with one or more OEM partners for the production, in the short-term, of some of our convenience food products and frozen products should our facilities be inadequate to meet increasing demand. We are also exploring the possibility of leasing additional production lines to expand our production capacity. We did not lease any production facility during 2016. We may decide to lease additional facilities in 2017, should circumstances require and subject to acceptable costing. In the long-term, we plan to increase our own production capacity by acquiring or building new facilities, subject to the availability of adequate sources of funding.
Storage Capacity
Storage of our raw materials and inventory is a critical element of our business. Our raw materials and partially finished products need to be preserved in frozen storages (-18ºC to -20ºC) or constant temperature storages (-5ºC to 5ºC). Storage is particularly critical for our chestnut products because chestnuts are a seasonal fruit.
The following table illustrates on a facility by facility basis the type and capacity of our storage resources:
* Shandong Lorain move its convenience food product line, completed in December 2016, to Junan Hongrun due to the local government land seizures requirement.
All of the listed storage facilities are owned by us. We did not add to our storage capacity during 2016.
Agricultural Operations
We grow or set up agricultural co-ops with local farmers to supply ourselves with a small portion of chestnut, fruit and vegetable products. For the year ended December 31, 2016, the supplies coming from agricultural operations is still a low proportion of the total. We believe that we will continue to develop more agricultural facilities in the long-term. We anticipate that self-grown agricultural products and agricultural products grown in cooperation with local farmers will enable us to assure adequacy of supply, promote quality and reduce cost, particularly for our high margin offerings. For example, by growing Korean cultivar chestnuts domestically, we expect to significantly reduce our supply costs for this premium product, while ensuring superior quality.
Lands in which we grow our agricultural products for such products are shown in the following table.
We began growing chestnuts in Shandong Province in 2003. Unlike most vegetables and fruits, chestnut trees have a 3-5 year growing phase before they can be harvested. Our current chestnut planting base has been self-supplying limited quantities of chestnuts to our production since 2007. In the end of 2016, we leased two woods in Junan County Shandong Province, China to plant more chestnuts trees, which we expect will expand the production of our self-supplied chestnuts in a near future. However, there is no guarantee that we will be successful in that regard.
We began growing strawberries in 2008 in Shandong and peaches, apricots, pears and blackberries in 2009 in Beijing. We use these fruits in some of our frozen fruit products.
We plan to continue to expand our agricultural operations over the next a few years. Among other things, we plan to increase our self-production in China of Korean cultivar chestnuts. We expect to obtain funding for this expansion through a combination of commercial and government loans, including loans under Chinese government programs to promote agricultural industrialization. There is no assurance, however, that adequate funding for these purposes will be available to us.
Raw Materials
In 2015 and 2016, approximately 78% and 85% of our procured raw materials, respectively, consisted of agricultural products, including primarily chestnuts and vegetables, approximately 7% and 6%, respectively, consisted of packaging materials and approximately 15% and 9% consisted of condiments such as sugar, salt and flour.
Our Supply Sources
Our business depends on obtaining a reliable supply of various agricultural products, including chestnuts, vegetables, red meat, fish, eggs, rice and flour. Because of the diversity of available sources of these raw materials, we believe that our raw materials are currently in adequate supply and will continue to be so in the future.
We obtain our agricultural raw materials from three sources: domestic procurement (excluding self-supply), overseas markets, and self-supply. Domestic and overseas procurement accounted for 91% and 6.8%, respectively, of our total raw material costs in 2016, while self-supply accounted for 2.2% . We obtained substantially all of our agricultural raw materials from domestic sources during 2016.
In 2016 and 2015, respectively, we procured approximately 31,892 and 44,383 metric tons of chestnuts and approximately 32,487 and 53,106 metric tons of vegetables and other raw materials from a number of third party suppliers, domestic and overseas, and produced approximately 438 and 568 metric tons of chestnuts and other products from our own agricultural operations.
We select suppliers based on price and product quality. We typically rely on numerous domestic and international suppliers, including some with whom we have a long-term relationship. Our top 10 suppliers accounted for 13.4% and 13.6% of the total procurement in 2015 and 2016 in value terms respectively. We purchase from suppliers and farmers pursuant to supply contracts and underlying purchase orders. We have not entered into any long-term contracts with any of our suppliers.
Our suppliers generally include wholesale agricultural product companies, agricultural associations and distributors. Some raw materials must be imported at higher costs, however. Occasionally, we also work directly with farmers. For instance, we operate an initiative which involves a series of cooperation and lease agreements between Shandong Lorain, Beijing Lorain and local farmers. This initiative involves approximately 1,000 acres of land which is used primarily to produce Japanese and Korean style chestnuts, sticky corn and pumpkins for our operations.
Procurement Cost and Quality Control
To control procurement costs, we have built our facilities near domestic sources of agricultural raw materials. For example, Junan Hongrun and Shandong Lorain are located in Shandong Province, which is China’s largest supplier of fresh products by volume. Shandong Province is also a major chestnut producing region. Local procurement reduces our costs, especially transportation costs. It also gives us first-hand harvest and market information, which provides us with an advantage in price negotiations with suppliers.
Some raw materials must be imported at higher cost. As discussed, we have begun to develop our agricultural capabilities in order to control costs, particularly with respect to imported raw materials such as Korean-style chestnuts.
Pricing for agricultural products reflects several external factors, such as weather conditions and commodity market fluctuations, which are beyond our control. We obtain contemporaneous information on local harvests and collect daily reported price information on harvests in other markets from which we procure our products. We also attempt to predict harvest yields in advance based on our information gathering. We use this harvest information to negotiate best pricing with our suppliers.
We impose strict standards on our suppliers. During the harvest season, our internal procurement function personnel may visit our sources of supply to assure that the products we are purchasing comply with our standards.
Our Customers
Our products are sold in Chinese domestic markets as well as exported to foreign countries and regions such as Japan and South Korea. In 2015 and 2016, approximately 80.1% and 82.1%, respectively of our sales were made domestically in China and approximately 19.9% and 17.9% were to international customers, primarily Japan and South Korea. Our top ten customers contributed 12.3% and 12.1% of our total revenues in 2015 and 2016 respectively.
Domestic
In China, we sell our products through our own sales team and through third-party distributors. We have 26 sales offices in 31 provinces in China. In 2015 and 2016, we sold approximately 60.0% and 72.6%, respectively, of our products directly to our Chinese and overseas customers and approximately 40.0% and 27.4% through third-party distributors. In view of a significant decline in our sales volume in 2016, we decided to cut spending. By comparison, the performance of our third-party distributors is far from expected, and our direct-selling business is the main source of revenue. In addition, due to the low demand of the market, the third-party distributors need less the products, which result that our relationship not as close as the previous years, leading to the increase of bad debts. Therefore, we decided to reduce the proportion of third-party distributors and enhance our own sales team.
We sell our products in all first-tier cities in China, including Beijing, Shanghai, Tianjin and Guangzhou. Our sales team sells our products directly to supermarket chains, mass merchandisers, large wholesalers and others in these markets. In second-tier and third-tier cities, we currently sell our products to third-party distributors, such as food companies or trading companies with established distribution channels in such regions, rather than through our own sales team, in order to enable us to penetrate such markets more quickly without spending significant capital. We also sell to small customers through independent sales representatives.
The terms of a typical sales contract between us and our distributors provide that we are responsible for transportation costs and the distributors are responsible for storage costs. Furthermore, the distributors have the right to return products that fail to satisfy specified quality standards, at our cost. The majority of such contracts require the distributors to pay us in cash in full upon delivery, and the remaining contracts provide for short-term credit, usually two to three weeks. In addition, we typically offer distributors performance-based incentives, such as a cash bonus equal to 1% to 1.5% of total revenues generated by such distributor which exceed previously established sales targets.
International
Our export sales destinations include:
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Asia pacific, primarily Japan, South Korea and Malaysia, but also Singapore, Philippines, and Australia;
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Europe, primarily France and Portugal, but also Belgium;
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the Middle East, primarily Israel;
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North America, including the United States
Outside China, sales in Europe decreased by 95.4% in 2016 as a result of a bad sales performance in France and Portugal and the shutdown of Athena Group. Sales in Asia countries also decreased by 19.2% due to weak demand in Asia countries.
We sell our products to international markets primarily through export and trading agents and companies in China, as well as our own sales team located in China and Japan. Our sales team sells directly to wholesalers, food processors and mass merchandisers. Many of our customers are well known in their local food market. We have established long-term relationships with many international customers, especially in Japan and South Korea.
Our Sales and Marketing Efforts
We seek to expand our customer base by:
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Direct sales communications with our large customers;
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Sales through distributors to new customer bases;
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Referrals from existing customers; and
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Participation in domestic and international food exhibitions and trade conferences.
We have not spent a significant amount of capital on advertising in the past, and our advertising budget continues to be limited. In 2016 our marketing and branding efforts included supermarket advertising and internet advertising.
We intend to increase our advertising and branding efforts given the consumer nature for many of our products. For the near future, our marketing efforts will continue to focus primarily on the domestic Chinese, Japan and South Korea markets for our chestnut and convenience food products.
Competition and Market Position
The overall food market is diverse, both globally and in China. We do not have a significant market share in any of our business segments.
Chestnut Products
We compete in the chestnut market primarily on the basis of the uniqueness of our products, quality, price and brand recognition. We also utilize our proprietary, patented and patent-pending technology in the production of our chestnut products to our competitive advantage.
The world market for chestnut products is highly fragmented. Our principal competitors in the chestnut product market are currently Hebei Liyuan, a Chinese company, and Foodwell Corporation, a South Korean company and Concept Fruit, a European company.
Convenience Food Products
The market competition for convenience food products is based mostly upon quality and product variety. We attempt to use our modern food processing technology, such as nitrogen preservation, to produce a wide variety of high quality convenience foods.
The convenience food market in China is highly fragmented and we do not face competitive pressure from any particular competitor or small group of competitors.
Frozen Food Products
In the frozen food product market, competition is based primarily upon quality, ability to provide a reliable product supply and customer relationships.
Our strongest competitors in the frozen food products market are currently Beijing Liliangzi Food Co. Ltd., Hangzhou Dadi Food Co. Ltd. and Tianjin Jinkaili Food Co. Ltd., all of which are located in China.
Competitive Advantages
We believe that we enjoy a number of competitive advantages, both domestically and internationally.
We have developed brand equity for our chestnut products in China, Japan and South Korea over the past 18 years. Our customers are willing to pay a premium for some of our chestnut products because of our brand equity. In addition, we believe that we have a strong distribution channel for our products in the markets in which we currently operate.
We believe that we are able to provide our customers with greater selection and a more reliable supply than many of our competitors, which is especially important for our supermarket chain and large wholesaler customers. We produced 60 chestnut products in 2016. We believe that we are the only provider of certain bottom-open chestnut and sweetheart chestnut products in China.
Labor is a large portion of total operating costs for food companies. We believe that we have a lower labor cost structure and a more abundant labor supply than many of our international competitors.
We are focused on managing our costs in other ways as well. We seek to locate our production facilities in close proximity to our main domestic sources of raw material supply to reduce transportation costs and give us first-hand knowledge of market factors affecting our cost of raw material supply. Our agricultural self-supply program, while modest at present, is expected to grow and to become a significant element of our cost containment efforts.
We use modern food processing technology and innovation in our formulation and manufacturing processes to create high quality products. Nitrogen preservation in particular, used in the production of convenience foods, is an innovative technology which has not been widely applied in China.
We are dedicated to innovation of our products. From 2012 to 2016, we were successfully granted 4 new patents. We applied for three patents to State Intellectual Property Office of the PRC during 2015. In addition, As of December 31, 2016, we possessed 16 patents for utility models and 15 patents for appearance design. See “Intellectual Property” below. We believe that our technology gives us an advantage over our Chinese and international competitors, allowing us to produce chestnut and convenience food products that are superior in quality and to offer more product varieties.
We believe that our reputation for quality contributes to our competitiveness. We maintain high food safety standards, in order to satisfy both domestic and international requirements. We also regularly conduct tests for quality of our products and compliance with standards.
Intellectual Property
Trademarks
We have registered in the PRC the trademark which we use on all of our products sold in China.
Patents
We were granted two patents by the State Intellectual Property Office of the PRC during 2012, including the preparation of aerated snack beans and frozen bottom open chestnuts. One patent for preparation of liquor preserved fish and soup was approved in 2013. In 2014, our patent application during 2012 for the preservation, storage and processing procedures for chestnuts was approved. We made application for three patents to State Intellectual Property Office of the PRC during 2015.
In addition to the above-mentioned patents, we also possess 16 patents for utility models and 15 patents for appearance design.
We take reasonable steps to protect our proprietary information and trade secrets, such as limiting disclosure of proprietary plans, methods and other similar information on a need-to-know basis and requiring employees with access to our proprietary technology to enter into confidentiality arrangements. We believe that our proprietary technology and trade secrets are adequately protected.
Our Employees
As of December 31, 2016, we had a total of 1,425 employees. Approximately 1,075 of our full-time employees are directly employed by our subsidiary companies and the remaining employees are employed by outsourcing agents that we use to meet our staffing needs. Compared to 2015, the total employees decreased by 54.8% due to our significant production capacity declining and bad operating performance. All of the departments were hit as a result of huge loss, especially the production department and domestic sales department, because (a) all the part-time employees belong to production department. Since our revenue from main business decreased significantly, we dismissed almost all of part-time workers, approximately 1,500 workers in 2016. (b) we shut down 12 sales offices in 2016 to reduce the personnel and administrative expenses. As required by Chinese law, all employees are party to a written employment contract. We compensate the employees outsourced from agents directly and pay agents a service fee. Agents are responsible for the pension and social insurance benefits of the leased employees, as described below.
The following table sets forth the allocation of employees, both direct and leased, by job function.
We believe that the relationship between management and our employees is good. We have not experienced any significant problems or disruption to our operations due to labor disputes, nor have we experienced any difficulties in recruitment and retention of experienced staff.
Our Shandong Lorain subsidiary has an employee relations department for the purpose of advancing employee welfare, encouraging employee participation in decision making and enhancing relations among employees and between employees and our management team.
We compensate our production line employees by unit produced (piece work) and compensate other employees with a base salary and bonus based on performance. We also provide training for our staffs from time to time to enhance their technical and product knowledge, including knowledge of industry quality standards.
Our employees participate in state pension scheme and various types of social insurance organized by municipal and provincial governments. Outsourcing agents are responsible for contributions on behalf of the leased employees.
Our Research and Development Activities
Our research and development efforts are focused on three objectives:
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Superior product safety and quality; and
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Reduction of operating costs; and
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Driving growth through the development of new products.
We have research and development staffs at each of our facilities. In total, 32 employees are dedicated to research and development.
We rely heavily on customer feedback to assist us in the modification and development of our products. We also utilize customer feedback to assist us in the development of new products. In 2016, we added 1 new product in our frozen foods segments.
The amount we spent on research and development activities during the years ended December 31, 2016 and 2015 was not a material portion of our total expenses for those years.
Government Regulation
As a manufacturer and distributor of food products, we are subject to regulations of China’s Agricultural Ministry and Ministry of Health. This regulatory scheme governs the manufacture (including composition and ingredients), labeling, packaging and safety of food. It also regulates manufacturing practices, including quality assurance programs, for foods through its current manufacturing practice regulations, and specifies the standards of identity for certain foods.
We have obtained approvals from Chinese authorities for products that requires the approval under regulations, including chestnuts, frozen vegetables and fruits, fish, and canned products. Production of new products that do not fall into categories of products would require separate approval from the appropriate Chinese authorities. We have consistently obtained such approvals for our newly developed products in the past and do not anticipate any difficulties in obtaining new approvals in the future if needed.
In addition, we are required to obtain governmental approval, and to register with the State Administration for Industry and Commerce, in order to open a new facility in China. We have consistently obtained such approvals, and made such registrations, for our new facilities in the past and do not anticipate any difficulties in filing new registrations and obtaining new approvals in the future if needed.
Under the relevant PRC sanitation laws governing food export, unless an exporter’s products are exempted from inspection, products must be inspected in accordance with the Law of the PRC on Import and Export Commodity Inspection. We have not been exempted from inspection. In the past, we were authorized by the relevant authorities to conduct self-inspection of certain of our export products. However, currently, the relevant authorities have imposed tighter food safety control in China, and as a result, all of our exported food products must be inspected by relevant government agencies. We believe that all of our exported products are currently in compliance with such requirements and we do not anticipate any difficulties in complying with such rules in the future.
In addition, we are required to obtain a license from the local branch of the Entry-Exit Inspection and Quarantine Bureau of China for our exported products. We have consistently obtained such licenses in the past and we do not anticipate any difficulties in obtaining such licenses in the future.
ITEM 1A.
ITEM 1A. RISK FACTORS
RISK FACTORS
Business Risks
We may be forced to delisting from NYSE Exchange if we are failure to satisfy a continued listing rule or standard.
On April 18, 2017, we received a letter from NYSE MKT LLC (the “Exchange”) stating that the Exchange has determined that we are not in compliance with Sections 134 and 1101 of the NYSE MKT Company Guide (the “Company Guide”) due to we are failure to timely file with the SEC its Annual Report on Form 10-K for the year ended December 31, 2016. The letter also states that the failure to timely file its Annual Report on Form 10-K is a material violation of its listing agreement with the Exchange and, therefore, pursuant to Section 1003(d) of the Company Guide, the Exchange is authorized to suspend and, unless prompt corrective action is taken, remove the Company’s securities from the Exchange. The Exchange has informed us that, in order to maintain its listing on the Exchange, we must, by May 18, 2017, submit a plan of compliance (the “Plan”) advising the Exchange of actions it has taken or will take to regain compliance with Sections 134 and 1101 of the Company Guide by October 18, 2017 (the “Plan Period”). The Plan was submitted and accepted by the Exchange, allowing us to be able to continue listing during the Plan Period. However, based on recent discussions with the Exchange, the Exchange staff may initiate delisting proceedings. Because we have not filed all of our required SEC reports as of the close of the Plan Period, among other concerns.
Our operating results may have been material adverse effected during the year ended December 31, 2015 due to the restatement of prior financial statements
We have discovered errors in the timing of revenues recognized during the year ended December 31, 2015. We recognize revenue upon shipping of products to its customers where title of the goods passes upon departure from our facilities; however, in certain instances, contractual terms dictate that the customers are afforded seven days after the receipt of goods at their premises to inspect the goods for defects or spoilage and notify us. If we are not contacted within those seven days, our obligation to the customer are considered fully discharged and revenue should be recognized. Given the timing of these seven days, we believe that certain sales transactions have been erroneously recognized during the year ended December 31, 2015. We have rectified this error and the impact of our financial position and result of operations during the year ended December 31, 2015, which may result in material adverse effect.
We lack the ability to sustain our operations if our cash flow continues to decline and cannot be replenished through financing
Our financial statements have been prepared on a going-concern basis. The going-concern basis assumes that assets will be realized and liabilities will be settled in the ordinary course of business in the amounts disclosed in the financial statements. Our ability to continue as a going concern is greatly dependent on our ability to realize its non-cash current assets such as receivables and inventory into cash in order to settle its current obligations. For the year ended December 31, 2016, we incurred a substantial loss of $136,361,080. As of December 31, 2016, we had a working capital deficit of approximately $21,271,226. These conditions raise substantial doubt as to whether we may continue as a going concern. To improve our solvency, we are working to obtain new working capital through private placements of our common stock or convertible debt securities to qualified investors. But we cannot assure the financing succeed.
We may not be able to obtain an adequate supply of high quality raw materials.
Our business depends on obtaining a reliable supply of various agricultural products, including chestnuts, vegetables, fruits, red meat, fish, eggs, rice, flour and packaging products. During 2016, the cost of our raw materials decreased from $143,226,607 to $85,249,363, a decrease of approximately 40.48% . We may have to increase the number of our suppliers of raw materials and expand our own agricultural operations in the future to meet growing production demands. Despite our efforts to control our supply of raw materials and maintain good relationships with our suppliers, we could lose one or more of our suppliers at any time. The loss of several suppliers may be difficult to replace and could increase our reliance on higher cost or lower quality suppliers, which could negatively affect our profitability. In addition, if we have to increase the number of our suppliers of raw materials in the future to meet growing production demands, we may not be able to locate new suppliers who could provide us with sufficient materials to meet our needs. Any interruptions to, or decline in, the amount or quality of our raw materials supply could materially disrupt our production and adversely affect our business and financial condition and financial prospects.
The prices that we have paid for our raw materials recently have experienced significant fluctuation. If these price fluctuations continue, our profit margins may be materially adversely affected.
The average price that we paid for chestnuts in China in 2015 and 2016 was approximately $1,600 per metric ton and $1,765 per metric ton, respectively, excluding value added taxes. We do not currently hedge against changes in our raw material prices. Consequently, if the costs of our raw materials increase further, and we are unable to offset these increases by raising the prices of our products, our profit margins and financial condition could be adversely affected.
Price inflation in China could affect our results of operation if we are unable to pass along raw material price increases to our customers.
Inflation in China has been consistently increasing in recent years. Because we purchase raw materials from suppliers in China, price inflation directly causes an increase in the cost of our raw materials. Price inflation could affect our results of operation if we are unable to pass along raw material price increases to customers. In addition, if inflationary trends continue in China, China could lose its competitive advantage as a low-cost manufacturing venue, which could in turn lessen some of the competitive advantages of our being based in China. Accordingly, inflation in China may weaken our competitiveness domestically or in international markets.
Our sales and reputation may be affected by product liability claims, litigation or, product recalls in relation to our products.
The sale of products for human consumption involves an inherent risk of injury to consumers. We face risks associated with product liability claims, litigation, or product recalls, if our products cause injury or become adulterated or misbranded. Our products are subject to product tampering and contamination, such as mold, bacteria, insects, shell fragments and off-flavor contamination, during any of the procurement, production, transportation and storage processes. If any of our products were to be tampered with, or become tainted in any of these respects, and we were unable to detect this, our products could be subject to product liability claims or product recalls. Our ability to sell products could be reduced if certain pesticides, herbicides or other chemicals used by growers have left harmful residues on portions of our raw materials or if our raw materials have been contaminated by other agents.
We have never had any major product recall in the past but we have experienced product liability claims that were made by our customers. The amounts of such claims were immaterial. However, claims of product defect or product liability for material amounts, individually or in the aggregate, may be made in the future.
We have not procured a product liability or general liability insurance policy for our business, as the insurance industry in China is still in an early stage of development. To the extent that we suffer a loss of a type which would normally be covered by product liability or general liability insurance in the United States, we would incur significant expenses in defending any action against us and in paying any claims that result from a settlement or judgment against us. Product liability claims and product recalls could have a material adverse effect on the demand for our products and on our business goodwill and reputation. Adverse publicity could result in a loss of consumer confidence in our products.
Our expansion strategy may not prove successful and could adversely affect our existing business.
Our growth strategy includes the expansion of our manufacturing operations, including new production lines and agricultural operations. We plan to expand our sales in China and internationally. We will need to engage in various forms of promotional and marketing activities in order to further develop the branding of our products and to increase our market share in new and existing markets. The implementation of this strategy may involve large transactions and present financial, managerial and operational challenges. We could also experience financial or other setbacks if any of our growth strategies incur problems of which we are not presently aware. If we fail to generate sufficient sales in new markets or increase our sales in existing markets, we may not be able to recover the production, distribution, promotional and marketing expenses, as well as administrative costs we have incurred in developing such markets.
Our results of operations could be affected by natural events in the locations in which our customers operate.
Several of our customers have operations in locations that are subject to natural disasters, such as severe weather and geological events, which could disrupt the operations of those customers and suppliers as well as our operations. If our customers suffer from these events, their operations may be negatively impacted. As a result, some or all of those customers may reduce their orders for our products, which could adversely affect our revenue and results of operations.
The acquisition of other businesses could pose risks to our profitability.
We may try to grow through acquisitions in the future. Any proposed acquisition could result in accounting charges, potentially dilutive issuances of equity securities, and increased debt and contingent liabilities, any of which could have a material adverse effect on our existing business and the market price of our common stock. Acquisitions, in general, entail many risks, including risks relating to the failed integration of the acquired operations, diversion of management’s attention, and the potential loss of key employees of the acquired organizations. We may be unable to successfully integrate businesses or the personnel of any business that might be acquired in the future, and our failure to do so could have a material adverse effect on our business and on the market price of our common stock.
A significant amount of our revenues is dependent on a limited number of customers and the loss of any one of our major customers could materially and adversely affect our growth and our revenues.
A significant portion of our revenues has historically been derived from a limited number of customers, particularly in our chestnut products segment. Sales to our ten largest customers accounted for approximately 12.3% and 12.1% of our total revenues in 2015 and 2016, respectively. The loss of any one of these customers, or a material decrease in purchases by any one of these customers, could adversely impact our revenues.
We rely primarily on distributors to sell our products. Any delays in delivery or poor handling by our distributors or third-party transport operators may affect our sales and damage our reputation.
In 2016, we sold our products through over 130 distribution service providers. The services provided could be suspended and could cause interruption to the supply of our products to domestic or overseas customers. Delivery disruptions may occur for various reasons beyond our control, including poor handling by service providers or third party transport operators, transportation bottlenecks, natural disasters and labor strikes, and could lead to delayed, damaged or lost deliveries. If our products are not delivered in a timely manner, our reputation could be harmed. If our products are damaged in the process of being delivered, we may be liable to pay for such damages incurred.
Failure of the market to accept our new products, or failure to obtain regulatory approval for our new products, may cause us to lose our competitive position in the food industry.
We introduced 7 new products in 2012, 6 new products in 2013, 3 new products in 2014, 6 new products in 2015 and 1 new product in 2016. We plan to introduce approximately 5 new products in 2017. The success of the new products we introduce depends on our ability to anticipate the tastes and dietary habits of consumers and to offer products that appeal to their preferences. We intend to introduce new products as well as alternative flavors, sizes and packaging for our existing products. We may not be able to gain market acceptance for our new products. Consumer preferences change, and any new products that we introduce may fail to meet the particular tastes or requirements of consumers, or may be unable to replace their existing preferences. Our failure to anticipate, identify or react to these particular tastes or changes could result in reduced demand for our products, which could in turn cause us to be unable to recover our development, production and marketing costs.
We are dependent on certain key personnel and loss of these key personnel could have a material adverse effect on our research and development, operations and revenue.
The Lorain Group Companies were founded in 1994 by Si Chen, our chairman and chief executive officer. Mr. Chen, together with other senior management, has been a key driver of our strategy and has been fundamental to our achievements to date. The successful management of our business is, to a considerable extent, dependent on the services of Mr. Chen and other senior management. We compete for qualified personnel with other food processing companies, food retailers and research institutions. Consequently, we may either lose key employees to our competitors or we may need to significantly increase the compensation of such employees in order to retain them. The loss of the services of any key management employee or failure to recruit a suitable or comparable replacement could have a significant impact upon our ability to manage our business effectively, and our business and future growth may be adversely affected.
We face increasing competition from domestic and foreign companies.
The food industry in China is fragmented. Our ability to compete against other national and international enterprises is, to a significant extent, dependent on our ability to distinguish our products from those of our competitors by providing large volumes of high quality products that appeal to consumers’ tastes and preferences at reasonable prices. Some of our competitors have been in business longer than we have and are more established. Our competitors may provide products comparable or superior to those we provide or adapt more quickly than we do to evolving industry trends or changing market requirements. Increased competition may result in price reductions, higher raw materials prices, reduced margins and loss of market share, any of which could materially adversely affect our profit margins.
An increase in the cost of energy could affect our profitability.
Although energy costs were stable in 2016, we might experience significant increases in energy costs in the future, which would result in higher distribution, freight and other operating costs. Our future operating expenses and margins will be dependent on our ability to manage the impact of cost increases.
Our products are subject to counterfeiting or imitation, which could impact our reputation.
To date, we have experienced limited counterfeiting and imitation of our products. However, counterfeiting or imitation of our products may occur in the future and we may not be able to detect it and deal with it effectively. Any occurrence of counterfeiting or imitation could impact negatively upon our reputation, particularly if the counterfeit or imitation products cause sickness, or injury to consumers. In addition, counterfeit or imitation products could result in our need to incur costs with respect to the detection or prosecution of such activities.
We may face challenges in expanding our cross-border operations
As we continue expanding our existing cross-border operations into existing and other markets, we will face risks associated with expanding into markets in which we have limited or no experience. The expansion of our cross-border business will also expose us to risks relating to staffing and managing cross-border operations, tariffs and other trade barriers, differing and potentially adverse tax consequences, increased and conflicting regulatory compliance requirements and policies, lack of acceptance of our products, challenges caused by distance, language and cultural differences, exchange rate risk and political instability. Accordingly, any efforts we make to expand our cross-border operations may not be successful, which could limit our ability to grow our revenue, net income and profitability.
We may have liquidity risk in relating to the decrease of cash flow and the bad debt loss.
We have a markedly decrease on our revenue from sales in 2016. At December 31, 2016 and 2015, cash and cash equivalents (including restricted cash) were $1.4 million and $25.5 million, respectively. The decrease of cash and cash equivalents (including restricted cash) are by $18.7 million, or by 36.5% due to the bad debt loss. If we cannot increase the quantity of our products sales, we may not be available to manage cash flow.
We may no longer be able to compete in Europe and have suffered significant losses in China.
We terminated the French operation due to its operational loss. We suffered from the investigation with respect to the origin of canned chestnuts sold by Conserverie Minerve (“Minerve”, a former subsidiary of Athena) issued Centre Technique Conservation of Produits Agricoles (“CTCPA”), an industry trade association for canned, preserved and dehydrated food products in France. CTCPA stated that only chestnuts based on the European or Japanese cultivars can be used in canned chestnut products sold in France according to CTCPA policies and that canned chestnut products must also have received certification from the International Featured Standards (“IFS”), a qualified third party certification agency in Europe that certifies food products, especially for retail industry. Although, a proceeding from local court provided Minerve (now Athena) protection from creditors initiating any actions against Athena until March 2016, Athena still cost a lot to recycle market products, seal the finished products, and thousands of tons of chestnuts during 2016.
Since the sales of revenue from Chinese market decreased by 46.05% in 2016 and we may lose our Europe market due to the termination of our French company, our competition advantage has been greatly weakened.
Chinese chestnut sales declined due to natural hazard and fierce market competition.
Chinese Domestic sales of chestnuts has decreased due to competition from the market and the raw material expense increased. In 2016, Luotian, Hubei, our main chestnuts supply area, has been hit by flooding, cutting chestnuts production by about 50% and the purchase price increased by 20% to 30%. As in previous years, the annual chestnuts output was 40,000 tons in Luotian, accounted for 8% of the Chinese chestnut production. About 50% chestnuts in Luotian supplied to Luotian market to further processing, and about 20% of which supplied to Wuhan market. But, due to the rise in price in 2016, less than 20% will be supplied to Luotian market. However, other main chestnuts producing area in China were harvest in China which result in a much lower price compared with that in Luotian. Our chestnuts purchased in Luotian much increased by 20% and the sales revenue in Luotian Lorain was deceased by 44.9 % in 2016.
Regulatory Risks
We are subject to extensive regulations by the Chinese government.
The food industry is subject to extensive regulations by Chinese government agencies. Among other things, these regulations govern the manufacturing, importation, processing, packaging, storage, exportation, distribution and labeling of our products. New or amended statutes and regulations, increased production at our existing facilities, and our expansion into new operations and jurisdictions may require us to obtain new licenses and permits and could require us to change our methods of operations at costs that could be substantial.
Our failure to comply with PRC environmental laws may require us to incur significant costs.
We carry on our business in an industry that is subject to PRC environmental protection laws and regulations. These laws and regulations require enterprises engaged in manufacturing and construction that may cause environmental waste to adopt effective measures to control such waste. In addition, such enterprises are required to pay fines, or to cease operations entirely under extreme circumstances, should they discharge waste substances. The Chinese government may also change the existing laws or regulations or impose additional or stricter laws or regulations, compliance with which may cause us to incur significant capital expenditures, which we may be unable to pass on to our customers through higher prices for our products.
Our failure to comply with PRC hygiene laws may require us to incur significant costs.
Manufacturers in the Chinese food industry are subject to compliance with PRC food hygiene laws and regulations. These food hygiene laws require all enterprises engaged in the production of chestnuts and various vegetables and fruits to obtain a hygiene license for each of their production facilities. Such laws also require manufacturers to comply with regulations with respect to food, food additives, packaging, and food production sites, facilities and equipment. Failure to comply with PRC food hygiene laws may result in fines, suspension of operations, loss of hygiene licenses and, in more extreme cases, criminal proceedings against an enterprise and its management. The Chinese government may also change the existing laws or regulations or impose additional or stricter laws or regulations, compliance with which may cause us to incur significant capital expenditures, which we may be unable to pass on to our customers through higher prices for our products.
Chinese government forcing relocation may require us to incur significant costs.
Shandong Lorain was demanded to move its production lines to the factory of Junan Hongrun according to a new city zoning plan where Shandong Lorain resident, so that the land can be used for other urban use. Shandong Lorain has started this relocation process in July 2016 and finished this process in December,2016. During the relocation process, we were not allowed to produce our products with full capacity. As a result, the revenue from sales of chestnuts food products was $ 30.4 million and $54.3 million in 2016 and in 2015, respectively, decreasing by approximately 44%.
We cannot predict when the compensation for relocation will be received and whether the amount of compensation for land requisition can make up for our loss during the relocation period. If we cannot receive sufficient compensation next year, the relocation will cost us a significant loss.
Financial Risks
Our operations are cash intensive, and our business could be adversely affected if we fail to maintain sufficient levels of working capital.
We spend a significant amount of cash on our operations, principally to procure raw materials for our products. Many of our suppliers, including chestnut, vegetable and fruit farmers, and suppliers of packaging materials, do not allow us to pay on credit. However, some of the suppliers with whom we have a long-standing business relationship allow us to pay on credit. We fund the majority of our working capital requirements out of cash flow generated from operations. If we fail to generate sufficient sales, or if our suppliers stop offering us credit terms, we may not have sufficient liquidity to fund our operating costs and our business could be adversely affected.
We also fund approximately 30.2% of our working capital requirements from the proceeds of short-term loans from Chinese and overseas banks. Our average loan balance from short-term bank loans in 2016 was approximately $30.7 million. We expect to continue to do so in the future. Such loans are generally secured by our fixed assets, receivables and/or guarantees by third parties. The term of almost all such loans is one year or less. Historically, we have rolled over such loans on an annual basis. However, we may not be able to roll over such loans in the future or may not have sufficient funds available to pay all of our borrowings upon maturity. Failure to roll over our short-term borrowings at maturity or to service our debt could result in the imposition of penalties, including increases in rates of interest, legal actions against us by our creditors, or even insolvency.
Management anticipates that our existing capital resources and cash flows from operations and current and expected short-term bank loans will be adequate to satisfy our liquidity requirements through 2017. However, if available liquidity is not sufficient to meet our operating and loan obligations as they come due, our plans include considering pursuing alternative financing arrangements or further reducing expenditures as necessary to meet our cash requirements. However, there is no assurance that, if required, we will be able to raise additional capital or reduce discretionary spending to provide the required liquidity. Currently, the capital markets for small capitalization companies are difficult and banking institutions have become stringent in their lending requirements. Accordingly, we cannot be sure of the availability or terms of any third party financing.
We are subject to credit risk in respect of accounts receivables.
In 2008 and 2009, some of our customers, including some of our large supermarket customers, delayed their payments for up to 60 to 90 days beyond their term. Our cash flow suffered while waiting for such payments. Consequently, at times we had to delay payments to our suppliers and to postpone business expansion as a result of these delayed payments. Starting in 2008 and through 2016, we gradually shortened credit terms for many of our domestic customers from between 30 and 180 days to between 30 and 60 days; international customers are typically extended 90 days credit. Our large customers may fail to meet these shortened credit terms, in which case we may not have sufficient cash flow to fund our operating costs and our business could be adversely affected.
We may enter into additional financing agreements which may have a dilutive effect to our earnings per share and the rights of certain stockholders.
Additional financings could result in significant dilution to our earnings per share or the issuance of securities with rights superior to our current outstanding securities. We may also grant registration rights to investors purchasing our equity or debt securities in the future.
We may be unable to raise additional capital.
If we are unable to raise additional financing when needed, we may be unable to implement our long-term business plan, develop or enhance our products and services, take advantage of future opportunities or respond to competitive pressures on a timely basis, if at all. In addition, a lack of additional financing could force us to substantially curtail or cease operations.
We may be exposed to potential risks relating to our internal control over financial reporting and our ability to have such controls attested to by our independent auditors.
The SEC, under Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring public companies to provide in their annual reports on Form 10-K a report by management with respect to the company’s disclosure controls and procedures and internal control over financial reporting. We are currently required to comply with this requirement. In addition, such rules require the independent registered public accounting firm auditing a company’s financial statements to attest to the operating effectiveness of such company’s internal controls. However, because we are a smaller reporting company, we are not required to receive an attestation report from a registered public accounting firm. We can provide no assurance that we will comply with all of the requirements imposed thereby. Further, we cannot assure that we will receive a positive attestation from our independent auditors. Investors and others may lose confidence in the reliability of our financial statements in the event we identify significant deficiencies or material weaknesses in our internal controls that we cannot remediate in a timely manner or if we are unable to receive a positive attestation from our independent auditors with respect to our internal controls.
We defaulted on debt relating to our bad operation performance and lack of finance from funding activities.
Pursuant to a Share Pledge Agreement, dated October 19, 2010 (the “Share Pledge Agreement”), Mr. Si Chen, our chief executive officer and chairman, has pledged 5,313,574 shares of Common Stock (the “Pledged Shares”) for the benefit of DEG-Deutsche Investitions- und Entwicklungsgesellshaft mbH (“DEG”) in order to secure the obligations of the Company and its subsidiary Junan Hongrun Foodstuff Co., Ltd. (“Junan Hongrun”) under a Loan Agreement, dated May 31, 2010, among the Company, DEG and Mr. Si Chen (the “Loan Agreement”). In the event that the value of the pledged assets is less than 150% of the amounts made available to the Junan Hongrun under the Loan Agreement, DEG has the right to require additional security in the form of fixed assets or shares under the Loan Agreement and Share Pledge Agreement. Pursuant to a letter agreement, dated November 15, 2012, Mr. Si Chen has pledged an additional 5,480,492 shares of Common Stock to DEG under the Pledge Agreement in order to secure the obligations of the Borrower under the Loan Agreement. The total number of shares pledged under the Pledge Agreement is now 10,794,066 shares of Common Stock. For so long as no event of default under the Loan Agreement has occurred, Mr. Si Chen continues to retain all voting rights with respect to the Pledged Shares.
On September 7, 2016, DEG acquired beneficial ownership of 10,794,066 shares of Common Stock upon foreclosure of the pledge from Mr. Si Chen. Such shares constitute approximately 28.2% of the total number of shares of Common Stock of the Issuer outstanding as of September 30, 2016.
If we were unable to pay off the loan on time to DEG due to the bad performance of our operation and decrease of our revenue in the near future, DEG has right to acquired more shares of Common Stock pledged by Mr. Si Chen.
We may suffer other defaults on our debt due to our poor performance.
Risks Related To Doing Business In China
Changes in China’s political or economic situation could harm us and our operating results.
Economic reforms adopted by the Chinese government have had a positive effect on the economic development of the country. However, the Chinese government could change these economic reforms at any time. Such changes could negatively impact our operations and profitability.
The structure of the Chinese economy may inhibit our ability to expand our business.
The Chinese economy differs from the economies of most countries belonging to the Organization for Economic Cooperation and Development, or OECD, in several ways. For example, state-owned enterprises constitute a large portion of the Chinese economy. In addition, weak corporate governance practices and the lack of flexible currency exchange policies continue to persist. As a result of these differences, we may not develop in the same way or at the same rate as might be expected if the Chinese economy were similar to those of the OECD member countries.
Our business is largely subject to the uncertain legal environment in China.
The Chinese legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which precedents set in earlier legal cases are not generally used. Laws, regulations and legal requirements relating to foreign investments in China are still evolving, and their interpretation and enforcement involve uncertainties. These uncertainties could limit the legal protections available to foreign investors, such as the right of foreign enterprises to hold required business licenses and permits.
It may be difficult for our stockholders to effect service of process against our subsidiaries or our officers and directors.
Our operating subsidiaries were organized under the laws of China and France and substantially all of their assets are located outside the U.S. In addition, our executive officers and directors are residents of China and substantially all of their assets are located outside the U.S. As a result, it could be difficult for our stockholders to effect service of process in the U.S., or to enforce a judgment obtained in the U.S., against our officers and directors in China.
Restrictions on currency exchange may limit our ability to receive and use our revenues effectively.
The majority of our revenues are settled in Renminbi and U.S. dollars, and any future restrictions on currency exchanges may limit our ability to use revenue generated in Renminbi to fund any future business activities outside China or to make dividends or other payments in U.S. dollars. Although the Chinese government introduced regulations in 1996 to allow greater convertibility of the Renminbi for current account transactions, significant restrictions still remain. For instance, foreign enterprises may only buy, sell or remit foreign currencies after providing valid commercial documents at banks in China authorized to conduct foreign exchange business. In addition, conversion of Renminbi for capital account items, including direct investment and loans, is subject to governmental approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. The Chinese regulatory authorities may impose more stringent restrictions on the convertibility of the Renminbi in the future.
Failure to comply with PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may have negative effects on our company.
In October 2005, the PRC State Administration of Foreign Exchange, or SAFE, issued the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose Companies by Residents Inside China, generally referred to as Circular 75, which required PRC residents to register with the local SAFE branch before establishing or acquiring control over an offshore special purpose vehicle, or SPV, for the purpose of engaging in an equity financing outside of China on the strength of domestic PRC assets originally held by those residents. Internal implementing guidelines issued by SAFE, which became public in June 2007 (known as Notice 106), further expanded the reach of Circular 75.
ILH acquired certain interests in the Lorain Group Companies controlled by Si Chen, our Chairman and Chief Executive Officer. Pursuant to Circular 75 and Notice 106, if a PRC resident has completed a round-trip investment through its established SPV but has not yet completed the required procedures of SAFE registration for offshore investment of the SPV, he must retroactively register the SPV with SAFE.
In order to avoid such SAFE registration requirements, a Japanese individual, Hisashi Akazawa, was designated as a nominee holder of ILH when ILH was established. Mr. Akazawa granted an option to our Chairman and Chief Executive Officer, Mr. Chen, allowing Mr. Chen to buy 90% of Mr. Akazawa’s interest in the Company at a fixed price at a future time in accordance with the terms of an option agreement between the two parties. On December 22, 2008, Mr. Chen exercised this option. In addition, on that date, Mr. Chen acquired all of the remaining shares of our company held by Mr. Akazawa. As a result, Mr. Chen is the beneficiary of ILH and may be required to register with and obtain approvals from SAFE or its agency with respect to the direct offshore investment activities related to the acquisition of the Lorain Group Companies.
If the failure to identify and characterize Mr. Chen as a beneficial owner of ILH is determined by the PRC authorities to be a serious violation of the requirements of the PRC Company Law and the PRC Regulation of Registration of Companies, the Lorain Group Companies may be ordered by the company registration authority in the PRC to make corrections on its filed registration, to be fined an amount no less than RMB 5,000 and no more than RMB 50,000 or, in the worse scenario, to have its company registration certificate revoked or its business licenses canceled.
On July 14, 2014, the SAFE issued the Circular Relating to Foreign Exchange Administration of Offshore Investment, Financing and Roundtrip Investment by Domestic Residents Through Special Purpose Vehicles, or Circular 37. Circular 37 repeals and replaces the Notice Concerning Foreign Exchange Controls on Domestic Residents’ Financing and Roundtrip Investment Through Offshore Special Purpose Vehicles, or Circular 75. Under Circular 37, PRC residents are required to register with the SAFE or its local branches prior to establishing, or acquiring control of, an offshore company for the purpose of investment or financing that offshore company with equity interests in, or assets of, a PRC enterprise or with offshore equity interest or assets legally held by such PRC resident. In addition, PRC residents are required to amend their registrations with the SAFE and its local branches to reflect any material changes with respect to such PRC resident’s investment in such offshore company, including changes to basic information of such PRC resident, increase or decrease in capital, share transfer or share swap, merger or division. In the event that a PRC shareholder fails to make the required registration or update the previously filed registration, the PRC subsidiaries of that offshore special purpose vehicle may be prohibited from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to their offshore parent company, and the offshore parent company may also be prohibited from contributing additional capital into its PRC subsidiaries. Furthermore, failure to comply with the various foreign exchange registration requirements described above could result in liability under the PRC laws for evasion of applicable foreign exchange restrictions.
We have requested our relevant shareholders who are subject to the SAFE regulations to make the necessary registrations under the SAFE regulations. However, we may not be fully informed of the identities of the beneficial owners of our company. We do not have control over our beneficial owners and cannot assure you that all of our PRC resident beneficial owners will comply with SAFE regulations. The failure of our beneficial owners who are PRC residents to comply with these SAFE registrations may subject such beneficial owners or our PRC subsidiaries to fines and legal sanctions. Furthermore, since Circular 37 was recently promulgated and it is unclear how this regulation, and any future regulation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant PRC government authorities, we cannot predict how these regulations will affect our business operations or future strategy. Failure to register or comply with relevant requirements may also limit our ability to contribute additional capital to our PRC subsidiaries and limit our PRC subsidiaries’ ability to distribute dividends to our company. These risks may have a material adverse effect on our business, financial condition and results of operations.
If the failure to identify, characterize and register Mr. Chen as a beneficial owner of ILH is determined by the PRC authorities to be a violation of the requirements of registration and disclosure under new Circular 37, the Lorain Group Companies may be ordered by the authority in the PRC to make corrections on its filed registration, to be fined an amount up to RMB 50,000 for Mr. Chen and up to RMB 300,000 for the Lorain Group Companies.
Furthermore, since Circular 37 was recently promulgated and it is unclear how this regulation, and any future regulation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant PRC government authorities, we cannot predict how these regulations will affect our business operations or future strategy. Failure to register or comply with relevant requirements may also limit our ability to contribute additional capital to our PRC subsidiaries and limit our PRC subsidiaries’ ability to distribute dividends to our company. These risks may have a material adverse effect on our business, financial condition and results of operations.
Our financial condition is affected by the foreign exchange rate between the U.S. dollar and the Renminbi.
Our financial condition is affected by the foreign exchange rates, primarily the rate between the U.S. dollar and the Renminbi, as well as Euro and Renminbi. In the event that the Renminbi appreciates against the U.S. dollar and Euro, our costs will increase.
We may encounter credit risks from our suppliers in China.
Our Procurement staff left before goods were verified and received into inventory. We did not place significant new orders or make additional payments to vendors and suppliers, especially, peasant suppliers whom do not abide by contract law and have not fulfilled their obligations.
Risks Related To the Market For Our Stock
Certain of our stockholders have the ability to delay or prevent adoption of important business decisions based on their ownership of a significant percentage of our outstanding voting securities.
DEG is the record owner of approximately 28.2% of our outstanding voting securities. As a result, DEG possesses significant influence over our business.
Certain provisions of our Articles of Incorporation may make it more difficult for a third party to effect a change-in-control.
Our Articles of Incorporation authorize our board of directors to issue up to 5,000,000 shares of preferred stock without stockholder approval. The preferred stock may be issued in one or more series, the terms of which may be determined at the time of issuance by the board of directors without further action by the stockholders. These terms may contain voting rights, including the right to vote as a series on particular matters, preferences as to dividends and liquidation, conversion rights and redemption rights provisions. The issuance of any preferred stock could diminish the rights of holders of our common stock, and therefore could reduce the value of such common stock. In addition, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with, or sell assets to, a third party. The ability of our board of directors to issue preferred stock could make it more difficult to acquire our company and could negatively affect the market price of our common stock.
We do not expect to pay dividends in the future, and any return on your investment may be limited to the value of the shares you acquire.
Other than a special cash dividend which we paid to holders of our common stock as of April 16, 2007, we have never declared or paid cash dividends. We do not anticipate paying any cash dividends on our common stock in the foreseeable future and any return on your investment may be limited to the value of the shares of our common stock that you acquire. We currently intend to retain and use any future earnings for the development and expansion of our business.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
Our primary facilities, which are owned except where otherwise indicated, are as follows:
As described above, in 2016, we ceased operations in France, Dongguan and Shandong.
In the aggregate, we currently have land use rights to, or lease, 70 properties with approximately 307,897 square meters, consisting of manufacturing facilities, office buildings and land reserved for future expansion. We believe our current facilities provide adequate capacity for our current and projected needs.
All land in China is owned by the State. Individuals and companies are permitted to acquire land use rights for specific purposes. In the case of land used for industrial purposes, the land use rights are granted for a period of up to 50 years. This period may be renewed at the expiration of the initial and any subsequent terms. Granted land use rights are transferable and may be used as security for borrowings and other obligations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
There is a lawsuit currently pending in the Supreme Court of Shandong Province, which was initially filed by Shandong Lorain, a subsidiary of the Company, against Junan Hengji Real Estate Development Co., Ltd. ("Junan Hengji") in November 2013 at Linyi City Intermediate People's Court of Shandong Province (the "Linyi Court").
Shandong Lorain added Jiangsu Hengan Industrial Investment Group Co., Ltd. ("Heng An Investment") as a co-defendant after the case was first filed at Linyi Court.
In September 2010, Shandong Lorain and Junan Hengji entered into a cooperative development agreement (the "Agreement") and in March 2011, Heng An Investment, an affiliated company of Junan Hengji also entered into the Agreement with Shandong Lorain to jointly develop the project with Junan Hengji. Pursuant to the Agreement, Junan Henji and Heng An Investment are required to pay Shandong Lorain a total RMB 20 million (approximately $3,225,806) fixed return according to the development status of the project developed by Junan Hengji and Heng An Investment. The payment was due and unpaid to Shandong Lorain. Shandong Lorain and the Company evaluated the potential claims against Junan Hengji and Heng An Investment, disputes between the parties with respect to out of pocket expenses paid by Junan Hengji, as well as the litigation fee that is required to be paid to the court based upon the amount claimed. Ultimately, Shandong Lorain decided to file the lawsuit with Linyi Court to claim a fixed return of RMB 10 million (approximately $1,636,902) first.
In January 2014, the Linyi Court had its first trial session. During the trial, Heng An Investment filed a counterclaim against Shandong Lorain for repayment of out of pocket expenses which would off-set the entire fixed return plus additional unpaid expenses of RMB 4,746,927 (approximately $765,633). Shandong Lorain responded that Heng An Investment does not have standing to file the counter-claim because the out of pocket payments was made by Junan Hengji. In November 2014, the court had a second trial session and completed its discovery process. On March 21, 2015, Shandong Lorain received Linyi Court's decision that rejected Shandong Lorain's claim for RMB 10,000,000 against Junan Hengji and Heng An Investment. On April 3, 2015, Shandong Lorain appealed the decision to the Supreme Court of Shandong Province. In November 2015, Supreme Court of Shandong Province vacated the decision of the Linyi Court and remanded the case back to the Linyi Court for a retrial. The retrial took place on April 25, 2016, at the Linyi City Intermediate People’s Court, and the decision thereon is currently pending. The Company anticipates that Shandong Lorain will prevail on retrial.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market for our Common Stock
Our common stock is quoted on the NYSE American (formerly known as the American Stock Exchange, the NYSE Amex Equities Exchange and the NYSE MKT) under the symbol “ALN”. As of October 14, 2017 the closing price for our common stock was $0.37 per share.
The following table sets forth, for the periods indicated, the high and low sales prices of our common stock. These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.
Approximate Number of Holders of Our Common Stock
As of September 30, 2017, there were 311 stockholders of record of our common stock. This does not include the holders whose shares are held in a depository trust in “street” name.
Dividend Policy
We have not declared or paid cash dividends other than the payment of a dividend in April 2007 in connection with our reverse merger. Any future decisions regarding dividends will be made by our board of directors. We currently intend to retain and use any future earnings for the development and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future.
Issuances of Unregistered Securities
We issued $3.5 million Convertible Promissory Note to Jade Lane Group Limited in March 2014. Under the terms of the Note, interest on the outstanding Principal Amount accrues at a rate of 4.5% per annum, and all accrued but unpaid interest is due and payable on June 30, 2014 and on the last day of each quarter thereafter. If the Note is not converted pursuant to the terms of the Note, additional interest on the outstanding Principal Amount shall accrue at a rate of 4.5% per annum and payable at the maturity of the Note. Unless the Note is otherwise accelerated or converted, the unpaid Principal Amount of the Note, together with all accrued but unpaid interest, is due and payable, at the election of the Holder, on September 13, 2014 or March 13, 2015 (“Maturity Date”), provided, however, if Holder fails to notify the Company in writing by August 13, 2014 that it elects the maturity date of September 13, 2014, then the Maturity Date will be extended to March 13, 2015.
In addition, under the terms of the Note, at any time commencing on or after September 13, 2014 and before March 13, 2015, the Holder, at Holder’s option and upon five (5) days prior written notice to the Company, may convert in whole or in part the outstanding Principal Amount into a number of shares of Common Stock of the Company (“Common Stock”) on a per share conversion price of $1.15 per share, as may be adjusted from time to time pursuant to the terms and conditions of the Note (“Conversion Price”); provided, however, the Company will not effect any conversion of the Note, and the Holder will not have the right to convert any portion of the Note, to the extent (but only to the extent) that the Holder would beneficially own in excess of the Beneficial Ownership Limitation (as defined below), which beneficial ownership will be calculated in accordance with Section 13(d) of the Securities Exchange Act of 1934, as amended. The “Beneficial Ownership Limitation” is 9.99% of the number of shares of Common Stock outstanding immediately after giving effect to the issuance of shares of Common Stock issuable upon conversion of the Note.
The Note was secured by the personal guarantee of Si Chen, the Company’s chief executive officer and chairman.
On March 12, 2015, the Company and Jade Lane Group Limited entered into an agreement to repayment terms of the promissory note in the amount of $3,500,000 issued to the Company on March 13, 2014. On April 20, 2015, the Company repaid the promissory note in form of both cash payment of $791,433 and conversion of 2,355,276 shares of common stock at a conversion price of $1.15 per share.
On February 19, 2014, the Company’s board of directors approved the 2014 Equity Incentive Plan (“2014 Plan”), which was approved at the annual stockholders meeting on June 9, 2014. Subject to adjustment as provided in the 2014 Plan, the total number of shares of Common Stock reserved and available for delivery in connection with awards under the 2014 Plan is 3,000,000. In 2015, 987,500 shares were issued to employees as stock awards under the 2014 plan.
Securities Authorized for Issuance under Equity Compensation Plans
The information in Item 12 of this report is incorporated herein by reference.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Not applicable.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We are an integrated food manufacturing company headquartered in Shandong Province, China. We develop, manufacture and sell the following types of food products:
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Chestnut products,
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Convenience foods (including ready-to-cook, or RTC, foods, ready-to-eat, or RTE, foods); and
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Frozen food products.
We conduct our production activities in China. Our products are sold in the Chinese domestic markets as well as exported to foreign countries and regions such as Japan and South Korea. We have developed brand equity for our chestnut products in China, Japan and South Korea over the past 18 years. We produced 214 products in 2016. We derive most of our revenues from sales in China, South Korea and Japan. In 2017, our primary strategy is to continue building our brand recognition in China through consistent marketing efforts towards supermarkets, wholesalers, and significant customers, enhancing the cooperation with other manufacturers and factories, and enhancing the turnover for our existing chestnut, convenience and frozen food products. In addition, we are working to expand our marketing efforts in Asia and Europe. We currently have limited sales and marketing activity in the United States, although our long-term plan is to significantly expand our activities there. In addition, we are working to developing new products and developing new sales channels.
Production Factors that Affect our Financial and Operational Condition
Our business depends on obtaining a reliable supply of various agricultural products, including chestnuts, vegetables, fruits, red meat, fish, eggs, rice, flour and packaging products. During 2016, the cost of our raw materials decreased from $143,226,607 to $85,249,363.35 for a decrease of approximately 40.48% . We may have to increase the number of our suppliers of raw materials and expand our own agricultural operations in the future to meet growing production demands. Despite our efforts to control our supply of raw materials and maintain good relationships with our suppliers, we could lose one or more of our suppliers at any time. The loss of several suppliers may be difficult to replace and could increase our reliance on higher cost or lower quality suppliers, which could negatively affect our profitability. In addition, if we have to increase the number of our suppliers of raw materials in the future to meet growing production demands, we may not be able to locate new suppliers who could provide us with sufficient materials to meet our needs. Any interruptions to, or decline in, the amount or quality of our raw materials supply could materially disrupt our production and adversely affect our business and financial condition and financial prospects.
The average price that we paid for chestnuts in the China domestic market in 2016 and 2015 was approximately $1,765 metric ton and $1,600 per metric ton, respectively, excluding value added taxes. In the past few years, increasing inflation pressures weighed on the Chinese economy which reflected on agricultural product prices. We do not have effective means and do not currently hedge against changes in our raw material prices. Consequently, if the costs of our raw materials increase further and we are unable to offset these increases by raising the prices of our products, our profit margins and financial condition could be adversely affected.
Uncertainties that Affect our Financial Condition
We spend a significant amount of cash on our operations, principally to procure raw materials for our products. Many of our suppliers, including chestnut, vegetable and fruit farmers, and suppliers of packaging materials, require us to pay for their supplies in cash on the same day that such supplies are delivered to us. However, some of the suppliers with whom we have a long-standing business relationship allow us to pay on credit. We fund the majority of our working capital requirements out of cash flow generated from operations. If we fail to generate sufficient sales, or if our suppliers stop offering us credit terms, we may not have sufficient liquidity to fund our operating costs and our business could be adversely affected.
We also funded approximately 37.7% and 30.2% of our working capital requirements in 2015 and 2016, respectively, from the proceeds of short-term loans from Chinese and foreign banks. We expect to continue to do so in the future. Such loans are generally secured by our fixed assets, receivables and/or guarantees by third parties. Our average loan balance from short-term bank loans in 2016 and 2015were approximately $30.7 million and $39.0 million, respectively. The term of almost all such loans is one year or less. Historically, we have rolled over such loans on an annual basis. However, in recent years, the Chinese government has implemented more stringent credit policies to curb inflation and soaring property prices, which could negatively impact our ability to obtain or roll over these short term loans, and hence not having sufficient funds available to pay all of our borrowings upon maturity. Failure to roll over our short-term borrowings at maturity or to service our debt could result in the imposition of penalties, including increases in rates of interest, legal actions against us by our creditors, or even insolvency. We obtained long term loans, private placement financing and a convertible promissory note during the period 2011 to 2014. We can provide no assurances that we will be able to enter into any future financing or refinancing agreements on terms favorable to us, especially considering the current instability of the capital markets.
We anticipate that our existing capital resources, including cash flows from operations, current and expected short-term bank loans will be adequate to satisfy our liquidity requirements through 2017. However, if available liquidity is not sufficient to meet our operating and loan obligations as they come due, our plans include considering pursuing alternative financing arrangements or further reducing expenditures as necessary to meet our cash requirements. However, there is no assurance that, if required, we will be able to raise additional capital or reduce discretionary spending to provide the required liquidity. Currently, the capital markets for small capitalization companies are difficult and banking institutions have become stringent in their lending requirements. Accordingly, we cannot be sure of the availability or terms of any third party financing.
In 2008 and 2009, some of our customers, including some of our large supermarket customers, delayed their payments for up to 60 to 90 days beyond their term. Our cash flow suffered while waiting for such payments. Consequently, at times we had to delay payments to our suppliers and to postpone business expansion as a result of these delayed payments. Starting in 2008 and through 2016 we gradually shortened credit terms for many of our domestic customers from between 30 and 180 days to between 30 and 60 days; international customers are typically extended 90 days credit. Our large customers may fail to meet these shortened credit terms, in which case we may not have sufficient cash flow to fund our operating costs and our business could be adversely affected.
Restatement of prior financial statements
We have discovered errors in the timing of revenues recognized during the year ended December 31, 2015. We recognize revenue upon shipping of products to its customers where title of the goods passes upon departure from our facilities; however, in certain instances, contractual terms dictate that the customers are afforded seven days after the receipt of goods at their premises to inspect the goods for defects or spoilage and notify us. If we are not contacted within those seven days, our obligation to the customer are considered fully discharged and revenue should be recognized. Given the timing of these seven days, we believe that certain sales transactions have been erroneously recognized during the year ended December 31, 2015. We have rectified this error and the impact of our financial position and result of operations during the year ended December 31, 2015.
Results of Operations
The following tables set forth key components of our results of operations for the periods indicated, and the differences between the two periods expressed in dollars and percentages.
Year Ended December 31, 2016 Compared to Year Ended December 31, 2015
Revenue
Net Revenues. Net revenues decreased by $61.0 million, or approximately 43.4%, to $79.7 million in 2016 from $140.7 million in 2015.
Since 2015, more competitors entered the convenience food industry that develop more types of products. Our current products have not met customers’ demand in the most recent year due to our failure to invest in research and development. In addition, we have faced significant competition from Chinese online ordering platforms since 2015, which platforms offer convenient and efficient meals directly from restaurants. In addition, Dongguan Lorain ceased operations in October 2016 due to its high cost of environmental compliance cost, the overlap of products and market with Luotian Lorain, both of which focus on the southern market of China, and poor performance of sales revenue.
Cost of Revenues. Our cost of revenues decreased $45.6 million, or approximately 39.7%, to $69.2 million in 2016 from $114.7 million in 2015, as a result of decrease of net revenue.
Gross Profit. Our gross profit decreased $15.5 million, or 59.6%, to $10.5 million in 2016 from $26.0 million in 2015, mainly attributed to the fact that revenues decreased by $79.2 million. The gross profit ratio decreased from 12.6% to 7.1% in 2016, it is mainly attributes to the reason that we ceased to sell convenience foods products since 2016, shut Athena Group and Dongguan Lorain, the cost of chestnuts slightly increased and the sales of chestnuts in China declined.
Operating Expenses
Selling and Marketing Expenses. Our selling and marketing expenses decreased approximately $0.7 million, or 10.7%, to $6.1 million in 2016 from $6.9 million in 2015. The decrease is attributable to decreases of employee salary, travel expense, entertainment expense and storage charge by 19.03%, 52.23%, 71.27% and 60.05%, respectively, in 2016.
General and Administrative Expenses. Our general and administrative expenses increased approximately $35.1 million, or 620.0%, to $ 40.8 million in 2016 from $5.7 million in 2015. The increase mainly due to the bad debt including unrecovered trade receivables and other receivables $ 35,590,795 that management determined cannot be recovered, which accounted for 87.2% of total general and administrative expenses in 2016, respectively. In 2016, the credit terms for many of our domestic customers was between 30 and 60 days; international customers are typically extended 90 days credit. Our cash flow suffered while waiting for such payments. Many of our direct clients, such as supermarkets and restaurants, did not make payments promptly due to poor sales. In addition, third party distributors’ ability to collect accounts receivable was worsened due to the bad sales performance and such distributors’ inability to collect receivables from their own clients. Other receivables that become bad debt include (i) raw materials we paid for but the suppliers did not provide the raw materials ordered by us and refused to refund the advance payment, or we did not agree on the quality of the raw materials and (ii) advance payments made by our salesmen for raw materials, and such salesmen left the company before we could confirm that the goods had been warehoused. Most of the aforementioned receivables were incurred after 2014, and under accounting principles we determined that 2016 was a suitable time to increase the ratio of provision for bad debts exceeding half a year to 50% and to 100% for over one year.
Government Subsidy Income
Government subsidy income decreased from approximately $1.9 million in 2015 to $1.2 million in 2016, representing grants received mostly from the Junan County, Beijing and Luotian government to assist us in our research and business development.
Income Before Taxation and Non-Controlling Interest
Income before taxation and non-controlling interest decreased $90.6 million, or 1820%, to negative $85.6 million in 2016 from $4.9 million in 2015, mainly due to provision for $45.6 million cost of revenue in 2016. In addition, decrease of gross profit and increase of general and administrative expense also leads to the decrease of income before taxation and non-controlling interest.
On December 1, 2016, we entered into two contracts of Transfer of Land Contract Right with village committee of Lanling County Jinling Town Qiaoshangou Village and village committee of Junan County Zhubian Town Huanheya Village, respectively, according to which, we contracted about 515 acres and 208 acres woods respectively to plant chestnut trees. The valid period of both of the contracts are 30 years. The consideration of contract is $543,809 (RMB3,750,000) and $200,992 (RMB1,386,000), respectively.
On November 6, 2016, we entered in to a nursery stock purchase agreement with Linyi Lingang Development District Runfa Nursery Stock Cooperation, according to which we purchased 812,500 chestnut seedlings in a consideration of $12,470,634 (RMB85,995,000). We paid to the seller $1,247,063 (RMB8,559,500) upon the execution of the agreement and agreed to pay the rest purchase fee when over 95% of the chestnut seedlings survived.
On December 1, 2016, we entered in to a nursery stock purchase agreement with Linyi Lingang Development District Runfa Nursery Stock Cooperation, according to which we purchased 327,600 chestnut seedlings in a consideration of $5,027,843 (RMB34,671,000). We paid to the seller $502,784 (RMB3,467,100) upon the execution of the agreement and agreed to pay the rest purchase fee when over 95% of the chestnut seedlings survived.
Income Taxes
Income taxes decreased approximately $1.5 million, or 43.5%, to $1.9 million in 2016, as compared to $3.4 million in 2015. This decrease was attributable to the lower income (excluding impairment) earned in 2016 as compared to 2015.
Non-Controlling Interest
Shandong Economic Development Investment holds 19.8% of the equity of our subsidiary Shandong Lorain, and Biobranco II, Alcides Branco, and Nuno Branco hold 49% of the equity of the Athena Group, which is reflected in the non-controlling interest of $7.3million in 2016 and $7.7million in 2015.
Loss attributable to common stockholders
Loss attributable to common stockholders decreased $138.6 million, or 5,290.7%, to negative $135.9 million in 2016 from $2.6 million in 2015. As our 51% controlled overseas subsidiaries suffered loss in 2016, its minority shareholders bore their proportion of loss.
Liquidity and Capital Resources General
The financial statements have been prepared on a going-concern basis. The going-concern basis assumes that assets will be realized and liabilities will be settled in the ordinary course of business in the amounts disclosed in the financial statements. Our ability to continue as a going concern is greatly dependent on our ability to realize its non-cash current assets such as receivables and inventory into cash in order to settle its current obligations. For the year ended December 31, 2016, we incurred a substantial loss of $136,361,080. As of December 31, 2016, we had a working capital deficit of approximately $21,271,226. These conditions raise substantial doubt as to whether we may continue as a going concern.
Our primary capital needs have been to fund the working capital requirements necessitated by our sales growth, adding new products and expanding our facilities. In the past, our primary sources of financing have been cash generated from operations and short-term loans from banks in China. In addition, we obtained long term loans, private placement financing and convertible promissory note during the period 2011 to 2015.
At December 31, 2016 and 2015, cash and cash equivalents (including restricted cash) were $1.4 million and $25.5 million, respectively. The debt to assets ratio was 55.4% and 31.3% as of December 31, 2016 and 2015, respectively. We expect to continue to finance our operations and working capital needs in 2017 from cash generated from operations, short-term bank loans. As such, we are in discussions regarding potential financing transactions. If available liquidity is not sufficient to meet our operating and loan obligations as they come due, our plans include pursuing alternative financing arrangements or reducing expenditures as necessary to meet our cash requirements. However, there is no assurance that we will be able to raise additional capital or reduce discretionary spending to provide liquidity, if needed. Currently, the capital markets for small capitalization companies are difficult. Accordingly, we cannot be sure of the availability or terms of any alternative financing arrangements.
The following table provides detailed information about our net cash flow for all financial statement periods presented in this report.
Operating Activities
Net cash provided by operating activities for 2016 and 2015 was $29.7 million and $18.3 million respectively. The decrease of approximately $48.0 million in net cash flows provided by operating activities resulted primarily from the increase in trade and other receivables of approximately $13.0 million in 2016.
Investing Activities
Net cash used in investing activities for 2016 and 2015 were $8.9 million and $9.1 million, respectively, with the increase of approximately $18.0 million cash provided in investing activities primarily from a decrease in restricted cash of $7.1 million and disposition of an investment for $1.9 million in 2016.
Financing Activities
Net cash used in financing activities for 2016 and 2015 were $3.0 million and $14.7 million, respectively, with the increase of $17.7 million cash provided in financing activities from loan proceeds from bank borrowings and debentures for approximately $3.1 million and no repayment long-term borrowings and notes payable in 2016.
Loan Facilities
As of December 31, 2016 and 2015, we carried $22.7 million and $21.4 million short term bank loans from foreign and Chinese domestic banks.
Critical Accounting Policies
The preparation of financial statements in conformity with United States generally accepted accounting principles requires our management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements, including the notes thereto, and related disclosures of commitments and contingencies, if any. We consider our critical accounting policies to be those that require the more significant judgments and estimates in the preparation of financial statements, including the following:
Restatement of prior financial statements -- The Company has discovered errors in the timing of revenues recognized during the year ended December 31, 2015. The Company recognizes revenue upon shipping of products to its customers where title of the goods passes upon departure from the Company’s facilities; however, in certain instances, contractual terms dictate that the customers are afforded seven days after the receipt of goods at their premises to inspect the goods for defects or spoilage and notify the Company. If the Company is not contacted within those seven days, the Company’s obligation to the customer are considered fully discharged and revenue should be recognized. Given the timing of these seven days, the Company believes that certain sales transactions have been erroneously recognized during the year ended December 31, 2015. The Company has rectified this error and the impact of the Company’s financial position and result of operations.
Method of Accounting -- We maintains its general ledger and journals with the accrual method accounting for financial reporting purposes. The financial statements and notes are representations of management. Accounting policies adopted by the Company conform to generally accepted accounting principles in the United States of America and have been consistently applied in the presentation of financial statements, which are compiled on the accrual basis of accounting.
Use of estimates -- The preparation of the financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make 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. Management makes these estimates using the best information available at the time the estimates are made; however, actual results could differ materially from those estimates.
The use of estimates is critical to the carrying value of asset accounts such as accounts receivable, inventory, fixed assets, and intangible assets. We use estimates to account for the related bad debt allowance, inventory impairment charges, depreciation and amortization of our assets. In the food processing industry, these accounts have a significant impact on the valuation of our balance sheet and the results of our operations.
Principles of consolidation -- The consolidated financial statements are presented in US Dollars and include the accounts of the Company and its commonly controlled entity. All significant inter-company balances and transactions are eliminated in combination.
As of December 31, 2016, the particulars of the commonly controlled entities are as follows:
In 2014, the Company invested $2,100,000 in Athena/Minerve Group whereby the Company controlling shareholder of Minerve. Minerve conducted operations in manufacturing, packaging and sales activities in France and import and storage operations in Portugal. During the years ended December 31, 2015, the financial position and results of operations of Minerve were accounted for as subsidiaries in the Company’s financial statements; however, during the year ended December 31, 2016, Minerve became insolvent and compelled into bankruptcy by creditors, and, ultimately liquidation. Accordingly, the Company lost control of Minerve and written of the value of its investment in Minerve. All receivables due by Minerve to subsidiaries still controlled by the Company have been written off. The Company’s consolidated financial statements at December 31, 2015 have been recast to provide improved comparability for the Company’s continuing operations.
Management has eliminated all significant inter-company balances and transactions in preparing the accompanying consolidated financial statements. Ownership interests of subsidiaries that the Company does not wholly-own are accounted for as non-controlling interests.
Shandong Economic Development Investment Corporation, which is a PRC state-owned entity, holds 19.8% equity interest in Shandong Lorain.
Accounting for the Impairment of Long-Lived Assets -- The long-lived assets held and used by us are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. It is reasonably possible that these assets could become impaired as a result of technology or other industry changes. Determination of recoverability of assets to be held and used is by comparing the carrying amount of an asset to future net undiscounted cash flows to be generated by the assets.
If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. The Company recognized impairment losses on certain long-lived assets during 2016.
Revenue recognition -- The Company's revenue recognition policies are in compliance with Staff accounting bulletin (SAB) 104. Sales revenue is recognized at the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist and collectibility is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as unearned revenue.
The Company's revenue consists of invoiced value of goods, net of a value-added tax (VAT). The Company allows its customers to return products if they are defective. However, this rarely happens and amounts returned have been de minimis.
Financial Instruments
The Company’s financial instruments, including cash and equivalents, accounts and other receivables, accounts and other payables, accrued liabilities and short-term debt, have carrying amounts that approximate their fair values due to their short maturities. ASC Topic 820, “Fair Value Measurements and Disclosures,” requires disclosure of the fair value of financial instruments held by the Company. ASC Topic 825, “Financial Instruments,” defines fair value, and establishes a three-level valuation hierarchy for disclosures of fair value measurement that enhances disclosure requirements for fair value measures. The carrying amounts reported in the consolidated balance sheets for receivables and current liabilities each qualify as financial instruments and are a reasonable estimate of their fair values because of the short period of time between the origination of such instruments and their expected realization and their current market rate of interest. The three levels of valuation hierarchy are defined as follows:
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Level 1 inputs to the valuation methodology are quoted prices for identical assets or liabilities in active markets.
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Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
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Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.
The Company analyzes all financial instruments with features of both liabilities and equity under ASC 480, “Distinguishing Liabilities from Equity,” and ASC 815. As of December 31, 2016 and 2015, the Company did not identify any assets and liabilities whose carrying amounts were required to be adjusted in order to present them at fair value.
Recent accounting pronouncements
In January 2015, The FASB issued ASU No. 2015-01, “Income Statement-Extraordinary and Unusual Items (Subtopic 225-20)”. This Update eliminates from GAAP the concept of extraordinary items. Subtopic 225-20, Income Statement-Extraordinary and Unusual Items, required that an entity separately classify, present, and disclose extraordinary events and transactions. Presently, an event or transaction is presumed to be an ordinary and usual activity of the reporting entity unless evidence clearly supports its classification as an extraordinary item. Paragraph 225-20-45-2 contains the following criteria that must both be met for extraordinary classification:
1.
Unusual nature. The underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into account the environment in which the entity operates.
2.
Infrequency of occurrence. The underlying event or transaction should be of a type that would not reasonably be expected to recur in the foreseeable future, taking into account the environment in which the entity operates.
If an event or transaction meets the criteria for extraordinary classification, an entity is required to segregate the extraordinary item from the results of ordinary operations and show the item separately in the income statement, net of tax after income from continuing operations. The entity also is required to disclose applicable income taxes and either present or disclose earnings-per-share data applicable to the extraordinary item.
The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments prospectively. A reporting entity also may apply the amendments retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The effective date is the same for both public business entities and all other entities.
The Company adopted ASU No. 2015-01 prospectively and has applied it to the presentation of the financial statements.
In September 2015, the FASB issued ASU 2015-16, the guidance eliminates the requirement to restate prior period financial statements for measurement period adjustments following a business combination. The new guidance requires that the cumulative impact of a measurement period adjustment (including the impact on prior periods) be recognized in the reporting period in which the adjustment is identified. The prior period impact of the adjustment should be either presented separately on the face of the income statement or disclosed in the notes. The Company is currently evaluating the impact the pronouncement will have on the Company’s consolidated financial statements.
As of December 31, 2016, there are no other recently issued accounting standards not yet adopted that would or could have a material effect on the Company’s consolidated financial statements.
Off-Balance Sheet Arrangements
We do not have any off-balance arrangements.
Correction of Error
The Company discovered errors in the timing of revenues recognized during the year ended December 31, 2015. The Company recognizes revenue upon shipping of products to its customers where title of the goods passes upon departure from the Company’s facilities; however, in certain instances, contractual terms dictate that the customers are afforded seven days inspection period after the receipt of goods at their premises to inspect the goods for defects or spoilage and notify the Company. If the Company is not contacted within those seven days, the Company’s obligation to the customer are considered fully discharged and revenue should be recognized. Given the timing of these seven days inspection period, the Company believes that certain sales transactions have been erroneously recognized during the year ended December 31, 2015. The Company has corrected this error and adjusted for the impact upon the Company’s financial position and result of operations as detailed below, which include the regrouping of amounts attributable to Discontinued Operations.
The effect of correction of these errors on results of operations for the above mentioned financial statements is as follows for 2015.
The effect of correction of these errors on retained earnings and significant asset and liability accounts is as follows:
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY FINANCIAL DATA
The full text of our audited consolidated financial statements As of December 31, 2016 begins on page of this Annual Report on Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934 (“Exchange Act”)) that are designed to ensure that information required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including to our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
As required by Rule 13a-15 under the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures As of December 31, 2016. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that As of December 31, 2016, our disclosure controls and procedures were not effective due to the material weakness in our internal control over financial reporting described below.
Internal Controls Over Financial Reporting
Management’s Annual Report on Internal Control over Financial Reporting.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based upon the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that evaluation, our management concluded that, As of December 31, 2016, our internal controls over financial reporting are not effective.
The material weakness and significant deficiency identified by our management As of December 31, 2016 relates to the ability of the Company to record transactions and provide disclosures in accordance with U.S. GAAP. We did not have sufficient and skilled accounting personnel with an appropriate level of experience in the application of U.S. GAAP commensurate with our financial reporting requirements. For example, our staff members do not hold licenses such as Certified Public Accountant or Certified Management Accountant in the U.S., have not attended U.S. institutions for training as accountants, and have not attended extended educational programs that would provide sufficient relevant education relating to U.S. GAAP. Our staff will require substantial training to meet the demands of a U.S. public company and our staff’s understanding of the requirements of U.S. GAAP-based reporting are inadequate.
Remediation Initiative
We plan to provide U.S. GAAP training sessions to our accounting team. The training sessions will be organized to help our corporate accounting team gain experience in U.S. GAAP reporting and to enhance their awareness of new and emerging pronouncements with potential impact over our financial reporting. We plan to continue to recruit experienced and professional accounting and financial personnel and participate in educational seminars, tutorials, and conferences and employ more qualified accounting staff in future.
Changes in Internal Controls over Financial Reporting.
Other than as described above, during the fiscal year ended December 31, 2016, there were no material changes in our internal control over financial reporting identified in connection with the evaluation performed during the fiscal year covered by this Annual Report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations over Internal Controls.
Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Our internal control over financial reporting includes those policies and procedures that:
(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.
Management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our internal controls will prevent or detect all misstatements. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of such controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of internal controls can provide absolute assurance that all control issues and instances of misstatements, if any, have been detected or prevented. Also, projections of any evaluation of the effectiveness of controls in future periods are subject to the risk that those internal controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Restatement of prior financial statements
The Company has discovered errors in the timing of revenues recognized during the year ended December 31, 2015. The Company recognizes revenue upon shipping of products to its customers where title of the goods passes upon departure from the Company’s facilities; however, in certain instances, contractual terms dictate that the customers are afforded seven days after the receipt of goods at their premises to inspect the goods for defects or spoilage and notify the Company. If the Company is not contacted within those seven days, the Company’s obligation to the customer are considered fully discharged and revenue should be recognized. Given the timing of these seven days, the Company believes that certain sales transactions have been erroneously recognized during the year ended December 31, 2015. The Company has rectified this error and the impact of the Company’s financial position and result of operations.
ITEM 9B.
ITEM 9B. OTHER INFORMATION.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Directors
The following table sets forth the name, age and position of each of our current directors as well as the date that each officer began their service as a director.
MR. SI CHEN. Mr. Chen became our chief executive officer and director in May 2007 upon the completion of our recapitalization, and was also appointed our president in September 2009. Mr. Chen founded Shandong Lorain, our first subsidiary, in 1994, and served as the chairman of our subsidiaries since that time. Mr. Chen earned an associate degree from Linyi Normal University. Mr. Chen has been our Company’s founder and Chairman and Chief Executive Officer since inception. He is the individual most familiar with our business and industry, including the regulatory structure and other industry-specific matters, as well as being most capable of effectively identifying strategic priorities and leading the discussion and execution of strategy.
MR. YUNDONG LU. Mr. Lu was appointed as our Chief Operating Officer and was elected as a member of our board of directors effective August 1, 2008. Mr. Lu joined the Company in 1994 and has held various positions since then. From April 2003 to May 2005, Mr. Lu was the General Manager of Beijing Lorain and the Deputy General Manager of our subsidiaries. From May 2005 to February 2007, Mr. Lu was the General Manager of Lorain International Trading and the Deputy General Manager of our subsidiaries. From February to August 2008, Mr. Lu was the General Manager of our subsidiaries. Mr. Lu was recognized as an Outstanding Entrepreneur in Shandong Province in 2007. Mr. Lu earned an MBA from Shandong University and a Bachelor of Arts degree from Shandong University. Mr. Lu, has been our Company’s Chief Operating Officer since 2008 and he has worked with our Company since 1994. Because of his tenure with the Company, he is familiar with our business and industry, including the regulatory structure and other industry-specific matters.
MR. YUNQIANG SUN. Mr. Sun has been an accounting manager of Shandong Lorain Co., Ltd. since 2014. From 2009 to 2014, Mr. Yunqiang Sun served as the Chief Financial officer of Shandong Quanrixing Food Co., Ltd. From 2007 to 2009, he served as Account Manager of Shandong Linyi Kaijia Food Co., Ltd. From 1992 to 2007, he served as Chief Financial Officer of Shandong Chunyuan Food Co., Ltd. Mr. Yunqiang holds a degree in Economics from Linyi Trading College.
MR. MAOQUAN WEI. Mr. Wei, who has served as a member of our board of directors since 2008, is a retired government official who held various positions in the government of Junan County, Shandong Province, China from 1990 to 2003, during which time Mr. Wei was responsible for overseeing the agricultural development of Junan County in the Shandong Province of China. Most recently, from 1998 to 2003, Mr. Wei was the Chairman of the Political Conservative Conference of Junan County. Mr. Wei also served as the Deputy Secretary of County Committee and Deputy Chairman of Junan County. Mr. Wei has helped lead Junan County to win numerous honors, including Top 100 National Fruit Products County and National Chestnut Base County. Although retired, Mr. Wei’s expertise and experience with the agricultural economy and resources in the countryside is invaluable to our business.
MR. DEKAI YIN. Mr. Yin was appointed one of our directors in September 2009. He has been working as the President of Zibo branch of the Agricultural Bank of China since 2004. Before that position, Mr. Yin served as the Vice President and the President at Linyi branch of the Agricultural Bank of China from 1995-2004. Mr. Yin has a degree in economic management and is regarded as a senior economist due to his distinguished expertise in the banking and accounting industries and economic development. Our company greatly benefits from Mr. Yin’s invaluable expertise in banking and accounting systems and operations.
MR. HONGXIANG YU. Hongxiang Yu, age 37, has served as the head of the internal auditing department of Hongrun Construction Group Co., Ltd., a company listed on the Shenzhen Stock Exchange, and as general manager for Hongrun’s foundation engineering subsidiary from August 2006. In September 2015, Mr. Yu established and has been the Chairman of Shanghai Highlights Asset Management Co., Ltd., a company engaged in assets management and private equity investment in China. Since April 1, 2016, Mr. Yu has also served as the Vice Chairman of Tianjin Dragon Film Limited, a company engaged in investment in film industry including the both upstream and downstream chain of film production business in China. Mr. Yu received his Bachelor degree in International Trade in 2004 from University of Portsmouth and his Master degree in International Human Resources Management in 2006 from University of Portsmouth in U.K.
There are no arrangements or understandings between any of our directors and any other person pursuant to which any director was selected to serve as a director of our company. Directors are elected until their successors are duly elected and qualified. There are no family relationships among our directors or officers.
Executive Officers
Our executive officers are appointed by our Board and serve at their discretion. The following table sets forth the name, age and position of each of our current executive officers as well as the date that each officer began their service as an executive officer.
See “Directors” on page 1 above for information on Messrs. Chen, Lu and Sun.
There are no arrangements or understandings between any of our executive officers and any other person pursuant to which any executive officer was selected to serve as an executive officer of our company.
Audit Committee
The Audit Committee assists our board in monitoring:
-
our accounting, auditing, and financial reporting processes;
-
the integrity of our financial statements;
-
internal controls and procedures designed to promote our compliance with accounting standards and applicable laws and regulations; and
-
the appointment and evaluation of the qualifications and independence of our independent auditors.
Dekai Yin, Hongxiang Yu, and Maoquan Wei, all of whom are independent directors under SEC rules and the rules of NYSE Amex, are currently serving as members of the Audit Committee. Mr. Yu is the chairman of the Audit Committee and is our audit committee financial expert.
The Audit Committee has adopted a written charter, a copy of which is available on our website on the Corporate Governance page under the Investor link at http://www.americanlorain.com, and a printed copy of which is available to any shareholder requesting a copy by writing to: American Lorain Corporation, c/o Board of Director Office, Beihuan Zhong Road, Junan County, Shandong, People’s Republic of China, 276600
Shareholder Nominations for Director
Shareholders may propose candidates for board membership by writing to American Lorain Corporation, c/o Board of Director Office, Beihuan Zhong Road, Junan County, Shandong, People’s Republic of China, 276600. Any such proposal shall contain the name, holdings of our securities and contact information of the person making the nomination; the candidate's name, address and other contact information; any direct or indirect holdings of our securities by the nominee; any information required to be disclosed about directors under applicable securities laws and/or stock exchange requirements; information regarding related party transactions with our company and/or the stockholder submitting the nomination; any actual or potential conflicts of interest; the nominee's biographical data, current public and private company affiliations, employment history and qualifications and status as "independent" under applicable securities laws and stock exchange requirements. Nominees proposed by stockholders will receive the same consideration as other nominees.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires our executive officers, directors and persons who beneficially own more than 10% of our common stock to file initial reports of ownership and reports of changes in ownership with the Securities and Exchange Commission, which we also refer to throughout this report as the SEC. Based solely on our review of the copies of such forms furnished to us and written representations from our executive officers, directors and such beneficial owners, we believe that all filing requirements of Section 16(a) of the Exchange Act were timely complied with during the fiscal year ended December 31, 2016
Code of Ethics
Our Board adopted a Code of Ethics that applies to all of our directors, executive officers, including our principal executive officer, principal financial officer and principal accounting officer, and employees. The Code of Ethics addresses, among other things, honesty and ethical conduct, conflicts of interest, compliance with laws, regulations and policies, including disclosure requirements under the federal securities laws, confidentiality, trading on inside information, and reporting of violations of the code. The Code of Ethics is available on the Corporate Governance page of our website under the Investor link at www.americanlorain.com, and a copy of the Code of Ethics is available to any shareholder requesting a copy by writing to: American Lorain Corporation, c/o Board of Director Office, Beihuan Zhong Road, Junan County, Shandong, China 276600. We intend to disclose on our website, in accordance with all applicable laws and regulations, amendments to, or waivers from, our Code of Ethics.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth information concerning all forms of compensation earned by our named executive officers during the fiscal years ended December 31, 2015 and 2016 for services provided to us and our subsidiaries. None of our current executive officers earned compensation that exceeded $100,000 during the fiscal years ended December 31, 2015 or 2016.
Pursuant to Mr. Chen’s employment agreement, we paid Mr. Chen a base salary of $66,000 in cash during fiscal years ended December 31, 2016 and 2015. Mr. Chen’s employment agreement does not provide any change in control or severance benefits and we do not have any separate change-in-control agreements with Mr. Chen or any of our other executive officers.
Pursuant to Mr. Sun’s employment agreement, we are obligated to pay Mr. Zhou a base salary of RMB 15,000 per month ($2,258 at then current exchange rate).
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth information regarding beneficial ownership of our common stock as of September 29, 2016 (i) by each person who is known by us to beneficially own more than 5% of our common stock; (ii) by each of our named executive officers and directors and (iii) by all of our officers and directors as a group. Beneficial ownership is determined in accordance with the rules of the SEC that deem shares to be beneficially owned by any person who has voting or investment power with respect to such shares. Except as otherwise indicated, the persons listed below have advised us that they have direct sole voting and investment power with respect to the shares listed as owned by them.
Unless otherwise specified, the address of each of the persons set forth below is c/o American Lorain Corporation, Beihuan Zhong Road, Junan County, Shandong, China 276600.
In the table below, percentage ownership is based on 38,259,490 shares of our common stock outstanding as of September 29, 2016.
* Less than 1%
(1)
10,794,066 shares of common stock that has been pledged under the Share Pledge Agreement, dated October 19, 2010, for the benefit of DEG-Deutsche Investitions- und Entwicklungsgesellshaft mbH (“DEG”) in order to secure the obligations of the Company and its subsidiary Junan Hongrun Foodstuff Co., Ltd. under a Loan Agreement, dated May 31, 2010, among the Company, DEG and Mr. Si Chen (the “Loan Agreement”) transferred to DEG on September 7, 2016 by DEG notifing the Agent under the Pledge Agreement that the Company was in default under the Loan Agreement.
(2)
On September 7, 2016, DEG acquired beneficial ownership of 10,794,066 shares of Common Stock upon foreclosure of the pledge from Mr. Si Chen.
(3)
Based on information supplied by Tongley Investment Ltd. in a Schedule 13G/A filed with the SEC on February 18, 2014. The address of Tongley Investment Ltd. is P.O. Box 957, Offshore Incorporations Centre, Road Town, Tortola, British Virgin Islands
(4)
On March 13, 2014 in exchange for US$3.5 million, the Company issued a Convertible Promissory Note (“Note”) in the principal amount of US$ 3.5 million (the “Principal Amount”) to Jade Lane Group Limited, a company incorporated under the laws of British Virgin Islands (the “Holder”). The Maturity Date for the Note was March 13, 2015. For details, please see the Form 8-K filed by the Company on March 20, 2014. Based on information supplied by Jade Lane Group Limited in a Schedule 13D filed with the SEC on July 17, 2014 and Notification and Confirmation Letter between the Company and Jade Lane Group Limited (Jade Lane) dated March 12, 2015, Jade Lane will redeem $791,433 principle and covert the remaining principle $2,708,567 to 2,355,276 shares of common stock of the Company at $1.15 per share. The 2,355,276 shares were issued on April 20, 2015. Jade Lane is the sole general partner of Jade Lane I, L.P. (“JLI”). Ms. Chen Wenxuan is the sole director of Jade Lane and has voting and dispositive power over the shares held by JLI; however, Jade Lane and Ms. Chen Wenxuan each disclaim beneficial ownership of shares held by JLI, except to the extent of their pecuniary interests therein.Jade Lane is a corporation organized under the laws of the British Virgin Islands with a principal business involving investments. The principal office for Jade Lane is located at Unit 1109-1116, HSBC Building, Shanghai IFC, 8 Century Avenue, Pudong District, Shanghai 200120, China. JLI is a corporation organized under the laws of the British Virgin Islands with a principal business involving investments. The principal office for JLI is located at Unit 1109- 1116, HSBC Building, Shanghai IFC, 8 Century Avenue, Pudong District, Shanghai 200120, China. Ms. Chen’s business address is Unit 1109-1116, HSBC Building, Shanghai IFC, 8 Century Avenue, Pudong District, Shanghai 200120, China. Ms. Chen’s present principal occupation is Managing partner of HFG CHINA, but she is also a director of Jade Lane.
(5)
On August 25, 2016, the Board appointed Hongxiang Yu as a member of the Board, the Chairman of the Corporate Governance and Nominating Committee, a member of the Audit Committee and the Compensation Committee of the Board, to serve until him successor has been duly elected and qualified.
(6)
Mr. Sun was appointed CFO on November 22, 2016.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
Related Party Transactions
Pursuant to a Share Pledge Agreement, dated October 19, 2010 (the “Share Pledge Agreement”), the Mr. Si Chen, our chief executive officer and chairman, has pledged 5,313,574 shares of Common Stock (the “Pledged Shares”) for the benefit of DEG-Deutsche Investitions- und Entwicklungsgesellshaft mbH (“DEG”) in order to secure the obligations of the Company and its subsidiary Junan Hongrun Foodstuff Co., Ltd. (“Junan Hongrun”) under a Loan Agreement, dated May 31, 2010, among the Company, DEG and Mr. Si Chen (the “Loan Agreement”). In the event that the value of the pledged assets is less than 150% of the amounts made available to the Junan Hongrun under the Loan Agreement, DEG has the right to require additional security in the form of fixed assets or shares under the Loan Agreement and Share Pledge Agreement. Pursuant to a letter agreement, dated November 15, 2012, Mr. Si Chen has pledged an additional 5,480,492 shares of Common Stock to DEG under the Pledge Agreement in order to secure the obligations of the Borrower under the Loan Agreement. The total number of shares pledged under the Pledge Agreement is now 10,794,066 shares of Common Stock. For so long as no event of default under the Loan Agreement has occurred, Mr. Si Chen continues to retain all voting rights with respect to the Pledged Shares.
On March 13, 2014, Mr. Si Chen, our chief executive officer and chairman, provided a personal guaranty of the March 13, 2014 Convertible Promissory Note issued by the Company to an investor in the principal amount of $3.5 million.
On September 7, 2016, DEG acquired beneficial ownership of 10,794,066 shares of Common Stock upon foreclosure of the pledge from Mr. Si Chen. Such shares constitute approximately 28.2% of the total number of shares of Common Stock of the Issuer outstanding as of September 30, 2015.
Policy for Approval of Related Party Transactions
Our Audit Committee Charter provides that all related party transactions required to be disclosed under SEC rules are to be reviewed by the Audit Committee.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
WWC., P.C. is the Company’s independent registered public accounting firm for the fiscal year ending December 31, 2016 and the accounting fees is $170,000.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) (1 and 2) Financial Statement and Schedules
The financial statements contained in the “Audited Financial Statements” beginning on page of this Annual Report on Form 10-K.
(b) Exhibits
* Filed herewith
** Furnished herewith
 Management contract, compensatory plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
AMERICAN LORAIN
CORPORATION
Date: October 30, 2017 By:/s/ Si Chen
Si Chen, Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this annual report has been signed by the following persons in the capacities and on the dates indicated.
Signature Title Date
President, Director and Chief October 30, 2017
Executive Officer
/s/ Si Chen (Principal Executive Officer)
Si Chen
Chief Financial Officer
(Principal Financial Officer and
Principal
/s/ Yunqiang Sun
Accounting Officer) October 30, 2017
Yunqiang Sun
/s/ Yundong Lu Chief Operating Officer and Director October 30, 2017
Yundong Lu
/s/ Dekai Yin Director October 30, 2017
Dekai Yin
/s/ Maoquan Wei
Director October 30, 2017
Maoquan Wei
/s/ Hongxiang Yu
Director October 30, 2017
Hongxiang Yu
American Lorain Corporation
Audited Consolidated Financial Statements
December 31, 2016 and 2015
American Lorain Corporation
Audited Consolidated Financial Statements
December 31, 2016 and 2015
Report of Independent Registered Public Accounting Firm
To: The Board of Directors and Stockholders of
American Lorain Corporation
We have audited the accompanying balance sheets of American Lorain Corporation and its subsidiaries (collectively the “Company”) as of December 31, 2016 and 2015, and the related statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2016. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.
The Company identified an error in its financial statements as of December 31, 2015 and for the year then ended. It has rectified the error in the accompanying financial statements. For further details, refer to Note 22. We do not qualify our opinion on the accompanying financial statements in regards to this matter.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the financial statements, the Company had incurred substantial losses during the year and had working capital deficit, which raises substantial doubt about its ability to continue as a going concern. Management’s plans in regards to these matters are also described in Note 3. These financial statements do not include any adjustments that might result from the outcome of this uncertainty.
San Mateo, California WWC, P.C.
October 30, 2017 Certified Public Accountants
American Lorain Corporation
Consolidated Balance Sheets
As of December 31, 2016 and 2015
American Lorain Corporation
Consolidated Statements of Operations and Comprehensive Loss
For the years ended December 31, 2016 and 2015
American Lorain Corporation
Consolidated Statements of Stockholders’ Equity
For the years ended December 31, 2016 and 2015
American Lorain Corporation
Consolidated Statements of Cash Flows
For the years ended December 31, 2016 and
American Lorain Corporation
Notes to Financial Statements
1.
Organization and Principal Activities
American Lorain Corporation (the “Company” or “ALN”) is registered as a corporation in the state of Nevada. The Company conducts its primary business activities through its subsidiaries located in the People’s Republic of China. Those subsidiaries develop, manufacture, and market convenience foods, chestnut products, and frozen foods; these products are sold to both domestic markets and international markets.
2.
Summary of Significant Accounting Policies
Method of accounting
Management has prepared the accompanying financial statements and these notes in accordance to generally accepted accounting principles in the United States of America; the Company maintains its general ledger and journals with the accrual method accounting.
Restatement of prior financial statements
The Company has discovered errors in the timing of revenues recognized during the year ended December 31, 2015. The Company recognizes revenue upon shipping of products to its customers where title of the goods passes upon departure from the Company’s facilities; however, in certain instances, contractual terms dictate that the customers are afforded seven days after the receipt of goods at their premises to inspect the goods for defects or spoilage and notify the Company. If the Company is not contacted within those seven days, the Company’s obligation to the customer are considered fully discharged and revenue should be recognized. Given the timing of these seven days, the Company believes that certain sales transactions have been erroneously recognized during the year ended December 31, 2015. The Company has rectified this error and the impact of the Company’s financial position and result of operations are detailed below.
Principles of consolidation
The accompanying consolidated financial statements include the assets, liabilities, and results of operations of the Company, and its subsidiaries, which are listed below:
In 2014, the Company invested $2,100,000 in Athena/Minerve Group whereby the Company controlling shareholder of Minerve. Minerve conducted operations in manufacturing, packaging and sales activities in France and import and storage operations in Portugal. During the years ended December 31, 2015, the financial position and results of operations of Minerve were accounted for as subsidiaries in the Company’s financial statements; however, during the year ended December 31, 2016, Minerve became insolvent and compelled into bankruptcy by creditors, and, ultimately liquidation. Accordingly, the Company lost control of Minerve and written of the value of its investment in Minerve. All receivables due by Minerve to subsidiaries still controlled by the Company have been written off. The Company’s consolidated financial statements at December 31, 2015 have been recast to provide improved comparability for the Company’s continuing operations.
Management has eliminated all significant inter-company balances and transactions in preparing the accompanying consolidated financial statements. Ownership interests of subsidiaries that the Company does not wholly-own are accounted for as non-controlling interests.
American Lorain Corporation
Notes to Financial Statements
Shandong Economic Development Investment Corporation, which is a PRC state-owned entity, holds 19.8% equity interest in Shandong Lorain.
Use of estimates
The preparation of the financial statements requires management to make 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. Management makes these estimates using the best information available at the time the estimates are made; however, actual results could differ materially from those estimates.
Cash and cash equivalents
The Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents.
Investment securities
The Company classifies securities it holds for investment purposes into trading or available-for-sale. Trading securities are bought and held principally for the purpose of selling them in the near term. All securities not included in trading securities are classified as available-for-sale.
Trading and available-for-sale securities are recorded at fair value. Unrealized holding gains and losses on trading securities are included in the net income. Unrealized holding gains and losses, net of the related tax effect, on available for sale securities are excluded from net income and are reported as a separate component of other comprehensive income until realized. Realized gains and losses from the sale of available-for-sale securities are determined on a specific-identification basis.
A decline in the market value of any available-for-sale security below cost that is deemed to be other-than-temporary results in a reduction in carrying amount to fair value. The impairment is charged as an expense to the statement of income and comprehensive income and a new cost basis for the security is established. To determine whether impairment is other-than-temporary, the Company considers whether it has the ability and intent to hold the investment until a market price recovery and considers whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for the impairment, the severity and duration of the impairment, changes in value subsequent to year end, and forecasted performance of the investee.
Premiums and discounts are amortized or accreted over the life of the related available-for-sale security as an adjustment to yield using the effective-interest method. Dividend and interest income are recognized when earned.
Trade receivables
Trade receivables are recognized and carried at the original invoice amount less allowance for any uncollectible amounts. An estimate for doubtful accounts is made when collection of the full amount is no longer probable. Bad debts are written off as incurred.
Inventories
Inventories consist of raw materials and finished goods which are stated at the lower of cost or market value. Finished goods are comprised of direct materials, direct labor, inbound shipping costs, and allocated overhead. The Company applies the weighted average cost method to its inventory.
American Lorain Corporation
Notes to Financial Statements
Advances and prepayments to suppliers
The Company makes advance payment to suppliers and vendors for the procurement of raw materials. Upon physical receipt and inspection of the raw materials from suppliers the applicable amount is reclassified from advances and prepayments to suppliers to inventory.
Plant and equipment
Plant and equipment are carried at cost less accumulated depreciation. Depreciation is provided over their estimated useful lives, using the straight-line method. The Company’s typically applies a salvage value of 0% to 10%. The estimated useful lives of the plant and equipment are as follows:
The cost and related accumulated depreciation of assets sold or otherwise retired are eliminated from the accounts, and any gain or loss are included in the Company’s results of operations. The costs of maintenance and repairs are recognized to expenses as incurred; significant renewals and betterments are capitalized.
Construction in progress and prepayments for equipment
Construction in progress and prepayments for equipment represent direct and indirect acquisition and construction costs for plants, and costs of acquisition and installation of related equipment. Amounts classified as construction in progress and prepayments for equipment are transferred to plant and equipment when substantially all the activities necessary to prepare the assets for their intended use are completed. Depreciation is not provided for assets classified in this account.
Land use rights
Land use rights are carried at cost and amortized on a straight-line basis over a specified period. Amortization is provided using the straight-line method over 40-50 years.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of the net identifiable assets acquired in a business combination. The Company conducts an annual assessment of its goodwill for impairment. If the carrying value of its goodwill exceeds its fair value, then impairment has incurred; accordingly, a charge to the Company’s results of operations will be recognized during the period. Fair value is generally determined using a discounted expected future cash flow analysis.
Accounting for the impairment of long-lived assets
The Company annually reviews its long-lived assets for impairment or whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. Impairment may be the result of becoming obsolete from a change in the industry, introduction of new technologies, or if the Company has inadequate working capital to utilize the long-lived assets to generate the adequate profits. Impairment is present if the carrying amount of an asset is less than its expected future undiscounted cash flows.
If an asset is considered impaired, a loss is recognized based on the amount by which the carrying amount exceeds the fair market value of the asset. Assets to be disposed are reported at the lower of the carrying amount or fair value less costs to sell.
Statutory reserves
Statutory reserves are referring to the amount appropriated from the net income in accordance with laws or regulations, which can be used to recover losses and increase capital, as approved, and are to be used to expand production or operations. PRC laws prescribe that an enterprise operating at a profit must appropriate and reserve, on an annual basis, an amount equal to 10% of its profit. Such an appropriation is necessary until the reserve reaches a maximum that is equal to 50% of the enterprise’s PRC registered capital.
American Lorain Corporation
Notes to Financial Statements
Foreign currency translation
The accompanying financial statements are presented in United States dollars. The functional currencies of the Company are the Renminbi (RMB) and the Euro (EUR). The Company’s assets and liabilities are translated into United States dollars from RMB and EUR at year-end exchange rates, and its revenues and expenses are translated at the average exchange rate during the period. Capital accounts are translated at their historical exchange rates when the capital transactions occurred.
The RMB is not freely convertible into foreign currencies and all foreign exchange transactions must be conducted through authorized financial institutions.
Revenue recognition
The Company recognizes revenue in accordance to guidance found in Staff Accounting Bulletin (SAB) 104, where persuasive evidence of arrangement exists, the price has been fixed or is determinable, the delivery has been completed and no other significant obligations of the Company exists, and collectability of payment is reasonably assured. Payments received prior to all of the foregoing criteria are recorded as customer deposits. Recorded revenue is derived from the value of goods invoiced less value-added tax (VAT).
Advertising
All advertising costs are expensed as incurred.
Shipping and handling
All outbound shipping and handling costs are expensed as incurred.
Research and development
All research and development costs are expensed as incurred.
Retirement benefits
Retirement benefits in the form of mandatory government sponsored defined contribution plans are charged to the either expenses as incurred or allocated to inventory as part of overhead.
Income taxes
The Company accounts for income tax using an asset and liability approach and allows for recognition of deferred tax benefits in future years. Under the asset and liability approach, deferred taxes are provided for the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is provided for deferred tax assets if it is more likely than not these items will either expire before the Company is able to realize their benefits, or that future realization is uncertain.
American Lorain Corporation
Notes to Financial Statements
Comprehensive income
The Company uses FASB ASC Topic 220, “Reporting Comprehensive Income”. Comprehensive income is comprised of net income and all changes to the statements of stockholders’ equity, except the changes in paid-in capital and distributions to stockholders due to investments by stockholders.
Earnings per share
The Company computes earnings per share (“EPS”) in accordance with ASC Topic 260, “Earnings per share”. Basic EPS is measured as the income or loss available to common shareholders divided by the weighted average common shares outstanding for the period. Diluted EPS presents the dilutive effect on a per share basis from the potential conversion of convertible securities or the exercise of options and or warrants; the dilutive effects of potentially convertible securities are calculated using the as-if method; the potentially dilutive effect of options or warrants are calculated using the treasury stock method. Securities that are potentially an anti-dilutive effect (i.e. those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS.
Financial instruments
The Company’s financial instruments, including cash and equivalents, accounts and other receivables, accounts and other payables, accrued liabilities and short-term debt, have carrying amounts that approximate their fair values due to their short maturities. ASC Topic 820, “Fair Value Measurements and Disclosures,” requires disclosure of the fair value of financial instruments held by the Company. ASC Topic 825, “Financial Instruments,” defines fair value, and establishes a three-level valuation hierarchy for disclosures of fair value measurement that enhances disclosure requirements for fair value measures. The carrying amounts reported in the consolidated balance sheets for receivables and current liabilities each qualify as financial instruments and are a reasonable estimate of their fair values because of the short period of time between the origination of such instruments and their expected realization and their current market rate of interest. The three levels of valuation hierarchy are defined as follows:
•
Level 1 - inputs to the valuation methodology used quoted prices for identical assets or liabilities in active markets.
•
Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
•
Level 3 - inputs to the valuation methodology are unobservable and significant to the fair value measurement.
The Company analyzes all financial instruments with features of both liabilities and equity under ASC 480, “Distinguishing Liabilities from Equity,” and ASC 815.
Commitments and contingencies
Liabilities for loss contingencies arising from claims, assessments, litigation, fines and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated.
Recent accounting pronouncements
In January 2017, the FASB issued guidance which simplifies the accounting for goodwill impairment. The updated guidance eliminates Step 2 of the impairment test, which requires entities to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value, determined in Step 1. The Company is currently evaluating the impact on the financial statements of this guidance.
In January 2017, the FASB amended the existing accounting standards for business combinations. The amendments clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The Company is currently evaluating the impact on the financial statements of this guidance.
American Lorain Corporation
Notes to Financial Statements
In November 2016, the FASB issued guidance, which addresses the presentation of restricted cash in the statement of cash flows. The guidance requires entities to show the changes in the total of cash, cash equivalents, restricted cash, and restricted cash equivalents in the statement of cash flows. As a result, entities will no longer present transfers between cash and cash equivalents and restricted cash and restricted cash equivalents in the statement of cash flows. The Company is currently evaluating the timing and the impact of this guidance on the financial statements.
In October 2016, the FASB issued guidance, which amends the existing accounting for Intra-Entity Transfers of Assets Other Than Inventory. The guidance requires an entity to recognize the income tax consequences of intra-entity transfers, other than inventory, when the transfer occurs The Company is currently evaluating the timing and the impact of this guidance on the financial statements.
In August 2016, the FASB issued guidance, which amends the existing accounting standards for the classification of certain cash receipts and cash payments on the statement of cash flows. The Company is currently evaluating the timing and the impact of this guidance on the financial statements.
In June 2016, the FASB issued guidance, which requires credit losses on financial assets measured at amortized cost basis to be presented at the net amount expected to be collected, not based on incurred losses. Further, credit losses on available-for-sale debt securities should be recorded through an allowance for credit losses limited to the amount by which fair value is below amortized cost. The Company is currently evaluating the timing and the impact of this guidance on the financial statements.
In February 2016, the FASB issued guidance, which amends the existing accounting standards for leases. Consistent with current guidance, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification. Under the new guidance, a lessee will be required to recognize assets and liabilities for all leases with lease terms of more than twelve months. The Company is currently evaluating the timing and the impact of this guidance on the financial statements.
In January 2016, the FASB issued guidance, which amends the existing accounting standards for the recognition and measurement of financial assets and financial liabilities. The updated guidance primarily addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The Company is currently evaluating the timing and the impact of this guidance on the financial statements.
3.
Going Concern
The accompanying financial statements have been prepared on a going-concern basis. The going-concern basis assumes that assets will be realized and liabilities will be settled in the ordinary course of business in the amounts disclosed in the financial statements. The Company’s ability to continue as a going concern is greatly dependent on the Company’s ability to realize its non-cash current assets such as receivables and inventory into cash in order to settle its current obligations. For the year ended December 31, 2016, the Company incurred a substantial loss of $136,361,080. As of December 31, 2016, the Company had a working capital deficit of approximately $21,086,641. These conditions raise substantial doubt as to whether the Company may continue as a going concern.
To improve its solvency, the Company is working to obtain new working capital through private placements of its common stock or convertible debt securities to qualified investors.
4.
Restricted Cash
Restricted cash represents interest bearing deposits placed with banks to secure banking facilities in the form of loans and notes payable. The funds are restricted from immediate use and are designated for settlement of loans or notes when they become due.
American Lorain Corporation
Notes to Financial Statements
5.
Trade Receivables
The Company extends credit terms of 15 to 60 days to the majority of its domestic customers, which include third-party distributors, supermarkets and wholesalers; international customers are typically extended 90 days credit.
6.
Inventories
7.
Plant and Equipment
Depreciation expense for the years ended December 31, 2016 and 2015 was $1,934,411 and $2,075,599, respectively.
8.
Intangible Assets
American Lorain Corporation
Notes to Financial Statements
All land is owned by the government in China. Land use rights represent the Company’s purchase of usage rights for a parcel of land for a specified duration of time, typically 50 years. Amortization expense for the years ended December 31, 2016 and 2015 were $299,177 and $682,391, respectively.
9.
Goodwill
On August 8, 2015, the Company re-organized its French operations by merging the operations of Conserverie Minerve into its immediate parent Athena, and concurrently, Athena wound up and dissolved Conserverie Minerve. Athena subsequently changed its own legal name to Conserverie Minerve and to continue its business. At the date of acquisition, the net liability of Conserverie Minerve was $3,255,911(EUR 2,968,089); the purchase consideration paid for the Athena (aka Conserverie Minerve) was $2,100,000. The acquisition of Athena and its then subsidiaries gave rise to goodwill in the amount of $6,786,928. As of December 31, 2015, the surviving business entity, Conserverie Minerve, on a post merged basis, recognized net operating losses during the year ended December 31, 2015. As of December 31, 2015, the Company was unable to determine if the Conserverie Minerve would be able to generate future profit and positive operating cash flows to justify the carrying value of goodwill in the amount of $6,786,928; accordingly, the Company elected to write-off the goodwill that it had recognized during its acquisition of Conserverie Minerve. Conserverie Minerve had a goodwill of its own that had accumulated over the years as result of its acquisition of subsidiaries; at December 31, 2015, the outstanding balance was $3,219,172. As mentioned in “Note 2 - Summary of Significant Accounting Policies-Principles of Consolidation”, Conserverie Minerve has been liquidated and the Company no longer has any interest in Conserverie Minerve; accordingly, all remaining goodwill has been de- recognized.
10.
Bank Loans
Bank loans include bank overdrafts and short-term bank loans for continuing operations consisted of the following:
American Lorain Corporation
Notes to Financial Statements
The short-term loans, which are denominated in Renminbi and Euros, were primarily obtained for general working capital. If not otherwise specifically indicated above, short-term bank loans are guaranteed either by other companies within the group, or by personnel in senior management positions within the group.
* Note: As of December 31, 2016, these loans have not been repaid and are considered in default. The Company is in negotiations to renew these loans or modify the repayment terms.
11.
Current Portion - Long Term Debt
Current portions of notes payable, debentures, and long-term debt for continuing operations consisted of the following:
American Lorain Corporation
Notes to Financial Statements
The Company began repaying its loan with DEG in semi-annual installments on December 15, 2012. As of December 31, 2016, and 2015, the Company had not repaid any principal. The loan was collateralized with the following terms:
(a.)
A first ranking mortgage in the amount of about USD $12,000,000 on the Company’s land and building in favor of DEG.
(b.)
A share pledge, by Mr. Si Chen (a major shareholder, and Chairman and CEO of the Company) as the sponsor of the loan, to secure approximately USD $12,000,000 of the loan.
(c.)
The total amount of the first ranking mortgage as indicated in the Loan Agreement (Article 12(1)(a)) and the value of the pledged shares by Mr. Si Chen (Loan Agreement (Article 12(1)(a))) should be at least USD 24,000,000 in aggregate.
(d.) A personal guarantee by Mr. Si Chen in form and substance satisfactory to DEG.
The Company defaulted on its loan with DEG; accordingly, on December 7, 2016, DEG exercised its rights to foreclose on 10,794,066 shares pledged by Mr. Si Chen.
The Company is in default of the debentures that were issued by Guoyuan Securities and Daiwa SSC Securities and negotiating with the debenture holders to extend repayment terms.
12.
Taxes Payable
Taxes payable consisted of the following:
13.
Long Term Debt
Non-current portions of notes payable and debentures for continuing operations consisted of the following:
14.
Equity
For the year ended December 31, 2015, the Company issued 987,500 shares as stock compensation to employees and 2,355,276 shares upon conversion of the convertible promissory note to Jade Lane.
American Lorain Corporation
Notes to Financial Statements
For the year ended December 31, 2016, the Company issued 15,000 shares as stock compensation to employees.
15.
Income Taxes
All of the Company’s continuing operations are located in the PRC. The corporate income tax rate in the PRC is 25%.
The following tables provide the reconciliation of the differences between the statutory and effective tax expenses for the years ended December 31, 2016 and 2015:
Per Share Effect of Tax Exemption
The difference between the U.S. federal statutory income tax rate and the Company’s effective tax rate was as follows for the years ended December 31, 2016 and 2015:
16.
(Loss) Earnings Per Share
Components of basic and diluted (loss) earnings per share were as follows:
American Lorain Corporation
Notes to Financial Statements
17.
Lease Commitments
During the year ended December 31, 2013, the Company entered into three operating lease agreements leasing three plots of land where greenhouses are maintained to grow seasonal crops. The leases were signed by Junan Hongrun Foodstuff Co., Ltd. and they expire on April 25, 2033, May 19, 2033, and June 19, 2033.
The minimum future lease payments for these properties at December 31, 2016 are as follows:
The outstanding lease commitments for the three greenhouses as of December 31, 2016 was $2,857,577.
18.
Capital Lease Obligations
The Company leases certain machinery and equipment under leases classified as capital leases. For the year ended December 31, 2015, the Company entered into the following capital leases:
American Lorain Corporation
Notes to Financial Statements
(a.)
On July 1, 2015, the Company entered into a capital lease agreement in the amount of RMB 1,057,571, which was approximately USD 166,447, with Lessor A leasing: five production machines, two packaging machines, one assembly line, and ten vending machines with an interest rate of 7% for a period of 36 months with an expiration date of June 30, 2018 with an option to buy the leased assets following the lease expiration for RMB 1.
(b.)
On July 1, 2015, the Company entered into a capital lease agreement in the amount of RMB 2,805,493, which was approximately USD 441,546, with Lessor A leasing one hundred vending machines with an interest rate of 7% for a period of 36 months with an expiration date of June 30, 2018 with an option to buy the leased assets following the lease expiration for RMB 1.
(c.)
On August 25, 2015, the Company entered into a capital lease agreement in the amount of RMB 2,163,845, which was approximately USD 340,539, with Lessor B leasing eight production machines with an interest rate of 7% for a period of 30 months with an expiration date of February 25, 2018 with an option to buy the leased assets following the lease expiration for RMB 100.
(d.)
On August 25, 2015, the Company entered into a capital lease agreement in the amount of RMB 530,439, which was approximately USD 83,484, with Lessor B leasing four production machines with an interest rate of 7% for a period of 30 months with an expiration date of February 25, 2018 with an option to buy the leased assets following the lease expiration for RMB 100.
(e.)
On August 25, 2015, the Company entered into a capital lease agreement in the amount of RMB 777,228, which was approximately USD 122,325, with Lessor B leasing one assembly line with an interest rate of 7% for a period of 30 months with an expiration date of February 25, 2018 with an option to buy the leased assets following the lease expiration for RMB 100.
(f.)
On August 25, 2015, the Company entered into a capital lease agreement in the amount of RMB 1,647,563, which was approximately USD 259,304, with Lessor B leasing one freezing unit with an interest rate of 7% for a period of 30 months with an expiration date of February 25, 2018 with an option to buy the leased assets following the lease expiration for RMB 100.
The following is a schedule showing the future minimum lease payments under capital leases together with the present value of the net minimum lease payments as of December 31, 2016:
As of December 31, 2016, the present value of minimum lease payments due within one year is $1,007,185. The Company recorded impairment on the leased assets that underlie these lease obligations; the Company’s management believes it is appropriate to account for all remaining lease obligations as current given that these leased assets are no longer generating long term benefits to the Company.
19.
Contingencies and Litigation
There is a lawsuit currently pending in the Linyi City Intermediate People’s Court of Shandong Province, which was initially filed by Shandong Lorain, a subsidiary of the Company, against Junan Hengji Real Estate Development Co., Ltd. ("Junan Hengji") in November 2013 at Linyi City Intermediate People's Court of Shandong Province (the "Linyi Court"). Shandong Lorain added Jiangsu Hengan Industrial Investment Group Co., Ltd. ("Heng An Investment") as a co-defendant after the case was first filed at the Linyi Court.
In December 2010, Shandong Lorain and Junan Hengji entered into a cooperative development agreement (the "Agreement") and in March 2011, Heng An Investment, an affiliated company of Junan Hengji, also entered into the Agreement with Shandong Lorain to jointly develop the project with Junan Hengji. Pursuant to the Agreement, Junan Henji and Heng An Investment are required to pay Shandong Lorain a total of RMB 20 million (approximately $3,225,806) fixed return according to the development status of the project developed by Junan Hengji and Heng An Investment. The payment was due but unpaid in Year. In deciding to bring suit, Shandong Lorain and the Company evaluated the potential claims against Junan Hengji and Heng An Investment, disputes between the parties with respect to out-of-pocket expenses paid by Junan Hengji, as well as the litigation fee that is required to be paid to the court based upon the amount claimed. Ultimately, Shandong Lorain decided to file the lawsuit with Linyi Court to claim a fixed return of RMB 10 million (approximately $1,499,390).
American Lorain Corporation
Notes to Financial Statements
In January 2014, the Linyi Court held its first trial session. During the trial, Heng An Investment filed a counterclaim against Shandong Lorain for repayment of out-of-pocket expenses which would offset the entire fixed return plus additional unpaid expenses of RMB 4,746,927 (approximately $765,633). Shandong Lorain responded that Heng An Investment does not have standing to file the counter-claim because the out-of-pocket payments were made by Junan Hengji. In November 2014, the court held a second trial session and completed its discovery process. On March 21, 2015, Shandong Lorain received the Linyi Court's decision that rejected Shandong Lorain's claim for RMB 10,000,000 against Junan Hengji and Heng An Investment. On April 3, 2015, Shandong Lorain appealed the decision to the Supreme Court of Shandong Province.
In November 2015, the Supreme Court of Shandong Province vacated the decision of the Linyi Court and remanded the case back to the Linyi Court for a retrial. The retrial took place on April 25, 2016, at the Linyi City Intermediate People’s Court, and the decision thereon is currently pending.
20.
Other Expenses
Other expense consisted of the following:
21.
Discontinued Operations
The Company has reclassified the results of operations and the financial position of Shandong Lorain, Dongguan Lorain, the Minerve Group as discontinued operations. Selected details regarding those discontinued operations are provided below.
American Lorain Corporation
Notes to Financial Statements
American Lorain Corporation
Notes to Financial Statements
22.
Correction of Error
The Company discovered errors in the timing of revenues recognized during the year ended December 31, 2015. The Company recognizes revenue upon shipping of products to its customers where title of the goods passes upon departure from the Company’s facilities; however, in certain instances, contractual terms dictate that the customers are afforded seven days inspection period after the receipt of goods at their premises to inspect the goods for defects or spoilage and notify the Company. If the Company is not contacted within those seven days, the Company’s obligation to the customer are considered fully discharged and revenue should be recognized. Given the timing of these seven days inspection period, the Company believes that certain sales transactions have been erroneously recognized during the year ended December 31, 2015. The Company has corrected this error and adjusted for the impact upon the Company’s financial position and result of operations as detailed below, which include the regrouping of amounts attributable to Discontinued Operations as discussed in Note 21 above.
The effect of correction of these errors on results of operations for the above mentioned financial statements is as follows for 2015.
The effect of correction of these errors on retained earnings and significant asset and liability accounts is as follows:
American Lorain Corporation
Notes to Financial Statements
23.
Risks
A.
Credit risk
The Company’s deposits are made with banks located in the PRC. They do not carry federal deposit insurance and may be subject to loss of the banks become insolvent.
Since the Company’s inception, the age of account receivables has been less than one year indicating that the Company is subject to minimal risk borne from credit extended to customers.
B.
Interest risk
The company is subject to interest rate risk when short term loans become due and require refinancing.
C.
Economic and political risks
The Company’s operations are conducted in the PRC. Accordingly, the Company’s business, financial condition, and results of operations may be influenced by changes in the political, economic, and legal environments in the PRC.
The Company’s operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. The Company’s results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation, among other things.
D.
Environmental risks
The Company has procured environmental licenses required by the PRC government. The Company has both a water treatment facility for water used in its production process and secure transportation to remove waste off site. In the event of an accident, the Company has purchased insurance to cover potential damage to employees, equipment, and local environment.
E.
Inflation Risk
Management monitors changes in prices levels. Historically inflation has not materially impacted the company’s financial statements; however, significant increases in the price of raw materials and labor that cannot be passed to the Company’s customers could adversely impact the Company’s results of operations.