NOTES
TO FINANCIAL STATEMENTS
|
Note
1-
|
BASIS
OF PRESENTATION
|
The
consolidated financial statements of Shandong Zhouyuan Seed and Nursery Co.,
Ltd. ( the
"Company"), included
herein were prepared, without audit, pursuant to rules and regulations of
the
Securities and Exchange Commission. Because certain information and notes
normally included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America were condensed
or
omitted pursuant to such rules and regulations, these financial statements
should be read in conjunction with the financial statements and notes thereto
included in the audited financial statements of the Company as included in
the
Company's Form 10-
KSB for the year ended December 31, 2006.
|
Note
2-
|
ORGANIZATION
AND OPERATIONS
|
Shandong
Zhouyuan Seed and Nursery
Co.,Ltd. f/k/a Pingchuan Pharmaceuticals, Inc. (“Pingchuan”) was organized under
the laws of the State of North Carolina on July 20, 199. The Company currently
engages in the business of development, production and distribution of hybrid
crop seeds in the People's Republic of China ("PRC'), through its whole owned
subsidiary, Infolink Pacific Limited
("Infolink").
On
January 30, 2007, Pingchuan issued
to Mr. Wang, Zhigang and Ms. You, Li 55,000,000 shares of
its capital
stock in exchange for all of the capital stock of Infolink.
Infolink
was incorporated on September
28, 2006 in British Virgin Islands (“BVI”) under the BVI Business Companies Act,
2004, for the purpose of seeking and consummating a merger or acquisition
with a
business entity organized as a private corporation, partnership, or sole
proprietorship as
defined by Statement of Financial Accounting Standards
(SFAS) No. 7.
On
October 18, 2006, Mr. Li Han Xun and
Ms. You Li (collectively the "Trustees"), both of whom are citizens of the
People's Republic of China ("PRC") and owned a 60% equity ownership interest
in
Shandong Zhouyuan Seed and Nursery Co., Ltd. ( "Zhouyuan" ), executed
Trust and Indemnity Agreements with Infolink, pursuant which the Trustees
assigned to Infolink all of the beneficial interest in the Trustee's equity
ownership interest in Zhouyuan. These arrangements have been undertaken solely
to satisfy PRC regulations, which prohibits foreign companies from owning
or
operating the business of sale and development of crop seeds in
PRC.
SHANDONG
ZHOUYUAN SEED AND NURSERY CO., LTD.
F/K/A
PINGCHUAN PHARMACEUTICALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
2-
|
ORGANIZATION
AND OPERATIONS (continued)
|
Through
the agreements described in the preceeding paragraph Infolink is deemed a
60%
beneficiary
resulting in Zhouyuan
being deemed a subsidiary of Infolink under the requirements of Financial
Interpretation 46 (Revised) "Consolidation of Variable Interest Entities"
issued
by the Financial Accounting Standards Board ("FASB"). The Agreements provided
for effective control of Zhouyuan to be transferred to Infolink at October
18,
2006. Infolink did not have any operating activity prior to the share exchange
with Zhouyuan. The majority shareholders of Infolink and Zhouyuan were
substantially the same. These transactions have been accounted for on a basis
similar to a reorganization between entities under common control. Accordingly,
Infolink's consolidated financial statements are prepared by including the
consolidated financial statements of Zhouyuan through October 18, 2006, and
subsequently Infolink's consolidated financial statements include the financial
statements of Zhouyuan
Zhouyuan
was incorporated in Laizhou
City, Shandong Province, PRC on October 26, 2001. Zhouyuan engages in
the business of development, production and distribution of hybrid crop seeds
in PRC.
Under
the Company Law of PRC, two
formerly state owned companies, Laizhou Yongzhou Seed Ltd and Laizhou
Agriculture Science Research and Development Ltd., were reformed and merged
into
one company named Laizhou Huiyuan Seed Ltd ("Huiyuan") on October 26, 2001.
On
December 24,
2002, Huiyuan changed its name to Shandong Zhouyuan Seed and
Nursery Co., Ltd.
Zhouyuan
owns 80% of Laizhou Tianzhe
Seed Research and Development Ltd. ("Tianzhe"), which was incorporated in
Laozhou City, Shandong Province, PRC on October 24, 2004 under the
Company Law of PRC. Tianzhe engages in the research and development
of
crop seeds.
The
merger of Zhouyuan with Infolink
resulted in a capital transaction accounted for as a reverse merger. The
transaction was treated for accounting purposes as a recapitalization of
the
accounting acquirer (Infolink) and a reorganization of the accounting acquiree
(Pingchuan). Accordingly, the historical financial statements presented prior
to
the merger are the historical financial statements of
Infolink, which
includes Infolink's wholly-owned subsidiary, Zhouyuan.
Infolink,
Zhouyuan, and Tianzhe are hereafter referred to as the "Company".
SHANDONG
ZHOUYUAN SEED AND NURSERY CO., LTD.
F/K/A
PINGCHUAN PHARMACEUTICALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
2-
|
ORGANIZATION
AND OPERATIONS (continued)
|
Going
Concern
As
reflected in the accompanying consolidated financial statements, the Company
has
an accumulated deficit of $2,402,975 at September 30, 2007 that includes
operating losses of $322,586 and $610,269 for the year ended December 31,
2006
and the nine months ended September 30, 2007, respectively. Additionally,
the
Company was in default on bank loans and interest payments, totaling $1,677,088,
as of September 30, 2007. These factors raise substantial doubt about its
ability to continue as a going concern. In view of the matters described
above,
recoverability of a major portion of the recorded asset amounts shown in
the
accompanying consolidated balance sheet is dependent upon continued operations
of the Company, which in turn is dependent upon the Company's ability to
raise
additional capital, obtain financing and succeed in its future operations.
The
financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or amounts and
classification of liabilities that might be necessary should the Company
be
unable to continue as a going concern
Management
has taken the following steps to revise its operating and financial
requirements, which it believes are sufficient to provide the Company with
the
ability to continue as a going concern. The Company is actively pursuing
additional funding and a potential merger or acquisition candidate and strategic
partners, which would enhance stockholders' investment. Management believes
that
the above actions will allow the Company to continue operations through the
next
fiscal year.
|
Note
3-
|
SIGNIFICANT
ACCOUNTING POLICIES
|
Basis
of Presentation
The
accompanying consolidated financial statements are prepared in accordance
with
generally accepted accounting principles in the United States of America
("US
GAAP"). This basis of accounting differs from that used in the statutory
accounts of the Company, which are prepared in accordance with the "Accounting
Principles of China " ("PRC GAAP"). Certain accounting principles, which
are
stipulated by US GAAP, are not applicable in the PRC GAAP. The difference
between PRC GAAP accounts of the Company and its US GAAP financial statements
is
immaterial.
The
Company maintains its books and accounting records in PRC currency "Renminbi"
("RMB"), which is determined as the functional currency. Assets and
liabilities of the Company are translated at the prevailing exchange rate
at the
end of the accounting period. Contributed capital accounts are translated
using
the historical rate of exchange when capital is injected. Income statement
accounts are translated at the average rate of exchange during the accounting
period Translation adjustments arising from the use of different exchange
rates
from period to period are include in the cumulative translation adjustment
account in shareholders' equity. Gain and losses resulting from foreign currency
transactions are included in operations.
SHANDONG
ZHOUYUAN SEED AND NURSERY CO., LTD.
F/K/A
PINGCHUAN PHARMACEUTICALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
3-
|
SIGNIFICANT
ACCOUNTING POLICIES
(continued)
|
Basis
of Presentation (continued)
Translation
adjustments resulting from this process are included in accumulated other
comprehensive
income (loss) in
the consolidated statement of shareholders ’ equity and amounted to $72,862 and
$52,626 as of September 30, 2007 and December 31, 2006, respectively. The
balance sheet amounts with the exception of equity at September 30, 2007
were
translated at 7.51RMB to $1.00 USD as compared to 7.80 RMB at December 31,
2006.
The equity accounts were stated at their historical rate. The average
translation rates applied to income statement accounts for the nine months
ended
September 30, 2007 was 7.67 RMB as compared to 7.96 RMB for the year
ended December 31, 2006.
Use
of Estimates
The
preparation of financial statements
in conformity with generally accepted accounting principles 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 revenue and expenses
during the reporting period. Actual results when
ultimately realized
could differ from those estimates.
Cash
and Cash Equivalents
Cash
and cash equivalents include cash
on hand, deposits in banks with maturities of three months or less, and all
highly liquid investments which are unrestricted as to withdrawal or use,
and
which have
original maturities of three months or less.
Accounts
Receivable
Accounts
receivable are recorded at the
invoiced amount and do not bear interest. The Company extends unsecured credit
to its customers in the ordinary course of business but mitigates the associated
risks by performing credit checks and actively pursuing past due accounts.
An
allowance for doubtful accounts is established and determined based on
managements' assessment of known requirements, aging of receivables, payment
history, the customer's current credit worthiness, and the
economic
environment.
Concentrations
of Credit Risk
Financial
instruments that subject the
Company to concentrations of credit risk consist primarily of
cash and
cash equivalents. The Company maintains its cash and cash equivalents with
high-quality institutions. Deposits held with banks may exceed the amount
of
insurance provided on such deposits. Generally these deposits may be redeemed
upon demand and therefore bear minimal risk.
SHANDONG
ZHOUYUAN SEED AND NURSERY CO., LTD.
F/K/A
PINGCHUAN PHARMACEUTICALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
3-
|
SIGNIFICANT
ACCOUNTING POLICIES
(continued)
|
Fair
Value of Financial Instruments
The
carrying value of financial instruments including cash and cash equivalents,
receivables, accounts
payable and
accrued expenses, approximates their fair value at September 30, 2007 due
to the
relatively short-term nature of these instruments.
Advance
to Suppliers
The
Company purchases seeds from the
suppliers throughout the operating cycle. The majority of the seeds is purchased
from the growers from the end of November through the following February.
Pursuant to some purchase contracts, the Company may advance certain amount
of
purchase price to
growers.
Inventories
Inventories
are stated at the lower of
cost or market value. Actual cost is used to value raw materials
and
supplies. Finished goods and work in process are valued at First-In-First-Out
(FIFO) method.
Valuation
of Long-Lived assets
The
Company periodically analyzes its
long-lived assets for potential impairment, assessing the appropriateness
of
lives and recoverability of unamortized balances through measurement of
undiscounted operating cash flows on a basis consistent with accounting
principles generally accepted
in the United States of
America.
Property,
Plant and Equipment
Property,
plant and equipment are
carried at cost. The cost of repairs and maintenance is expensed as
incurred; major replacements and improvements are
capitalized.
When
assets are retired or disposed of,
the cost and accumulated depreciation are removed from the
accounts, and
any resulting gains or losses are included in income in the year of
disposition.
Depreciation
is calculated on a
straight-line basis over the estimated useful life of the assets. The
percentages or depreciable life applied are:
|
Property
and plant
|
30
years
|
|
Machines
and equipment
|
7
years
|
|
Office
equipment
|
5
years
|
|
Motor
vehicles
|
5
years
|
SHANDONG
ZHOUYUAN SEED AND NURSERY CO., LTD.
F/K/A
PINGCHUAN PHARMACEUTICALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
3-
|
SIGNIFICANT
ACCOUNTING POLICIES
(continued)
|
Land
Use Right
All
land
belongs to the State in PRC. Enterprises and individuals can pay the State
a fee
to obtain a
right to use a piece
of land for commercial purpose or residential purpose for a period of 50
years
or
70 years, respectively. The right of land usage can be
sold, purchased, and exchange in the market.
The
Company obtained the right to use a
piece of land at which its headquarter building is located for a period of
50
years, from December 30, 1998 to December 30, 2045, and a piece of land at
which
its packing facilities and warehouse are located for a period of 50 years
from
September 10, 2003 to September 10, 2053. We amortize the cost of these and
usage rights over a period of 50 years, using
straight-line method with
no residual value.
Acquired
Seed Patents, net
Acquired
intangible assets consist
primarily of purchased technology rights and are stated at cost less accumulated
amortization. Amortization is calculated on a straight-line basis over the
estimated
useful lives of these assets of an average of 10 years and
recorded in cost of revenues.
Short-term
Loans
Short-term
loans are temporally loans
from third parties to finance the Company’s operation due to lack of cash
resources. These loans are unsecured, non-interest bearing and have no fixed
terms of repayment, therefore, deemed payable on demand. Cash flows from
these
activities are classified as
cash flows from financing
activates.
Due
to Employees
Due
to employees are temporally
short-term loans from our employees to finance the Company’ s operation due to
lack of cash resources. These loans are unsecured, non-interest bearing and
have
no fixed terms of repayment, therefore, deemed payable on demand. Cash flows
from these activities are
classified as cash flows from financing
activates.
SHANDONG
ZHOUYUAN SEED AND NURSERY CO., LTD.
F/K/A
PINGCHUAN PHARMACEUTICALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
3-
|
SIGNIFICANT
ACCOUNTING POLICIES
(continued)
|
Revenue
Recognition
The
Company derives its revenue primarily from the sale of various branded
conventional seeds and
branded
seeds with biotechnology traits. Revenue is recognized when pervasive evidence
of an arrangement exists, products have been delivered, the price is fixed
or
determinable, collectibility is reasonably assured and the right of return
has
expired. The estimated amounts of revenues billed in
excess of revenues
recognized are recorded as deferred revenues.
Research
and Development Costs
Research
and development costs relating
to the development of new products and processes, including significant
improvements and refinements to existing products, are expensed as incurred.
The
Research and development cost was immaterial for the Company for the nine
months
ended
September 30, 2007 and 2006, and was included into general and
administration expenses.
Advertising
Costs
Advertising
costs are expensed as
incurred and included as part of selling and marketing expenses. Advertising
expenses were $1,625 and $1,156 for the nine months ended September 30, 2007
and
2006, respectively.
Pension
and Employee Benefits
Full
time
employees of the PRC entities participate in a government mandated
multi-employer
defined
contribution plan pursuant to which certain pension benefits, medical care,
unemployment
insurance, employee housing fund and other welfare benefits
are provided to employees. Chinese labor regulations require the Company
to
accrue for these benefits based on certain percentages of the employees'
salaries. The total provisions for such employee benefits were $24,469 and
$25,930 for the nine months ended September 30, 2007 and 2006,
respectively.
Reverse
Stock Split
Effective
on January 2, 2007, the Company filed with the Secretary of State of the
State
of North Carolina Articles of Amendment to its Articles of Incorporation.
The
amendment effected a reverse stock split of the Company's common stock in
the
ratio of 1:6. All share and per share information included in these consolidated
financial statements have been adjusted to reflect this reverse stock
split.
SHANDONG
ZHOUYUAN SEED AND NURSERY CO., LTD.
F/K/A
PINGCHUAN PHARMACEUTICALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
3-
|
SIGNIFICANT
ACCOUNTING POLICIES
(continued)
|
Statutory
Reserves
Pursuant
to the laws applicable to the PRC, PRC entities are required to make
appropriations to three
non-distributable reserve
funds, the
statutory surplus reserve, statutory public welfare fund, and discretionary
surplus reserve, based on after-tax net earnings as determined in accordance
with the PRC GAAP. Appropriation to the statutory surplus reserve should
be at
least 10% of the after-tax net earnings until the reserve is equal to 50%
of the
Company's registered capital. Appropriation to the statutory public welfare
fund
is 10% of the after-tax net earnings. The statutory public welfare fund is
established for the purpose of providing employee facilities and other
collective benefits to the employees and is non-distributable other than
in
liquidation. No appropriations to the discretionary surplus reserve are made
at
the discretion of the Board of Directors. The statutory surplus reserve fund
and
statutory public welfare fund are included into retained earnings in the
balance
sheet
presented Since the Company has been accumulating deficiency no
such reserve funds have been
Income
Taxes
The
Company accounts for income taxes
in interim periods as required by Accounting Principles Board Opinion No.
28
"Interim Financial Reporting" and as interpreted by FASB Interpretation No.
18,
"Accounting for Income Taxes in Interim Periods". The Company has determined
an
estimated annual effect tax rate. The rate will be revised, if necessary,
as of
the end of each successive interim
period during the Company's fiscal
year to its best current estimate.
The
estimated annual effective tax rate
is applied to the year-to-date ordinary income (or loss) at the
end of
the interim period.
Earnings
(Loss) Per Share
The
Company reports earnings per share
in accordance with the provisions of SFAS No. 128, “ Earnings Per Share.” SFAS
No. 128 requires presentation of basic and diluted earnings per share in
conjunction with the disclosure of the methodology used in computing such
earnings per share. Basic earnings (loss) per share is computed by dividing
income (loss) available to common shareholders by the weighted-average number
of
common shares outstanding during the period. Diluted earnings per share is
computed similar to basic earnings per share except that the denominator
is
increased to include the number of additional common shares that would have
been
outstanding if the potential common shares had been issued and if the additional
common shares were dilutive. There are no
potentially dilutive securities
for the nine months ended September 30, 2007 and 2006,
respectively.
SHANDONG
ZHOUYUAN SEED AND NURSERY CO., LTD.
F/K/A
PINGCHUAN PHARMACEUTICALS, INC.
NOTES
TO FINANCIAL STATEMENTS
|
Note
4-
|
ACCOUNTS
RECEIVABLE
|
Accounts
receivable consists of the following:
|
|
|
September
30,
2007
|
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
$
|
14,445
|
|
|
Less:
Allowance for bad
debt
Accounts receivable, net
|
|
|
(1,576
|
)
|
|
|
|
$
|
12,869
|
|
We
use
indirect method to write off accounts receivable. The bad debt expenses was
$0
and $0 for the nine months ended September 30, 2007 and 2006,
respectively.
Inventories
consist of following:
|
|
|
September
30,
|
|
|
|
|
2007
|
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
Finished
goods
|
|
|
121,149
|
|
|
Supply
and packing materials
|
|
|
98,500
|
|
|
|
|
|
219,649
|
|
|
Note
6-
|
PROPERTY
AND EQUIPMENT
|
The
following is a summary of property, plant and equipment-at cost, less
accumulated depreciation:
|
|
|
September
30,
|
|
|
|
|
2007
|
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
Property
and plant
|
|
$
|
1,855,324
|
|
|
Machines
and equipment
|
|
|
187,161
|
|
|
Office
equipment
|
|
|
20,503
|
|
|
Motor
vehicles
|
|
|
95,562
|
|
|
|
|
|
2,158,550
|
|
|
Less:
Accumulated depreciation
|
|
|
(394,195
|
)
|
|
|
|
|
1,764,355
|
|
|
Add:
Construction in progress
|
|
|
39,167
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,803,522
|
|
Depreciation
expense charged to operations was $78,055 and $77,707 for the nine months
ended
September
30, 2007 and 2006, respectively.
SHANDONG
ZHOUYUAN SEED AND NURSERY CO., LTD.
F/K/A
PINGCHUAN PHARMACEUTICALS, INC.
NOTES
TO FINANCIAL STATEMENTS
The
following is a summary of land use right, less amortization:
|
|
|
September
30,
|
|
|
|
|
2007
|
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
Land
use right
|
|
|
480,876
|
|
|
Less:
Amortization
|
|
|
(38,470
|
)
|
|
|
|
|
442,406
|
|
Amortization
expense charged to operations was $7,571 and $7,263 for the nine months
ended
September
30, 2007 and 2006, respectively.
|
Note
8-
|
ACQUIRED
SEED PATENTS
|
The
following is a summary of acquired seed patents, less amortization:
|
|
|
September
30,
|
|
|
|
|
2007
|
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
Acquired
seed patents
|
|
$
|
1,384,311
|
|
|
Less:
Amortization
|
|
|
(819,051
|
)
|
|
|
|
$
|
565,260
|
|
Amortization
expense charged to operations was $101,684 and $97,547 for the nine months
ended
September 30, 2007 and 2006, respectively.
|
Note
9-
|
RECEIVABLE
FROM SALE OF LAND USE
RIGHT
|
In
2004,
the Company sold land use rights to a real estate development company for
$1,228,858. The real estate development company owes the Company $317,627
as of
September 30, 2007. The parties agreed that the real estate development company
would pay interest annually at 7.488% on $133,021 (RMB 1,000,000) and the
rest
of the balance bears no interest.
The
receivable from sale of land use right consists of the following:
|
|
|
September
30,
|
|
|
|
|
2007
|
|
|
|
|
(unaudited)
|
|
|
|
|
|
|
|
Balance
bearing interest at 7.488%
|
|
|
133,021
|
|
|
Balance
bearing no interest
|
|
|
184,606
|
|
|
|
|
|
317,627
|
|
SHANDONG
ZHOUYUAN SEED AND NURSERY CO., LTD.
F/K/A
PINGCHUAN PHARMACEUTICALS, INC.
NOTES
TO FINANCIAL STATEMENTS
Bank
loans consist of the following as of September 30, 2007:
|
Financial
Institutions
|
|
Loan
Amount
|
|
Duration
|
|
Annual
Interest
Rate
|
|
Collateral
|
|
|
|
|
|
|
|
|
|
|
|
Agricultural
Bank of China
|
|
$545,387
|
|
04/21/04--04/21/05
|
|
6.903%
|
|
Headquarter
Building and land usage right
|
|
|
|
|
|
|
|
|
|
|
|
Agricultural
Bank of China
|
|
532,085
|
|
11/26/04--11/26/05
|
|
7.488%
|
|
Guaranteed
by a real estate development company
|
|
|
|
|
|
|
|
|
|
|
|
Agricultural
Bank of China
|
|
266,042
|
|
01/09/06--01/07/07
|
|
7.488%
|
|
Usage
right of the land located in Chenggang Street
|
|
|
|
|
|
|
|
|
|
|
|
Agricultural
Bank of China
|
|
66,511
|
|
11/26/04--11/26/05
|
|
7.488%
|
|
Guaranteed
by a real estate development company
|
|
|
|
$
1,410,025
|
|
|
|
|
|
|
The
Company was in default on these bank loans, totally $1,410,025 , as of September
30, 2007. The Company was also in default on bank loan interest payments
of
$267,063 as of September 30, 2007.
In
2004, the Company sold the usage
right of a piece of land, which the Company used to secure its bank loans,
to a
real estate development company. The real estate company agreed to guarantee
these bank
loans.
Interest
expense for these bank loans
was $134,468 and $114,844 for the nine months ended September
30, 2007
and 2006, respectively.
SHANDONG
ZHOUYUAN SEED AND NURSERY CO., LTD.
F/K/A
PINGCHUAN PHARMACEUTICALS, INC.
NOTES
TO FINANCIAL STATEMENTS
On
April 5,2005, the Company engaged a
consultant for a eighteen-month period ended October 4, 2008.
The terms
of the agreement are for the consultant to receive 800,000 shares of common
stock valued at
$0.28 per share,
totaling $224,000, which will be amortized over the beneficial period. The
consultant
assists the Company in establish two distribution centers in
the Center Region, PRC.
On
April
5,2005, the Company engaged another consultant for a twenty-four-month period
ended April
4, 2009. The terms of
the agreement are for the consultant to receive 1,200,000 shares of common
stock
valued at $0.28 per share, totaling $336,000, which will be amortized
over the beneficial period. The consultant assists the Company in website
design, building, maintenance, and hosting.
On
April 5,2005, the Company engaged
another consultant for a twenty-four-month period ended April
4, 2009.
The terms of the agreement are for the consultant to receive 1,000,000 shares
of
common stock
valued at $0.28 per
share, totaling $280,000, which will be amortized over the beneficial period.
The
consultant assists the Company in establish two distribution centers
in the Southwest Region, PRC.
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Note
13-
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COMMITMENTS
AND CONTINGENCIES
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The
Company faces a number of risks and challenges not typically associated with
companies in North America and Western Europe, since its assets exist solely
in
the PRC, and its revenues are derived from its operations therein. The PRC
is a
developing country with an early stage market economic system, overshadowed
by
the state. Its political and economic systems are very different from the
more
developed countries and are
in a
state of change. The PRC also faces many social, economic and
political
challenges that may produce major shocks and instabilities and even crises,
in
both its domestic arena and in its relationships with other countries, including
the United States. Such shocks, instabilities and crises may in turn
significantly and negatively affect the Company's performance.
On
August 1, 2006 Greentree Financial
Group, Inc. ("Greentree"), a former consultant to a subsidiary of the Company,
filed a breach of contract complaint in the Superior Court in Mecklenberg
County, North
Carolina for non payment of contractual obligations for
2004 and 2005. The claim is for $49,000 in cash
and $40,000 worth of stock
as
compensatory damages or $80,000 in liquidated damages. The Company failed
to
appear to the Court, and the Court rendered a judgment, which orders the
the
Company to pay the plaintiff a sum of $201,500, with interest thereon at
the
rate of 8.000% per annum from the date of
Entry of the Judgment until
paid; and for the costs of this action, in full, to be taxed by the Clerk.
The
Company will appeal the case.
ITEM
2. MANAGEMENT DISCUSSION AND ANALYSIS
A
Warning Concerning Forward- Looking
Statements
The
information in this discussion
contains forward-looking statements within the meaning of Section 27A of
the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. These forward-looking statements include
statements regarding our capital needs, business strategy and
expectations. Any statements contained herein that are not statements
of historical facts may be deemed to be forward-looking
statements. Readers are cautioned that there are risks and
uncertainties which may cause actual future results to differ from the results
anticipated in these forward-looking statements. Some of the more
significant risks are set forth below in the section titled “Risk Factors That
May Affect Future Results.”
These
factors and other risks, known
and unanticipated, may cause Zhouyuan’s results to differ significantly from
those anticipated in this report. Readers are cautioned not to place
undue reliance on the forward-looking statements in this report, which reflect
management's opinions only as of the date hereof. We disclaim any obligation
to
publicly update these statements, or disclose any difference between its
actual
results and those reflected in these statements.
Results
of Operations
Our
lack
of financial resources has made it difficult for us to establish the broad
marketing network necessary to achieve widespread distribution of our
seeds. But because seeds are a relatively low margin product,
profitable operations depend on high volume sales. The result of our
limited distribution has been that we have realized negative gross profit
in
each of the past two fiscal years. The revenue from our sales during
that period exceeded the cost of the seeds by less than 20%, leaving
insufficient net revenue to offset the amortization of our intellectual
property.
In
the
first nine months of 2007 our sales revenue increased by 77% from the level
achieved in the first nine months of 2006. In the three months ended
September 30, 2007, the rate of improvement was more dramatic, due to the
near
absence of revenue in the third quarter of 2006. Nevertheless, our
revenue from seed sales for the nine months ended September 30, 2007 exceeded
the cost of the seeds by only $154,415, of which $50,258 was the spread realized
in the third quarter. After amortizing the value of our seed patents,
we were left with a gross margin of only $52,731 for the first nine months
of
2007 and only $15,888 for the third quarter. Clearly, in order to
generate sufficient gross margin to sustain our operations, we will have
to
increase our sales significantly.
To
sustain operations, we pared down a portion of our discretionary spending
– our
selling expenses – from $40,639 in the nine months ended September 30, 2006 to
$16,670 in the nine months ended September 30, 2007. This decision
was necessitated by our lack of revenue, but had the inevitable result of
reducing our already modest revenue. The benefits of that contraction
were more than offset, however, by two events:
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In
April 2007 we contracted to issue 3,000,000 shares of common stock
to
three consultants, who will assist us in developing our business
plan. The market value of those shares will be amortized as
expense over the duration of the consulting agreements. As a
result, we incurred a $228,667 consulting fees expense in the nine
months
ended September 30, 2007, including $114,334 in the third
quarter. The remainder of the value of the shares, $611,333,
was recorded as “deferred compensation” on our balance sheet, and will be
amortized in future periods.
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·
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In
August a judgment for $201,500 was entered against our parent corporation
in a North Carolina court. The judgment was in favor of the
company that assisted us in becoming a public company in
2004. We intend to appeal from the
judgment. Nevertheless, we have recorded the entire amount of
the judgment as an expense in the period ended September 30,
2007.
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The
net
result of our inadequate revenue and recent expenses was that we realized
a net
loss before minority interest of $742,469 in the nine months ended September
30,
2007, compared to a net loss before minority interest of $388,399 in the
nine
months ended June 30, 2006. Our net loss before minority interest for
the quarter ended September 30, 2007 was $202,490, compared to a net loss
before
minority interest of $152,746 in the third quarter of 2006.
Our
statement of operations records an adjustment for “minority
interest.” For the first nine months of 2007 the minority interest
adjustment reduced our net loss by $132,200; in the third quarter the reduction
was $34,680. This represents the reversal of the portion of the loss
incurred by our operating subsidiary, Zhouyuan, that is attributable to the
40%
of Zhouyuan in which the Delaware parent corporation has no equity
interest. If Zhouyuan realizes income in the future, a proportionate
reduction in our consolidated income will be recorded for the same
reason.
Our
business operates entirely in
Chinese Renminbi, but we report our results in our SEC filings in U.S.
Dollars. The conversion of our accounts from RMB to Dollars results
in translation adjustments, which are reported as a middle step between net
income and comprehensive income. The net income or net loss is added
to the retained earnings on our balance sheet; while the translation adjustment
is added to a line item on our balance sheet labeled “accumulated other
comprehensive income,” since it is more reflective of changes in the relative
values of U.S. and Chinese currencies than of the success of our
business. For the first nine months of 2007 we recorded $20,200 in
unrealized gains on foreign currency translation.
Liquidity
and Capital
Resources
At
September 30, 2007 we had a working
capital deficit of $2,538,100, representing an increase of $441,867 in our
deficit since December 31, 2006. We had only $6,978 in liquid assets,
and only $12,869 in accounts receivable (net of allowance). At the
same time we owed the Agricultural Bank of China $1,410,025 plus $267,063
in
accrued interest, and had other past-due obligations that far exceeded our
ability to pay.
We
remain in default with respect to
our obligations to the Bank. Negotiations are ongoing with respect to
a restructuring of the debt. At the same time, we cannot sustain
operations for any significant period of time unless we obtain additional
capital. Our efforts to attract capital are hindered, however, by our
default to the Bank. The survival of our business, therefore, depends
on our ability to develop a comprehensive debt relief and financing
package. Unfortunately, because our operations have produced only a
trickle of cash during the past two years, we can only achieve financing
if we
convince the investor that an investment in our company can be leveraged
into a
significant increase in revenues and cash flows.
On
May
16, 2007 we entered into an Agreement on Joint Development of Zhouyuan Building
Project. The counterparty to the agreement was Jixi Xingcheng Real
Estate Development Ltd. The agreement provides that the parties will
cooperate in the development of the building and underlying land now owned
by
Shandong Zhouyuan, with Jixi Xingcheng bearing financial and managerial
responsibility for the construction project and the sale of the resulting
units. The agreement provides that, after completion of the planning
and design proposals, the parties will mutually determine the allocation
of
profits from the project according to their respective investments in the
project. If successful, this project could significantly enhance our
cash flow. We cannot determine at this time, however, whether the
project will be successful.
In
the
event that we are unable to achieve a restructuring of our debt, it is likely
that we will be required to sell our real property. This will have
the effect of terminating the development project, eliminating the revenue
stream that we could obtain by leasing a portion of the property, and would
necessitate that we ourselves commence payment of lease fees. This
would cause a further deterioration of our financial results.
We
believe that our business plan is
sound, and that our products are marketable. With adequate capital,
we believe that Zhouyuan can be prosperous and profitable. We have no
assurance, however, that the necessary capital can be achieved.
Off-Balance
Sheet Arrangements
We
do not
have any off-balance sheet arrangements that have or are reasonably likely
to
have a current or future effect on our financial condition or results of
operations.
Risk
Factors That May Affect Future
Results
You
should carefully consider the risks
described below before buying our common stock. If any of the risks
described below actually occurs, that event could cause the trading price
of our
common stock to decline, and you could lose all or part of your
investment.
There
is no assurance that we will be
able to generate profits from our business.
To
date we have been unsuccessful in
establishing a sufficient market for our seeds to assure us of
profitability. In 2006 our sales were 34% lower than in 2005, and in
neither year were sales at a level that could sustain
profits. Although sales levels are higher in the current year than in
2007, we are still not near a revenue level at which we can be
profitable. Unless we are able to obtain sufficient capital
investment to permit us to expand operations, it is unlikely that we will
be
able to operate at a profitable level. We have no commitment from any
source for financing, and there is no assurance that we will be able to obtain
the necessary financing. Without financing, it is likely that our
business will fail.
If
we are unable to settle our bank
obligations, we may lose control of our business.
We
are currently in default with
respect to principal and interest payments due on $1.6 million in obligations
to
the Agricultural Bank of China. Our current financial situation does
not permit us to satisfy the debt as written. We have been in
negotiations with the Bank regarding a restructuring of the debt. If
those negotiations do not reach a satisfactory conclusion, we may lose the
realty that we pledged to secure the debt and may face a judgment that could
force us into bankruptcy.
We
will be unable to compete
effectively unless we maintain a technological advantage over our
competitors.
The
physics of seed generation has been
advancing rapidly in the past forty years. Innovations in design of
seeds and methods of growing seeds are constant. Our ability to
compete effectively in this market will depend on our ability to stay in
the
vanguard of technological change. However, we compete against many
larger enterprises that have considerable resources to apply to research
and
development. If we are unable to gain access to the latest
discoveries in seeds, we will not be able to compete effectively, and our
business will fail.
Our
business and growth will suffer if
we are unable to hire and retain key personnel that are in high
demand.
Our
future success depends on our
ability to attract and retain highly skilled marketing personnel, chemists,
manufacturing technicians and engineers. Qualified individuals are in
high demand in China, and there are insufficient experienced personnel to
fill
the demand. Therefore we may not be able to successfully attract or
retain the personnel we need to succeed.
We
may have difficulty establishing adequate management and financial controls
in
China.
The
People’s Republic of China has only
recently begun to adopt the management and financial reporting concepts and
practices that investors in the United States are familiar with. We
may have difficulty in hiring and retaining employees in China who have the
experience necessary to implement the kind of management and financial controls
that are expected of a United States public company. If we cannot
establish such controls, we may experience difficulty in collecting financial
data and preparing financial statements, books of account and corporate records
and instituting business practices that meet U.S. standards.
We
may be unable to protect our proprietary and technology
rights.
The
Company's success will depend in part on its ability to protect its proprietary
rights and technologies. Zhouyuan relies on a combination of patents,
trademark laws, trade secrets, confidentiality provisions and other contractual
provisions to protect its proprietary rights. However, these measures
afford only limited protection. Zhouyuan’s failure to adequately
protect its proprietary rights may adversely affect our competitive
prospects. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy aspects of Zhouyuan’s products or to
obtain and use trade secrets or other information that it regards as
proprietary.
Zhouyuan’s
means of protecting its proprietary rights in the People’s Republic of China may
not be adequate. The system of laws and the enforcement of existing
laws in China may not be as certain in implementation and interpretation
as in
the United States. The Chinese judiciary is relatively inexperienced
in enforcing corporate and commercial law, leading to a higher than usual
degree
of uncertainty as to the outcome of any litigation. The inability to
enforce or obtain a remedy for theft of our proprietary information may have
a
material adverse impact on our business operations.
Government
regulation may hinder
our ability to function efficiently
.
The
national, provincial and local
governments in the People’s Republic of China are highly
bureaucratized. The day-to-day operations of our business require
frequent interaction with representatives of the Chinese government institutions
in order to obtain and maintain the licenses needed to market hybrid seeds
in
China. The effort to obtain the registrations, licenses and permits
necessary to carry out our business activities can be
daunting. Significant delays can result from the need to obtain
governmental approval of our activities. These delays can have an
adverse effect on the profitability of our operations. In addition,
compliance with regulatory requirements applicable to manufacturing operations
and production may increase the cost of our operations, which would adversely
affect our profitability.
We
are subject to the risk of
natural disasters
.
Our
revenue stream depends on our
ability to deliver seeds at the beginning of their growing
season. Our supply of seeds and their timely availability can be
negated by drought, flood, storm, blight, or the other woes of
farming. Any such event or a combination thereof could render us
unable to meet the demands of our distribution network. This could
have a long-term negative effect on our ability to grow our business, in
addition to the near-term loss of income.
Capital
outflow policies in China
may hamper our ability to pay dividends to shareholders in the United
States.
The
People’s Republic of China has
adopted currency and capital transfer regulations. These regulations require
that we comply with complex regulations for the movement of capital. Although
Chinese governmental policies were introduced in 1996 to allow the
convertibility of RMB into foreign currency for current account items,
conversion of RMB into foreign exchange for capital items, such as foreign
direct investment, loans or securities, requires the approval of the State
Administration of Foreign Exchange. We may be unable to obtain all of the
required conversion approvals for our operations, and Chinese regulatory
authorities may impose greater restrictions on the convertibility of the
RMB in
the future. Because most of our future revenues will be in RMB, any inability
to
obtain the requisite approvals or any future restrictions on currency exchanges
will limit our ability to pay dividends to our shareholders.
Currency
fluctuations may adversely
affect our operating results.
Zhouyuan
generates revenues and incurs
expenses and liabilities in Renminbi, the currency of the People’s Republic of
China. However, as a subsidiary of the Parent Corporation, it will
report its financial results in the United States in U.S. Dollars. As
a result, our financial results will be subject to the effects of exchange
rate
fluctuations between these currencies. From time to time, the
government of China may take action to stimulate the Chinese economy that
will
have the effect of reducing the value of Renminbi. In addition,
international currency markets may cause significant adjustments to occur
in the
value of the Renminbi. Any such events that result in a devaluation
of the Renminbi versus the U.S. Dollar will have an adverse effect on our
reported results. We have not entered into agreements or purchased
instruments to hedge our exchange rate risks.
We
have limited business insurance
coverage.
The
insurance industry in China is
still at an early stage of development. Insurance companies in China offer
limited business insurance products, and do not, to our knowledge, offer
business liability insurance. As a result, we do not have any business liability
insurance coverage for our operations. Moreover, while business disruption
insurance is available, we have determined that the risks of disruption and
cost
of the insurance are such that we do not require it at this time. Any business
disruption, litigation or natural disaster might result in substantial costs
and
diversion of resources.
The
Parent Corporation is not likely to
hold annual shareholder meetings in the next few years.
Management
does not expect to hold
annual meetings of shareholders in the next few years, due to the expense
involved. The current members of the Board of Directors were
appointed to that position by the previous directors. If other
directors are added to the Board in the future, it is likely that the current
directors will appoint them. As a result, the shareholders of the
Parent Corporation will have no effective means of exercising control over
the
operations of the Parent Corporation or Zhouyuan.