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PINGTAN MARINE ENTERPRISE LTD. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of the results of operations and financial condition of Pingtan Marine Enterprise Ltd. for the three and nine months ended September 30, 2014 and 2013 should be read in conjunction with the Pingtan Marine Enterprise Ltd. unaudited condensed financial statements and the notes thereto contained elsewhere in this report. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under the Risk Factors, Special Note Regarding Forward-Looking Statements and Business sections in our Form 10-K/A as filed with the Securities and Exchange Commission on November 10, 2014. We use words such as "anticipate," "estimate," "plan," "project," "continuing," "ongoing," "expect," "believe," "intend," "may," "will," "should," "could," and similar expressions to identify forward-looking statements. References to the "Company," "us" or "we" refer to Pingtan Marine Enterprise Ltd.. Overview We are a marine enterprises group primarily engaging in ocean fishing through our wholly-owned PRC operating subsidiary or VIE, Fujian Provincial Pingtan County Ocean Fishing Group Co., Ltd., or Pingtan Fishing. We harvest a variety of fish species with many of our-owned or licensed vessels operating within the Indian Exclusive Economic Zone and the Arafura Sea of Indonesia. We provide high quality seafood to a diverse group of customers including distributors, restaurant owners and exporters in the PRC. In June 2013, we expanded our fleet from 40 to 86 through a purchase of 46 fishing trawlers from a related party for a total consideration of $410.1 million. We began operating the vessels in the third quarter of 2013 and since then we have been entitled to their net profits from there operation. These vessels are fully licensed to fish in Indonesian waters. Each vessel carries crew of 10 to 15 persons. These vessels have resulted in additional carrying capacity of approximately 45,000 to 50,000 tons for us. In September 2013, we further increased our fleet to 106 vessels with the acquisition of 20 newly-built fishing trawlers, which were initially ordered in September 2012. These vessels have an expected run-in period of 3 - 6 months, during which each is placed into the sea for testing prior to full operation. These vessels are fully licensed to fish in Indian and Indonesian waters. At full operation, each vessel is capable of harvesting 900 to 1,000 tons of fish. We expect that the expansions of our fleet will greatly increase our fish harvest volume and revenue. Subsequent to our fleet expansions, in September 2013, the Ministry of Agriculture of the People's Republic of China ("MOA") issued a notification that it would suspend accepting shipbuilding applications for tuna harvesting vessels, squid harvesting vessels, Pacific saury harvesting vessels, trawlers operating on international waters, seine on international waters, and trawlers operating on the Arafura Sea, Indonesia. We believe the announcement is a positive indicator for long-term stability and balance in China's fishing industry. We believe that this has helped to ensure our fishing productivity in international waters, while also serving as a major barrier to entry for competitors in our industry and strengthening our competitive position in the markets. 39 On December 4, 2013, in connection with the sale of CDGC to Hong Long, we acquired 25-year operating license rights in connection with the lease of 20 fishing vessels for the appraised fair market value of approximately $216.1 million, whereby we are entitled to 100% of the operations and net profits (losses) from the vessels for the term of the lease. The 20 vessels were leased from Hong Long, a related party under common control. Accordingly, the transaction between us and Hong Long was accounted as a common control transaction pursuant to ASC 805-50 and it related subsections. Pursuant to ASC 805-50, we recorded the value of $26,435,403 as the cost of the vessels which was the net historical carrying amount recorded in Hong Long's books at thedate of sale of CDGC to Hong Long. We currently operate 129fishing vessels and is the second largest China based fishery company operating its vessels outside of China waters. As of September 30, 2014, we own 107 trawlers and 2 drifters and have exclusive operating license rights to 20 drifters. Our fleet has an average useful life of approximately 16 years. These vessels are fully licensed to fish in Indonesian or Indian waters. Among the 129 fishing vessels, 117 of these vessels are operating in the Arafura Sea in Indonesia, and the remaining 12 vessels are operating in the Bay of Bengal in India. Currently we catch nearly 30 different species of fish including ribbon fish, Indian white shrimp, croaker fish, pomfret, Spanish mackerel, conger eel, squid and red snapper. All of our catch is shipped back to China. Our fishing vessels transport frozen catch to a cold storage warehouse at nearby onshore fishing bases. We then arrange periodic charted transportation ships to deliver frozen stocks to its eight cold storage warehouses located in one of China's largest seafood trading centers, Mawei Seafood Market in Fujian Province. We derive our revenue primarily from the sales of frozen seafood products. We sell our products directly to customers including distributors, restaurant owners and exporters, and most of our customers have long-term and trustworthy cooperative relationship with us. Our existing customers also introduce new customers to us from time to time. Our operating results are subject to seasonal variations. Harvest volume is the highest in the fourth quarter of the year and harvest volumes in the second and third quarters are relatively low due to the spawn season of certain fish species, including ribbon fish, cuttlefish, butterfish, and calamari. Based on past experiences, demand for seafood products is the highest from December to January during Chinese New Year. We believe that our profitability and growth are dependent on our ability to expand the customer base. With the expansions of operating capacity and expected increases in harvest volume in the coming years, we will continue to develop new customers from existing and new territories in China. Discontinued operations In December 2013, we have completed the sale of the China Dredging Group ("CDGC") business, which has been reported as discontinued operations for the three and nine months ended September 30, 2013, to Hong Long, a related party owned by the wife of our Chairman and CEO, Mr. Xinrong Zhuo. In exchange for (i) offset of our current $155.2 million 4% promissory note due to Hong Long; (ii) the assignment of the 25-year exclusive operating license rights for 20 new fishing vessels to us, with a fair market value of $216.1 million (iii) offset of PME's current accounts payable due to CDGC with amount $172.5 million. In connection with these 20 fishing vessels, Hong long received subsidies from China's central government budget in 2012, and a recent notification from the Government prohibits the sale or transfer of ownership for a period of 10 years for fishing vessels that have received such subsidies. 40 The Board, excluding Mr. Zhuo and our Senior Officer, Mr. Bin Lin, retained our independent financial advisor to provide a fairness opinion on the transaction proposed by Mr. Zhuo. Subsequent to the receipt of the fairness opinion from our independent financial advisor on October 28, 2013, the Board would evaluate potential alternative proposals received during a 30 day period. After receiving no alternative proposals, on December 3, 2013, the Board, excluding Mr. Zhuo and Mr. Lin approved moving forward with the transaction and executed and closed the Share Purchase Agreement. The total consideration of the transaction is approximately $543.8 million with a gain on sale of $117.5 million which was recorded as an adjustment to our equity as it was sold to a related party under common control. Significant factors affecting our results of operations • Governmental policies: Fishing is a highly regulated industry and our operations require licenses and permits. Our ability to obtain, sustain or renew such licenses and permits on acceptable terms is subject to changes in regulations and policies and is at the discretion of the applicable governments. Our inability to obtain, or loss or denial of extensions, to any of its applicable licenses or permits could hamper our ability to generate revenues from its operations. • Resource & environmental factors: Our fishing expeditions are based in India and Indonesia. Any earthquake, tsunami, adverse weather or oceanic conditions or other calamities in such areas may result in disruption to our operations and could adversely affect our sales. Adverse weather conditions such as storms, cyclones and typhoons or cataclysmic events may also decrease the volume of fish catches or may even hamper our operations. Our fishing volumes may also be adversely affected by major climatic disruptions such as El Nino, which in the past has caused significant decreases in seafood catch worldwide. Besides weather patterns, other unpredictable factors, such as fish migration, may also have impact our harvest volume. • Fluctuation on fuel prices: Our operations may be adversely affected by fluctuations in fuel prices. Changes in fuel prices may ultimately result in increases in the selling prices of our products, and may, in turn, adversely affect our sales volume, revenue and operating profit. • Competition: We engage in fishing business in the Arafura Sea in Indonesia and the Bay of Bengal in India. Competition within our dedicated fishing areas is not significant as the region is not overfished and regulated by the government, which limits the number of vessels that are allowed to fish in the territories. Competition in the market in China is high. We compete with other fishing companies which offer similar and varied products. There is significant demand for fish in the Chinese market. Our catch appeals to a wide segment of consumers because of the low price points of our products. We have been able to sell our catch at market prices and such market prices have been increasing significantly since 2012. • Fishing licenses: Each of our fishing vessels requires an approval from the Ministry of Agriculture of the People's Republic of China to carry out ocean fishing projects in foreign territories. These approvals are valid for a period of three to twelve months, and are awarded to us at no cost. We apply for the renewal of the approval prior to expiration to avoid interruptions of our fishing vessels' operations. Each of our fishing vessels operating in Indonesian waters requires a fishing license granted by the authority in Indonesia. Indonesian fishing licenses remain effective for a period of twelve months and we apply for renewal upon expiration. We record cost of Indonesian fishing licenses in prepaid expenses on the accompanying consolidated balance sheets and amortize the cost over the effective period of the licenses. 41 Principal income statement components Revenue We recognize revenue from sales of frozen fish and other marine catches when persuasive evidence of an arrangement exists, delivery has occurred, the price to the customer is fixed or determinable, and collection of the resulting receivable is reasonably assured. With respect to the sales to third party customers the majority of whom are sole proprietor regional wholesalers in China, we recognize revenue when customers receive purchased goods at our cold storage warehouse, after payment is received or credit sale is approved for recurring customers with excellent payment histories. We do not offer promotional payments, customer coupons, rebates or other cash redemption offers to customers. We do not accept returns from customers. Payments received from customers prior to delivery of goods are recorded as advance from customers. Cost of revenue Our cost of revenues primarily consists of fuel costs, freight, direct labor costs, depreciation, maintenance fees and other overhead costs. Fuel costs generally accounted for the majority of our cost of revenues. Gross profit Our gross profit is affected primarily by changes in production cost. Fuel cost, freight and labor costs together account for about 85.3% and 84.1% of cost of revenue for the nine months ended September 30, 2014 and 2013, respectively. The fluctuation of fuel price, freight price and exchange rates may significantly affect our cost level and gross profit. Selling expense Our selling expense includes storage and shipping fees, insurance, traveling expense for our sales personnel and other miscellaneous expenses. Our sales activities are conducted through direct selling by our internal sales staff. Because of the strong demand for our products and services, we do not have to aggressively market and distribute our products, thus our selling expenses have been relatively small as a percentage of our revenue. General and administrative expense Our general and administrative expense includes compensation and related benefits, professional fees, travel and entertainment expense, business insurance, rental and related administrative service charge and other miscellaneous items related to our corporate administrative activities. We expect that our general and administrative expense will increase as we incur significant costs associated with our public company reporting requirements, costs associated with newly applicable corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002 and other rules implemented by the Securities and Exchange Commission. Other income / expense Other income / expense mainly include interest income from bank deposits, interest expenses of short-term and long-term borrowings, foreign currency transaction gain/loss, grant income, dividend income from cost-method investment and other miscellaneous income and expense, net. 42 Income tax Under the current laws of the Cayman Islands and British Virgin Islands, we are not subject to any income or capital gains tax, and dividend payments we make are not subject to any withholding tax in the Cayman Islands or British Virgin Islands. Under the current laws of Hong Kong, we are not subject to any income or capital gains tax and dividend payments and are not subject to any withholding tax in Hong Kong. Our VIE, Pingtan Fishing, is a qualified ocean fishing enterprise certified by the Ministry of Agriculture of the PRC. The qualification is renewed on April 1 each year. Pingtan Fishing is exempt from income tax derived from its ocean fishing operations in the periods it processes a valid Ocean Fishing Enterprise Qualification Certificate issued by the Ministry of Agriculture of the PRC.In addition, Pingtan Fishing is not subject to foreign income taxes for its operations in India and Indonesia Exclusive Economic Zones. Other comprehensive income Our comprehensive income consists of net income and foreign currency translation adjustments. We translate our assets and liabilities of foreign operations at the rate of exchange in effect on the balance sheet date. We translate income and expenses at the average rate of exchange prevailing during the period. The related translation adjustments are reflected in "Accumulated other comprehensive income" in the equity section of our unaudited condensed consolidated balance sheets. Foreign currency gains and losses resulting from transactions are included in earnings. Income per ordinary share Income per ordinary share (basic and diluted) is based on the net income divided by the weighted average number of ordinary shares outstanding during each period. Ordinary share equivalents of approximately 9 million are not included in the calculation of diluted earnings per ordinary share if their effect would be anti-dilutive. RESULTS OF OPERATIONS Comparison of results of operations for the three and nine months ended September 30, 2014 and 2013 Revenue For the three months ended September 30, 2014 and 2013, our revenue by species of fish was as follows (dollars in thousands, except for average price): Three Months Ended September 30, 2014 2013 (As Restated) Volume Average % of Volume Average % of Revenue (KG) price revenue Revenue (KG) price revenue Indian white shrimp $ 13,004 1,049,036 $ 12.40 23.9 % $ 2,204 193,774 $ 11.37 10.7 % Ribbon fish 12,309 4,975,947 2.47 22.6 % 6,406 2,270,353 2.82 31.1 % Spanish mackerel 5,671 1,629,428 3.48 10.4 % 583 176,550 3.30 2.8 % Black pomfret 5,501 2,052,621 2.68 10.1 % 1,903 811,050 2.35 9.2 % Croaker fish 3,968 1,394,588 2.85 7.3 % 2,154 929,572 2.32 10.5 % Conger eel 2,613 981,565 2.66 4.8 % 862 293,400 2.94 4.2 % other 11,351 3,784,844 3.00 20.9 % 6,497 1,855,904 3.50 31.5 % $ 54,417 15,868,029 $ 3.43 100.0 % $ 20,609 6,530,603 $ 3.16 100.0 % 43 For the three months ended September 30, 2014, we had revenue of $54,417,000, as compared to revenue of $20,609,000 for the three months ended September 30, 2013, an increase of $33,808,000, or 164.0%. The increase was primarily attributable to an increase in sales volume as a result of the addition of 66 fishing vessels in June and September 2013, which were operating at full capacity in the third quarter of 2014; and the addition of 20 new fishing vessels acquired from Hong Long in December 2013, which were ready for use at the beginning of 2014. Sales volume in the third quarter of 2014 increased 143.0% to 15,868,029 kg from 6,530,603 kg in the third quarter of 2013. Average unit selling price increased 8.5% in the third quarter of 2014 compared to the third quarter of 2013 mainly due to the higher demand of natural seafood in China. For the nine months ended September 30, 2014 and 2013, our revenue by species of fish was as follows (dollars in thousands, except for average price): Nine Months Ended September 30, 2014 2013 (As Restated) Volume Average % of Volume Average % of Revenue (KG) price revenue Revenue (KG) price revenue Ribbon fish $ 51,444 19,927,679 $ 2.58 29.1 % $ 20,025 9,296,266 $ 2.15 32.5 % Indian white shrimp 36,173 3,725,436 9.71 20.4 % 10,409 1,282,892 8.11 16.9 % Black pomfret 24,021 10,098,347 2.38 13.6 % 5,731 2,474,892 2.32 9.3 % Croaker fish 14,722 5,473,622 2.69 8.3 % 8,285 4,230,120 1.96 13.4 % Spanish mackerel 9,046 2,778,814 3.26 5.1 % 1,207 355,800 3.39 2.0 % Conger eel 6,237 2,462,951 2.53 3.5 % 1,393 486,000 2.87 2.3 % other 35,266 13,325,615 2.65 20.0 % 14,591 4,693,950 3.11 23.6 % $ 176,909 57,792,464 $ 3.06 100.0 % $ 61,641 22,819,920 $ 2.70 100.0 % For the nine months ended September 30, 2014, we had revenue of $176,909,000, as compared to revenue of $61,641,000 for the nine months ended September 30, 2013, an increase of $115,268,000, or 187.0%. The increase was mainly due to increase in sales volume as a result of the addition of 66 fishing vessels into our operation in June and September 2013, most of which were operating at full capacity in the nine months ended September 30, 2014; and the addition of 20 new fishing vessels acquired from Hong Long in December 2013, which were put in our operation in the nine months ended September 30, 2014. Sales volumes in the nine months ended September 30, 2014 increased 153.3% to 57,792,464 kg from 22,819,920 kg in the comparable period of 2013. Average unit sales prices increased 13.3% in the nine months ended September 30, 2014 compared to the corresponding period of 2013, which was driven by the higher demand of natural seafood in China. Cost of revenue The following table sets forth our cost of revenue information, both in amounts and as a percentage of revenue for the three months ended September 30, 2014 and 2013 (dollars in thousands): Three Months Ended September 30, 2014 2013 (As Restated) % of cost of % of % of cost of % of Amount revenue revenue Amount revenue revenue Fuel cost $ 24,019 61.7 % 44.1 % $ 7,422 57.2 % 36.0 % Freight 3,792 9.7 % 7.0 % 1,264 9.7 % 6.1 % Labor cost 5,241 13.5 % 9.6 % 1,322 10.2 % 6.4 % Depreciation 403 1.0 % 0.7 % 883 6.8 % 4.3 % Maintenance fee 3,149 8.1 % 5.8 % 908 7.0 % 4.4 % Spare parts 341 0.9 % 0.6 % 650 5.0 % 3.2 %Fishing license and agent fee 1,988 5.1 % 3.7 % 528 4.1 % 2.6 % Total cost of revenue $ 38,933 100.0 % 71.5 % $ 12,977 100.0 % 63.0 % 44 Cost of revenue for the three months ended September 30, 2014 was $38,933,000, representing an increase of $25,956,000 or approximately 200.0% as compared to $12,977,000 for the three months ended September 30, 2013. The increase was principally due to the increase in our revenue. The following table sets forth our cost of revenue information, both in amounts and as a percentage of revenue for the nine months ended September 30, 2014 and 2013 (dollars in thousands): Nine Months Ended September 30, 2014 2013 (As Restated) % of cost of % of % of cost of % of Amount revenue revenue Amount revenue revenue Fuel cost $ 75,470 63.7 % 42.7 % $ 24,045 61.1 % 39.0 % Freight 13,122 11.1 % 7.4 % 4,851 12.3 % 7.9 % Labor cost 12,442 10.5 % 7.0 % 4,230 10.7 % 6.9 % Depreciation 3,538 3.0 % 2.0 % 1,138 2.9 % 1.8 % Maintenance fee 7,729 6.5 % 4.4 % 2,126 5.4 % 3.4 % Spare parts 1,088 0.9 % 0.6 % 1,596 4.1 % 2.6 %Fishing license and agent fee 5,000 4.3 % 2.8 % 1,394 3.5 % 2.3 % Total cost of revenue $ 118,389 100.0 % 66.9 % $ 39,380 100.0 % 63.9 % Cost of revenue for the nine months ended September 30, 2014 was $118,389,000, representing an increase of $79,009,000 or approximately 200.6% as compared to $39,380,000 for the nine months ended September 30, 2013. The increase was primarily attributable to the increase in our revenue. Gross profit The following table sets forth information as to our revenue, gross profit and gross margin for the three and nine months ended September 30, 2014 and 2013 (dollars in thousands). Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 2014 2013 (As Restated) (As Restated) Revenue $ 54,417 $ 20,609 $ 176,909 $ 61,641 Cost of revenue $ 38,933 $ 12,977 $ 118,389 $ 39,380 Gross profit $ 15,484 $ 7,632 $ 58,520 $ 22,261 Gross margin 28.5 % 37.0 % 33.1 % 36.1 % Gross profit for the three months ended September 30, 2014 was $15,484,000, representing an increase of $7,852,000 or approximately 102.9% as compared to $7,632,000 for the three months ended September 30, 2013 as a result of business expansion. Gross margin decreased to 28.5% for the three months ended September 30, 2014 from 37.0% for the three months ended September 30, 2013, primarily due to the increase in fuel cost and maintenance fee for our fishing vessels and the increase in labor cost. Gross profit for the nine months ended September 30, 2014 was $58,520,000, representing an increase of $36,259,000 or approximately 162.9% as compared to $22,261,000 for the nine months ended September 30, 2013 as a result of business expansion. Gross margin decreased to 33.1% for the nine months ended September 30, 2014 from 36.1% for the nine months ended September 30, 2013, primarily due to the increase in fuel cost and maintenance fee for our fishing vessels. We expect our gross margin will remain in its current level with minimal increase in the near future. 45 Selling expense Selling expense totaled $676,000 for the three months ended September 30, 2014, as compared to $362,000 for the three months ended September 30, 2013, an increase of $314,000 or approximately 86.6%. Selling expense totaled $1,915,000 for the nine months ended September 30, 2014, as compared to $731,000 for the nine months ended September 30, 2013, an increase of $1,184,000 or approximately 162.0%. Selling expense for the three and nine months ended September 30, 2014 and 2013 consisted of the following (dollars in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 2014 2013 (As Restated) (As Restated) Storage fee $ 185 $ 113 $ 736 $ 257 Shipping and handling fee 112 86 478 168 Insurance 311 119 583 156 Other 68 44 118 150 $ 676 $ 362 $ 1,915 $ 731 · Storage fee for the three months ended September 30, 2014 increased by $72,000, or 63.7%, as compared to the three months ended September 30, 2013. Storage fee for the nine months ended September 30, 2014 increased by $479,000, or 186.4%, as compared to the nine months ended September 30, 2013. The increase was primarily attributable to the increase in our business revenue. · Shipping and handling fee for the three months ended September 30, 2014 increased by $26,000, or 30.2%, as compared to the three months ended September 30, 2013. Shipping and handling fee for the nine months ended September 30, 2014 increased by $310,000, or 184.5%, as compared to the nine months ended September 30, 2013. The increase was mainly attributable to the increase in our business revenue. · Insurance for the three months ended September 30, 2014 increased by $192,000, or 161.3%, as compared to the three months ended September 30, 2013. Insurance for the nine months ended September 30, 2014 increased by $427,000, or 273.7%, as compared to the nine months ended September 30, 2013. The increase was primarily attributable to the increase in our business revenue. · Other selling expense, which primarily consisted of customs service charge, inspection and examination for fishing vessels and advertising expense, for the three months ended September 30, 2014 increased by $24,000, or 54.5%, as compared to the three months ended September 30, 2013. The increase in other selling expense was primarily attributable to the increase in our business revenue. Other selling expense for the nine months ended September 30, 2014 decreased by $32,000, or 21.3%, as compared to the nine months ended September 30, 2013 which was primarily attributable to the more strict control on our selling expenditure. 46 General and administrative expense General and administrative expense totaled $829,000 for the three months ended September 30, 2014, as compared to $1,178,000 for the three months ended September 30, 2013, a decrease of $349,000 or approximately 29.7%. General and administrative expense totaled $2,407,000 for the nine months ended September 30, 2014, as compared to $2,345,000 for the nine months ended September 30, 2013, an increase of $62,000 or approximately 2.6%. General and administrative expense for the three and nine months ended September 30, 2014 and 2013 consisted of the following (dollars in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 2014 2013 (As Restated) (As Restated)Compensation and related benefits $ 288 $ 164 $ 710 $ 302 Professional fees 141 843 439 1,315 Travel and entertainment 48 28 245 36Rent and related administrative service charge 119 118 357 125 Liability insurance - - 288 320 Other 233 25 368 247 $ 829 $ 1,178 $ 2,407 $ 2,345 · Compensation and related benefits for the three months ended September 30, 2014 increased by $124,000, or 75.6%, as compared to the three months ended September 30, 2013. Compensation and related benefits for the nine months ended September 30, 2014 increased by $408,000, or 135.1%, as compared to the nine months ended September 30, 2013. The increase was primarily attributable to our business expansion. · Professional fees, which consist of legal fees, accounting fees, internal control consulting services and other fees associated with being a public company, for the three months ended September 30, 2014 decreased by $702,000, or 83.3%, as compared to the three months ended September 30, 2013. Professional fees for the nine months ended September 30, 2014 decreased by $876,000, or 66.6%, as compared to the nine months ended September 30, 2013. The decrease for the three and nine months ended September 30, 2014 was primarily attributable to the decrease in legal and accounting service charge. During the nine months ended September 30, 2013, we incurred and paid legal fee and accounting service fee for our merger transaction, while, we did not incur comparable expenses in the corresponding period of 2014. · Travel and entertainment expense for the three months ended September 30, 2014 increased by $20,000, or 71.4% as compared to the three months ended September 30, 2013. Travel and entertainment expense for the nine months ended September 30, 2014 increased by $209,000, or 580.6% as compared to the nine months ended September 30, 2013. We increased our travel and entertainment expenditure in the three and nine months ended September 30, 2014 as compared to the corresponding periods in 2013 in order to increase our visibility. · Rent and related administrative service charge for the three months ended September 30, 2014 increased by $1,000, or 0.8%, as compared to the three months ended September 30, 2013. Rent and related administrative service charge for the nine months ended September 30, 2014 increased by $232,000, or 185.6%, as compared to the nine months ended September 30, 2013. We rent an office in Hong Kong beginning July 2013 and we pay monthly rental and related administrative service fee of approximately $38,000 (HK$ 298,500). Therefore, our rental and related administrative service charge for the nine months ended September 30, 2014 increased as compared to the comparable period of 2013. 47 · Liability insurance, which primarily consist of director and officer liability insurance, for the nine months ended September 30, 2014 decreased by $32,000, or 10.0%, as compared to the nine months ended September 30, 2013, due to the restriction on corporation spending. · Other general and administrative expense, which primarily consist of vehicle expense, communication fee, office supply, depreciation, miscellaneous taxes and bank service charge, for the three months ended September 30, 2014 increased by $208,000, or 832.0%, as compared to the three months ended September 30, 2013, which was primarily attributable to an increase in bank service charge of approximately $159,000 and an increase in other miscellaneous items of approximately $49,000. Other general and administrative expense for the nine months ended September 30, 2014 increased by $121,000, or 49.0%, as compared to the nine months ended September 30, 2013 which was primarily attributable to an increase in bank service charge of approximately $164,000, offset by a decrease in other miscellaneous items of approximately $43,000. Operating income For the three months ended September 30, 2014, operating income was $13,980,000, as compared to $6,092,000 for the three months ended September 30, 2013, an increase of $7,888,000 or 129.5%. For the nine months ended September 30, 2014, operating income was $54,198,000, as compared to $19,185,000 for the nine months ended September 30, 2013, an increase of $35,013,000 or 182.5%. Other income (expense) Other income (expense) includes interest income, grant income, investment income, foreign currency transaction gain/loss, other income/expense and interest expense. For the three months ended September 30, 2014, other income amounted to $215,000 as compared to other expense of $1,048,000 for the three months ended September 30, 2013, an increase of $1,263,000 or 120.5%, which was mainly attributable to a decrease in interest expense of approximately $735,000 mainly due to the low annual interest rate for our short-term bank loans from China Development Bank and an increase in government grant income of approximately $547,000, offset by a decrease in foreign currency transaction gain of approximately $23,000. For the nine months ended September 30, 2014, other expense amounted to $1,773,000 as compared to other expense of $1,869,000 for the nine months ended September 30, 2013, a decrease of $96,000 or 5.2%, which was mainly attributable to an increase in government grant income of approximately $1,036,000 and an increase in investment income of approximately $279,000, offset by an increase in interest expense of approximately $965,000 due to the increase in our interest bearing bank loans and an increase in foreign currency transactionloss of approximately $261,000. Income tax We are exempted from income tax for income generated from our ocean fishing operations in China for the three and nine months ended September 30, 2014 and 2013. Net income from continuing operations As a result of the factors described above, our net income from continuing operations was $14,195,000, or $0.18 per ordinary share (basic and diluted) for the three months ended September 30, 2014, as compared with $5,044,000, or $0.06 per ordinary share (basic and diluted) for the three months ended September 30, 2013, an increase of $9,151,000 or 181.4%. Our net income from continuing operations was $52,426,000, or $0.66 per ordinary share (basic and diluted) for the nine months ended September 30, 2014, as compared with $17,316,000, or $0.22 per ordinary share (basic and diluted) for the nine months ended September 30, 2013, an increase of $35,110,000 or 202.8%. 48 Net income from discontinued operations, net of income tax We did not have any discontinued operations during the three and nine months ended September 30, 2014. Our net income from discontinued operations, net of income tax, for the three and nine months ended September 30, 2013 was $12,363,000 and $39,462,000, or $0.16 and $0.50 per ordinary share (basic and diluted), respectively. Foreign currency translation adjustment Our reporting currency is the U.S. dollar. The functional currency of our parent company and subsidiaries of Merchant Supreme and Prime Cheer is the U.S. dollar and the functional currency of the Company's subsidiary of Pingtan Guansheng and operating VIEs is the Chinese Renminbi ("RMB"). The financial statements of our subsidiary of Guansheng and VIEs are translated to U.S. dollars using period end rates of exchange for assets and liabilities, and average rates of exchange (for the period) for revenues, costs, and expenses. Net gains and losses resulting from foreign exchange transactions are included in the consolidated statements of operations. As a result of foreign currency translations, which are a non-cash adjustment, we reported a foreign currency translation gain of $302,000 for the three months ended September 30, 2014, as compared to a foreign currency translation gain of $797,000 for the three months ended September 30, 2013. We reported a foreign currency translation loss of $691,000 for the nine months ended September 30, 2014, as compared to a foreign currency translation gain of $6,551,000 for the nine months ended September 30, 2013. This non-cash gain/loss had the effect of increasing/decreasing our reported comprehensive income. Comprehensive income As a result of our foreign currency translation gain/loss, we had comprehensive income for the three months ended September 30, 2014 of $14,497,000, compared to $18,203,000 for the three months ended September 30, 2013. We had comprehensive income for the nine months ended September 30, 2014 of $51,735,000, compared to $63,329,000 for the nine months ended September 30, 2013. Liquidity and Capital Resources Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations and otherwise operate on an ongoing basis. At September 30, 2014 and December 31, 2013, we had cash balances of approximately $11,798,000 and $8,157,000, respectively. Significant portion of these funds are located in financial institutions located in China and will continue to be indefinitely reinvested in China operations. The following table sets forth a summary of changes in our working capital from December 31, 2013 to September 30, 2014 (dollars in thousands): December 31, 2013 to September 30, 2014 September 30, December 31, Percentage 2014 2013 Change Change (As Restated) Working capital: Total current assets $ 65,456 $ 30,706 $ 34,750 113.2 % Total current liabilities 74,061 50,790 23,271 45.8 % Working capital deficit: $ (8,605 ) $ (20,084 ) $ 11,479 (57.2 )% 49 Our working capital deficit decreased $11,479,000 to $8,605,000 at September 30, 2014 from working capital deficit of $20,084,000 at December 31, 2013. This decrease in working capital deficit is primarily attributable to an increase in cash of $3,641,000, an increase in accounts receivable, net of allowance for doubtful accounts, of $32,434,000 mainly due to the significant increase in our revenue, an increase in prepaid expense - related parties of $3,108,000, an increase in deferred expense - related parties of $2,236,000, an increase in advance to suppliers of $258,000, an increase in other receivable of $157,000, a decrease in accounts payable of $1,873,000, a decrease in accounts payable - related parties of $9,464,000 due to the payments made to our related parties in 2014, a decrease in advance from customers of $135,000 and a decrease in deferred grant income of $520,000, offset by a decrease in inventories, net of reserve for obsolete inventories, of $3,062,000, a decrease in prepaid expense of $4,021,000, an increase in short-term bank loans of $36,986,000 in order to satisfy our working capital requirement from our expanding operations, an increase in long-term bank loans - current portion of $6,644,000, an increase in accrued liabilities and other payable of $169,000, an increase in due to related parties of $673,000 and an increase in dividend payable of $791,000. Because the exchange rate conversion is different for the unaudited condensed consolidated balance sheets and the unaudited condensed consolidated statements of cash flows, the changes in assets and liabilities reflected on the unaudited condensed consolidated statements of cash flows are not necessarily identical with the comparable changes reflected on the unaudited condensed consolidated balance sheets. Cash flows for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013 The following summarizes the key components of our cash flows for the nine months ended September 30, 2014 and 2013 (dollars in thousands): Nine Months Ended September 30, 2014 2013 (As Restated)Net cash provided by operating activities from continuing operations $ 16,379 $ 4,070 Net cash used in investing activities for continuing operations (38,481 ) (291,894 ) Net cash provided by financing activities from continuing operations 25,876 47,854 Net cash provided by operating activities from discontinued operations - 69,653 Net cash provided by investing activities from discontinued operations - 7,624 Net cash used in financing activities for discontinued operations - (560 ) Effect of exchange rate on cash (133 ) 2,162 Net increase (decrease) in cash $ 3,641 $ (161,091 ) Net cash flow provided by operating activities from continuing operations was $16,379,000 for the nine months ended September 30, 2014 as compared to $4,070,000 for the nine months ended September 30, 2013, an increase of approximately $12,309,000. · Net cash flow provided by operating activities from continuing operations for the nine months ended September 30, 2014 primarily reflected net income of $52,426,000 and the add-back of non-cash item consisting of depreciation of $4,022,000, and changes in operating assets and liabilities primarily consisting of a decrease in prepaid expense of $3,956,000, a decrease in inventories of $2,919,000 and an increase in accrued liabilities and other payable of $241,000, offset primarily by an increase in accounts receivable of $32,622,000 mainly due to the significant increase in our sales revenue, an increase in other receivable of $157,000, an increase in prepaid expense - related parties of $3,112,000, an increase in deferred expense - related parties of $2,239,000, an increase in advance to suppliers of $258,000, a decrease in accounts payable of $1,839,000, a decrease in accounts payable - related parties of $6,850,000 due to the payments made to our related parties in 2014 and a decrease in advance from customers of $130,000. 50 · Net cash flow provided by operating activities from continuing operations for the nine months ended September 30, 2013 primarily reflected net income of $17,316,000 adjusted for non-cash item consisting of depreciation of $1,161,000, and changes in operating assets and liabilities primarily consisting of a decrease in accounts receivable of $1,569,000, an increase in accounts payable - related parties of $495,000, an increase in advance from customers of $473,000 and an increase in accrued liabilities and other payable of $5,613,000, offset mainly by a decrease in prepaid expense of $4,479,000, a decrease in inventories of $5,192,000 and an increase in advance from customers - related parties of $12,983,000. Net cash flow used in investing activities for our continuing operations was $38,481,000 for the nine months ended September 30, 2014 as compared to $291,894,000 for the nine months ended September 30, 2013. During the nine months ended September 30, 2014, we made the prepayments for shops purchase and fishing vessels construction of $22,462,000, and made payments for purchase of property, plant and equipment of $1,269,000 and made investment in joint venture interest of $15,946,000, offset by proceeds from government grants for fishing vessels construction of $1,195,000. During the nine months ended September 30, 2013, we made payment for fishing vessels deposit of $3,272,000, and made payments for purchase of property, plant and equipment of $213,814,000, and made advance to related parties of $4,045,000, and had a decrease in cash related to sale of subsidiary CDGC of $76,988,000, offset by proceeds from government grants for fishing vessels construction of $6,224,000. Net cash flow provided by financing activities from continuing operations was $25,876,000 for the nine months ended September 30, 2014 as compared to $47,854,000 for the nine months ended September 30, 2013. During the nine months ended September 30, 2014, we received proceeds from short-term bank loans of $44,891,000, and received proceeds from long-term bank loans of $3,742,000, and received advance from related parties of $650,000, offset by the repayments of short-term bank loans of $17,725,000, and repayments of long-term bank loans of $5,683,000. During the nine months ended September 30, 2013, we received proceeds from short-term bank loans of $43,440,000, and received proceeds from long-term bank loans of $45,889,000, and received advance from related parties of $3,847,000, and acquired cash in recapitalization of $3,565,000, offset by the repayments of short-term bank loans of $46,996,000, and repayments of long-term bank loans of $1,891,000. We noted the negative working capital and believe this is a temporary trend giving the fact that we still have positive cash flow from operations. We believe our working capital situation will be turned around in the near future. We have historically funded our capital expenditures from our working capital and bank loans. As of September 30, 2014, we have contractual commitments of approximately $44.5 million related to three shop purchase agreements and a joint venture commitment. We intend to fund the costs with our existing working capital and by obtaining financing mainly from local banking institutions with which we have done business in the past. We believe that the relationships with local banks are in good standing and based on our experience, we did not encounter difficulties in obtaining needed borrowings from local banks. We believe that our available cash together with our cash flow from operations and secured bank financing and/or other third party financing will be sufficient to meet our anticipated cash requirements for the next twelve months. Contractual Obligations and Off-Balance Sheet Arrangements Contractual obligations We have certain fixed contractual obligations and commitments that include future estimated payments. Changes in our business needs, cancellation provisions, changing interest rates, and other factors may result in actual payments differing from the estimates. We cannot provide certainty regarding the timing and amounts of payments. We have presented below a summary of the most significant assumptions used in our determination of amounts presented in the tables, in order to assist in the review of this information within the context of our consolidated financial position, results of operations, and cash flows. 51 The following tables summarize our contractual obligations as of September 30, 2014 (dollars in thousands), and the effect these obligations are expected to have on our liquidity and cash flows in future periods. Payments Due by Period Less than 1 1-3 3-5 Contractual obligations: Total year years years 5+ years Related party office lease obligation $ 11 $ 11 $ - $ - $ - Related party rental and related administrative service charge obligation 115 115 - - - Shop purchase obligation 3,545 3,545 - - - Registered capital contribution obligation in joint venture interest 40,953 - - - 40,953 Short-term bank loans (1) 36,071 36,071 - - - Long-term bank loans 71,603 26,896 27,757 9,962 6,988 Total $ 152,298 $ 66,638 $ 27,757 $ 9,962 $ 47,941 (1) Historically, we have refinanced these short-term bank loans for an additional term of six months to one year and we expect to continue to refinance these loans upon expiration. Off-balance sheet arrangements Guarantees and collateral provided to related parties In October 2012, Pingtan Fishing entered into two pledge contracts with China Minsheng Banking Corp., Ltd. Pursuant to the terms of the pledge contracts, Pingtan Fishing assigned 10 fishing vessels, as collateral to secure Hong Long's long-term loans from the financial institution in amount of approximately $10.8 million, which are due on April 18, 2015. In addition to the collateral provided to Hong Long, Pingtan Fishing also guaranteed the repayment of $46.3 million for Hong Long's long-term loans. In December 2013, Pingtan Fishing entered into a guarantee agreement with Ping An Bank Co., Ltd. Pursuant to the terms of the guarantee agreement, Pingtan Fishing provide maximum guarantees approximately of $8.3 million to Hong Long's credit line in amount of $16.5 million which is due on December 23, 2014. As of the filing date of this report, Pingtan Fishing has not receive any demand from the lender that collateralized properties are intended to be disposed of or to make any payments under the guarantee. Other arrangements Pursuant to the Share Purchase Agreement dated December 4, 2013, where the Company exited and sold China Dredging Group Co., Ltd and its subsidiaries to Hong Long , the Company is required to indemnify Hong Long and the same indemnification responsibility applies to Hong Long breach for the events arriving out of any of the Share Purchase Agreement or the memorandum of agreement in relation to the sale, purchase and delivery of the vessels for two years until December 3, 2015 and would be liable for the full amount of damages that exceed $1 million. The amount of damage shall be the amount finally determined by a court of competent jurisdiction or appropriate governmental administrative agency, or the amount agreed to upon settlement in accordance with the terms of the Share Purchase Agreement. 52 Recent accounting pronouncements In April 2014, the FASB issued ASU 2014-08, "Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity." The amendments in this ASU change the criteria for reporting discontinued operations while enhancing disclosures in this area. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. Those strategic shifts should have a major effect on the organization's operations and financial results and include disposals of a major geographic area, a major line of business, or a major equity method investment. The new guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. Additionally, the new guidance requires disclosure of the pre-tax income attributable to a disposal of a significant part of an organization that does not qualify for discontinued operations reporting. The amendments in the ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. We have not early adopted it and do not expect the adoption of ASU 2014-08 to have a material impact on our consolidated financial statements. In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. The standard is effective for annual periods beginning after December 15, 2016, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). Early adoption is not permitted. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements. In June 2014, the FASB issued Accounting Standards Update No. 2014-12, Compensation - Stock Compensation (Topic 718), Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (a consensus of the FASB Emerging Issues Task Force) (ASU 2014-12). The guidance applies to all reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period. The amendments require that a performance target that affects vesting and that could be achieved after the requisite service period is treated as a performance condition. For all entities, the amendments in this Update are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The effective date is the same for both public business entities and all other entities. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements. In August 2014, the FASB issued Accounting Standards Update No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entities Ability to Continue as a Going Concern (ASU 2014-15). The guidance in ASU 2014-15 sets forth management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern as well as required disclosures. ASU 2014-15 indicates that, when preparing financial statements for interim and annual financial statements, management should evaluate whether conditions or events, in the aggregate, raise substantial doubt about the entity's ability to continue as a going concern for one year from the date the financial statements are issued or are available to be issued. This evaluation should include consideration of conditions and events that are either known or are reasonably knowable at the date the financial statements are issued or are available to be issued, as well as whether it is probable that management's plans to address the substantial doubt will be implemented and, if so, whether it is probable that the plans will alleviate the substantial doubt. ASU 2014-15 is effective for annual periods ending after December 15, 2016, and interim periods and annual periods thereafter. Early application is permitted. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements. Results of Discontinued Operations Three and nine months ended September 30, 2013 During the year ended December 31, 2013, we decided to exit our dredging businesses (see Note 2 - Discontinued Operations) in order to increase the focus on our core operations and to improve overall profitability. In addition, we established certain targets in the areas of internal control in order to enhance our profitability profile. As a result of this business exit, we believe we are better positioned to achieve future financial success. The sale of our wholly owned subsidiary of CDGC is reflected as discontinued operations. Our operating results for the three and nine months ended September 30, 2013 have been retroactively adjusted to properly reflect discontinued operations. The transaction involved no cash but our $155.2 million, 4% promissory note due on June 19, 2015 was forgiven. We do not foresee any material impact on our liquidity and financial condition as a result of this disposal. We also do not anticipateany contingencies which would be required to accrue and include in our 2013 financials. 53 Revenues are derived from contract revenues of our dredging service. The table below sets forth more detail regarding the results of discontinued operations (dollars in thousands): Three Months Ended Nine Months Ended September 30, 2013 September 30, 2013 % of % of Amount revenue Amount revenue Revenue $ 54,323 100.0 % $ 131,610 100.0 % Cost of revenue (33,521 ) (61.7 )% (74,762 ) (56.8 )% Gross profit 20,802 38.3 % 56,848 43.2 % Operating expenses (2,200 ) (4.1 )% (5,615 ) (4.3 )% Income from operations 18,602 34.2 % 51,233 38.9 % Income before income taxes 17,089 31.5 % 51,665 39.3 % Income taxes (4,726 ) (8.7 )% (12,203 ) (9.3 )% Net income $ 12,363 22.8 % $ 39,462 30.0 % |