HOGS Zhongpin Inc. (MM)

Item 1. Financial Statements

The accompanying unaudited condensed consolidated balance sheets, statements of operations and comprehensive income, and statements of cash flows and the related notes thereto, have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the disclosures required by GAAP for complete financial statements. The condensed consolidated financial statements reflect all adjustments, consisting only of normal, recurring adjustments, which are, in the opinion of management, necessary for a fair presentation for the interim periods.

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the notes to the aforementioned condensed consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2012.

The results of operations for the three months ended March 31, 2013 are not necessarily indicative of the results to be expected for the entire fiscal year or any other period.

The accompanying notes are an integral part of these condensed consolidated financial statements.

The accompanying notes are an integral part of these condensed consolidated financial statements.

The accompanying notes are an integral part of these condensed consolidated financial statements.

ZHONGPIN INC.

(1)         Includes a 1.19% ownership interest of another six stockholders with respect to which Henan Zhongpin Food Company Limited is entitled to all economic benefits and the right to vote pursuant to the terms of a trust agreement with such stockholders.

Consolidation and Basis of Presentation

The accompanying condensed consolidated financial statements include the accounts of Zhongpin Inc. and its subsidiaries (collectively referred to herein as the “Company”). All significant intercompany accounts and transactions have been eliminated during the process of consolidation. The condensed consolidated financial statements were prepared in accordance with GAAP for interim financial information.

Non-controlling Interests

Effective July 1, 2009, the Company adopted the authoritative pronouncement issued by the Financial Accounting Standards Board (the “FASB”) regarding non-controlling interests in consolidated financial statements. The pronouncement requires non-controlling interests to be separately presented as a component of equity in the consolidated financial statements.

ZHONGPIN INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Foreign Currency Translations and Transactions

RMB, the national currency of China, is the primary currency that the Company’s China-based subsidiaries use. The United States dollar (“U.S. dollar”) is the functional currency used by Falcon and Zhongpin Inc. to record all of their activities. The Company uses the U.S. dollar for financial reporting purposes.

The Company translates assets and liabilities into U.S. dollars using the middle rate published by the People’s Bank of China as of the balance sheet date. The condensed consolidated statement of income is translated at average rates during the reporting period. Adjustments resulting from the translation of financial statements from RMB into U.S. dollars are recorded in stockholders' equity as part of accumulated comprehensive loss – translation adjustments. Gains or losses resulting from transactions in currencies other than RMB are reflected in income for the reporting period.

Use of Estimates

The preparation of financial statements in conformity with GAAP 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 reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Certain accounting principles require subjective and complex judgments to be used in the preparation of financial statements. Accordingly, a different financial presentation could result depending on the judgments, estimates, or assumptions that are used. Such estimates and assumptions include, but are not specifically limited to, those required in the valuation of long-lived assets, allowance for doubtful accounts, reserves for inventory obsolescence, valuation allowances for value added tax (“VAT”) recoverable, deferred tax assets and determination of stock based compensation.

Revenue Recognition

Revenues generated from the sales of various meat products and vegetables and fruits are recognized when these products are delivered to customers in accordance with previously agreed upon pricing and delivery arrangements, and the collectability of these sales is reasonably assured. Since the products sold by the Company are primarily perishable and frozen food products, the right of return is only valid for a few days and has been determined to be insignificant by the management of the Company. Accordingly, no provision has been made for returnable goods. Revenues presented on the consolidated statements of operations and comprehensive income are net of sales taxes.

Cash and Cash Equivalents

The Company considers all highly-liquid investments with maturity of three months or less to be cash equivalents. The Company maintains its cash accounts at creditworthy financial institutions and closely monitors the movements of its cash positions.

Restricted Cash and Bank Notes Payable

Under the terms of the credit agreements with certain of its lenders, Henan Zhongpin has agreed to maintain with such lenders an amount of cash that will serve as collateral for its delivery of such lenders’ bank promissory notes. The amount of bank promissory notes that are to be delivered by Henan Zhongpin to such lenders can be up to twice the amount of such deposits. As such deposits may not be withdrawn by Henan Zhongpin without restriction, such cash deposits are presented as “restricted cash” on the consolidated balance sheets.

ZHONGPIN INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Bank Notes Receivable

The Company only accepts notes issued by banks in the normal course of business as payment for products sold by the Company. These bank notes receivable have maturity dates of up to 180 days and bear no interest. In addition, the Company may also acquire bank notes receivable, with maturity of less than six months, from third parties, at a lower cost compared to the face value of the bank notes, so as to earn the interest.

The Company can hold these bank notes until the maturity date and collect the amount from the issuing banks, or the Company can use these bank notes as means for payment for goods or services received. The Company accrues no provision for these bank notes because such bank notes have little risk of default in China.

Accounts Receivable

During the normal course of business, the Company's policy is to ask customers to make deposits in reasonable and meaningful amounts on a case-by-case basis. For certain customers, the Company may extend unsecured credit.

The Company regularly evaluates and monitors the creditworthiness of each of its customers in accordance with the prevailing practice in the meat industry and based on general economic conditions in China. The Company maintains a general policy of providing 100% allowance for doubtful accounts in an amount equal to the aggregate amount of those accounts that are not collected within one year plus an amount equal to 5% of the aggregate amount of accounts receivable less than one year old. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. The Company also examines the credit terms of significant customers regularly and asks for more cash deposits if these customers appear to have any indicators of delaying their payments to the Company. Such deposits are usually applied for the collection of the outstanding accounts receivable during the year. With such a practice in place, the Company did not have any specific allowance for doubtful accounts provided against specific customers at March 31, 2013 and December 31, 2012, respectively.

The following table presents allowance activities in accounts receivable.

Inventories

Inventories are comprised of raw materials and low-value consumables, work-in-progress, and finished goods. Inventories are stated at the lower of cost or market-based prices according to the weighted average method. Production cost components include the purchase cost of live hogs, direct labor, depreciation, packaging material, utility expense and other manufacturing overhead. By using a systematic costing system, the production cost is allocated to various products at the stage of work-in-progress and finished goods, respectively. Net realizable value is the estimated selling price, in the ordinary course of business, less estimated costs to complete and dispose. The Company regularly inspects the shelf life of prepared foods and, if necessary, write down their carrying value based on their salability and expiration dates as cost of goods sold.

Property, Plant and Equipment

Property, plant and equipment are recorded at cost and are stated net of accumulated depreciation. Depreciation expense is determined using the straight-line method over the estimated useful lives of the assets. Leased properties under capital leases are also amortized over the estimated useful life of the property due to the transfer of ownership or availability of bargain purchase option at the end of the lease term. Estimated useful lives of the assets are as follows:

Maintenance and repairs are charged directly to expense as incurred, whereas improvements and renewals are generally capitalized in their respective property accounts. When an item is retired or otherwise disposed of, the cost and applicable accumulated depreciation are removed and the resulting gain or loss is recognized and reflected as a line item under other income (expenses).

Land Use Rights

The Chinese government owns all of the parcels of land on which the Company's plants are built. In China, land use rights for commercial purposes are granted by the PRC government typically for a term of 40-50 years. The Company is required to pay a lump sum of money to the State Land and Resource Ministry of the applicable locality to acquire such rights. The Company capitalizes the lump sum of money paid and amortizes these land use rights by using the straight line method over the term of the land use license granted by the applicable governmental authority.

Construction in Progress and Interest Capitalization

Construction in progress is stated at cost. The cost accumulation process starts from the time the construction project is set-up and ends at the time the project has been put into service and all regulatory permits and approvals have been received. The Company borrows bank loans from time to time for these construction projects. The interest costs incurred for these construction projects have been capitalized during the construction process.

Impairment of Long-Lived Assets

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable through the estimated undiscounted cash flows expected to result from the use and eventual disposition of that asset. Whenever any such impairment exists, an impairment loss will be recognized for the amount by which the carrying value exceeds the fair value.

Fair Value of Financial Instruments

The carrying amount of cash and cash equivalents, accounts receivable, other receivables, advance to vendors, accounts payable and accrued liabilities, capital lease obligations and short-term loans are reasonable estimates of their fair value because of the short maturity of these items. The carrying amounts of capital lease obligations approximate their fair value based on the Company’s current incremental borrowing rates for similar types of arrangements. Long-term debt approximates fair value since the bank term loans are fixed rate instruments and bear interests at the rate dictated and published by the People's Bank of China. The current rates published by the People's Bank of China approximate the interest rates of the loans outstanding.

Employee Benefit Plan

Full time employees of the PRC entities participate in a government mandated employer defined contribution plan, pursuant to which certain pension benefits, medical care, unemployment insurance 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 provision for such employee benefits was $655,743 and $227,438 for three months ended March 31, 2013 and 2012.

ZHONGPIN INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Shipping and Handling Cost

All shipping and handling fees are included in selling expenses. Shipping and handling fees amounted to $2.4 million and $ 2.4 million for the three months ended March 31, 2013 and 2012, respectively.

Advertising Costs

Advertising costs are expensed as incurred. Advertising expense amounted to $377,261 and $282,921 for the three months ended March 31, 2013 and 2012, respectively.

Value Added Tax

All China-based enterprises are subject to a VAT imposed by the PRC government on their domestic product sales. The output VAT is charged to customers who purchase goods from the Company and the input VAT is paid when the Company purchases goods from its vendors. Input VAT rates are 13% for most of the purchasing activities conducted by the Company. Output VAT rate is 13% for chilled pork products, frozen pork products and vegetable and fruit products, and 17% for prepared meat products. The input VAT can be offset against the output VAT. The VAT payable or recoverable balance presented on the condensed consolidated balance sheets represents either the input VAT less than or larger than the output VAT. The debit balance represents a credit against future collections of output VAT instead of a receivable.

On a quarterly basis, the Company forecasts for each of its subsidiaries separately the amount of sales revenue necessary to fully utilize the VAT recoverable. Once the VAT recoverable for a subsidiary is determined to be non-recoverable in part or in full, the VAT recoverable is written off and booked as cost of goods sold or as impairment loss, depending on the nature of the event triggering the VAT write-off. The factors considered when evaluating to which account VAT recoverable is written off are as follows: i) if VAT is determined to be non-recoverable due to significant underperformance relative to expected historical or projected future operating results or negative industry or economic trend, VAT recoverable will be written-off to cost of goods sold, or ii) if VAT is determined to be non-recoverable due to significant changes in the strategy of the overall business, VAT recoverable would be written off as impairment loss. VAT write-off amounted to $1.9 million and nil for the three months ended March 31, 2013 and 2012, respectively.

Leases

The Company classified its leases at the inception date as either a capital lease or an operating lease. A lease is a capital lease if the following conditions exist: a) ownership is transferred to the lessee by the end of the lease term, b) there is a bargain purchase option, c) the lease term is at least 75% of the property’s estimated remaining economic life or d) the present value of the minimum lease payments at the beginning of the lease term is 90% or more of the fair value of the leased property to the lessor at the inception date. A capital lease is accounted for as if there was an acquisition of an asset and an incurrence of an obligation at the inception of the lease. All other leases are accounted for as operating leases. In March 2013, the Company entered into a sale-leaseback agreement with CMB Financial Leasing Co., Ltd. (“CMB Leasing”) to sell and lease back equipment. For details of the transaction, see Note 14, “ Commitments and Contingencies”.

Stock Compensation

The Company receives employee and certain non-employee services in exchange for (a) equity instruments of the Company or (b) liabilities that are based on the fair value of the Company's equity instruments or that may be settled by the issuance of such equity instruments. The Company accounts for stock compensation expense under the fair value recognition provisions of the FASB Accounting Standards Codification (ASC) Topic 718 (ASC 718), which requires companies to estimate the fair value of share-based payment awards on the date of grant using an option pricing model. See Note 10, "Equity Transactions", for further discussion on stock compensation expense.

ZHONGPIN INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Earnings Per Share

Basic earnings per share does not include dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution of securities that could share in the earnings of an entity, similar to fully-diluted earnings per share. Such shares are excluded if determined to be anti-dilutive. Of the 787,000 options outstanding at March 31, 2013, 514,000 options were anti-dilutive and therefore excluded from the computation of diluted earnings per share for the three months ended March 31, 2013. The number of shares of common stock underlying the outstanding stock warrants and options at March 31, 2013 and December 31, 2012 were 273,000 and 240,000, respectively, which were all included in the computation of diluted earnings per share.

Government Subsidies

The Company’s subsidiaries in China receive government subsidies from local Chinese government agencies in accordance with relevant Chinese government policies. In general, the Company presents the government subsidies received as part of other income unless the subsidies received are earmarked to compensate a specific expense, which have been accounted for by offsetting the specific expense, such as interest expenses. Unearned government subsidies received are deferred for recognition until the criteria for such recognition could be met.

Research and Development Expenses

Research and development costs are expensed as incurred. The research and development expenses for the three-month periods ended March 31, 2013 and 2012 were $132,331 and $86,628, respectively. The Company did not receive government subsidies that were specified for supporting the Company’s research and development efforts for the three-month periods ended March 31, 2013 and 2012.

Comprehensive Income (Loss)

The Company adopted FASB ASC 220, Comprehensive Income , which establishes standards for reporting and presentation of comprehensive income (loss) and its components in a full set of general-purpose financial statements. The Company has chosen to report comprehensive income (loss) in the statements of operations and comprehensive income. Comprehensive income (loss) is comprised of net income and all changes to shareholders' equity except those due to investments by owners and distributions to owners.

Recently Issued Accounting Pronouncements

In January 2013, the FASB issued Accounting Standards Update (“ASU”) 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities , which clarified that the scope of ASU 2011-11, Disclosures about Offsetting Assets and Liabilities , would apply to derivatives including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with Section 210-20-45 or Section 815-10-45 or are subject to a master netting arrangement or similar agreement. This ASU is effective for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. Retrospective presentation for all comparative periods presented is required. The adoption of ASU 2013-01 did not have a material impact on the Company’s consolidated financial statements.

In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income , which superseded and replaced the presentation requirements for reclassifications out of accumulated other comprehensive income in ASUs 2011-05 (issued in June 2011) and 2011-12 (issued in December 2011) for all public and private organizations. The amendments would require an entity to provide additional information about reclassifications out of accumulated other comprehensive income. For public entities, the amendments are effective prospectively for reporting periods beginning after December 15, 2012, with early adoption permitted. The adoption of ASU 2013-02 did not have a material impact on the Company’s consolidated financial statements.

The depreciation and amortization expenses for the three months ended March 31, 2013 and 2012 were $5,899,289 and $5,537,984, respectively.

Of the above information, property, plant and equipment under the sale-leaseback agreement at cost at March 31, 2013 and December 31, 2012 is as follows:

The deferred losses included in the property, plant and equipment balance were $3,713,441 and nil at March 31, 2013 and December 31, 2012, respectively, and would be amortized over the lease term. Of the depreciation expenses, $78,888 and $164,939 were amortization of deferred loss and depreciation expense from assets under capital lease, respectively, for the three months ended March 31, 2013; and $373,995 and $280,688 were amortization of deferred loss and depreciation expense from assets under capital lease, respectively, for the three months ended March 31, 2012.

The amortization expenses for the three months ended March 31, 2013 and 2012 were $644,802 and $516,966, respectively.

Estimated cost to complete current construction in progress is $9.3 million. 

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ZHONGPIN INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Short-term bank loans are due within one year. Of the $246.8 million and $176.4 million aggregate principal amount of short-term bank loans at March 31, 2013 and December 31, 2012, loans in the aggregate principal amount of $113.2 million and $116.1 million were guaranteed by the Company’s subsidiaries in China, loans in the aggregate principal amount of $8.0 million and $8.0 million were secured by the land use right of the Company’s subsidiaries in China, $111.2 million and $85.4 million aggregate principal amount of loans was credit loans, and loans in the aggregate principal amount of $14.4 million and $19.1 million were guaranteed by Henan Huanghe Enterprises Group Co., Ltd., an unaffiliated third party (“Huanghe Group”). These loans bear interest at prevailing lending rates in China ranging from 5.88 % to 7.20% per annum.

In March 2013, Henan Zhongpin issued RMB600 million (approximately US$95.7 million) aggregate principal amount of 5.15% unsecured non-convertible one-year bonds which will mature and be repaid on March 27, 2014.

In March 2013, Henan Zhongpin entered into a loan agreement with China Construction Bank pursuant to which Henan Zhongpin borrowed RMB 20 million ($3.2 million). All amounts borrowed under the loan agreement bear interest at a fixed rate of 6.15% and are payable in March 2015. Borrowings under the loan agreement are secured by land use rights, property and plant of Henan Zhongpin.

In March 2013, Henan Zhongpin entered into a loan agreement with the Agriculture Bank of China pursuant to which Henan Zhongpin borrowed RMB 100 million ($16.0 million). All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (6.46% per annum on March 31, 2013 and adjustable on each anniversary of the agreement based on the prime rate published by the People’s Bank of China for loans with the same or similar terms) and are payable in installments on various scheduled repayment dates between June 2013 and March 2016. Borrowings under the loan agreement are secured by the land use rights, property and plant of Henan Zhongpin.

In January 2013, Taizhou Zhongpin entered into a loan agreement with the Agriculture Bank of China pursuant to which Taizhou Zhongpin may borrow up to RMB 180 million ($28.7 million). Taizhou Zhongpin drew down RMB 44 million ($7.0 million) in January 2013 and RMB 120 million ($19.1 million) in March 2013. All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (7.04% per annum on March 31, 2013 and adjustable on each anniversary of the agreement based on the prime rate published by the People’s Bank of China for loans with the same or similar terms) and RMB 164 million ($26.2 million) are payable in installments on various scheduled repayment dates between January 2014 and January 2018. Borrowings under the loan agreement are guaranteed by Henan Zhongpin and secured by land use rights of Taizhou Zhongpin.

In April 2012, Changchun Zhongpin entered into a loan agreement with China Development Bank pursuant to which Changchun Zhongpin may borrow up to RMB 300 million ($47.9 million). Changchun Zhongpin drew down RMB 125 million ($19.9 million) in April 2012, RMB 76 million ($12.1 million) in July 2012, RMB39 million ($6.2 million) in October 2012 and RMB 60 million ($9.6 million) in February 2013. All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (7.21% per annum on March 31, 2013 and adjustable immediately following the publishing of rate adjustments by the People’s Bank of China during the term of the loan) and are payable in installments on various scheduled repayment dates between April 2013 and May 2020. Borrowings under the loan agreement are guaranteed by Henan Zhongpin and secured by all of Henan Zhongpin’s equity interests in Tianjin Zhongpin and Yongcheng Zhongpin.

ZHONGPIN INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

In April 2012, Henan Zhongpin entered into a loan agreement with China Construction Bank pursuant to which Henan Zhongpin borrowed RMB 15 million ($2.4 million). All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (6.65% per annum on March 31, 2013 and adjustable on each anniversary of the agreement based on the prime rate published by the People’s Bank of China for loans with the same or similar terms) and are payable in March 2014. Borrowings under the loan agreement are secured by the land use rights, property and plant of Yongcheng Zhongpin.

In March 2012, Henan Zhongpin entered into a loan agreement with China Construction Bank pursuant to which Henan Zhongpin borrowed RMB 50 million ($8.0 million). All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (6.65% per annum on March 31, 2013 and adjustable on each anniversary of the agreement based on the prime rate published by the People’s Bank of China for loans with the same or similar terms) and are payable in March 2014. Borrowings under the loan agreement are secured by the land use rights, property and plant of Yongcheng Zhongpin.

In June 2011, Henan Zhongpin entered into a loan agreement with China Construction Bank pursuant to which Henan Zhongpin borrowed RMB 50 million ($8.0 million). All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (6.08% per annum on March 31, 2013 and adjustable on each anniversary of the agreement based on the prime rate published by the People’s Bank of China for loans with the same or similar terms) and are payable in installments in March and June 2013. Borrowings under the loan agreement are secured by the land use rights, property and plant of Henan Zhongpin. Henan Zhongpin has repaid $3.2 million in March 2013, and $4.8 million remained outstanding as of March 31, 2013.

In September 2010, Henan Zhongpin entered into a loan agreement with the Agriculture Bank of China pursuant to which Henan Zhongpin borrowed RMB 75 million ($12.0 million). All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (6.40% per annum on March 31, 2013 and adjustable in the month immediately following the publishing of rate adjustments by the People’s Bank of China during the term of the loan) and are payable in installments on various scheduled repayment dates between September 2011 and December 2014. Borrowings under the loan agreement are guaranteed by Zhumadian Zhongpin. Henan Zhongpin has repaid an aggregate of $0.7 million, and $11.3 million remained outstanding as of March 31, 2013.

In July 2010, Tianjin Zhongpin entered into a loan agreement with the Agriculture Bank of China pursuant to which Tianjin Zhongpin may borrow up to RMB 300 million ($47.9 million). Tianjin Zhongpin drew down RMB 50 million ($8.0 million) in July 2010, RMB 80 million ($12.8 million) in November 2010 and RMB 110 million ($17.5 million) in May 2011. As of March 31, 2013, the total outstanding balance under the agreement was $38.3 million and Tianjin Zhongpin had $9.6 million available for borrowing under the loan agreement. All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (6.40% per annum on March 31, 2013 and adjustable in the month immediately following the publishing of rate adjustments by the People’s Bank of China during the term of the loan) and are payable in installments in June 2013, 2014 and 2015. Borrowings under the loan agreement are secured by the land use rights, property and plant of Tianjin Zhongpin.

In June 2010, Henan Zhongpin entered into a loan agreement with China Construction Bank pursuant to which Henan Zhongpin borrowed RMB 40 million ($6.4 million). All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (5.76% per annum on March 31, 2013 and adjustable on each anniversary of date of the agreement based on the prime rate published by the People’s Bank of China for loans with the same or similar terms) and are payable on June 29, 2013. Borrowings under the loan agreement are secured by the land use rights, property and plant of Henan Zhongpin.

ZHONGPIN INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

In April 2010, in connection with the purchase of a piece of land from Changge Old Town, Changge Old Town extended a loan to Henan Zhongpin with a principal amount of RMB 10.2 million ($1.6 million) and bearing interest at the rate of 7.00% per annum payable on June 30, 2010 and each anniversary thereafter. Such loan does not have a fixed term and the principal amount of the loan should be repaid by Henan Zhongpin upon six months prior written notice from Changge Old Town. The full amount of the loan remained outstanding as of March 31, 2013.

In December 2009, Henan Zhongpin entered into a loan agreement with the Agriculture Bank of China pursuant to which Henan Zhongpin borrowed RMB 70 million ($11.2 million). All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (6.40% per annum on March 31, 2013 and adjustable in the month immediately following the publishing of rate adjustments by the People’s Bank of China during the term of the loan) and are payable in installments on various scheduled repayment dates between December 2010 and December 2014. Borrowings under the loan agreement are secured by the land use rights, property and plant of Luoyang Zhongpin. Henan Zhongpin has repaid an aggregate of $1.5 million, and $9.7 million remained outstanding as of March 31, 2013.

In November 2009, Henan Zhongpin entered into a loan agreement with China Merchants Bank pursuant to which Henan Zhongpin borrowed RMB 95 million ($15.2 million). The first 50% of the loan was drawn down in November 2009 and the remaining 50% of the loan was drawn down in March 2010. All amounts borrowed under the loan agreement bear interest at a floating rate that is based on the prime rate published by the People’s Bank of China for loans with the same or similar terms on the drawdown date (6.40% per annum on March 31, 2013 and adjustable in the month immediately following the publishing of rate adjustments by the People’s Bank of China during the term of the loan) and are payable in installments on various scheduled repayment dates between November 2012 and November 2014. Borrowings under the loan agreement are guaranteed by Luoyang Zhongpin.

In May 2002, Henan Zhongpin entered into a loan agreement with the Bank of Communications, Zhengzhou Branch, which is the intermediary bank for a 40-year term loan in the amount of $2,504,969 from the Canadian government. Under the terms of the loan agreement, 58% of the principal amount ($1,452,882) of this loan bears interest at the fixed rate of 6.02% per annum and remaining principal amount of this loan is interest free. The loan is repayable in a fixed amount of $42,083, which includes both principal and interest, that is payable on a semi-annual basis through November 15, 2041. Borrowings under the loan agreement are guaranteed by the Financing Department of Henan province.

Of the $435.5 million short-term and long-term loans outstanding as of March 31, 2013, $134,154,317 are secured by land use rights and property, plant and equipment of the Company’s subsidiaries. The total amount of land use rights and property, plant and equipment pledged was $191,620,720 as of March 31, 2013.

During the three months ended March 31, 2013 and 2012, the stock-based compensation expenses were nil and $417,749, respectively.

During the three months ended March 31, 2013 and 2012, no warrants or options were exercised.

During the three months ended March 31, 2013 and 2012, the Company repurchased nil and 368,300 shares of common stock from the public market, respectively. The average cost per share, including commission, was $8.4023 for repurchased shares for the three months ended March 31, 2012.

Of the 787,000 options and warrants outstanding at March 31, 2013, 514,000 options were anti-dilutive and therefore excluded from the computation of diluted earnings per share for the three months ended March 31, 2013. 273,000 options and warrants were dilutive and therefore included in the computation of diluted earnings per share for the three months ended March 31, 2013.

The Company has adopted ASC Topic 820, Fair Value Measurement and Disclosure , which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. It does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. It establishes a three-level valuation hierarchy of valuation techniques based on observable and unobservable inputs, which may be used to measure fair value and include the following:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

ZHONGPIN INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Classification within the hierarchy is determined based on the lowest level of input that is significant to the fair value measurement.

The carrying value of financial items of the Company including cash and cash equivalents, restricted cash, other receivables, advance to vendors, accrued liabilities and short-term borrowings loans, approximate their fair values due to their short-term nature and are classified within Level 1 of the fair value hierarchy. The Company’s financial items are classified within Level 1 of the fair value hierarchy. The carrying amount of cash and cash equivalents, accounts receivable, other receivables, advance to vendors, accounts payable, accrued liabilities, short-term financial bonds and short-term loans are reasonable estimates of their fair value because of the short term nature of these items.

The following table sets forth the Company's financial assets and liabilities not measured at fair value on a recurring basis and where they are classified within the hierarchy as of March 31, 2013:

Note receivable approximates fair value since it bears interest at Shanghai interbank offered rate, as is normally charged for notes of similar nature. Long-term debt approximates fair value since the bank term loans are fixed rate instruments and bear interests at the rate dictated and published by the People's Bank of China. The current rates published by the People's Bank of China approximate the interest rates of the loans outstanding.

The Company operates in only one segment: meat production. The Company's vegetable and fruit operations, both financially and operationally, do not represent a significant enough portion of its business to constitute a separate segment. However, the Company’s product lines are divided into two divisions: pork and pork products, and vegetables and fruits.

The pork and pork products division is involved primarily in the processing of live hogs into fresh, frozen and processed pork products. The pork and pork products division markets its products domestically to retail stores and to food retailers, food service distributors, restaurant operators and noncommercial food service establishments, such as schools, hotel chains, healthcare facilities, the military and other food processors, as well as in certain international markets on a limited basis.

The vegetables and fruits division is involved primarily in the processing of fresh vegetables and fruits. The Company contracts with more than 100 farms in Henan province and nearby areas to produce high-quality vegetable varieties and fruits suitable for export purposes. The proximity of the contracted farms to operations ensures freshness from harvest to processing. The Company contracts with those farms to grow more than 25 categories of vegetables and fruits, including asparagus, sweet corn, broccoli, mushrooms, lima beans and strawberries.

Mutual Guarantee

In May 2012, Henan Zhongpin entered into a mutual guarantee agreement with Huanghe Group, upon the expiration of a previous mutual guarantee agreement between Henan Zhongpin and Huanghe Group. Under the agreement, Henan Zhongpin agreed to guarantee bank loans of Huanghe Group in an amount up to $23.9 million and Huanghe Group agreed to guarantee Henan Zhongpin’s bank loans in an amount up to $23.9 million. The agreement will expire in May 2013. At the expiration of the agreement, each party will remain obligated under its guarantee for any loans of the other party that are outstanding on the date of expiration of the agreement.

The business purpose for the mutual guarantee is to provide each party with a credit line from banks that would have otherwise been unavailable absent the guarantee. As bank credit loans are generally unavailable in China, companies are required to provide either a pledge of assets, a third-party guarantee or a combination of both in order to receive loans. In the case of pledges, companies can pledge their assets, including, among other things, land, buildings and machines, to banks as collateral to secure loans; however, banks generally will only loan up to 50% to 70% of the value of the pledged assets. Alternatively, if a company provides the banks with a guarantee agreement, the banks generally will loan up to 90% to 100% of the amount being guaranteed.

Henan Zhongpin’s obligation as guarantor to repay loans on behalf of Huanghe Group will only arise if Huanghe Group cannot repay its loans and proceeds from liquidating Huanghe Group’s pledged assets are insufficient to cover its outstanding debt. Henan Zhongpin’s actual liability for such guarantee, should the guarantee obligation become due, will vary depending on the difference between the outstanding bank loan plus accrued interest and the proceeds received for the liquidated collateral. Henan Zhongpin did not pledge any of its assets in connection with the mutual guarantee agreement as this guarantee was not based on credit quality concerns, but rather based on the local banks’ requirements. In the event Henan Zhongpin is required to pay all or a portion of any loans covered by the mutual guarantee, Henan Zhongpin would seek reimbursement for such payment from Huanghe Group.

At March 31, 2013, Henan Zhongpin had outstanding guarantees for $19.7 million of Huanghe Group’s bank loans under the agreement. All of the bank loans guaranteed by Henan Zhongpin will mature within the next 12 months. As a result, the maximum potential amount of future payments (undiscounted) Henan Zhongpin could be obligated to make under the mutual guarantee at such date was $19.7 million. The Company did not record any liability on its balance sheet with respect to this mutual guarantee as the Company believes, based upon its continuing due diligence on Huanghe Group and its business, that Henan Zhongpin’s liability there under remains contingent.

ZHONGPIN INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Legal Proceedings

On March 27, 2012, the Company announced that its Board of Directors had received a preliminary, non-binding proposal from the Company’s Chairman and Chief Executive Officer, Xianfu Zhu, stating that Mr. Zhu intended to seek to purchase the remaining shares of the Company that he does not presently own (the “Proposed Buyout”). Following this announcement, at least three lawsuits have been filed in Delaware naming the members of the Company's Board of Directors and/or the Company as defendants. On November 26, 2012, the Company announced that it had entered into a definitive merger agreement with Golden Bridge Holdings Limited, a Cayman Islands exempted company ("Parent"), Golden Bridge Merger Sub Limited, a Delaware corporation and wholly owned subsidiary of Parent ("Merger Sub") and Mr. Xianfu Zhu, which was subsequently amended and restated on February 8, 2013 (the “Merger Agreement”). Pursuant to the Merger Agreement and subject to the satisfaction or waiver of the conditions to the transactions contemplated thereby, at the effective time of the merger, each share of the Company common stock issued and outstanding immediately prior to the effective time (other than shares owned by (i) Parent or Merger Sub, (ii) Mr. Xianfu Zhu, Mr. Baoke Ben, Mr. Chaoyang Liu, Mr. Qinghe Wang, Mr. Shuichi Si and Ms. Juanjuan Wang, (iii) the Company or any direct or indirect wholly-owned subsidiary of the Company or (iv) stockholders who have properly exercised and perfected appraisal rights under Delaware law), will be converted automatically into the right to receive $13.50 in cash, without interest. On March 15, 2013, the Company filed with the SEC a Schedule 13e-3 relating to the Proposed Buyout together with a preliminary proxy statement relating to a special meeting of stockholders to adopt the Merger Agreement (collectively, and together with all filings with the SEC that are ancillary thereto, and all amendments and supplements thereof, the “Transaction Filings”).

Following the November 2012 announcement of the Merger Agreement, two additional lawsuits were filed in Delaware naming as defendants the members of the Company’s Board of Directors, the Company, Parent, and Merger Sub. It is possible that more lawsuits will occur. 

On April 3, 2012, a verified shareholder class action lawsuit was filed by Phillip Meeks in the Court of Chancery of the State of Delaware against the Company and members of its Board of Directors, alleging that, inter alia, the Company's Board of Directors breached their fiduciary duties in connection with the Proposed Buyout, and that the price per share proposed by Mr. Zhu represented inadequate consideration in light of the Company’s intrinsic value and future prospects, and that the Company aided and abetted the breach of fiduciary duties. The plaintiff seeks damages, declaratory relief and injunctive relief, including an order preventing the Company from proceeding with the Proposed Buyout or any transaction with Mr. Zhu, as well as an award of plaintiffs’ attorneys’ fees and costs. The Company believes that none of the defendants has yet responded to the complaint.

On April 11, 2012, a verified shareholder class action lawsuit was filed by Richard Bauschard in the Court of Chancery of the State of Delaware against members of the Company's Board of Directors, alleging that, inter alia, the Board of Directors breached their fiduciary duties in connection with the Proposed Buyout, and that the price per share proposed by Mr. Zhu represented inadequate consideration in light of the Company’s intrinsic value and future prospects. The plaintiff seeks damages, declaratory relief and injunctive relief, including an order preventing the defendants from proceeding with the Proposed Buyout or any transaction with Mr. Zhu, as well as an award of plaintiffs’ attorneys’ fees and costs. On April 12, 2013, plaintiff Richard Bauschard filed an amended complaint. The amended complaint names the same defendants and includes the same cause of action alleging breach of fiduciary duties, but the amended complaint includes additional allegations relating to the terms of the Merger Agreement and the disclosures contained in the preliminary proxy statement filed by the Company on March 15, 2013 with the SEC. The Company believes that none of the defendants has yet responded to the complaint.

ZHONGPIN INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

On April 18, 2012, a verified shareholder class action lawsuit was filed by Harry Vonderlieth in the Court of Chancery of the State of Delaware against the Company and members of its Board of Directors, alleging that, inter alia, the Company's Board of Directors breached their fiduciary duties to the shareholders in connection with the Proposed Buyout, and that the price per share proposed by Mr. Zhu represented inadequate consideration in light of the Company’s intrinsic value and future prospects, and that the Company aided and abetted the breach of fiduciary duties. The plaintiff seeks damages, declaratory relief and injunctive relief, including an order preventing the Company from proceeding with the Proposed Buyout or any transaction with Mr. Zhu, as well as an award of plaintiffs’ attorneys’ fees and costs. The Company believes that none of the defendants has yet responded to the complaint. On May 2, 2013, plaintiff Harry Vonderlieth voluntarily dismissed this case and the Court of Chancery of the State of Delaware granted the dismissal on May 3, 2013.

On December 4, 2012, after the announcement of the Company’s entering into the Merger Agreement, a verified shareholder class action lawsuit was filed by Ernesto Rodriguez in the Court of Chancery of the State of Delaware against the Company and members of its Board of Directors, Parent and Merger Sub, alleging that, inter alia, the Company’s Board of Directors breached their fiduciary duties to the Company’s shareholders in connection with the Proposed Buyout and the Merger Agreement, and that the price per share and other terms provided for in the Merger Agreement are inadequate and unfair in light of the Company’s intrinsic value and future prospects, and that the Company, Parent and Merger Sub aided and abetted the breach of fiduciary duties.  The plaintiff seeks damages, declaratory relief and injunctive relief, including an order preventing the Company from proceeding with the Proposed Buyout or any transaction with Mr. Zhu, as well as an award of plaintiffs’ attorneys’ fees and costs. On or about February 6, 2013, the plaintiff served document discovery on the individual defendants. On April 12, 2013, plaintiff Ernesto Rodriguez filed an amended complaint. The amended complaint names the same defendants and includes the same cause of action alleging breach of fiduciary duties, but the amended complaint includes additional allegations relating to the disclosures contained in the preliminary proxy statement filed by the Company on March 15, 2013 with the SEC. The Company believes that none of the defendants has yet responded to the complaint or the discovery served by the plaintiff. 

On April 23, 2013, after the announcement of the Company’s entering into the Merger Agreement and certain of the Transaction Filings were made, a verified shareholder class action lawsuit was filed by Alan Hall in the Court of Chancery of the State of Delaware against the Company and members of its Board of Directors, Parent and Merger Sub, alleging that, inter alia, the Company’s Board of Directors breached their fiduciary duties to the Company’s shareholders in connection with the Proposed Buyout and the Merger Agreement, and that the price per share and other terms provided for in the Merger Agreement are inadequate and unfair in light of the Company’s intrinsic value and future prospects, that the Transaction Filings contain materially misleading misstatements and omissions, and that the Company, Parent and Merger Sub aided and abetted the breach of fiduciary duties. The plaintiff seeks damages, declaratory relief and injunctive relief, including an order preventing the Company from proceeding with the Proposed Buyout, or any transaction with Mr. Zhu, as well as an award of plaintiffs’ attorneys’ fees and costs. The Company believes that none of the defendants has yet responded to the complaint.

On or about April 22, 2013, plaintiff Richard Bauschard filed a motion to consolidate and appoint lead counsel with the Court of Chancery of the State of Delaware, moving the Court for an order providing for (i) the consolidation of the aforesaid lawsuits filed by Phillip Meeks, Richard Bauschard, Harry Vonderlieth and Ernesto Rodriguez, and (ii) the appointment of lead counsel and Delaware liaison counsel in the consolidated matter. The Company believes that none of the defendants has yet responded to the motion.

The Company intends to defend against the pending class action litigation vigorously.

In accordance with accounting standards regarding loss contingencies, the Company accrues an undiscounted liability for those contingencies where the incurrence of a loss is probable and the amount can be reasonably estimated, and the Company discloses the amount accrued and an estimate of any reasonably possible loss in excess of the amount accrued, if such disclosure is necessary for the Company’s financial statements not to be misleading. The Company does not accrue liabilities when the likelihood that the liability has been incurred is probable but the amount cannot be reasonably estimated, or when the liability is believed to be only reasonably possible or remote.

ZHONGPIN INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Because litigation outcomes are inherently unpredictable, the evaluation of legal proceedings often involves a series of complex assessments by management about future events and can rely heavily on estimates and assumptions. If the assessments indicate that loss contingencies that could be material to any one of the Company’s financial statements are not probable, but are reasonably possible, or are probable, but cannot be estimated, then the Company discloses the nature of the loss contingencies, together with an estimate of the possible loss or a statement that such loss is not reasonably estimable.

With respect to the legal proceedings and claims described above, such litigation is still in its preliminary stages and the final outcome, including the Company’s liability, if any, with respect to such litigation, is uncertain. At present, the Company is unable to estimate a reasonably possible range of loss, if any, that may result from such litigation. If an unfavorable outcome were to occur in the litigation described above, the impact could be material to the Company’s business, financial condition, or results of operations.

In addition, it is not possible to determine the maximum potential amount under the indemnification provisions under the terms and conditions of applicable bylaws, certificates or articles of incorporation, agreements or applicable law due to the limited history of prior indemnification claims and the preliminary stages of the litigation.

Capital Leases

In March 2013, Henan Zhongpin entered into a sale-leaseback agreement with CMB Leasing pursuant to which Henan Zhongpin sold to CMB Leasing equipment with a net book value of $47.6million for $43.8 million and leased such equipment back. The lease payments for this equipment are paid on a quarterly basis over a four-year period and consist of a fixed payment based upon a 48-month amortization of the purchase price plus an interest component that is based upon the rate announced from time to time by the People’s Bank of China for three-year loans. At March 31, 2013, the quarterly rental fee under the agreement was $2,246,214, which included an interest component calculated at the rate of 5.82% and adjustable in the quarter following any rate adjustments published by the People’s Bank of China. The sale-leaseback agreement will end in March 2017. Henan Zhongpin has the right to repurchase all of the equipment under the sale-leaseback agreement for a nominal purchase price at the end of the lease term. The sale-leaseback agreement was guaranteed by Mr. Xianfu Zhu, the Company’s Chairman and Chief Executive Officer.