Farmmi(FAMI) - 2019 Q4 - Annual Report

Part I Key Information The company presents historical financial data and outlines significant risks from customer concentration and its VIE structure Selected Financial Data The company shows revenue growth from FY2017-2019 but recorded a net loss in FY2019 after two years of profitability Selected Financial Data (All amounts in U.S. dollars) | Statement of Operations Data | FY 2019 | FY 2018 | FY 2017 | | :--- | :--- | :--- | :--- | | Revenues | $30,841,875 | $29,819,088 | $26,665,601 | | Gross profit | $5,422,124 | $5,067,615 | $4,524,722 | | Income from operations | $3,035,613 | $3,077,928 | $3,469,229 | | Net income (loss) | $(311,004) | $3,229,266 | $3,270,346 | | Earnings (loss) per share, basic and diluted | $(0.03) | $0.29 | $0.33 | | Balance Sheet Data (As of Sep 30) | 2019 | 2018 | 2017 | | :--- | :--- | :--- | :--- | | Total assets | $30,482,631 | $22,075,997 | $13,843,929 | | Total liabilities | $8,145,080 | $2,862,355 | $3,191,015 | | Total stockholders' equity | $21,498,503 | $18,338,270 | $9,756,338 | Risk Factors The company faces significant risks from customer concentration, China operations, its VIE structure, and internal controls - The company has a high concentration of customers, with China Forest accounting for a significant portion of total revenue over the past three fiscal years[19][21] Customer and Supplier Concentration | Concentration | FY 2019 | FY 2018 | FY 2017 | | :--- | :--- | :--- | :--- | | Top Customer (China Forest) | 64.30% | 67.72% | 75.77% | | Largest Supplier | 50.08% | 54.03% | 60.32% | - The company's e-commerce business is conducted through a Variable Interest Entity (VIE), Nongyuan Network, due to PRC restrictions on foreign investment in telecommunications[92][94][95] - The company has identified material weaknesses in its internal control over financial reporting, specifically a lack of sufficient personnel with U.S. GAAP knowledge[157] - As a 'foreign private issuer' and 'emerging growth company', Farmmi is exempt from certain U.S. reporting and governance requirements, which may result in less information available to investors[146][150][152] Information on the Company Details the company's history as a holding company, its business of selling edible fungi, and its complex VIE structure History and Development of the Company The company was spun off from Forasen Group in 2015 and completed its NASDAQ IPO in February 2018 - The company was established in July 2015 to spin off the edible fungi business from Forasen Group, which is controlled by CEO Yefang Zhang and her husband, director Zhengyu Wang[180][182] - Completed its Initial Public Offering (IPO) on NASDAQ under the symbol 'FAMI' in February 2018, raising approximately $6 million in net proceeds[186] - In November 2018, FMI completed a $7.5 million private placement of senior convertible notes and warrants with an institutional investor[188] Business Overview The company primarily processes and sells edible fungi, with sales concentrated in China and a growing e-commerce segment - The company's primary business is processing and selling edible fungi, mainly Shiitake and Mu Er mushrooms[193][213] Revenue by Geographic Market (FY2019) | Market | Revenue Percentage | | :--- | :--- | | Domestic (China) | 93.17% | | International | 6.83% | - The company is expanding its e-commerce business, which accounted for 20.05% of total sales in FY2019, up from 11.32% in FY2018[211][270] - Key competitive advantages include a sophisticated quality control system (HACCP, BRC certified), established supplier relationships, and a favorable location in Lishui[289][293][295] Organizational Structure The company is a Cayman holding company using a VIE structure to operate its e-commerce business in the PRC - The company utilizes a complex structure with a Cayman Islands parent, a Hong Kong holding company, and multiple PRC subsidiaries (WFOEs)[359][360][361] - Due to PRC restrictions on foreign ownership, the company's e-commerce business is operated through a VIE, Nongyuan Network, which is controlled contractually[367][322] - Control over the VIE is established through several key agreements: an Exclusive Management Consulting and Technology Service Agreement, a Proxy Agreement, an Exclusive Call Option Agreement, and an Equity Pledge Agreement[370][371][374][377] Property, Plants and Equipment The company leases its main processing facilities from a related party and owns minimal fixed assets - The company leases its two main factory properties in Lishui from Forasen Group, a related party[391] - Fixed assets consist of office equipment, vehicles, machinery, and leasehold improvements, with a net book value of $139,468 as of September 30, 2019[393][555] Operating and Financial Review and Prospects Details a 3.4% revenue increase in FY2019 but a net loss of $0.3 million due to significant financing costs Results of Operations (FY2019 vs. FY2018) Revenue grew 3.4% in FY2019, but a net loss was recorded due to over $3.3 million in convertible note expenses Financial Performance Summary (FY2019 vs. FY2018) | Metric | FY 2019 | FY 2018 | Change (%) | | :--- | :--- | :--- | :--- | | Total Revenues | $30,841,875 | $29,819,088 | +3.43% | | Gross Profit | $5,422,124 | $5,067,615 | +7.00% | | Income from Operations | $3,035,613 | $3,077,928 | -1.37% | | Net (Loss) Income | $(311,004) | $3,229,266 | -109.63% | - The net loss in FY2019 was primarily driven by expenses related to the senior convertible notes issued in November 2018, including $1,197,317 in interest expense and $2,113,492 in amortization of debt issuance costs[466][467][472] Revenue by Product (FY2019 vs. FY2018) | Product Category | FY 2019 Revenue | FY 2018 Revenue | Change (%) | | :--- | :--- | :--- | :--- | | Shiitake | $17,893,893 | $16,753,076 | +6.81% | | Mu Er | $11,659,409 | $12,190,340 | -4.36% | | Other | $1,288,573 | $875,672 | +47.15% | Results of Operations (FY2018 vs. FY2017) Revenue grew 11.8% in FY2018 driven by Mu Er sales, while net income remained flat due to higher operating costs Financial Performance Summary (FY2018 vs. FY2017) | Metric | FY 2018 | FY 2017 | Change (%) | | :--- | :--- | :--- | :--- | | Total Revenues | $29,819,088 | $26,665,601 | +11.83% | | Gross Profit | $5,067,615 | $4,524,722 | +12.00% | | Income from Operations | $3,077,928 | $3,469,229 | -11.28% | | Net Income | $3,229,266 | $3,270,346 | -1.26% | - The 11.83% revenue growth in FY2018 was largely due to a 31.93% increase in sales of Mu Er mushrooms, driven by increased orders from major customer China Forest[475][479] - Operating expenses rose sharply in FY2018, with selling and distribution expenses up 291% and general and administrative expenses up 58%, primarily due to IPO-related costs[487][488] Liquidity and Capital Resources Cash decreased significantly to $135,125 in FY2019 due to a $10.8 million negative operating cash flow Cash Flow Summary | Cash Flow Activity | FY 2019 | FY 2018 | | :--- | :--- | :--- | | Net cash used in operating activities | $(10,773,287) | $(2,725,010) | | Net cash used in investing activities | $(94,905) | $(64,715) | | Net cash provided by financing activities | $6,056,040 | $6,127,320 | - Cash significantly decreased to $135,125 at FYE 2019 from $4,925,165 at FYE 2018, mainly due to a $10.8 million cash outflow from operations[499][509] - The large cash use in operations was driven by an increase of $5.8 million in accounts receivable and an $8.7 million increase in advances to suppliers[509] - Financing activities in FY2019 provided $6.1 million in cash, primarily from the $7.5 million convertible note issuance, offset by debt repayments and financing costs[511] Directors, Senior Management and Employees The company is led by its CEO and controlling shareholder, with a five-member board and 101 employees as of FY2019 - The company is led by CEO and Chairwoman Yefang Zhang. Her husband, Zhengyu Wang, is a director. The Board of Directors consists of five members, including three independent directors[518][519][520] Executive Compensation (FY2019) | Name | Position | Total Compensation ($) | | :--- | :--- | :--- | | Yefang Zhang | CEO | 176,646.98 | | Jun Zhou | CFO | 75,818.98 | | Liang Han | COO | 46,244.78 | - As of September 30, 2019, the company had 101 full-time employees, down from 122 in 2018. The production department is the largest, with 52 employees[567] - The company has established an incentive pool of 1,168,000 Ordinary Shares (10% of post-IPO shares) for employee stock and option grants[571] Major Shareholders and Related Party Transactions Ownership is highly concentrated with the CEO and her husband, and the company engages in significant related party leases - CEO Yefang Zhang and her husband, director Zhengyu Wang, are the controlling shareholders, beneficially owning approximately 66.0% of the company's shares as of December 31, 2019[576] Related Party Balances (as of Sep 30, 2019) | Related Party | Relationship | Due to Related Party ($) | | :--- | :--- | :--- | | Yefang Zhang | CEO | 2,652,882 | | Forasen Group | Owned by CEO/Director | 0 | - The company leases its main factory buildings from Forasen Group, a related party owned by the CEO and her husband[583] Financial Information The company has no material legal proceedings and does not plan to pay dividends, retaining earnings for growth - The company is not currently a party to any material legal or administrative proceedings[590] - The company has never declared or paid cash dividends and does not expect to in the foreseeable future, intending to retain earnings for business growth[591] - Dividend payments are also restricted by PRC regulations, which require PRC subsidiaries to set aside statutory reserves from after-tax profits before distributing dividends[593] The Offer and Listing The company's shares have traded on NASDAQ under 'FAMI' since February 2018, showing significant price volatility - The company's Ordinary Shares are listed on the NASDAQ Capital Market under the symbol 'FAMI'[599] Annual Stock Price Range | Fiscal Year Ended Sep 30 | High ($) | Low ($) | | :--- | :--- | :--- | | 2018 | 10.3234 | 2.68 | | 2019 | 5.87 | 1.12 | Additional Information Outlines material contracts, PRC exchange controls, and the potential classification as a PFIC for U.S. tax purposes - In November 2018, the company completed a $7.5 million private placement, issuing senior convertible notes due April 2020 and warrants to an institutional investor[602] - The company's operations are subject to PRC foreign exchange controls, which require government approval for capital account transactions and dividend distributions[607] - For U.S. investors, there is a risk that the company could be classified as a Passive Foreign Investment Company (PFIC), which would result in adverse U.S. federal income tax consequences[632][635] Quantitative and Qualitative Disclosures About Market Risk The company is exposed to interest rate, foreign exchange (RMB/USD), and commodity price risks - The company is exposed to interest rate risk on its bank loans; a 1 percentage point change in interest rates would affect profit by approximately $14,008[649] - The company faces foreign exchange risk as its functional currency is the Chinese Renminbi (RMB), while its financial statements are presented in U.S. dollars[653][655] - The company is exposed to commodity risk from potential price increases in raw edible fungi, which is its primary input[656] Part II Material Modifications to the Rights of Securities Holders and Use of Proceeds Details the use of approximately $4.9 million of its $6 million in IPO proceeds, primarily for securing farm supplies Use of IPO Proceeds | Use | Estimated Amount of Net Proceeds to be Spent | Approximate Amount Spent | | :--- | :--- | :--- | | Product Development | 16.67% | $225,238 | | Family Farms | 16.67% | $4,122,012 | | Farmmi Liangpin Market | 66.66% | $574,137 | | Total | 100.00% | $4,921,387 | Controls and Procedures Management concluded that disclosure controls and internal controls were ineffective due to a material weakness in accounting expertise - Management concluded that as of September 30, 2019, the company's disclosure controls and procedures were ineffective[664] - A material weakness in internal control over financial reporting was identified due to a lack of sufficient personnel with adequate knowledge of U.S. GAAP[666] - The company is in the process of implementing remedial actions, including improving review processes and enhancing documentation[667] Corporate Governance and Other Matters The company follows home country governance practices and has an audit committee financial expert on its board - The Board of Directors has identified Yunhao Chen as an 'audit committee financial expert'[668] Principal Accountant Fees (Friedman LLP) | Fee Type | FY 2019 | FY 2018 | | :--- | :--- | :--- | | Audit Fees | $200,000 | $185,000 | - As a foreign private issuer, the company is exempt from certain NASDAQ corporate governance rules and may follow its home country (Cayman Islands) practices[676][678] Part III Financial Statements Presents the audited consolidated financial statements for FY2017-2019, prepared in accordance with U.S. GAAP Consolidated Balance Sheet (as of Sep 30, 2019) | Account | Amount (USD) | | :--- | :--- | | Total Assets | $30,482,631 | | Current Assets | $29,705,028 | | Cash | $135,125 | | Accounts Receivable, net | $13,827,591 | | Advances to Suppliers | $14,034,379 | | Total Liabilities | $8,145,080 | | Current Liabilities | $8,145,080 | | Convertible notes payable | $2,926,361 | | Total Equity | $22,337,551 | Consolidated Statement of Operations (for year ended Sep 30, 2019) | Account | Amount (USD) | | :--- | :--- | | Total Revenues | $30,841,875 | | Gross Profit | $5,422,124 | | Income from Operations | $3,035,613 | | Net (Loss) Income | $(311,004) | | Basic and Diluted (Loss) per Share | $(0.03) | - The financial statements consolidate the company's subsidiaries and its Variable Interest Entity (VIE), Nongyuan Network, which generated $6.2 million in sales in FY2019[708][709] - Notes to the financial statements provide detailed breakdowns of accounts, significant accounting policies, related party transactions, debt instruments, and segment reporting[706][774][767]