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Zhongpin 2012 Q2: Higher revenues, lower net income

Zhongpin, a leading meat and food processing company in the People's Republic of China, has reported reported higher sales revenues and lower net income for the three months ended June 30, 2012 compared with the second quarter 2011.

Second quarter 2012 highlights:

Total sales revenues increased 11.4% to US$408.2 million for the three months ended June 30, 2012 from US$366.5 million in the second quarter 2011 primarily due to higher sales volume for pork products sold at lower average selling prices.

Net income decreased 43.0% to US$11.0 million in the second quarter 2012 from $19.3 million in the second quarter 2011 primarily due to a lower gross profit margin, the cost of more employees to support expansion, higher salaries, rising labour and utility costs, and higher interest expenses and income taxes. The higher expenses were mainly due to expansion of our business and intense competitive pressure in the pork market as the industry continues to consolidate and companies are required to vie aggressively to win additional market share in a variety of ways.

Guidance for 2012 is maintained: Zhongpin expects that sales revenues should be within a range of US$1.55 billion to $1.72 billion for 2012.

Gross profit margin is expected to be within the range of 8.6% to 10.2%. Net profit margin is expected to be within the range of 3.3% to 4.2%.


Capacity and market expansions in 2012
Zhongpin is investing approximately US$58.5 million to build a new production, research and development, and training complex in Changge, Henan province, excluding the cost of land use rights that it has already obtained.

When completed, this new facility should have an annual production capacity of about 100,000 metric tons for prepared pork products. Adjacent to this new production facility, Zhongpin plans to develop a center for research and development, training, and quality assurance and control. Construction for the first phase with a production capacity of approximately 50,000 metric tons for prepared pork products started in the second quarter of 2011 and trial production started in July 2012.

Zhongpin established a joint venture company in June 2011, of which the Company owns 65%, with Henan Xinda Animal Husbandry Company Limited. The joint venture company is financed by capital contributions and bank loans. All capital contributions to the joint venture company have been made. The joint venture company will provide 20,000 sire boars annually. Construction of the facility for sire boar breeding is continuing and the operations are expected to begin in the third quarter 2012.

Zhongpin is investing approximately US$18.0 million in a cold-chain logistics distribution center in Anyang, Henan province. This distribution center will have processing capacity, a temperature adjustable warehouse with a floor area of approximately 27,000 square meters, a distribution center, and a quality control center. The distribution center will be used for third-party cold-chain logistics service. Zhongpin expects to put this distribution center into operation in the third quarter of 2012.

Zhongpin plans to invest approximately US$87.5 million in a chilled and frozen food processing and distribution center in Kunshan, Jiangsu province, which is near Shanghai. The center will be built in three phases. The first phase will include a processing center, cold-chain logistics center, and business complex. Zhongpin expects to invest about $35.0 million on the first phase that should be put into operation in the fourth quarter of 2012.

Zhongpin will be investing approximately $10.5 million in a by-product processing plant in Changge, Henan province. This facility will have a production capacity for 100 million meters of casings and 300 billion units of raw material to make heparin sodium. The construction started in March 2012, and the new facility is expected to begin operations in the fourth quarter of 2012.

Zhongpin will be investing approximately US$49.0 million to build a slaughtering and processing plant, low temperature prepared pork plant, and logistics center in Tangshan, Hebei province. This facility will have an annual production capacity of about 60,000 metric tons for chilled pork, 20,000 metric tons for frozen pork, and 22,000 metric tons for prepared pork products. Construction is scheduled to start in the third quarter of 2012, and the new facility for chilled and frozen pork is expected to begin operations in the second quarter of 2013.

As of June 30, 2012, Zhongpin had an annual capacity of 728,760 metric tons for chilled and frozen pork, 126,000 tons for prepared pork products, 20,000 tons for pork oil, and 30,000 tons for vegetables and fruits, for a combined total of 904,760 metric tons. With the additional annual capacity of 50,000 metric tons for prepared pork products that started trial production in July, Zhongpin's total annual capacity for all products was 954,760 tons as of July 31, 2012.

Outlook for pork demand and pricing in China  
Zhongpin's outlook for hog prices and pork prices has decreased somewhat since the end of the first quarter 2012.

Although China's economy appears to be healthy and pork continues to be the preferred protein for most Chinese consumers, and the fundamental demand for pork should continue to be quite good, the vigorous competition for market share in the pork industry, as the industry consolidates, has helped to reduce pork prices in the second quarter 2012 more than the cost of hogs has decreased.

Zhongpin believes that hog prices may have reached the bottom of the current price decline, despite the current abundant supply of hogs. As the costs for breeding and feed are rising, the Chinese government has recently started to increase the nation's pork reserve, which in the past has generally had the effect of stabilizing hog prices somewhat above the cost to raise hogs.
 
Hog prices have declined about 15% from the end of January 2012 to early August 2012. Given the expected bottom, we still estimate hog prices to decline on average by 15% to 20% in the year 2012 compared with 2011. The hog price declines in the second quarter 2012 are consistent with that estimation for the year 2012.

Pork prices tend to follow hog prices, since most pork producers, including Zhongpin, try to maintain a good spread between the price of hogs and the price of pork.

Sales revenues in the second quarter 2012
Total sales revenues increased US$41.7 million or 11.4% to US$408.2 million for the three months ended June 30, 2012 from US$366.5 million in the second quarter 2011 primarily due to higher sales volume for pork and pork products resulted mainly from continued increases in the number of retail outlets, geographic expansion of its distribution network and processing facilities, and higher sales to chain restaurants, food service providers, and wholesalers and distributors in China, and higher selling prices for prepared pork products, partly offset by lower average selling prices for chilled and frozen pork. The following table shows tonnage, sales revenues, and average price per metric ton by product division for the second quarters of 2012 and 2011.

Chilled pork revenues increased on higher tonnage at lower average prices per ton. Chilled pork revenues increased 16% in the second quarter 2012 from the second quarter 2011. Chilled pork tonnage increased 29% and the average price per metric ton decreased 10% in the second quarter 2012 from the second quarter 2011. The higher revenues from chilled pork were mainly due to higher tonnage sold as a result of higher capacity, increased sales to existing customers, and increased volume of sales from new geographic markets, expanded points of sales, and acquired new customers, partly offset by the lower average selling price that resulted from fluctuations in prices for chilled pork in a more competitive market.

Frozen pork revenues decreased on lower tonnage at lower average prices. Frozen pork revenues decreased 13% in the second quarter 2012 from the second quarter 2011. Frozen pork tonnage decreased 3% and the average price per metric ton decreased 10% in the second quarter 2012 from the second quarter 2011. The lower sales volume was due to our strategic adjustment of our product mix towards selling less frozen pork products, which have a lower profit margin. The lower average selling price of frozen pork products was the result of fluctuations in prices for frozen pork in a more competitive market.

Prepared pork revenues increased on higher tonnage at higher average prices. Revenues from prepared pork products increased 51% in the second quarter 2012 from the second quarter 2011. Prepared pork tonnage increased 23% and the average price per metric ton increased 23% in the second quarter 2012 from the second quarter 2011. Prepared pork products are becoming more important to our business since customers are increasingly demanding them for their convenience and flavor and are willing to pay higher average prices for them. We plan to gradually increase sales from prepared pork products by building up our brand recognition and expanding our capacity for these products.

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