Muddy Waters Capital LLC

info@muddywatersresearch.com Director of Research: Carson C. Block, Esq.

Use of Muddy Waters reports is limited by the Terms of Service on its website, which are as follows. To be authorized to access such reports, you must agree to these terms, regardless of whether you have downloaded its reports directly from the Muddy Waters Research website or someone else has supplied the report to you without authorization from Muddy Waters Capital.

By downloading from, or viewing material on the Muddy Waters Research website, you agree to the following Terms of Service. You agree that use of Muddy Waters Capital LLC’s research is at your own risk. In no event will you hold Muddy Waters Capital LLC, Muddy Waters, LLC or any affiliated party liable for any direct or indirect trading losses caused by any information on this site. You further agree to do your own research and due diligence before making any investment decision with respect to securities covered herein. You represent that you have sufficient investment sophistication to critically assess the information, analysis and opinion contained herein. You further agree that you will not communicate the contents of this transcript to any other person unless that person has agreed to be bound by these same terms of service. If you download or receive this transcript as an agent for any other person, you are binding your principal to these same Terms of Service. You should assume that as of the publication date of our reports and research, Muddy Waters Capital LLC (possibly along with or through our members, partners, affiliates, employees, and/or consultants) along with our clients and/or investors and/or their clients and/or investors, has a short position in all stocks (and/or options, swaps, and other derivatives related to the stock) and bonds covered herein, and therefore stands to realize significant gains in the event that the price of either declines. We intend to continue transacting in the securities of issuers covered on this site for an indefinite period of time, and we may be long, short, or neutral at any time regardless of our initial position and views as stated in our research. This is not an offer to sell or a solicitation of an offer to buy any security, nor shall Muddy Waters offer, sell or buy any security to or from any person through this report or reports on the website. Muddy Waters Capital LLC is registered as an investment advisor only in the United States, but it does not render investment advice to anyone unless it has an investment adviser-client relationship evidenced in writing. If you are in the United Kingdom, you confirm that you are accessing research and materials as or on behalf of: (a) an investment professional falling within Article 19 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (the "FPO"); or (b) high net worth entity falling within Article 49 of the FPO. Our research and reports express our opinions, which we have based upon generally available information, field research, inferences and deductions through our due diligence and analytical process. To the best of our ability and belief, all information contained herein is accurate and reliable, and has been obtained from public sources we believe to be accurate and reliable, and who are not insiders or connected persons of the stock covered herein or who may otherwise owe any fiduciary duty or duty of confidentiality to the issuer. However, such information is presented “as is,” without warranty of any kind, whether express or implied. Muddy Waters Capital LLC makes no representation, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. Further, any report on this site contains a very large measure of analysis and opinion. All expressions of opinion are subject to change without notice, and Muddy Waters Capital LLC does not undertake to update or supplement any reports or any of the information, analysis and opinion contained in them. You agree not to distribute this information (whether the downloaded file, copies / images / reproductions, or the link to these files) in any manner other than by providing the following link: http://www.muddywatersresearch.com/research/. If you have obtained Muddy Waters Capital research in any manner other than by download from that link, you may not read such research without going to that link and agreeing to the Terms of Service. You further agree that any dispute arising from your viewing and use of any reports or other materials on the Muddy Waters Research website shall be governed by the laws of the State of California, without regard to any conflict of law provisions. You knowingly and independently agree to submit to the personal and exclusive jurisdiction of the superior courts located within the State of California and waive your right to any other jurisdiction or applicable law, given that Muddy Waters Capital LLC has offices in California. The failure of Muddy Waters Capital LLC to exercise or enforce any right or provision of these Terms of Service shall not constitute a waiver of this right or provision. If any provision of these Terms of Service is found by a court of competent jurisdiction to be invalid, the parties nevertheless agree that the court should endeavor to give effect to the parties’ intentions as reflected in the provision and rule that the other provisions of these Terms of Service remain in full force and effect, in particular as to this governing law and jurisdiction provision. You agree that regardless of any statute or law to the contrary, any claim or cause of action arising out of or related to use of this website or the material herein must be filed within one (1) year after such claim or cause of action arose or be forever barred.

1 of 13

China Huishan Part 2: Tax Bureau Evidence of Topline Fraud

In Part 1, we explained our conclusions that Huishan fraudulently inflates its profit margins, CapEx, and cash balance. In Part 2, we will detail our conclusion that Huishan’s reported revenue is also fraudulent. VAT data from the State Administration of Taxation (“SAT”) show that Huishan reports a significant amount of fraudulent revenue.1 Huishan has three categories of product sales: “dairy farming”, which is raw milk sales to third parties and internally; “liquid milk products”, which are the finished liquid milk products it sells under its brand; and, “milk powder products”, which is powdered milk it sells under its own brand. Huishan records all raw milk sales at the farm level. Our investigators obtained SAT data for the four entities that sell Huishan finished products: Liaoning Huishan Dairy Group Co., Ltd., Huishan Dairy (Shenyang) Sales Co., Ltd., Huishan Dairy (Jinzhou) Sales Co., Ltd., and Liaoning Huishan Liangpin Trading Co., Ltd.2 They did not obtain SAT data for the farms, so our analysis of revenue inflation is based solely on finished product sales, which account for approximately 79% of Huishan’s external sales. The table below shows the conclusions of our analysis of revenue inflation based on the SAT data

RMB (millions) SATAdjusted Reported

SAIC

CY15 Finished Product Sales 2,352 3,333 3,685

SAT Difference -29.43% -36.17%

Our SAT data is for calendar year 2015, while Huishan reports on a March 31st fiscal year. In order to see the overstatements, we have to estimate Huishan’s CY15 finished product revenue. We do this by dividing each of its March 31, 2015 and 2016 interim results by two, and adding them to its September 30, 2015 interim results. This totals RMB 3,332.5 million. We believe this method understates Huishan’s reported CY15 revenue, so our estimate of the percentage that is fraudulent is likely slightly lower than the actual amount. The SAIC files for these four entities show revenue totaling RMB 3,685. Because stock frauds now generally also report fraudulent numbers to SAIC, it is reasonable to assume that the books Huishan presented to its auditor are very close (if not exactly matching) the figures it reported to SAIC (in theory, SAIC

1 The SAT data was presented without chops, but we believe it is reliable based on our investigators’ assurances and our independent analysis of Huishan’s sales – a summary of which is presented in this report. 2 遼寧輝⼭乳業集團有限公司, 輝⼭乳業( 瀋陽) 銷售有限公司, 輝⼭乳業( 錦州) 銷售有限公司, 遼寧輝記良品

商貿有限公司 (Note: the English name as per FY2016 annual report is Liaoning Huishan Liangpin Trading Co., Ltd., however, according to Pinyin of the Chinese characters, the English name should be Liaoning Huiji Liangpin Trading Co., Ltd. Also there is no company name with Chinese name Liaoning Huishan Liangpin Trading Co., Ltd. per online search.)

2 of 13

numbers should be post-elimination for inter-company sales). After eliminating for internal sales, SAT data shows these four entities only had CY15 sales of RMB 2,352 million. That is 29.4% lower than our adjusted reported CY15 revenue, and 36.2% lower than the SAIC financials. A significant portion of Huishan’s reported sales are, in our opinion, fake. In addition to the SAT data, our analysis of Huishan’s historical claims about its sales strongly support our view. With our belief that Huishan also reports a massively inflated margin, real profits are therefore much lower than Huishan reports (to the extent they exist at all). Given Huishan’s massive debt, fake revenue, and fake profit margins, Huishan should have a difficult time avoiding a default on its debt. Evolution of Huishan’s Revenue Fraud We see Huishan as having morphed the story behind its reported revenue to make its fraud more sustainable. When Huishan first went public, the backbone of its fraudulent revenue was claimed massive milk yields. The table below compares Huishan’s claimed FY14 yield of 9.0 tons / cow, versus national averages, including that of China.3

3 National data is respectively from various sources and ranges from 2012 to 2016.

3 of 13

Huishan’s problem was that its yield story was suspicious. Cows’ living conditions are a large determinant of yields. It was clear to our experts that many of Huishan’s pre-IPO cow farms were of low quality, which made it highly unlikely they could support Huishan’s claimed yields. The state of Huishan’s pre-IPO farms almost certainly did not permit world-class yields. Conditions documented by our investigators reveal that initial construction quality of the pre-IPO farms was very poor and that maintenance CapEx has been insufficient to sustain an environment that is beneficial to a cow’s health and milk output. Our investigators visited 18 farms built prior to Huishan’s IPO in September 2013. They took photographs and interviewed numerous on-site employees that yielded useful insights. Issues include cracked walls, crumbling concrete, shoddy repairs, broken doors, rust, and damaged rooftops. Lack of farm building maintenance, a preponderance of debris, and generally disorganized and unkempt conditions were common. While not every farm visited appeared to be in a dilapidated state, the following photos reveal shortfalls in build quality and general upkeep that we believe is a systemic throughout most of the Huishan pre-IPO asset portfolio.

Damaged rooftops on cow sheds at Lujiapu Cow Farm expose cows to the elements. Photos by MWC investigator.

4 of 13

Rusting roof panels at Wangjia Farm. Photo by MWC investigator.

Calf housed in small shed on Xiushui Modern Dairy Farm. Photo by MWC investigator.

Crumbling gatehouse at Xiushui Modern Dairy Farm. Photo by MWC investigator. The signboard reads: Liaoning Huishan Holdings Group, Pengjia Farming Pengjiapu Modernized Cow Farm.4

4 Pengjia’s farm is owned by Chairman Yang’s Shenyang Dairy Co. and leased to Huishan. However, the operating entity Pengjia Farming is a Huishan Company.

5 of 13

Our experts assed that the pre-IPO farms are of poor quality. We asked two China dairy experts to provide independent assessments of the quality of the farm design and construction. Their general responses indicated that these farms are typical Chinese barn designs, were “built cheap” with “poor airflow” and “not built to last.”5 Moreover, they explained that these cost savings come with a cost to production and yield. They pointed out that it is common knowledge in their industry that the design and construction of cow sheds and related facilities and proper management of the environment and living conditions of the herd “enhances animal performance, comfort and well-being.”6 Huishan’s abundant sloganeering with such messages indicates that they know this too; however, they do not seem to take it to heart. The experts explained that poor design features seriously undermine the ability of cows to achieve and sustain high yields throughout their lactation period. Poor airflow results in discomfort in the heat of summer and cold of winter (known as heat/cold stress) leading to declining yields, reduced fertility, among other undesirable conditions.7 Good air flow helps flush air born viruses and pathogens out of the sheds which normally house hundreds of head of cattle and is therefore an important for maintaining the health of the herd. Without proper ventilation moisture and ammonia (from the cow urine) will also build up in the air posing health risks and also exacerbating corrosion in the building’s structural framing, roof, and other steel fixtures such as headlocks and cow pen loops.8 Excessive mud, excrement and urine pose not only health risks, but increase the risk of slips and falls that could injure the cows. Certain injuries would require these animals be culled prematurely.9 Dairy Expert A, with significant experience overseeing the development of large-scale farms that supply raw milk to large publicly-traded foreign and Chinese dairy farms, provided specific comments on the shortcomings of the design and construction of Huishan’s farms. His comments fell into two major categories: 1.) design issues that impact production, and 2.) overall construction quality.

5 For comparison, videos of Huishan’s competitors’ farms can be seen on YouTube. Two videos of site visits to Modern Dairy’s 40,000 cow farm which show the interior and exterior construction can be seen at: https://www.youtube.com/watch?v=SIojrmf5Irs , https://www.youtube.com/watch?v=oR6EcYGuOqM , https://www.youtube.com/watch?v=hUBIS2xeDOU 6 For a general primer on the good practices see the National Dairy Farm Program’s (FARM) Animal Care Manual, with special attention to Chapter 7 - Environment and Facilities: http://www.nationaldairyfarm.com/sites/default/files/FARM_manual_2013_WEB.pdf , http://www.nationaldairyfarm.com/video 7 Managing Heat and Cold Stress of Feedlot Holstein Steers, https://www.extension.umn.edu/agriculture/dairy/beef/heat-and-cold-stress.pdf 8 http://www.npl.co.uk/upload/pdf/corrosion_control_of_agricultural_equipment_and_buildings.pdf, pp. 4-5 9 For a general primer on the good practices see the National Dairy Farm Program’s (FARM) Animal Care Manual, with special attention to Chapter 7 - Environment and Facilities: http://www.nationaldairyfarm.com/sites/default/files/FARM_manual_2013_WEB.pdf , http://www.nationaldairyfarm.com/video

6 of 13

Design issues noted that likely impact production:

• Slope of roof, insufficient to take advantage of natural airflow through an open ridge. • Sidewalls appear to be only 3 meters high. Normally recommend 4.5~5m high and for

these walls to be built to facilitate cross-ventilating the cow sheds. • Low eaves provide poor ventilation.

Cow sheds at Lujiapu Cow Farm. Photo by MWC investigator.

• Roof is rusting on the inside indicating moisture accumulation from poor ventilation.

(l) Cow shed at Magang Farm. (r) Cow shed at Xiushui Farm, Photos by MWC investigator.

• Sidewalls with sliding windows will reduce airflow. Poor ventilation. • Light duty fans installed. Fans spaced at about 18 meters, fans this size are normally

recommend to be at about 12 meter intervals to create sufficient air flow. • In general, not enough air flow. The barns will never have enough airflow in summer

and will be way too airtight in winter.

7 of 13

Interior of Cow Shed on Magang Farm. Photo by MWC investigator.

• No evidence of spray systems over the backs of cows to keep cows cool in the summer

heat.

Overall Construction Quality:

• Steel supports and purlins look like they may be rusting, this would shorten barn life considerably

• Lightweight steel construction, which could be ok given the low roof (but presents a separate problem, see above)

• Brick barn ends – no strength and easily damaged by equipment. • Low quality concrete work • Poor quality water troughs, poorly installed.

Cow beds on Magang Farm. Photo by MWC investigator.

8 of 13

• Poor quality freestall loops and light duty appearance. Unlikely to last life of building, will lead to poor lying behavior, dirty cows, possible injuries

• No evidence of slope on floors to prevent waste from accumulating in stagnant pools. Leads to dirty cows, foot disease, possible injuries.

• Bedding looks to be poor quality. Many farms try to use dirt instead of good sand. Cows will not be comfortable in dirt.

Cowshed at Pengjiapu Modernized Cow Farm. Photos by MWC investigator.

Interior of cow sheds at Magang Farm (l) and Pengjiapu Modernized Cow Farm (r). Photos by MWC

investigator.

9 of 13

FY16 sales increased purportedly in part due to an online “sales miracle” – What miracle? In its FY16 annual report, Huishan stated “To create sales amidst adversities, we shifted from traditional price war to precise marketing by differentiation, and later on to the new model of “Internet +”, which led to a sales miracle of our liquid milk in the sluggish market of dairy products.” 10 However, the VAT data and SAIC financials for Huishan’s online sales subsidiary, Liaoning Huishan Liangpin Trading Company (Huiji), showed maximum CY15 online sales of only approximately RMB 1 million.11 VAT data shows offline sales (e.g., to restaurants) of approximately RMB 7.5 million, and SAIC financials show total sales of RMB 8.4 million. This implies maximum online sales of approximately RMB 1 million. While we don’t know if revenue generated via the WeChat sales channel is also recorded through Huiji— since similar pricing is available across these Huishan sites and based on our understanding of online sales in China, we believe it unlikely that sales will greatly exceed that of more traditional e-commerce platforms (such as those referenced by the company, JD.com and T-mall) or come anywhere close to rivalling the figures posted by Mengniu and Yili.12 While Huishan has a presence on China’s largest e-commerce platforms such as T-mall, JD.com, Suning and instant messaging platform WeChat, our analysis of snapshots of e-commerce data suggest that actual sales are slow and small. Among these platforms, T-mall displays monthly order fulfillments. When comparing top-selling products only, Huishan was easily outsold by competitors Mengniu and Yili by a magnitude measured in the thousands; moreover, both competitors have numerous products with sales of more than 10,000 units per month, while Huishan’s best was often just clearing 1,000 units. The three images below were recorded on December 10, 2016 for Huishan, Yili, and Mengniu.

Huishan’s pure UHT milk on its T-mall “Flagship Store”

10 Huishan 2016 Annual Report, p. 19 11 The Chinese name is 辽宁辉记良品商贸有限公司 (Liaoning Huiji Liangpin Trading Co. Ltd.). Its former name

was 辽宁辉山乳业集团商贸有限公司. 12 Huishan 2016 Annual Report, p. 39

10 of 13

Yili’s pasteurized pure milk on T-mall

Mengniu’s pasteurized pure milk on T-mall

We used algorithms to scrape the websites Suning and T-Mall over a 3-month period and monitor the number of products, the quantity sold, and prices for Huishan, Mengniu, and Yili. The data we collected corroborated a significant delta in the turnover with Mengniu and Yili exceeding Huishan in sales revenue by over 1500x.

Web Scraping Methodology: Web scraping is the process of extracting data from websites. In this case, we developed custom software to extract information such as stock keeping units (SKUs), number of each SKU sold, and price per SKU during a 3-month sampling period, which included major commercial holidays, to ascertain the sales volume of a large array of dairy products available for online purchase.

1. We interrogated each url every hour and saved the results. 2. For each scrape, we extracted all products on the page with an indicated price and quantity sold. 3. We ran a query to find the maximum and minimum quantity sold for each Product ID/SKU at each price point every month, allowing us to track price movement and quantity sold.

11 of 13

Note: Revenue on Huishan’s online sales outlets, TMall Taobao and Suning Huishan Flagship, were so small they

display as effectively zero. In the FY17 interim results report, Huishan appears to be walking back its claims and recalibrating its language. Management refrains from further discussion of any sales miracles and discuss only a “new ‘Internet+’ marketing system” for their foray into the East China market.13 Ultimately we think that Huishan management uses its online presence mainly to put a veneer of national-level presence on a middling, regional enterprise. FY17’s Sales Fraud is Based on an Incredible Claim of Sharply Rising ASPs. Huishan’s 1H17 claims about sales increases due to increased ASPs is, in our view, spurious. Despite the challenging sales environments in 2016 reported by Huishan and competitors, Huishan touts growth in sales and net profit that outstrips its industry peers.141516 However, former Huishan sales staff who focused on Shenyang, the leading city in the region where Huishan does business, told us that Huishan is only able to compete with the likes of Mengniu and Yili by discounting 5% to 10% on comparable products. We subsequently dispatched investigators to local supermarkets who noted that Huishan products seem to be heavily discounted along with those of the rest of the industry.

13 Huishan, Announcement of Interim Results for the Six Months Ended September 30, 2016 (published November 29, 2016): p. 39. 14 Huishan, Announcement of Interim Results for the Six Months Ended September 30, 2016 (published 29 November 2016), p. 37-38 15 Mengniu, 1H 2016, p.6 16 Yili, 1H 2016 results Q&A

0

10000000

20000000

30000000

40000000

50000000

60000000

TMall Taobao Suning Huishan Flagship TMall Mengniu Tmall Yili

E-Commerce Sites - Dairy-related Revenue by URL (RMB)

12 of 13

Source: Huishan 1H17 Interim Results Presentation

Source: Huishan 1H17 Interim Results Presentation

Furthermore, Huishan claims that the average selling price for its raw milk is higher than that of the overall market.17 Key competitors Mengniu and Yili, however, note the tremendous downward pressure on milk prices and that increased focus on high-end products accounted for increased revenue. 1819 Given Huishan’s almost non-existent sales on the internet, we see no conceivable way that its supposed strategy of going into third through sixth tier northeast cities – and now even “first tier villages” allows a regional, low-quality producer to outmaneuver two leading national producers of high-quality dairy products in this way.20 We believe Huishan is a fraud through and through.

17 Huishan, Announcement of Interim Results for the Six Months Ended September 30, 2016 (published 29 November 2016), p. 42 18 Mengniu 2016 1H Results, p. 6 and 13 19 https://xueqiu.com/5976555910/74151480 20 See 1H16 report p. 31, and FY16 presentation slide 12.

29.1%17.7% 16.9%

6.6% 2.3% 0.4% 0.2%

-5.0% -8.5%

-21.7% -23.2%

#Source: Annual Report *Not taking into account the relevant corporate tax adjustment

Huishan Continued to Outperform the Peers

Year-on-year growth: Sales

Peers comparison: Gross Profit Margin

Year-on-year growth in sales and net profit as well as gross profit margin outperformed industry

Huishan-Liquid milk

Huishan-Overall

China Shengmu

SanyuanMengniu YiliBright Dairy

BeingmateYST YashiliModern Dairy

60.4%51.7% 50.6% 47.8%

41.43% 39.0% 34.3% 33.7% 32.5% 31.8%

Beingmate Huishan-Overall

Yashili Bright Dairy

China Shengmu

MengniuYili SanyuanYST Modern Dairy

7

13 of 13