10-Q 1 v166204_10q.htm Unassociated Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
(Mark One)

x
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2009
 
or

¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from to .
 
Commission File Number 000-51200
 
Yongye International, Inc.
(Exact name of registrant as specified in its charter)

Nevada
20-8051010
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)

6 th Floor, Suite 608, Xue Yuan International Tower,
No. 1 Zhichun Road, Haidian District Beijing, PRC
(Address of principal executive offices)
 
Yongye Biotechnology International, Inc.
(Former name, former address and former fiscal year, if changed since last report)
 
+86 10 8232 8866
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes      ¨   No      x
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). * Yes ¨ No ¨ *The registrant has not yet been phased into the interactive data requirements.
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨
Accelerated filer ¨
   
Non-accelerated filer ¨ (Do not check if a smaller reporting company)
Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ¨
 
As of November 12, 2009, there were 34,573,673 shares of common stock, par value $.001 per share, issued and outstanding.

 
 

 

   
Page
   
Part I. Financial Information
3
Item 1.
Financial Statements
3
Item 2.
Management’s Discussion And Analysis Of Operations And Financial Conditions.
24
Item 3.
Quantitative And Qualitative Disclosures About Market Risk
35
Item 4.
Controls And Procedures
35
Item 4t.
Controls And Procedures
35
     
Part II. Other Information
36
Item 1.
Legal Proceedings
36
Item 2.
Unregistered Sales Of Equity Securities And Use Of Proceeds
36
Item 3.
Defaults Upon Senior Securities
36
Item 4.
Submission Of Matters To A Vote Of Security Holders
36
Item 5.
Other Information
36
Item 6.
Exhibits
36
 
 
2

 
 
PART I.
 
Financial Information
 
ITEM 1.
Financial Statements
 
YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED BALANCE SHEETS

   
September 30, 2009
   
December 31, 2008
 
             
CURRENT ASSETS
           
Cash
 
$
3,508,408
   
$
4,477,477
 
Accounts receivable, net - third parties
   
43,349,508
     
2,748,042
 
Inventories
   
30,954,407
     
20,708,193
 
Advance payments
   
305,807
     
44,051
 
Due from a related party
   
-
     
192,741
 
Prepaid expenses
   
124,040
     
189,478
 
Other receivables
   
315,051
     
680,752
 
Total Current Assets
   
78,557,221
     
29,040,734
 
                 
PROPERTY AND EQUIPMENT, NET
   
8,960,365
     
5,368,074
 
                 
INTANGIBLE ASSETS, NET
   
87,712
     
95,453
 
                 
TOTAL ASSETS
 
$
87,605,298
   
$
34,504,261
 
                 
CURRENT LIABILITIES
               
Long-term loans - current portion
 
$
211,766
   
$
167,652
 
Accounts payable - related party
   
5,424,246
     
46,739
 
Accounts payable - third parties
   
6,628,883
     
-
 
Income tax payable
   
7,288,478
     
219,366
 
Advance from customers
   
137,671
     
1,869,400
 
Accrued expenses
   
2,809,713
     
583,880
 
Due to a related party
   
1,443,489
     
-
 
Other payables
   
906,511
     
774,526
 
Derivative liabilities – fair value of warrants
   
22,277,122
     
2,107,931
 
Total Current Liabilities
   
47,127,879
     
5,769,494
 
                 
LONG-TERM LOANS
   
341,554
     
230,121
 
                 
EQUITY
               
Common stock: par value $.001; 75,000,000 shares authorized; 32,803,173 shares issued and outstanding at September 30, 2009 and 26,760,258 shares issued and outstanding December 31, 2008
   
32,803
     
26,760
 
Additional paid-in capital - Common stock
   
22,749,207
     
13,633,604
 
Retained earnings
   
15,620,486
     
13,310,794
 
Accumulated other comprehensive income
   
400,677
     
329,445
 
Total Equity of the Company’s Shareholders
   
38,803,173
     
27,300,603
 
Noncontrolling interest
   
1,332,692
     
1,204,043
 
Total Equity
   
40,135,865
     
28,504,646
 
                 
TOTAL LIABILITIES AND EQUITY
 
$
87,605,298
   
$
34,504,261
 

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

 
3

 

YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE (LOSS)/INCOME

   
For the Three Months Ended
  
  
For the Nine Months Ended
 
  
  
September 30, 2009
  
  
September 30, 2008
  
  
September 30, 2009
  
  
September 30, 2008
 
                         
SALES
                       
External customers
 
$
29,279,473
   
$
18,202,940
   
$
85,766,709
   
$
45,189,579
 
Related party
   
-
     
-
     
2,220,083
     
-
 
                                 
TOTAL SALES
   
29,279,473
     
18,202,940
     
87,986,792
     
45,189,579
 
                                 
COST OF SALES
   
13,435,326
     
9,278,944
     
41,274,810
     
21,697,964
 
                                 
GROSS PROFIT
   
15,844,147
     
8,923,996
     
46,711,982
     
23,491,615
 
                                 
SELLING EXPENSES
   
2,644,715
     
3,440,036
     
11,715,707
     
7,437,513
 
                                 
RESEARCH & DEVELOPMENT EXPENSES
   
69,871
     
-
     
1,482,888
     
-
 
                                 
GENERAL AND ADMINISTRATIVE EXPENSES
   
1,365,075
     
453,683
     
2,495,797
     
1,265,808
 
                                 
INCOME FROM OPERATIONS
   
11,764,486
     
5,030,277
     
31,017,590
     
14,788,294
 
                                 
OTHER EXPENSES/(INCOME)
                               
Interest expense/(income), net
   
9,080
     
(65,785
)    
25,538
     
(66,563
)
Other expenses /(income), net
   
(174,593
)    
340,087
     
(187,330
)    
726,927
 
Increase/(decrease) in fair value of derivative liabilities
   
15,836,189
     
(3,618,579
)    
20,905,136
     
(1,464,256
)
                                 
TOTAL OTHER EXPENSES/(INCOME), NET
   
15,670,676
     
(3,344,277
)    
20,743,344
     
(803,892
)
                                 
(LOSS)/INCOME BEFORE PROVISION FOR INCOME TAXES
   
(3,906,190
)    
8,374,554
     
10,274,246
     
15,592,186
 
                                 
PROVISION FOR INCOME TAXES
   
3,089,047
     
227,537
     
7,836,270
     
822,302
 
                                 
NET (LOSS)/INCOME
   
(6,995,237
)    
8,147,017
     
2,437,976
     
14,769,884
 
                                 
LESS: NET INCOME ATTRIBUTABLE TO THE NONCONTROLLING INTEREST
   
46,028
     
57,421
     
128,284
     
1,092,426
 
                                 
NET (LOSS)/INCOME ATTRIBUTABLE TO YONGYE INTERNATIONAL, INC.
   
(7,041,265
)    
8,089,596
     
2,309,692
     
13,677,458
 
                                 
OTHER COMPREHENSIVE INCOME
                               
Foreign currency translation adjustment
   
60,402
     
5,199
     
71,597
     
419,970
 
                                 
COMPREHENSIVE (LOSS)/INCOME
   
(6,934,835
)    
8,152,216
     
2,509,573
     
15,189,854
 
                                 
LESS: COMPREHENSIVE INCOME ATTRIBUTABLE TO THE NONCONTROLLING INTEREST
   
46,330
     
57,473
     
128,649
     
1,138,623
 
                                 
COMPREHENSIVE (LOSS)/INCOME ATTRIBUTABLE TO YONGYE INTERNATIONAL, INC.
 
$
(6,981,165
)  
$
8,094,743
   
$
2,380,924
   
$
14,051,231
 
                                 
Net (loss)/income per share:
                               
Basic
 
$
(0.22
)  
$
0.37
   
$
0.08
   
$
0.80
 
Diluted
 
$
(0.22
)  
$
0.20
   
$
0.08
   
$
0.69
 
Weighted average shares used in computation:
                               
Basic
   
32,730,054
     
21,594,470
     
29,926,052
     
17,194,563
 
Diluted
   
32,730,054
     
22,807,756
     
29,926,052
     
17,699,747
 

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

 
4

 

YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED STATEMENT OF CHANGES IN EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2009

       
Yongye International, Inc. Shareholders
                         
  
     
Common Stock
                                 
Comprehensive Income
 
  
     
Number of
 Shares
   
Amount
   
Additional
 Paid-in
 Capital – Common
 Stock
   
Accumulated
 Other
 Comprehensiv
 e
 Income
   
Retained
 Earnings
   
Noncontr
 olling
 Interest
   
Total
   
Attribut
 able to
 Yongye
 Internat
 ional,
 Inc.
 Shareho
 lders
   
Attribut
 able to
 Noncont
 rolling
 Interests
   
Total
 
  
 
Note
       
$
   
$
   
$
   
$
   
$
   
$
   
$
   
$
   
$
 
                                                                 
Balance as of December 31, 2008
       
26,760,258
     
26,760
     
13,633,604
     
329,445
     
13,310,794
     
1,204,043
     
28,504,646
                   
Net income
       
-
     
-
     
-
     
-
     
2,309,692
     
128,284
     
2,437,976
     
2,309,692
     
128,284
     
2,437,976
 
Foreign currency exchange translation adjustment, net of nil income taxes
       
-
     
-
     
-
     
71,232
     
-
     
365
     
71,597
     
71,232
     
365
     
71,597
 
Comprehensive income
                                                               
2,380,924
     
128,649
     
2,509,573
 
Common stock issued for cash May 8, 2009
 
7
   
5,834,083
     
5,834
     
7,907,201
     
-
     
-
     
-
     
7,913,035
                         
Warrants exercised
 
7
   
208,832
     
209
     
1,208,402
     
-
     
-
     
-
     
1,208,611
                         
Balance as of September 30, 2009
       
32,803,173
     
32,803
     
22,749,207
     
400,677
     
15,620,486
     
1,332,692
     
40,135,865
                         

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

 
5

 

YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
For the Nine Months Ended
  
  
For the Nine Months Ended
  
  
  
September 30, 2009
  
  
September 30, 2008
  
             
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net income
 
$
2,437,976
   
$
14,769,884
 
Adjustments to reconcile net income to net cash used in operating activities
               
Depreciation and amortization
   
385,337
     
115,541
 
Reversal of bad debt provision
   
(305,338
)
   
-
 
Increase/(decrease) in fair value of derivative liabilities
   
20,905,136
     
(1,464,256
Changes in assets and liabilities:
               
Accounts receivable - third parties
   
(40,270,694
)
   
(20,628,654
)
Accounts receivable - related party
   
23
     
-
 
Inventories
   
(10,190,333
)
   
(2,046,871
)
Advance payments
   
(116,740
   
(273,630
)
Due from a related party
   
-
     
(954,735
Prepaid expenses
   
65,754
     
-
 
Other receivables
   
366,797
     
(1,247,729
)
Accounts payable- related party
   
5,569,674
     
(13,471
Accounts payable- third parties
   
6,625,498
     
-
 
Income tax payable
   
7,065,369
     
414,009
 
Advance from customers
   
(1,733,928
)
   
120
 
Accrued expenses
   
2,223,070
     
1,498,297
 
Due to a related party
   
33
     
1,626,548
 
Other payables
   
130,611
     
85,783
 
                 
Net Cash Used in Operating Activities
   
(6,841,755
)
   
(8,119,164
)
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Acquisition of property and equipment
   
(2,655,816
)
   
(3,493,192
)
Addition to intangible assets
   
-
     
(122,899
)
Net Cash Used in Investing Activities
   
(2,655,816
)
   
(3,616,091
)
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Proceeds from bank loans
   
276,331
     
205,028
 
Repayment of bank loans
   
(121,877
)
   
-
 
Proceeds from common stock and warrants issued
   
9,222,157
     
19,450,651
 
Payment for common stock issuance costs
   
(836,456
)
   
(1,461,659
)
Net Cash Provided by Financing Activities
   
8,540,155
     
18,194,020
 
                 
EFFECT OF FOREIGN CURRENCY TRANSLATION ON CASH
   
(11,653
)
   
380,656
 
NET (DECREASE)/INCREASE IN CASH
   
(969,069
   
6,839,421
 
CASH– BEGINNING
   
4,477,477
     
8,137
 
CASH - ENDING
 
$
3,508,408
   
$
6,847,558
 
                 
Supplemental cash flow information:
               
Cash paid for income taxes
   
770,652
     
424,725
 
Cash paid for interest expense
   
33,236
     
-
 
Noncash investing and financing activities:
               

During the nine months ended September 30, 2008, the non-controlling shareholder of Yongye Nongfeng contributed a patent valued at $100,000 to Yongye Nongfeng.

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

 
6

 

YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2009

NOTE 1 -ORGANIZATION AND DESCRIPTION OF BUSINESS

A. Organization

Yongye International, Inc. (the “Company”, formerly known as “Golden Tan, Inc.” or “Yongye Biotechnology International, Inc.”) was incorporated in the State of Nevada on December 12, 2006. On April 17, 2008, the Company entered into a share exchange agreement (the “Exchange Agreement”) with Fullmax Pacific Limited (“Fullmax”), a privately held investment holding company organized on May 23, 2007 under the laws of the British Virgin Islands and the shareholders of Fullmax (the “Fullmax Shareholders”), who collectively owned all the issued and outstanding ordinary shares of Fullmax. Pursuant to the terms of the Exchange Agreement, the Fullmax Shareholders transferred to the Company all of their shares in exchange for 11,444,755 (the “Shares”) shares of the Company’s common shares (the “Share Exchange”). As a result of the Share Exchange, Fullmax became a wholly-owned subsidiary of the Company and the Fullmax Shareholders received approximately 84.7% of the Company’s issued and outstanding common shares. Immediately prior to the date of the Share Exchange, the Company was a publicly listed shell entity with no operations and had a nominal amount of cash and, Fullmax, through its wholly-owned subsidiary, Asia Standard Oil Limited (“ASO”) and indirect subsidiary, Yongye Nongfeng Biotechnology (“Yongye Nongfeng”), was engaged in the sale of fulvic acid based liquid and powder nutrient compounds for plant and animal feed used in the agriculture industry. The Share Exchange was accounted for as a reverse recapitalization, equivalent to the issuance of stock by Fullmax for the net monetary assets of the Company accompanied by a recapitalization.

In November 2007, ASO a Hong Kong investment holding company, entered into a Sino-Foreign cooperative joint venture contract (“Contract”) with Inner Mongolia Yongye Biotechnology Co., Ltd. (“Inner Mongolia Yongye”) to form a cooperative joint venture, Yongye Nongfeng, pursuant to which, Inner Mongolia Yongye and ASO is to own 10% and 90% of the equity interests in Yongye Nongfeng, respectively. Inner Mongolia Yongye was formed on September 16, 2003 in the People’s Republic of China (the “PRC”). Mr. Zishen Wu, Chief Executive Officer, President and Chairman of the Company, owns a controlling 91.67% of the equity interest in Inner Mongolia Yongye. Inner Mongolia Yongye’s primary business is the research, manufacturing, and sale of biochemical products for use in plants and animal growth.  Inner Mongolia Yongye is located in the City of Hohhot, Inner Mongolia Autonomous Region PRC.

On January 4, 2008, the incorporation and establishment of Yongye Nongfeng was approved by the Inner Mongolia Department of Commerce and the Inner Mongolia Administration for Industry and Commerce. The scope of business of Yongye Nongfeng is the research and development, manufacturing, distribution and sale of fulvic acid based liquid and powder nutrient compounds used in the agriculture.  The period of the cooperative joint venture is ten years and may be extended by a written application submitted to the relevant government authority for approval no less than six months prior to the expiration of the cooperative joint venture. Prior to the legal establishment of Yongye Nongfeng, both Fullmax and ASO were non substantive holding companies with no assets and operations and were primarily designed and used as legal vehicles to facilitate foreign participation in the business conducted by Inner Mongolia Yongye.

In May 2008, upon the agreement among Inner Mongolia Yongye, ASO and Yongye Nongfeng, the ownership of Yongye Nongfeng was revised, pursuant to which Inner Mongolia Yongye and ASO became 0.5% and 99.5% equity interest owner of Yongye Nongfeng, respectively. ASO did not fully inject its share of the capital into Yongye Nongfeng until May 31, 2009. Based upon actual capital injection into Yongye Nongfeng, Inner Mongolia Yongye and ASO were 0.6% and 99.4% owners of Yongye Nongfeng as of December 31, 2008.

B. Nature of Business

The Company, through its primary operating subsidiary, Yongye Nongfeng, is engaged in the manufacturing, development and sale of fulvic acid based liquid and powder nutrient compounds used in the agriculture industry in the PRC.
 
In January 2008, upon receiving governmental approval of the establishment, Yongye Nongfeng entered into an agreement (the “Agreement”) with Inner Mongolia Yongye, pursuant to which Yongye Nongfeng agreed to purchase finished goods products from Inner Mongolia Yongye at a fixed price of RMB 350 per case for fulvic acid based plant products and RMB 120 per case for fulvic acid based animal products.  The term of the Agreement was for the period from January 15, 2008 to January 14, 2013. Pursuant to the Agreement, the Company could terminate the Agreement by giving one month notice to Inner Mongolia Yongye. The Company terminated the Agreement in July 2009 as further described in the following paragraph.

 
7

 

In March 2009, in connection with the Yongye Nonfeng Restructuring, Yongye Nongfeng purchased production equipment, vehicle and office equipment from Inner Mongolia Yongye for approximately $577,000, $351,000 and $12,000, respectively, which represent the estimated fair value of the assets based on an appraisal by independent valuers. On June 1, 2009, Yongye Nongfeng obtained the approval from the Ministry of Agricultural for the fertilizer license to produce fulvic acid based products, to be held under its name, which was previously held in the name of Inner Mongolia Yongye. In addition, on June 1, 2009, Yongye Nongfeng purchased all of the inventories of Inner Mongolia Yongye relating to fulvic acid based products for $12,258,000 in cash.

Yongye Nongfeng and Inner Mongolia Yongye entered into certain lease-exchange arrangements related to land-use rights, buildings and equipment. (See Note 11)

On October 10, 2009, the “Yongye Nongfeng Restructuring” (See Note 7) was completed, whereby Yongye Nongfeng acquired production buildings and the land use right from Inner Mongolia Yongye.

NOTE 2 -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION

The accompanying consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) and include the financial statements of the Company and its subsidiaries. The accompanying unaudited consolidated balance sheet as of September 30, 2009, unaudited consolidated statements of operations and comprehensive income/(loss) for the three and nine months ended September 30, 2009 and unaudited consolidated statements of changes in equity and cash flows for the nine months ended September 30, 2009 include Yongye International, Inc. and its directly and indirectly owned subsidiaries, Fullmax, ASO and Yongye Nongfeng. The Company’s unaudited consolidated statements of income and comprehensive income for the three and nine months ended September 30, 2008 and statement of cash flows for the nine months ended September 30, 2009 consist of the financial results of Yongye Nongfeng for such periods and the financial results of Fullmax and ASO from the period April 17, 2008 to September 30, 2008.  For the period from January 1, 2008 to April 17, 2008, the financial results of Fullmax and ASO are not material.

All significant intercompany transactions and balances are eliminated on consolidation.

The accompanying unaudited consolidated financial statements as of September 30, 2009 and for the three months and nine months ended September 30, 2009 and 2008 have been prepared in accordance with U.S. GAAP for interim financial information. In the opinion of management, the accompanying unaudited consolidated interim financial statements include all adjustments considered necessary to ensure the financial statements are not misleading. Management has evaluated subsequent events through November 13, 2009, which was the date the interim financial statements as of and for the three and nine months ended September 30, 2009 were issued.

The Company's business is subject to seasonal variations; thus, the results of operations for the three and nine months ended September 30, 2009 and 2008 are not necessarily indicative of the results for the full fiscal year ending December 31, 2009. Generally, the second and third quarters are peak sales periods, and first and fourth quarters are low sales periods for the Company.

 
8

 

The unaudited consolidated interim financial statements should be read in conjunction with the Company's audited consolidated financial statements and notes thereto for the year ended December 31, 2008 that are included in the Company’s 2008 annual report on 10-K/A filed with the Securities and Exchange Commission on October 19, 2009.

NET (LOSS)/INCOME PER SHARE

Basic net (loss)/income per share is computed by dividing net (loss)/income attributable to common shareholders of the Company by the weighted average number of common shares outstanding during the period. Diluted net (loss)/income per share reflects the potential dilution that would occur upon the exercise of outstanding warrants. Common share equivalents are excluded from the computation of the diluted net (loss)/income per share in periods when their effect would be anti-dilutive.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
 
In June 2009, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS No. 168”). SFAS No. 168 establishes the FASB Accounting Standards Codification (the “Codification”) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with U.S. GAAP. Rules and interpretive releases of the Securities and Exchange Commission under the authority of the federal securities law are also sources of GAAP for SEC registrants. The Codification does not change current U.S. GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. This statement will have no impact on the Company’s consolidated financial statements, but it will change the referencing of authoritative accounting literature to conform to the Codification.
 
In September 2006, the FASB issued Statement No. 157, “Fair Value Measurement” (SFAS No. 157). Effective July 1, 2009, this standard was incorporated into the Financial Accounting Standards Board Accounting Standard Codification (ASC) Section 820, Fair Value Measurements and Disclosures (FASB ASC 820). FASB ASC 820 does not require new fair value measurements, but provides guidance on applying fair value and expands required disclosures. FASB ASC 820 is effective for the Company beginning in fiscal 2008, for fair value measurements of financial assets and financial liabilities and for fair value measurements of nonfinancial items that are recognized or disclosed at fair value in the financial statements on a recurring basis, and is effective beginning in fiscal 2009, for fair value measurements of nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. The disclosure of the Company’s fair value measurement required under FASB ASC 820 is included in Note 7 to consolidated interim financial statements.

 
9

 

In December 2007, the FASB issued FASB Statement No. 141(R), Business Combinations, and FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements an amendment to ARB No. 51. In April 2009, the FASB issued FSP FAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies, which amends and clarifies FASB 141 (R) to address application issues on initial recognition and measurement, subsequent measurement and disclosure of assets and liabilities arising from contingencies in a business combination. Effective July 1, 2009, SFAS No.141(R) and FSP FAS 141(R)-1 were incorporated into the ASC Section 805, Business Combinations (FASB ASC 805) and SFAS No.160 was incorporated into the ASC Section 810, Consolidation (FASB ASC 810). FASB ASC 805 and 810 require most identifiable assets, liabilities, noncontrolling interests, and goodwill acquired in a business combination to be recorded at “full fair value” and require noncontrolling interests (previously referred to as minority interests) to be reported as a component of equity, which changes the accounting for transactions with noncontrolling interest holders. Both Statements are effective for periods beginning on or after December 15, 2008, and earlier adoption is prohibited. FASB ASC 805 will be applied to business combinations occurring after the effective date. FASB ASC 810 will be applied prospectively to all noncontrolling interests, including any that arose before the effective date.   Other than the change in presentation of noncontrolling interests, the adoption of FASB ASC 805 and FASB ASC 810 has no impact on the Company’s financial statement.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133” (“SFAS No. 161”), which required enhanced disclosures about an entity’s derivative and hedging activities and was intended to improve the transparency of financial reporting. Effective July 1, 2009, SFAS No.161 and SFAS No.133 were incorporated into the ASC Section 815, Derivatives and Hedging (FASB ASC 815). FASB ASC 815 applies to all derivative instruments, including bifurcated derivative instruments and related hedging items accounted for under SFAS No. 133 and its related interpretations.  SFAS No. 161 amends and expands the disclosure requirements of SFAS No. 133 with the intent to provide users of financial statements with an enhanced understanding of:  (i) how and why an entity uses derivative instruments; (ii) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations; and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows.  The provisions of this standard do not require disclosures for earlier periods presented for comparative purposes at initial adoption FASB ASC 815 was effective for fiscal years and interim periods beginning after November 15, 2008.  The Company adopted this new standard effective January 1, 2009 (See Note 7).

NOTE 3-ACCOUNTS RECEIVABLE

Net accounts receivable at September 30, 2009 and December 31, 2008 consisted of the following:

   
September 30, 2009
   
December 31, 2008
 
Accounts receivable-third parties
 
$
43,349,508
   
$
3,053,380
 
Less: allowance for doubtful accounts
   
-
     
(305,338
)
Total
 
$
43,349,508
   
$
2,748,042
 

A bad debt provision of $305,338 was reversed for the nine months ended September 30, 2009 as the total amount of the related accounts receivable, which was previously provided for as of December 31, 2008 was repaid by the customer during the nine months ended September 30, 2009. No bad debt expense provision was required for the three and nine months ended September 30, 2009 as management believes no accounts are uncollectible as of September 30, 2009.

The Company’s normal credit terms to customers with well-established trading records are six months while the Company generally requests other customers to pay either in advance or upon delivery.

NOTE 4-INVENTORIES

Inventories at September 30, 2009 and December 31, 2008 consisted of the following:
 
   
September 30, 2009
   
December 31, 2008
 
             
Finished goods
 
$
18,921,648
   
$
20,664,930
 
Work in progress
   
5,044,463
     
-
 
Packing supplies
   
140,796
     
-
 
Raw materials
   
6,784,386
     
-
 
Consumables
   
63,114
     
43,263
 
Total
 
$
30,954,407
   
$
20,708,193
 
 
 
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NOTE 5-PROPERTY AND EQUIPMENT
 
Property and equipment at September 30, 2009 and December 31, 2008 consisted of the following:

   
September 30, 2009
   
December 31, 2008
 
             
Buildings and structures
 
$
5,643,881
   
$
3,656,992
 
Machinery and equipment
   
1,512,775
     
673,480
 
Office equipment and furniture
   
235,942
     
85,087
 
Vehicles
   
1,816,576
     
824,013
 
Software
   
17,198
     
17,156
 
Leasehold improvements
   
219,375
     
218,844
 
     
9,445,747
     
5,475,572
 
                 
Less: Accumulated depreciation
   
485,382
     
107,498
 
                 
Total
 
$
8,960,365
   
$
5,368,074
 
 
Depreciation expense for the three months ended September 30, 2009 and 2008 was $137,875 and $19,197, respectively.  Depreciation expense for the nine months ended September 30, 2009 and 2008 was $377,369 and $107,379, respectively. As of September 30, 2009, vehicles with an original carrying amount of $1,058,931 were pledged as security for the long-term banks loans of $646,279 which were provided by the banks for the purchase of the vehicles (See Note 6). An apartment with an original carrying value of $103,681 was pledged as security for a long-term bank loan of $72,394 which was provided by the bank for the purchase of the apartment (See Note 6).

NOTE 6 – LONG-TERM LOANS
 
From August 2008 to September 2009, the Company financed the purchase of twenty-two vehicles with bank loans of $646,279. The Company pledged the twenty-two vehicles with an initial carrying amount of $1,058,931 as security for the bank loans. The loans all have three-year terms and are paid in monthly installments. Interest rates on the loans range from 5.40% to 14.80% annually, and are subject to the change of the base interest rate prescribed by People’s Bank of China. In July, 2009, the Company financed the purchase of an apartment for the use by the Company’s management with a bank loan of $72,394. The Company pledged the apartment with initial carrying amount of $103,681as security for the bank loan. The loan has twenty-year term and is paid in monthly installments with interest rate of 4.16% annually, subject to the change of the base interest rate as prescribed by People’s Bank of China. All of these bank loans were initially obtained by individual employees/management of the Company on behalf of the Company. The Company and the individual employees/management entered into trust agreements whereby the Company is subject to all the risk and ownership of the vehicles and apartment and assumes all of the responsibility and obligations for making the monthly payments on the bank loans. The aggregate amount of such required payments at September 30, 2009 is as follows:
 
2009
 
$
63,451
 
2010
   
253,342
 
2011
   
207,342
 
2012
   
28,279
 
2013 and thereafter
   
88,948
 
Total
   
641,362
 
Less: Amount representing interest
   
(88,042
)
Total at present value
 
$
553,320
 
 
At September 30, 2009, the current portion of bank loans was $211,766 which is scheduled to be repaid on or before September 30, 2010, while the long-term portion of the bank loans is $341,554. The Company made total payments of $62,413, which included interest expense of $11,852, during the three months ended September 30, 2009.
 
According to the trust agreements, while the vehicles and apartment are registered under the individuals’ name, the Company is subject to the full risks and rewards of ownership of the vehicles and apartment, including the rights of official use and the rights to retain the legal title of the vehicles and apartment at the time of termination of the employment relationship with the individual. The Company assumes the risk of loss, damage, penalty and other obligations related to the operation and ownership of the vehicle and apartment, including repairs and maintenance. The Company is also required to make the initial down payment at the date of purchase and legally required to repay the bank loans. The individuals have no right to sell, lease, lend or pledge the vehicles or apartment to any other person or entity. Consequently, the Company has recognized the cost of the vehicles and apartment as assets and the bank loans as liabilities in its consolidated balance sheet.

 
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NOTE 7 - CAPITAL STOCK

Capital stock

Concurrent with the “Share Exchange”, the Company entered into a securities purchase agreement on April 17, 2008 with certain investors (the “April Investors”) for the sale in a private placement of an aggregate of 6,495,619 shares of the Company’s common stock, par value $0.001 per share (the “April Investor Shares”) for aggregate gross proceeds equal to $10,000,651 (the “April Offering”).

On September 5, 2008, the Company entered into a securities purchase agreement, with certain investors (the “September Investors”), for the sale in a private placement of an aggregate of 6,073,006 shares of the Company’s common stock, par value $0.001 per share (the “September Investor Shares”) for aggregate gross proceeds equal to approximately $9,350,000 (the “September Offering”).

On May 8, 2009, the Company entered into a securities purchase agreement with certain investors (the “May Investors”), for the sale in a private placement of an aggregate of 5,834,083 shares of the Company common stock, par value $0.001 per share (the “May Shares”) for a aggregate gross proceeds equal to $8,984,488 (the “May Offering”).

In connection with the May Offering, the Company entered into a registration rights agreement with the investors, in which the Company agreed to file a registration statement with the SEC to register for resale the shares, including the shares to be issued under the warrants (see below), within 45 calendar days of the closing date of the May Offering, and to use its best efforts to have the registration statement declared effective within 150 calendar days of the closing date of the May Offering.  The Company is obligated to pay liquidated damages of 1% of the dollar amount of the shares sold in the May Offering per month, payable in cash, up to a maximum of 10%, if the registration statement is not filed and declared effective within the foregoing time periods.  Offering expenses for the issuance of the shares were $836,456, which were recorded as a reduction of additional paid-in capital in the June 30, 2009 consolidated balance sheet.

During three months ended September 30, 2009, several “April Investors” and “September Investors” executed irrevocable exercise of a total number of 227,331 investor warrants as further described below and were issued 208,832 shares of common stock of the Company.

Warrants

Concurrent with the “April Investor Shares”, the Company issued 1,623,905 warrants to purchase 1,623,905 shares of the Company’s common stock (the “April Warrants”) to the “April Investors” as an inducement to the April offering. The warrants issued have a 5 years exercise period with an initial exercise price of $1.848. In addition, 649,562 warrants were issued to Roth Capital Partners LLC (“Roth”) as the placement agent with terms and exercise price identical to the warrants issued to the April Investors.

Concurrent with the “September Investor Shares”, the Company issued 1,518,253 warrants to purchase 1,518,253 shares of the Company’s common stock (the “September Warrants”) to the “September Investors” as an inducement to the September offering. The warrants issued have a 5 years exercise period with an initial exercise price of $1.848. In addition, 607,301 warrants were issued to Roth as the placement agent with terms and exercise price identical to the warrants issued to the September Investors.

On September 12, 2008 Roth Capital executed an irrevocable cashless exercise of its warrants and was issued 686,878 shares of common stock of the Company pursuant to the April 17, 2008 and September 5, 2008 warrants issued to Roth as placement agent. In exchange for the issuance of 354,987 shares, Roth surrendered 649,562 warrants received in the April Offering; and in exchange for the issuance of 331,891 shares, Roth surrendered 607,301 warrants received in the September Offering.

Concurrent with the offering of the “May Shares”, the Company issued to Roth Capital as the placement agent, 246,224 warrants (“Roth May Warrants”).  The warrants have a 5 years exercise period and an initial exercise price of $1.848.

During the three months ended September 30, 2009, 154,261 “September Warrants” were exercised for $237,562 of consideration paid by a “September Investor” to whom 154,261 shares of common stock were issued; several “April Investors” executed irrevocable cashless exercise of 73,070 “April Warrants” and were issued 54,571 shares of common stock.

 
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According to the terms of these warrants, the Company could be required to pay cash to the warrant holders under certain events that are not within the control of the Company.  Specifically, upon the occurrence of certain “fundamental transactions” as defined, the warrant holders (but not the shareholders of the Company’s common stock) are entitled to receive cash equal to the value of the warrants to be determined based on an option pricing model and certain specified assumptions set forth in the warrant agreement.  In addition, the terms of the warrants include a “down-round” provision under which the exercise price could be affected by future equity offerings undertaken by the Company.  If the Company issues any common stock or common stock equivalents, as defined, at any time the warrants are outstanding, at an effective price less than the then warrant exercise price, the exercise price of warrants will be reduced to the effective price of newly issued common stock or common stock equivalents.  In the “May Offering”, the Company issued new common stock at a price of $1.54 per share and accordingly, the exercise price of the April Warrants and the September Warrants was reduced to $1.54 per share.  The exercise price of Roth May Warrants ($1.848) was not affected but will be subject to potential down-round adjustments in future periods. As of September 30, 2009, there were 3,161,051 warrants outstanding, of which 1,550,835, 1,363,992, 246,224 warrants will expire if unexercised by April 2013, September 2013 and May 2014, respectively.

The potential cash payments and the down-round provision preclude the classification of these warrants as equity classification.  Accordingly, the warrants are accounted for as a liability and adjusted to fair value through earnings at each reporting date starting from the issuance date. The loss resulting from the increase in fair value of warrants was $15,836,189 and $20,905,136 for the three and nine months ended September 30, 2009. The gain resulting from the decrease in fair value of warrants was $3,618,579 and $1,464,256 for the three and nine months ended September 30, 2008.

The Company measures the fair value of the warrants based on the assumptions that market participants would use in pricing the asset or liability and establishes a fair value hierarchy that ranks the inputs used to measure fair value by their reliability. The three levels of the fair value hierarchy are as follows:
 
Level 1—quoted prices (unadjusted) in active markets for identical assets or liabilities that a company has the ability to access at the measurement date.
 
Level 2—inputs other than quoted prices included within Level 1 that are observable for similar assets or liabilities, either directly or indirectly.
 
Level 3—unobservable inputs for the asset or liability. Unobservable inputs are used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.

 
13

 
 
The estimated fair values of the Company’s Investor Warrants and Roth Warrants were determined at September 30, 2008, September 30, 2009 and December 31, 2008 using Binominal Option Pricing Model with Level 2 inputs.
 
The following table sets forth, by level within the fair value hierarchy, the Company’s financial liabilities that were measured on a recurring basis at fair value as of September 30, 2008, September 30, 2009 and December 31, 2008.

         
Fair Value Measurements Using:
 
   
 
   
Quoted Prices in
Active Markets for
Identical Financial
Assets and Liabilities
   
Significant Other
Observable Inputs
   
Significant
Unobservable Inputs
 
September 30, 2009
 
Total
   
Level 1
   
Level 2
   
Level 3
 
                         
Liabilities at fair value:
                       
Derivative liabilities—warrants
   
22,277,122
     
     
22,277,122
     
 
 
         
Fair Value Measurements Using:
 
   
 
   
Quoted Prices in
Active Markets for
Identical Financial
Assets and Liabilities
   
Significant Other
Observable Inputs
   
Significant
Unobservable Inputs
 
December 31, 2008
 
Total
   
Level 1
   
Level 2
   
Level 3
 
                         
Liabilities at fair value:
                       
Derivative liabilities—warrants
   
2,107,931
     
     
2,107,931
     
 
 
         
Fair Value Measurements Using:
 
   
 
   
Quoted Prices in
Active Markets for
Identical Financial
Assets and Liabilities
   
Significant Other
Observable Inputs
   
Significant
Unobservable Inputs
 
September 30, 2008
 
Total
   
Level 1
   
Level 2
   
Level 3
 
                         
Liabilities at fair value:
                       
Derivative liabilities—warrants
   
2,762,470
     
     
2,762,470
     
 

As of September 30, 2009 the fair value of the derivative liability related to the outstanding warrants is $22,277,122. The changes in the fair value of the warrants are recorded through earnings and amounted to $15,836,189 and $20,905,136 for the three and nine months ended September 30, 2009, respectively.

The fair values of the warrants are summarized as follows:

Fair value of Warrant per share (US$) at:
 
April Warrants
   
September Warrants
 
Roth May Warrants
               
Date of issuance
   
1.07
     
2.08
 
0.95
September 30, 2008
   
0.88
     
0.87
 
N/A
December 31, 2008
   
0.66
     
0.68
 
N/A
June 30, 2009
   
2.19
     
2.20
 
2.08
September 30, 2009
   
7.05
     
7.07
 
6.90
 
 
14

 
 
The fair values of the warrants as of September 30, 2009 were determined based on the Binominal option pricing model, using the following key assumptions:

   
April Offering
   
September
Offering
   
May Offering
 
                   
Expected volatility
   
65.0
%
   
63.5
%
   
61.0
%
                         
Expected dividends yield
   
0
%
   
0
%
   
0
%
                         
Time to maturity
 
3.55 years
   
3.93 years
   
4.61 years
 
                   
Risk-free interest rate per annum
   
2.218
%
   
2.218
%
   
2.218
%
                         
Fair value of underlying Common Shares (per share)
   
8.35
     
8.35
     
8.35
 
 
 
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Escrow shares

In connection with the April Offering, the Company entered into an escrow agreement with Roth as a representative of the April Investors, Tri-State Title & Escrow LLC (the “Escrow Agent”) and Full Alliance, one of the Company’s shareholders (the “April Escrow Agreement”), pursuant to which 2,000,000 shares of the Company held by Full Alliance (the “April Escrow Shares”) were delivered to the Escrow Agent. The April Escrow Shares were held for the Company’s achievement of $10,263,919 after tax net income (“ATNI”) for the year ended December 31, 2008 (the “2008 Net Income Threshold”). The ATNI threshold was achieved and the Escrow Shares were released in full back to Full Alliance in May 2009.

In connection with the September Offering, the Company entered into an escrow agreement with Roth, the Escrow Agent and Full Alliance (the “September Escrow Agreement”), pursuant to which 4,000,000 shares of the Company issued to Full Alliance in the Share Exchange (the “September Escrow Shares”) were delivered to the Escrow Agent. Of the September Escrow Shares, 2,000,000 shares (the “Make Good Escrow Shares”) are being held for the Company’s achievement of both 2008 and 2009 financial targets.

The Company has achieved the 2008 financial targets which were (i) the 2008 Net Income Threshold, and (ii) fully diluted earnings per share reported in the Company’s 2008 Annual Report on Form 10-K/A filed with the SEC (the “2008 Annual Report”) of no less than $0.42 (the “2008 Guaranteed EPS”). The Make Good Escrow Shares have been retained in Escrow Agent for the 2009 financial targets which are described in the following sentence. In the event that (i) the 2009 ATNI is less than $12,649,248, or the fully diluted earnings per share reported in 2009 Annual Report on Form 10-K filed with the SEC (the “2009 Annual Report”) is less than $0.42, all of the 2,000,000 Make Good Escrow Shares shall be distributed to the September Investors on a pro-rata basis, (ii) the 2009 ATNI equals or exceeds $12,649,248 and is less than $15,811,560, or the fully diluted earnings per share reported in the 2009 Annual Report, equals or exceeds $0.42 and is less than $0.53, then the Make Good Shares equal to the product of  (i)(A) $15,811,560 minus the 2009 ATNI, divided by (B) $15,811,560, and (ii) the Make Good Escrow Shares, shall be transferred to the September Investors on a pro-rata basis, and the remaining share shall be returned to Full Alliance, (iii) the 2009 ATNI exceeds $15,811,560, the 2,000,000 Make Good Escrow Shares will be released back to Full Alliance. Pursuant to both April Escrow agreements and September Escrow Agreements, for purposes of determining whether or not the ATNI has been met, the following items shall not be deemed to be an expense, charge, or any other deduction from revenues even though GAAP may require contrary treatment or the Annual Report for the respective fiscal years filed with the Commission by the Company may report otherwise: (i) any accounting charges for issuing warrants, (ii) the release of any of the Make Good Shares to the Make Good Pledgor as a result of the operation,  (iii) the release of any Existing Make Good Shares and (iv) the increase in the equity ownership of the Yongye Nongfeng in excess of 1.15% in connection with the Yongye Nongfeng Restructuring, as reflected in the provision for minority interest on the Company’s statement of operations. No other exclusions shall be made for any non-recurring expenses of the Company, including liquidated damages under the Transaction Documents, in determining whether any of the 2008 and 2009 ATNI, and 2008 and 2009 EPS has been achieved.

The remaining 2,000,000 escrow shares are being held for the timely approval obtained from Ministry of Agriculture of Inner Mongolia in relation to the transfer of fertilizer license to Yongye Nongfeng from Inner Mongolia Yongye and completion of Yongye Nongfeng’s restructuring (the “Restructuring Make Good Shares”). The fertilizer license is issued by the Ministry of Agriculture and provides the holder the right to manufacture and sell fertilizer products in the PRC.  As of October 10, 2009, the Company completed the restructuring under which the Company purchased the land use right with 79,920 square meters, buildings and equipment from Inner Mongolia Yongye (“Yongye Nongfeng Restructuring”) (See Note 14).

In the event that (1) the fertilizer license has not been issued to Yongye Nongfeng by June 30, 2009, or such later date as agreed to by the Company and the September Investors holding a majority of the September Investor Shares at such time (the “License Grant Date ”), or (2) the fertilizer license has been issued by the License Grant Date, but the Yongye Nongfeng Restructuring is not completed by the Restructuring Completion Date, the Restructuring Make Good Shares shall be transferred in accordance with the September Escrow Agreement to the September Investors on a pro-rata basis for no consideration. The “Restructuring Completion Date” shall be the date that is 132 calendar days after the License Grant Date.

The fertilizer license was issued on June 1, 2009 by the Ministry of Agriculture to Yongye Nongfeng in accordance with the deadline. In anticipation of the completion of the Yongye Nongfeng Restructuring, the Company acquired the production building from Inner Mongolia on September 16, 2009 for $1,442,759.

 
16

 

The purpose of the April Escrow Arrangement and September Escrow Arrangement was an inducement made to facilitate the respective offerings, and not part of a compensatory arrangement to management. The escrow shares will not be released or cancelled due to the discontinued employment of any management of the Company.

 
17

 
 
NOTE 8 – STATUTORY RESERVE

The Company’s subsidiary, Yongye Nongfeng, was required to allocate at least 10% of its after tax profits as determined under generally accepted accounting principal in the PRC to a statutory surplus reserve until the reserve balance reaches 50% of their registered capital. For the nine months ended September 30, 2009 and 2008, Yongye Nongfeng made appropriations to this statutory reserve of $2,328,546 and $783,084, respectively. The accumulated balance of the statutory reserve at Yongye Nongfeng as of September 30, 2009 and December 31, 2008 were $3,536,458 and $1,207,912, respectively.

In accordance with the PRC laws and regulations, Yongye Nongfeng is restricted in its ability to transfer a portion of its net assets to Yongye International, Inc. in the form of dividends, which amounted to $3,536,458 as of September 30, 2009.

NOTE 9 – INCOME TAXES

The Company’s effective income tax rates excluding the non-taxable / non-deductible effect of the gain / loss in fair value of warrants issued to April Investors and September Investors were 25.89% and 4.78% for the three-month period ended September 30, 2009 and 2008, respectively and 25.13% and 5.82% for the nine-month period ended September 30, 2009 and 2008, respectively. Income tax expense mainly consists of foreign income tax at statutory rates and the effects of permanent differences. According to the approval from the tax authority in the city level of Hohhot in Inner Mongolia Autonomous Region, Yongye Nongfeng was assessed to use the deemed profit method to determine the amount of income tax provision for the year ended December 31, 2008 which was based on 1.25% on its gross revenue. The deemed profit method is not applicable to Yongye Nongfeng for the year ending December 31, 2009. With effective from January 1, 2009, Yongye Nongfeng applied the statutory income tax rate of 25% on its assessable income in accordance with the relevant income tax rules and regulations of the PRC. 

The Company has a deferred tax asset on net operating losses of approximately $498,074 as of September 30, 2009. The ultimate realization of deferred tax assets depends on the generation of future taxable income during the periods in which those net operating losses are available. The Company considers projected future taxable income and tax planning strategies in making its assessment. At present, the Company does not have a sufficient operation in the United States to conclude that it is more-likely-than-not that the Company will be able to realize all of its tax benefits in the near future and therefore a valuation allowance of $498,074 was established for the full value of the deferred tax asset.
 
A valuation allowance will be maintained until sufficient positive evidence exists to support the reversal of any portion or all of the valuation allowance. Should the Company start operation in the United States in future periods with supportable trend, the valuation allowance will be reversed accordingly.
 
NOTE 10 – LEASE COMMITMENTS

The Company entered into an operating lease to secure an office space in Beijing, PRC. The lease term for the Beijing office is from January 1, 2008 to December 31, 2010. The lease expense for the Beijing office was $57,909 and $165,448 for the three and nine months ended September 30, 2009, respectively. The lease expense for the Beijing office was $57,809 and $154,238 for the three and nine months ended September 30, 2008, respectively. Future minimum lease payments under non-cancellable operating lease agreement at September 30, 2009 are as follows:

December 31, 2009
 
$
57,939
 
December 31, 2010
   
231,512
 
Total
 
$
289,451
 
 
NOTE 11 – RELATED PARTY TRANSACTIONS AND BALANCES
 
For the three and nine months ended September 30, 2009, the Company's subsidiary, Yongye Nongfeng purchased inventories from Inner Mongolia Yongye amounting to $0 and $37,923,422, respectively. For the three months and nine months ended September 30, 2008, Yongye Nongfeng purchased inventories from Inner Mongolia Yongye amounting to $ 6,128,774 and $23,597,523, respectively.


 
18

 

As of September 30, 2009 and December 31, 2008, accounts payable related party were $5,424,246 and $46,739, respectively, and represented the payable for the purchases of inventories from Inner Mongolia Yongye. Due from related party was $192,741 as of December 31, 2008 which represented the payment the Company made on behalf of Inner Mongolia Yongye for audit fees and research and development fees in the year ended December 31, 2008. For the nine months ended September 30, 2009, the Company sold products of $2,220,083 to Hubei Longshangxing Xinnongcun Fuwu Youxiangongsi, which is 51% owned by Inner Mongolia Yongye, for the sale of fulvic acid plant based products.

As of September 30, 2009, the amount due to a related party was $1,443,489 which mainly represented the payable for the purchase of production buildings from Inner Mongolia Yongye (See note 1).

For the nine months ended September 30, 2008, the Company borrowed $1,638,581 from Yin Ping, the wife of CEO Mr. Zishen Wu, $762,524 from Inner Mongolia Yongye and $10,000 from Kim McElroy, a director of the Company who resigned in April 2008. The amounts are unsecured and non-interesting bearing, and were repaid in full as of December 31, 2008.

In March 2009, Yongye Nongfeng purchased machinery and equipment, vehicles and office equipment in the amount of $940,531 from Inner Mongolia Yongye. In September 2009, Yongye Nongfeng purchased production buildings in the amount of $1,442,750 from Inner Mongolia Yongye (See Note 1).

 
19

 
 
Yongye Nongfeng and Inner Mongolia Yongye entered a series of lease-exchange arrangement to lease land, buildings and equipment to and from each other as follows:

·
On June 1, 2008, a land lease agreement was entered into in which Yongye Nongfeng would lease land of 74,153 square meters from Inner Mongolia Yongye from June 1, 2008 to May 31, 2009. On June 1, 2009, upon the expiry of this agreement, Yongye Nongfeng and Inner Mongolia Yongye entered into another lease agreement in which Yongye Nongfeng would lease a land of 79,920 square meters and a production building from Inner Mongolia Yongye from June 1, 2009 to October 10, 2009.
 
·
On September 28, 2008, a building lease agreement and an equipment lease agreement were entered into in which Inner Mongolia Yongye would lease a building and certain equipment from Yongye Nongfeng from September 28, 2008 to September 27, 2009, which was terminated on June 1, 2009.
 
·
On March 15, 2009, an equipment lease agreement was entered into in which Inner Mongolia Yongye would lease a set of production equipment from Yongye Nongfeng from March 15, 2009 to May 31, 2009. On June 1, 2009, this lease agreement was terminated.

Pursuant to these agreements, both Yongye Nongfeng and Inner Mongolia Yongye did not charge any rental to each other for the lease.  Additionally, the estimated rental income to be received and the rental expense to be paid by the Yongye Nongfeng are not material to the Company’s 2009 and 2008 results of operations and therefore have not been included.

NOTE 12 - NET (LOSS)/INCOME PER SHARE
 
The following table sets forth the computation of basic and diluted (loss)/income per share for the periods indicated:

   
Three months ended
   
Nine months ended
 
   
September 30, 2009
   
September 30, 2008
   
September 30, 2009
   
September 30, 2008
 
Numerator used in basic net (loss)/ income per share:
                       
Net (loss)/income attributable to Yongye International, Inc.
   
(7,041,265)
     
8,089,596
     
2,309,692
     
13,677,458
 
Decrease in fair value of derivative liabilities
   
-
     
(3,618,579)
     
-
     
(1,464,256)
 
Numerator used in diluted net income per share
   
(7,041,265)
     
4,471,017
     
2,309,692
     
12,213,202
 
                                 
Shares (denominator):
                               
                                 
Weighted average ordinary shares outstanding-basic
   
32,730,054
     
21,594,470
     
29,926,052
     
17,194,563
 
Plus: weighted average incremental shares from assumed exercise of warrants
   
-
     
1,213,286
     
-
     
505,184
 
                                 
Weighted average ordinary shares outstanding used in computing diluted net income per ordinary share
   
32,730,054
     
22,807,756
     
29,926,052
     
17,699,747
 
                                 
Net (loss)/income per ordinary share-basic
   
(0.22) 
     
0.37 
     
 0.08
     
0.80 
 
Net (loss)/income per ordinary share-diluted
 
$
(0.22)
   
$
0.20
   
$
0.08
   
$
0.69
 
 
 
20

 

As of September 30, 2009, the Company had 3,161,051 ordinary shares equivalents outstanding that could potentially dilute basic income per share in the future, but which were excluded in the computation of diluted income per share in the periods presented, as their effect would have been anti-dilutive.

NOTE 13 - CONCENTRATIONS AND CREDIT RISKS
 
At September 30, 2009 and December 31, 2008, the Company had a credit risk exposure of cash in banks of approximately $3,508,408 and $4,477,477, respectively that is uninsured by the government authority. To limit exposure to credit risk relating to deposits, the Company primarily places cash deposits only with large financial institution in the PRC with acceptable credit rating.

Five major customers accounted for 92% and one major customer accounted for 51% of the Company’s net revenue for the three months ended September 30, 2009. Five major customers accounted for 83% and one major customer accounted for 31% of the Company’s net revenue for the nine months ended September 30, 2009. Five major customers accounted for 99% and one major customer accounted for 65% of the Company’s net revenue for the three months ended September 30, 2008. Five major customers accounted for 97% and one major customer accounted for 41% of the Company’s net revenue for the nine months ended September 30, 2008. The Company’s total sales to five major customers were $26,724,973 and $73,451,769 for the three and nine months ended September 30, 2009, respectively. The Company’s total sales to five major customers were $18,091,398 and $43,766,085 for the three and nine months ended September 30, 2008, respectively. In addition, all these major customers are distributors in the PRC agriculture industry.

 
21

 
 
Three months ended September 30, 2009
 
Nine months ended September 30, 2009
 
Largest
Customers
 
Province
 
Amount of
Sales
 
% Total
Sales
 
Largest
Customers
 
Province
 
Amount of
Sales
 
% Total
Sales
 
Customer A
 
Jiangsu, Shanxi, Liaoning, Guangdong and Henan
   
14,840,002
 
51
%
Customer C
 
Hebei
   
27,230,124
 
31
%
Customer B
 
Inner Mongolia
   
4,614,438
 
16
%
Customer B
 
Inner
Mongolia
   
15,902,407
 
18
%
Customer C
 
Hebei
   
3,672,634
 
13
%
Customer A
 
Jiangsu, Shanxi, Liaoning, Guangdong and Henan
   
14,840,002
 
17
%
Customer D
 
Hubei
   
1,900,374
 
6
%
Customer F
 
Xinjiang
   
9,775,088
 
11
%
Customer E
 
Shandong
   
1,697,525
 
6
%
Customer G
 
Xinjiang
   
5,704,148
 
6
%
Total
       
26,724,973
 
92
%
Total
       
73,451,769
 
83
%
 
Three months ended September 30, 2008
 
Nine months ended September 30, 2008
 
Largest
Customers
 
Province 
 
Amount of
Sales
 
% Total
Sales
 
Largest
Customers
 
 Province
 
Amount of
Sales
 
% Total
Sales
 
Customer C
 
Hebei
 
  11,824,157
   
65
%
Customer C
 
Hebei
 
  18,697,216
 
  41
%
Customer F
 
Xinjiang
 
 3,834,862
   
 
21
%
Customer F
 
Xinjiang
 
 13,108,763
 
  29
%
Customer B
 
Inner Mongolia
 
 1,158,951
   
 
6
%
Customer H
 
Gansu
 
 5,633,389
 
  13
%
Customer E
 
Shandong
 
 639,144
   
 
4
%
Customer B
 
Inner
Mongolia
 
 4,708,453
 
  10
%
Customer H
 
Gansu
 
 634,284
   
 
3
%
Customer E
 
Shandong
 
 1,618,264
 
  4
%
Total
     
 18,091,398
   
 
99
%
Total
     
 43,766,085
 
  97
%
 
The Company’s operations are carried out in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC as well as by the general state of the PRC’s economy. The business may be influenced by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.

NOTE 14 – SUBSEQUENT EVENTS

The April Offering in 2008 and September Offering in 2008 included the issuance of warrants to purchase shares
of our common stock (See Note 7). As of September 30, 2009, there were 2,914,827 warrants outstanding. Between
October 1, 2009 and November 12, 2009, the holders of 1,924,309 warrants exercised their warrants, resulting in the issuance of 1,653,548 shares of common stock with net proceeds of approximately $237,561. Roth, the placement
agent also exercised the 246,224 warrants received in the May Offering in 2009 for 198,247 shares of common
stock. Approximately 990,518 warrants remain outstanding after these transactions.

On October 9, 2009, Yongye Nongfeng obtained a bank loan of $2,925,003 (RMB20,000,000) with annual interest rate of 5.31% and the term of twelve months. Buildings of $2,718,110 and land use right of $4,188,750 initial carrying value were pledged for the bank loan.

 
22

 

On October 10, 2009, the Company completed the Yongye Nonfeng Restructuring, whereby the Company acquired the land use right related to the manufacturing plant buildings from Inner Mongolia Yongye. Prior to this date and past of the process to complete the Yongye Nongfeng Restructuring, the Company acquired certain productive assets, including equipment and the manufacturing buildings from Inner Mongolia Yongye (See note 1 and note 7). The consideration paid for assets acquired from Inner Mongolia Yongye (the “Yong Ye Assets Acquisition”) consisted of cash of $4.7 million and the transfer of the Company's 4.5% equity interests in Yongye Nonfeng. On October 10, 2009, the Company transferred 4.5% of its equity interest in Yongye Nongfeng to Inner Mongolia Yongye.  The main purpose of the Company to acquire these productive assets is to expand the Company’s manufacturing business.

The Company will account for the Yong Ye Assets Acquisition as a business combination under ASC 805 whereby the Company will recognize and measure the identifiable assets acquired (including any intangible assets) and any liabilities assumed.  Management has determined that the acquisition date for this business combination was the closing date or on October 10, 2009, which is the date when all conditions precedent to the closing were met, including obtaining all the required licenses and permits from the PRC government to operate the Yong Ye Assets, obtaining approvals from the PRC government, and on which the Company legally transferred the equity interest in Yongye Nongfeng to Inner Mongolia Yongye.

The initial accounting for the business combination is incomplete, as the Company is in the process to finalize the fair values of 4.5% equity interest in Yongye Nongfeng and intangible assets acquired, if any. Upon the finalization of the purchase price allocation and the fair value of the consideration transferred, the Company will recognize any goodwill resulting from this business combination.

 
23

 
 
ITEM 2.
Management’s Discussion and Analysis of Operations and Financial Conditions.
 
The following discussion of the financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto. Except as otherwise indicated or as the context may otherwise require, all references to “we”, “the Company”, “us” and “our” refer to Yongye International, Inc. (f/k/a Yongye Biotechnology International, Inc.) and its consolidated subsidiaries. The following discussion contains forward-looking statements. The words or phrases “would be,” “will allow,” “expect to”, “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” or similar expressions are intended to identify forward-looking statements. Such statements include those concerning our expected financial performance, our corporate strategy and operational plans. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of risks and uncertainties, including: (a) those risks and uncertainties related to general economic conditions in China, including regulatory factors that may affect such economic conditions; (b) whether we are able to manage our planned growth efficiently and operate profitable operations, including whether our management will be able to identify, hire, train, retain, motivate and manage required personnel or that management will be able to successfully manage and exploit existing and potential market opportunities; (c) whether we are able to generate sufficient revenues or obtain financing to sustain and grow our operations; and (d) whether we are able to successfully fulfill our primary requirements for cash which are explained below under “Liquidity and Capital Resources”. Unless otherwise required by applicable law, we do not undertake, and we specifically disclaim any obligation, to update any forward-looking statements to reflect occurrences, developments, unanticipated events or circumstances after the date of such statement.
 
Company Overview
 
On April 17, 2008, we entered into a share exchange agreement (the “Exchange Agreement”) with Fullmax Pacific Limited, a company organized under the laws of the British Virgin Islands (“Fullmax”), the shareholders of Fullmax (the “Shareholders”), who together owned shares constituting 100% of the issued and outstanding ordinary shares of Fullmax (the “Fullmax Shares”), and our principal shareholder (the “Principal Shareholder”). Pursuant to the terms of the Exchange Agreement, the Shareholders transferred to us all of the Fullmax Shares in exchange for the issuance of 11,444,755 (the “Exchange Shares”) shares of our Common Stock (the “Share Exchange”). As a result of the Share Exchange, Fullmax became our wholly owned subsidiary and at that time, the Shareholders acquired approximately 84.7% of our issued and outstanding common stock.
 
Prior to the Share Exchange, we were a public “shell” company with nominal assets. We were incorporated in the State of Nevada on December 12, 2006 and were engaged in the business of offering sunless tanning services and selling tanning lotions. In 2008, we began to pursue an acquisition strategy, whereby we sought to acquire an undervalued business with a history of operating revenues in markets that provide room for growth.
 
Following the Share Exchange, we changed our name to Yongye Biotechnology International, Inc. and through our Cooperative Joint Venture subsidiary, Yongye Nongfeng Biotechnology Co. Ltd. (“Yongye Nongfeng”), are engaged in the research and development, manufacturing, distribution and sales of fulvic acid based liquid and powder nutrient compounds used in the agriculture industry.
 
Our headquarters is in Beijing, China and additional administrative offices and our manufacturing unit are located in Hohhot, Inner Mongolia, China. Currently, we sell two lines of products, both based on our fulvic acid compound base: a plant nutrition liquid compound and animal nutrition powder which is a food additive. Our products start with our proprietary fulvic acid base which is extracted from humic acid, and to which we add other natural substances to customize the base for use in our plant and animal product lines. Our plant products add naturally occurring macro and micro nutrients such as nitrogen, phosphorus, potassium, boron and zinc. Our animal products add natural herbs which help to reduce bacterial inflammation (mastitis) in cows. It also assists most animals digest food more completely and thus be more healthy. Based on industry research and government testing, we believe our proprietary technology for fulvic acid extraction creates some of the purest and most effective fulvic acid base on the market in China today. We believe our fulvic acid has a very light weight molecular composition, which may improve the overall permeability of cell walls, thus it allowing more complete transport of nutrients across plant membranes, and effectively strengthening the overall health of plants. We believe our proprietary process for extracting fulvic acid from humic acid and our patented process for mixing our plant nutrient and patent pending process for mixing our animal nutrient are key differentiators in the market. We believe this will help us ensure that we have a high quality product that we can control from procurement of raw materials to final production. We believe this also ensures our products provide reliable and predictable results from season to season.

 
24

 
 
In 2008, we sold approximately 5,100 tons of plant product (427,200 units), which represented 93% of revenue at USD $44.8M. We also sold approximately 6 tons of our animal product (approximately 98,000 units). This represented 7% of our total revenue or USD $3.25M. Yongye’s top 3 provinces by revenue for 2008 represented 82% of sales and were Hebei at $20,541,267 (43%), Xinjiang at $13,177,694 (27%) and Gansu at $ 5,663,011 (12%). By the end of 2008, our manufacturing partner’s capacity enabled us to sell approximately 10,000 ton per annum of Shengmingsu product. These facilities run at almost full capacity to meet peak season demands and store inventory for next year. On average, our Shengmingsu products sell for approximately $10,000 per ton.
 
Recent Developments
 
On June 11, 2009, we formed a corporation under the laws of the State of Nevada called “Yongye International, Inc.” (“Merger Sub”) and Yongye Biotechnology International, Inc. acquired one hundred of the shares of Merger Sub’s common stock for nominal cash. On June 23, 2009, Merger Sub was merged with and into Yongye Biotechnology International, Inc. As a result of the merger, Merger Sub ceased to exist and our corporate name was changed from “Yongye Biotechnology International, Inc.” to “Yongye International, Inc.” Except for the name change provided for in the Agreement and Plan of Merger, there was no change in our directors, officers, ownership structure or business.
 
On May 8, 2009, we entered into a securities purchase agreement (the “May Purchase Agreement”), with certain “accredited investors” (the “May Investors”) as such term is defined in the Securities Act of 1933, as amended (the “Securities Act”), for the issuance and sale of an aggregate of 5,834,083 shares of our Common Stock (the “May Shares”) for aggregate gross proceeds of approximately $8,984,488 (the “May Offering”). In connection with the May Offering, we entered into a registration rights agreement with the May Investors, in which we agreed to file a registration statement with the SEC to register for resale the May Shares and the Warrant Shares issuable upon the exercise of warrants issued to Roth as placement agent of the offering to purchase up to 246,224 shares of Common Stock (the “May Warrant Shares”), within 45 calendar days of the closing date of the May Offering, and to use our best efforts to have the registration statement declared effective within 150 calendar days of the closing date of the May Offering.  We are obligated to pay liquidated damages of 1% of the dollar amount of the May Shares sold in the May Offering per month, payable in cash, up to a maximum of 10%, if the registration statement is not filed and declared effective within the foregoing time periods.
 
The May Shares and May Warrant Shares were issued in reliance upon the private placement exemption from registration, Section 4(2) of the  Securities Act, due to the limited number of offerees and subsequent purchasers, the nature of activity by our placement agent, the availability and extent of information available to the offerees and subsequent purchasers, and the representations obtained by such subsequent purchasers regarding their financial sophistication and intent with respect to future transfers of such securities.

On October 9, 2009, Yongye Nongfeng obtained a bank loan of $2,925,003 (RMB20,000,000) with annual interest rate of 5.31% and the term of twelve months. Buildings of $2,718,110 and land use right of $4,188,750 initial carrying value were pledged for the bank loan.

On October 10, 2009, the Company completed the Yongye Nonfeng restructuring, whereby the Company acquired the land use right related to the manufacturing plant buildings from Inner Mongolia Yongye. Prior to this date and past of the process to complete the Yongye Nongfeng restructuring, the Company acquired certain productive assets, including equipment and the manufacturing buildings from Inner Mongolia Yongye. The consideration paid for assets acquired from Inner Mongolia Yongye consisted of cash of $4.7 million and the transfer of the Company's 4.5% equity interest in Yongye Nonfeng. On October 10, 2009, the Company transferred 4.5% of its equity interest in Yongye Nongfeng to Inner Mongolia Yongye.  The main purpose of the Company to acquire these productive assets is to expand the Company’s manufacturing business.

The Company will account for the Yong Ye assets acquisition as a business combination whereby the Company will recognize and measure the identifiable assets acquired (including any intangible assets) and any liabilities assumed.  Management has determined that the acquisition date for this business combination was the closing date or on October 10, 2009, which is the date when all conditions precedent to the closing were met, including obtaining all the required licenses and permits from the PRC government to operate the Yong Ye assets, obtaining approvals from the PRC government, and on which the Company legally transferred the equity interest in Yongye Nongfeng to Inner Mongolia Yongye.

The initial accounting for the business combination is incomplete, as the Company is in the process to finalize the fair values of 4.5% equity interest in Yongye Nongfeng and intangible assets acquired, if any. Upon the finalization of the purchase price allocation and the fair value of the consideration transferred, the Company will recognize any goodwill resulting from this business combination.

 
25

 
 
Factors affecting our operating results
 
Demand for Our Products
 
One major tenet of the PRC government’s 11th Five-Year National Economic and Social Plan (the “NESDP”) (2006-2010) is the focus towards developing China’s western region. This is one of the top-five economic priorities of the nation. The goal is to increase rural income growth which will in turn increase demand for more food and agriculture products. Currently, a large majority of our products are sold in this western region and we hope that this government focus will increase our opportunity to sell more plant and animal nutrients to farmers who have to keep up with the demand for higher quantity and higher quality of products.
 
According to the Asian Development Bank statistics, well over 60% of the nation’s total population of 1.3 billion people is comprised of low-income, rural farmers. According to the NESDP (2006-2010), raising the level of rural income is a top economic and social goal for the country. Many government initiatives, including removal of certain agricultural and local product taxes, have been implemented to spur rural income development. The government expects annual rural income to grow between 5% and 10% through 2010 (according to a study issued by the Chinese Academy of Sciences, in April 2009). Additionally, according to the National Population and Family Planning Commission, China’s population will reach 1.5 billion by 2030. Therefore, the country has the challenge of producing approximately 100 million more tons of crops needed to feed the additional 200 million people, which has put pressure on the agricultural system to increase production capacity.
 
Supply of Finished Goods
 
Before June 1, 2009, we purchased our finished goods from our main supplier, Inner Mongolia Yongye and then sold them through our distribution system. In order to generate greater profit margins, we set out to control our cost of goods sold and have put into place a fixed rate contract with our main supplier. Each quarter we will go through a review process with our supplier to adjust the fixed rate for the next quarter. We have not received any rate increases in 2008, or to date in 2009. Starting from June 1, 2009, we commenced the manufacturing of our product as part of the restructuring process. The Company obtained the building and land use right from Inner Mongolia on September 16, 2009 and October 10, 2009, respectively.
 
Earthquake in Sichuan
 
The earthquake in Sichuan was a devastating event in the recent history of China. While the impact was felt all the way to Beijing, the disruption of business and the ensuing relief efforts were largely contained to the province itself and mainly to the areas nearest the epicenter. Because of this, the impact to our business was minimal. China’s Agriculture Minister Sun Zhengcai said in an interview with Xinhua that, “The earthquake will not change the nation-wide situation of agricultural production this year since local output of the affected area is quite small compared to that of the whole country,” Sun acknowledged that, “The damage was mainly to planted crops and livestock,” he said, adding an urgent harvesting and planting effort has helped minimize the impact and which had no national implications.” Furthermore, he said that “food security remains guaranteed.”
 
Seasonality
 
Our Shengmingsu products faces seasonality similar to other companies in our sector. In general, the first and fourth quarters are typically our slowest quarters and in 2008 we brought in approximately 20% and 6% respectively of our total net sales in these quarters. The second and third quarters drive the bulk of our overall sales with 36% and 38% respectively of the year’s net sales.
 
26

 
Drought
 
In the last half year of 2008, it was widely reported that China faced substantial drought conditions in important agricultural areas (as noted by The Economist in its “China’s Dry Patch” article dated February 6, 2009). This led many to the conclusion that this weather condition would have an overall negative impact on China’s annual agricultural output for 2008 and potentially for 2009 which would then have an impact on our company’s revenue. At the time, we did not believe this to be the case and set out to corroborate this with related government agencies, our sales and support staff, distributors, and branded store network owners in our provincial locations. We then gathered localized information about ways the drought might impact our distributors, their customers and our end users and found that they believed it would not create an impact on their sales and thus on our revenue for 2008. We also do not believe it will impact our sales activities in 2009 at this point in time.
 
In the ensuing months after the initial reports, there were several key events which occurred to mitigate some of the impact of the drought conditions faced by the farmers such as additional governmental spending on increased efforts to irrigate land using other water sources and additional rainfall which fell on once drought impacted areas in northern China, as reported in Xinhua on February 9, 2008. The State Flood Control and Drought Relief Headquarters reported that there was a reduction of farmland affected because of these key events (Xinhua February 9, 2008). The government has also begun their stimulus injections into the agriculture community to help ward off the affects of any drought induced financial hardships (as reported in USA Today, February 8, 2009).
 
Additionally, we believe that several market conditions also bode well for us in the sales of our plant product during this time. Overall, the drought has impacted northern China and primarily large field crop growers such as wheat, corn and soy bean. Currently, our distributors concentrate on selling to farmers who grow economic crops such as tomatoes, celery, turnips, and carrots though in Xinjiang province our product is used on larger farms where field crops are grown such as Lajiao peppers. Additionally, in all drought situations, we believe that the drought resistant nature of our plant product will actually benefit crops because of the increased water retention characteristics of our product. Internal research has shown that fulvic acid has the ability to strengthen plant cells and root systems which then allows plants to retain water more effectively and use it more efficiently. This, along with other mitigating factors discussed above, should help us minimize the impact of the 2008 fall and winter drought on our sales in our current market area.
 
Agriculture Sector
 
Agriculture continues to be a heavily invested sector in China. Brand name investors continue to invest into China’s agriculture space because they have confidence in China’s long term outlook. The market volume for agriculture products is large, both for domestic sales and export and there is no set threshold for foreign investment into the sector as opposed to other industries, such as energy, finance, mining, and telecommunications. This is driven by the growing demand for higher quality food products domestically and international reliance on food products from China. Currently, China is the world’s biggest grower and consumer of grains and yet must boost crop yields by at least 1 percent a year to ensure the country has enough food to feed its 1.3 billion people, according to the Minister of Agriculture, Sun Zhengcai (China Economic Net, July 21, 2008). Additional policy changes will include protecting farmland and working to increase rural incomes to retain farming interest.
 
The goal is to maintain self-sufficiency in food production because no other country can feed the world’s biggest population, according to Sun.  ”Our strategy must be based on stable farmland, and seeking ways to improve yields,” Sun said in a speech to local officials, outlining the government’s near- and long-term agriculture policy and objectives. China, which harvested more summer crops, aims also to boost grain and oilseed output this year, Sun said. To ensure next year’s crops, officials must “stabilize” area planted in winter wheat and use idle land in the off season to grow rapeseed, Sun said.
 
This growth, however, does not come without challenges and China has faced many of these with regards to the continued concern over the quality of milk and eggs sold both domestically and internationally in the dairy industry.  We believe that the government is making every effort to bring back consumer confidence in these domestically produced products and overall this will bring about an even stronger industry once planned new licensing and safety procedures have been put into place.
 
New Land Reform Policy
 
Farmland in China is owned by the local government, but given to local farmers under 30 year use contracts. With the allure of higher incomes and better living conditions in the city, farmers have abandoned the land and no others farmers have stepped in to bring it back into production. This has created a shortage of a key raw material in the agricultural supply chain productive land. The government has acknowledged this issue and recently enacted a new land use reform policy which liberalizes the exchange of land among the nation’s farmers. This creates a new model for China’s 730 million farmers with the idea being to create more stable farmland by shifting the country away from the single household farm plot model to the amalgamation of larger-scale operations which should be more productive due to technology and economies of scale. Farmers will be able to transfer their land-use rights to others through a new market system for rural land-use rights. Chinese authorities commented that, “Without modernizing agriculture, China cannot modernize; without stability and prosperity in rural areas, China cannot have stability and prosperity. These changes are enacted to “ensure national food security and the supply of major agricultural products, and promote increases in agricultural production, farm incomes and rural prosperity.” (China’s Ongoing Agriculture Modernization, USDA, April 2009)

 
27

 

RESULTS OF OPERATIONS
 Summary Statement of Operations Data
  
   
For the Three Months Ended
   
For the Nine Months Ended
 
  
 
September 30, 2009
   
September 30, 2008
   
September 30, 2009
   
September 30, 2008
 
   
 
   
 
   
 
   
 
 
SALES
 
 
   
 
   
 
   
 
 
External customers
  $ 29,279,473     $ 18,202,940     $ 85,766,709     $ 45,189,579  
Related party
     -         -         2,220,083         -   
                                 
TOTAL SALES
    29,279,473       18,202,940       87,986,792       45,189,579  
                                 
COST OF SALES
     13,435,326         9,278,944         41,274,810         21,697,964   
                                 
GROSS PROFIT
    15,844,147       8,923,996       46,711,982       23,491,615  
                                 
SELLING EXPENSES
    2,644,715       3,440,036       11,715,707       7,437,513  
                                 
RESEARCH & DEVELOPMENT EXPENSES
    69,871       -       1,482,888       -  
                                 
GENERAL AND ADMINISTRATIVE EXPENSES
     1,365,075         453,683         2,495,797         1,265,808   
                                 
INCOME FROM OPERATIONS
    11,764,486       5,030,277       31,017,590       14,788,294  
                                 
OTHER EXPENSES/(INCOME)
                               
Interest Expense/(income), net
    9,080       (65,785 )         25,538       (66,563 )  
Other Expenses /(income), net
    (174,593 )         340,087       (187,330 )         726,927  
Increase/(decrease) in fair value of derivative liabilities
     15,836,189         (3,618,579 )          20,905,136         (1,464,256 )  
                                 
TOTAL OTHER EXPENSES/(INCOME), NET
     15,670,676         (3,344,277 )          20,743,344         (803,892 )  
                                 
(LOSS)/INCOME BEFORE PROVISION FOR INCOME TAXES
    (3,906,190 )         8,374,554       10,274,246       15,592,186  
                                 
PROVISION FOR INCOME TAXES
     3,089,047         227,537         7,836,270         822,302   
                                 
NET (LOSS)/INCOME
    (6,995,237 )         8,147,017       2,437,976       14,769,884