10-Q 1 v239249_10q.htm 10-Q 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, 2011
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 001-34444
 
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.)
 
6th Floor, Suite 608, Xue Yuan International Tower,
No. 1 Zhichun Road, Haidian District Beijing, PRC
(Address of principal executive offices)
 
 
(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 x     No ¨
 
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 x     No ¨
 
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 x
Non-accelerated filer ¨ (Do not check if a smaller reporting company)
Smaller reporting company ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨     No x
 
As of November 4, 2011, there were 50,537,044 shares of common stock, par value $.001 per share, issued and outstanding.
 
 
 

 
 
TABLE OF CONTENTS
 
     
Page
       
PART I. FINANCIAL INFORMATION
2
 
ITEM 1.
FINANCIAL STATEMENTS
2
 
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITIONS.
22
 
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  36
 
ITEM 4.
CONTROLS AND PROCEDURES
  37
     
PART II. OTHER INFORMATION   38
 
ITEM 1.
LEGAL PROCEEDINGS
  38
 
ITEM 1A.
RISK FACTORS
  38
 
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  60
 
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
60
 
ITEM 4.
(REMOVED AND RESERVED)
  60
 
ITEM 5.
OTHER INFORMATION
60
 
ITEM 6.
EXHIBITS
  60
 
 
i

 
 
PART I.
 
FINANCIAL INFORMATION
 
ITEM 1.
FINANCIAL STATEMENTS

YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES 
UNAUDITED CONSOLIDATED BALANCE SHEETS
 
   
Note
   
September 30, 2011
   
December 31, 2010
 
Current assets
                 
Cash
        $ 80,384,153     $ 41,913,469  
Restricted cash
          40,000       40,000  
Accounts receivable, net of allowance for doubtful accounts
    3       203,737,536       26,110,813  
Inventories
    4       48,634,045       65,878,047  
Deposits to suppliers
    5       5,265,686       10,906,295  
Prepaid expenses
            1,475,844       733,429  
Other receivables
            495,742       760,377  
Deferred tax assets, net
            -       158,675  
Total Current Assets
            340,033,006       146,501,105  
                         
Property, plant and equipment, net
    6       22,219,224       21,547,152  
Intangible asset, net
    7       22,243,738       23,598,739  
Land use right, net
    8       5,895,649       4,218,006  
Prepayment for mining project
    9       35,307,731       34,151,063  
Other assets
    10       17,408,099       7,325,049  
Goodwill
            10,633,263       10,284,922  
Total Assets
          $ 453,740,710     $ 247,626,036  
                         
Current liabilities
                       
Long-term loans and payables - current portion
    11     $ 2,153,241     $ 457,880  
Short-term bank loan
    13       15,636,728       -  
Accounts payable
            10,601,468       6,127,606  
Income tax payable
            15,696,964       6,137,119  
Advance from customers
            181,681       60,841  
Accrued expenses
    14       21,348,144       3,024,235  
Other payables
    12       3,337,617       5,310,517  
Derivative liabilities - fair value of warrants
    15       503,018       1,036,268  
Total Current Liabilities
            69,458,861       22,154,466  
                         
Long-term loans and payables
    11       3,699,863       383,285  
Total Liabilities
            73,158,724       22,537,751  
                         
Redeemable Series A convertible preferred shares: par value $.001; 7,969,044 shares authorized; 5,681,818 shares issued and outstanding as of September 30, 2011
    15       49,399,990       -  
Equity
                       
Common stock: par value $.001; 75,000,000 shares authorized; 49,370,711 shares issued and outstanding at September 30, 2011 and 48,187,044 shares issued and outstanding at December 31, 2010
            49,371       48,187  
Additional paid-in capital
            149,549,255       144,599,839  
Retained earnings
            150,970,751       63,943,371  
Accumulated other comprehensive income
            15,224,143       6,623,806  
Total equity attributable to Yongye International, Inc.
            315,793,520       215,215,203  
Noncontrolling interest
            15,388,476       9,873,082  
Total Equity
            331,181,996       225,088,285  
                         
Commitments and Contingencies
    19       -       -  
                         
Total Liabilities, Redeemable Series A Convertible Preferred Shares and Equity
          $ 453,740,710     $ 247,626,036  
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.
 
 
2

 
 
 YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
 
         
For the Three Months Ended
   
For the Nine Months Ended
 
   
Note
   
September 30,
2011
   
September 30,
2010
   
September 30,
2011
   
September 30, 
2010
 
                               
Sales
        $ 140,593,777     $ 71,752,069     $ 345,519,853     $ 186,101,173  
                                       
Cost of sales
          55,013,997       29,639,662       140,874,455       80,095,965  
                                       
Gross profit
          85,579,780       42,112,407       204,645,398       106,005,208  
                                       
Selling expenses
          25,557,635       15,574,981       62,391,878       38,206,314  
                                       
Research and development expenses
          4,541,392       2,170,951       11,150,006       4,509,847  
                                       
General and administrative expenses
          4,854,225       3,530,638       17,718,549       6,996,584  
                                       
Income from operations
          50,626,528       20,835,837       113,384,965       56,292,463  
                                       
Other (expenses)/income
                                     
Interest expense
          (496,509 )     (19,164 )     (806,371 )     (56,718 )
Interest income
          40,702       12,552       67,866       35,377  
Subsidy income
          -       1,427,259       655,071       1,751,732  
Other (expenses)/income, net
          76,321       2,067       177,940       (84,294 )
Change in fair value of derivative liabilities
    15       119,663       (12,077 )     533,250       157,393  
                                         
Total other (expenses)/income, net
            (259,823 )     1,410,637       627,756       1,803,490  
                                         
Earnings before income tax expense
            50,366,705       22,246,474       114,012,721       58,095,953  
                                         
Income tax expense
    17       9,116,471       3,705,985       21,876,518       9,389,307  
                                         
Net income
            41,250,234       18,540,489       92,136,203       48,706,646  
                                         
Less: Net income attributable to the noncontrolling interest
            2,126,046       962,222       5,108,823       2,511,385  
                                         
Net income attributable to Yongye International, Inc.
          $ 39,124,188     $ 17,578,267     $ 87,027,380     $ 46,195,261  
                                         
Earnings per share:
                                       
Basic earnings per common stock
    21     $ 0.69     $ 0.37     $ 1.66     $ 1.02  
Diluted earnings per common stock
    21     $ 0.69     $ 0.37     $ 1.65     $ 1.01  
                                         
Weighted average shares used in computation:
                                       
Basic earnings per common stock
    21       49,370,711       47,130,522       48,948,944       45,423,109  
Diluted earnings per common stock
    21       49,472,773       47,248,570       49,057,131       45,541,985  

The accompanying notes are an integral part of these unaudited consolidated financial statements.  
 
 
3

 
 
YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2011
 
          
Redeemable Series A Convertible
Preferred Shares
   
Common Stock
                     
Equity
             
                                             
Accumulated
   
attributable to
             
                                 
Additional
         
Other
   
Yongye
             
                                 
Paid-in
   
Retained
   
Comprehensive
   
International,
   
Noncontrolling
   
Total
 
   
Note
   
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Earnings
   
Income
   
Inc.
   
Interest
   
Equity
 
Balance as of January 1, 2011
              $ -       48,187,044     $ 48,187     $ 144,599,839       63,943,371       6,623,806       215,215,203       9,873,082       225,088,285  
Net income
                        -       -       -       87,027,380       -       87,027,380       5,108,823       92,136,203  
Foreign currency exchange translation adjustment, net of nil income taxes
          -       -       -       -       -       -       8,600,337       8,600,337       406,571       9,006,908  
Comprehensive income
                                                                  95,627,717       5,515,394       101,143,111  
Stock compensation to management and independent directors
    15               -       1,183,667       1,184       4,949,416       -       -       4,950,600       -       4,950,600  
Issuance of redeemable Series A convertible preferred shares
    15       5,681,818       49,399,990       -       -       -       -       -       -       -       -  
Balance as of September 30, 2011
            5,681,818     $ 49,399,990       49,370,711     $ 49,371     $ 149,549,255       150,970,751       15,224,143       315,793,520       15,388,476       331,181,996  

The accompanying notes are an integral part of these unaudited consolidated financial statements.
 
 
4

 
 
YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

   
For the Nine Months Ended
 
   
September 30,
2011
   
September 30,
2010
 
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net income
  $ 92,136,203     $ 48,706,646  
Adjustments to reconcile net income to net cash used in operating activities:
               
Depreciation and amortization
    5,320,798       2,249,302  
Change in fair value of derivative liabilities
    (533,250 )     (157,393 )
Stock compensation expense
    4,950,600       -  
Deferred tax expense
    162,234       -  
Changes in operating assets and liabilities:
               
Accounts receivable
    (174,681,910 )     (68,136,061 )
Inventories
    19,215,136       2,932,733  
Deposits to suppliers
    6,490,269       (3,102,063 )
Prepaid expenses
    (701,236 )     (719,328 )
Other receivables
    280,068       156,678  
Other assets
    (5,937,069 )     (5,954,038 )
Accounts payable-third parties
    4,067,065       352,970  
Accounts payable-related parties
    -       (880,505 )
Income tax payable
    9,233,827       3,626,988  
Advance from customers
    102,835       1,391,839  
Accrued expenses
    17,837,436       10,250,425  
Other payables
    1,546,503       (59,319 )
Net Cash Used in Operating Activities
    (20,510,491 )     (9,341,126 )
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Change in restricted cash
    -       (40,000 )
Payment for intangible asset
    (3,000,000 )     -  
Payment for mining project
    -       (28,866,259 )
Payment for land use right
    (1,600,867 )     -  
Proceeds from sale of property, plant and equipment
    -       92,629  
Purchase of property, plant and equipment
    (1,753,420 )     (6,464,728 )
Purchase of property, plant and equipment from a related party
    -       (1,663,769 )
Net Cash Used in Investing Activities
    (6,354,287 )     (36,942,127 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Proceeds from short-term bank loans
    15,384,852       -  
Repayment of long-term loans and payables
    (820,207 )     (447,800 )
Repayment of short term loans
    -       (2,925,675 )
Proceeds from preferred shares, net of issuance cost of $600,010
    49,399,990       -  
Proceeds from common stock issued and warrants exercised
    -       8,634,397  
Net Cash Provided by Financing Activities
    63,964,635       5,260,922  
                 
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH
    1,370,827       472,113  
NET INCREASE /(DECREASE) IN CASH
    38,470,684       (40,550,218 )
Cash at beginning of period
    41,913,469       65,518,181  
Cash at end of period
  $ 80,384,153     $ 24,967,963  
                 
Supplemental cash flow information:
               
Cash paid for income taxes
    12,480,456       5,765,758  
Cash paid for interest expense
    633,874       70,960  

Noncash investing and financing activities:
During the nine months ended September 30, 2011 and 2010, the Company acquired certain other assets of $5,504,199 and $452,432, respectively, by assuming long-term loans and payables.
 
The accompanying notes are an integral part of these unaudited consolidated financial statements.
 
 
5

 
 
 YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011 AND 2010

NOTE 1 -ORGANIZATION AND DESCRIPTION OF BUSINESS

Yongye International, Inc. (the “Company”) was incorporated in the State of Nevada on December 12, 2006. On April 17, 2008, the Company and the Company’s then principal shareholder 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 all the shareholders of Fullmax (the “Fullmax Shareholders”). 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 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 a nominal amount of cash and, Fullmax, through its wholly-owned subsidiary, Asia Standard Oil Limited (“ASO”) and indirect subsidiary, Yongye Nongfeng Biotechnology Co., Ltd. (“Yongye Nongfeng”), was engaged in the sale of fulvic acid based liquid and powder nutrient compounds. 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 entered into a Sino-Foreign cooperative joint venture contract with Inner Mongolia Yongye Biotechnology Co., Ltd. (“Inner Mongolia Yongye”) to form Yongye Nongfeng, pursuant to which, Inner Mongolia Yongye and ASO were 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 equity interest in Inner Mongolia Yongye.

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 industry. 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 connection with the September Offering (See Note 15), the Company entered into agreements to acquire the productive assets of Shengmingsu manufacturing business from Inner Mongolia Yongye (the “Acquisition”). In October, 2009, the Company completed the Acquisition. The consideration paid for the Acquisition consisted of cash of $4.7 million and 4.5% equity interests in Yongye Nongfeng. After the Acquisition, Inner Mongolia Yongye and ASO became 5% and 95% equity interest owner of Yongye Nongfeng, respectively.

On July 20, 2010, Yongye Nongfeng set up a wholly-owned subsidiary, Inner Mongolia Yongye Fumin Biotechnology Co., Ltd. (“Yongye Fumin”), with registered capital of $14,731,880 (equivalent to RMB 100 million). Yongye Fumin is engaged in the manufacturing and sale of fulvic acid based liquid and powder nutrient compounds. Yongye Fumin was established to expand the production capacity for fulvic acid based liquid and powder nutrient compounds, and to produce humic acid using lignite coal (See Note 9). The construction of the production plant of Yongye Fumin, which is located in Wuchuan County, was completed in the fourth quarter of 2010.
 
 
6

 
 
In May 2011, the Company entered into a securities purchase agreement with MSPEA Agriculture Holding Limited (“MSPEA”), an affiliate of Morgan Stanley, and Full Alliance International Limited (“Full Alliance”), the Company’s largest shareholder. According to the agreement, the Company issued 5,681,818 shares of redeemable Series A convertible preferred shares to MSPEA on June 9, 2011 (“Issuance Date”) for total gross proceeds of $50 million. The redeemable Series A convertible preferred shares can be converted into common stock of the Company at an initial conversion price of $8.80 subject to certain adjustments as specified in the agreement (See Note 15).
  
NOTE 2 -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted as permitted by rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). The December 31, 2010 consolidated balance sheet was derived from the audited consolidated financial statements of the Company. The accompanying unaudited consolidated financial statements should be read in conjunction with the December 31, 2010 audited consolidated financial statements of the Company included in the Company’s annual report on Form 10-K for the year ended December 31, 2010. 

In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of the financial position as of September 30, 2011, the results of operations for the three and nine months ended September 30, 2011 and 2010 and cash flows for nine months ended September 30, 2011 and 2010, have been made. 

The Company’s business is subject to seasonal variations; thus, the results of operations for the three months ended September 30, 2011 are not necessarily indicative of the results for the full fiscal year ending December 31, 2011. Generally, the second and third quarters are peak sales periods, and first and fourth quarters are low sales periods for the Company.

All significant intercompany transactions and balances are eliminated on consolidation.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
 
In June 2011, the FASB issued Accounting Standard Update (“ASU”) 2011-05, Comprehensive income (Topic 220), Presentation of Comprehensive Income. ASU 2011-05 increases the prominence of other comprehensive income in financial statements. Under this ASU, an entity will have the option to present the components of net income and comprehensive income in either one or two consecutive financial statements. The ASU eliminates the option in U.S. GAAP to present other comprehensive income in the statement of changes in equity. An entity should apply the ASU retrospectively. For a public entity, the ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted.
 
NOTE 3 – ACCOUNTS RECEIVABLE

Accounts receivable at September 30, 2011 and December 31, 2010 consisted of the following:

   
September 30, 2011
   
December 31, 2010
 
             
Accounts receivable
 
$
203,737,536
   
$
26,110,813
 
Less: allowance for doubtful accounts
   
-
     
-
 
Total
 
$
203,737,536
   
$
26,110,813
 

No provision for allowance for doubtful accounts was recorded as of September 30, 2011 and December 31, 2010 as management believes no accounts are uncollectible as of September 30, 2011 and December 31, 2010. There were no write-off of accounts receivable for the three and nine months ended September 30, 2011 and September 30, 2010.

 
7

 

The Company provides credit terms of up to six months to customers with well-established trading records.
 
NOTE 4 – INVENTORIES

Inventories at September 30, 2011 and December 31, 2010 consisted of the following:

   
September 30, 2011
   
December 31, 2010
 
             
Finished goods
  $ 31,094,924     $ 50,435,480  
Work in progress
    14,669,571       14,683,295  
Raw materials
    2,622,943       641,051  
Consumables and packing supplies
    246,607       118,221  
Total
  $ 48,634,045     $ 65,878,047  

NOTE 5 – DEPOSITS TO SUPPLIERS

The Company is required to pay deposits to the suppliers for the full amount of certain raw materials ordered. These raw materials primarily consist of lignite coal, chemical component materials and packing materials, and are expected to be delivered to the Company before the end of December 2011. The lignite coal and most chemical component materials will be consumed in the production process at Yongye Fumin. As of September 30, 2011 and December 31, 2010, the deposits to suppliers for raw materials amounted to $5,228,892 and $10,845,221, respectively, and deposits to other service providers amounted to $36,794 and $61,074, respectively.

The Company’s decision to make advanced orders of raw materials is mainly based upon (1) the current and projected future market price of raw materials, (2) the demand and supply situation in the raw materials market, and (3) the forecasted demand of products.

NOTE 6 – PROPERTY, PLANT AND EQUIPMENT
 
Property, plant and equipment at September 30, 2011 and December 31, 2010 consisted of the following:

   
September 30, 2011
   
December 31, 2010
 
             
Buildings
  $ 14,246,804     $ 13,168,830  
Machinery and equipment
    6,978,464       6,567,721  
Office equipment and furniture
    508,776       484,468  
Vehicles
    2,392,469       2,110,077  
Software
    19,795       19,146  
Leasehold improvements
    897,781       754,085  
      25,044,089       23,104,327  
Less: Accumulated depreciation and amortization
    2,824,865       1,557,175  
                 
Property, plant and equipment, net
  $ 22,219,224     $ 21,547,152  

Depreciation expense related to property, plant and equipment for the three months ended September 30, 2011 and 2010 was $434,217 and $189,548, respectively. Depreciation expense related to property, plant and equipment for the nine months ended September 30, 2011 and 2010 was $1,267,690 and $539,793, respectively. 

As of September 30, 2011 and December 31, 2010, twenty-five vehicles with initial carrying amount of $1,427,771 were pledged as security for the long-term banks loans of $232,066 and $315,426, respectively, provided by the banks for the purchase of the vehicles (See Note 11).

 
8

 

NOTE 7 – INTANGIBLE ASSET

Intangible asset at September 30, 2011 and December 31, 2010 consisted of the following:
 
   
September 30, 2011
 
   
Weighted
                   
   
average
   
Gross
         
Net
 
   
amortization
   
carrying
   
Accumulated
   
carrying
 
   
period
   
amount
   
amortization
   
amount
 
Amortizing intangible assets:
                       
Customer List
 
9 years
   
$
25,748,935
     
(3,576,241)
     
22,172,694
 
Patent
 
10 years
     
113,671
     
(42,627)
     
71,044
 
Total
       
$
25,862,606
     
(3,618,868)
     
22,243,738
 

   
December 31, 2010
 
   
Weighted
                   
   
average
   
Gross
         
Net
 
   
amortization
   
carrying
   
Accumulated
   
carrying
 
   
period
   
amount
   
amortization
   
amount
 
Amortizing intangible assets:
                       
Customer List
 
9 years
   
$
24,905,410
     
(1,383,634)
     
23,521,776
 
Patent
 
10 years
     
109,947
     
(32,984)
     
76,963
 
Total
       
$
25,015,357
     
(1,416,618)
     
23,598,739
 
 
Amortization expense for the three months ended September 30, 2011 and 2010 was $748,742 and $677,302, respectively. Amortization expense for the nine months ended September 30, 2011 and 2010 was $2,202,250 and $682,630, respectively. The estimated annual amortization expense for intangible asset in each of the next five years is $2,864,298.

On July 1, 2010, Yongye Nongfeng entered into an agreement with its provincial level distributor in Hebei Province, the PRC (“Seller”) to purchase the customer list, including the customer relationships, from Seller (“Customer List”). The acquisition of the Customer List allows Yongye Nongfeng to sell its products to sub-provincial level or regional distributors in Hebei Province directly. The consideration of the Customer List was 3,600,000 shares of common stock of the Company which was issued in July 2010 and $3 million cash. The $3 million cash consideration was paid in March 2011.

We determined that a nine-year period to amortize the customer list was appropriate, following the pattern in which the expected benefits of the acquired asset will be consumed or otherwise used up. The Company’s contract period with the provincial distributors (including sub-provincial level distributors after the acquisition) generally is for a period of three-years. The Company believes that it has historical experience in renewing or extending similar distributor contracts, which is consistent with the intended use of the Customer List. There are no legal or regulatory provisions that limit the useful life of the Customer List or that cause the cash flows and useful life of the Customer List to be constrained. In addition, the Company expects the effect of obsolescence, demand, competition, and other economic factors to be minimal.

The Company engaged an independent third party valuation firm in determining the fair value of the Customer List. The fair value of the Customer List was determined using an income approach and considered assumptions (including turnover rate) that a market participant would make consistent with the highest and best use of the asset by market participants. The period of expected cash flows used to measure the fair value of the Customer List was nine years. Without evidence to the contrary, the Company expects that the Customer List will be renewed or extended at the same rate as a market participant would expect, and no other factors would indicate a different useful life is more appropriate. Accordingly, in light of the absence any other of the entity-specific factors, the useful life of the Customer List was determined to be nine years.

 
9

 

A straight-line method of amortization has been adopted as the pattern in which the economic benefits of the Customer List are used up cannot be reliably determined.
 
NOTE 8 – LAND USE RIGHT

As of September 30, 2011 and December 31, 2010, land use right represented:

 
September 30, 2011
   
December 31, 2010
 
           
Land use right
$ 6,083,888     $ 4,331,801  
Less: Accumulated amortization
  188,239       113,795  
Total
$ 5,895,649     $ 4,218,006  

NOTE 9 - PREPAYMENT FOR MINING PROJECT

On March 1, 2010, the Company entered into an agreement with its major humic acid supplier, Wuchuan Shuntong Humic Acid Company Ltd. (“Vendor”), to acquire the permit for the rights to explore, develop and produce lignite coal resources (the “Mineral Right”) in a certain area (the “Project Site”) of Wuchuan County. The cash consideration of the permit is approximately RMB 240 million or USD $35 million. The permit allows the Company to complete all necessary administrative procedures and obtaining government approvals to acquire the Mineral Right. Pursuant to the agreement, Vendor is to assist the Company in completing all necessary administrative procedures and obtaining government approvals.

In August 2011, Inner Mongolia’s Ministry of Land and Resources granted the Company a Mineral Resource Exploration Permit which gives it exclusive exploration rights for the 29.74 square kilometer Project Site for an initial period of three years effective August 2, 2011. As of September 30, 2011, the Company has not obtained certain government approvals, including Geologic Report and Geologic Exploration Report, for it to acquire the Mineral Right. The Company believes the cost to be incurred in completing the remaining administrative procedures and obtaining government approvals are not significant. The Project Site in Wuchuan is located near Yongye Fumin’s product plant which manufactures the majority of the Company’s products. The Company believes the acquisition of the Mineral Right will allow it to secure a long term supply of humic acid, which is a major raw material used in the manufacture of fulvic acid based liquid and powder nutrient compounds, and which is sourced from lignite coals.
 
NOTE 10 – OTHER ASSETS

The Company entered into agreements with certain distributors, including sub-distributors pursuant to which the Company provided the distributor a free vehicle in exchange for the distributor agreeing to comply with certain sale conditions during the term of the agreement of five years.  The sales conditions included (1) meeting the annual sales target set by the Company; (2) not selling the products at a price lower than the price stipulated by the Company; and (3) selling the products only in Company’s approved territories.  To the extent the distributor fails any one of these conditions during the term of the agreement, the Company has the right to have the vehicles return back to the Company.

The cost of these vehicles has been recorded as “Other asset” which is expensed over a five-year period in “Cost of Sales”.

NOTE 11 – LONG-TERM LOANS AND PAYABLES

As of September 30, 2011 and December 31, 2010, the long-term loans and payables consisted of the following:

 
September 30, 2011
   
December 31, 2010
 
           
Vehicle loans-employees
$ 232,066     $ 315,426  
Vehicle loans-distributors
  5,621,038       525,739  
Total
$ 5,853,104     $ 841,165  

 
10

 

As of September 30, 2011 and December 31, 2010, vehicle-employees loans of $232,066 and $315,426, respectively, were secured by twenty-five vehicles with initial carrying amount of $1,427,771. The vehicle loans are payable in monthly installments over three to five years. Interest rates on the loans range from 5.40% to 14.54% annually, and are subject to the change of the base interest rate prescribed by People’s Bank of China. The vehicle loans were obtained by individual employees of the Company after the Company made the initial down payment of the purchase price of the vehicles. The Company and the individual employees entered into trust agreements that stipulate that (i) the vehicles are legally registered under the individuals’ name, (ii) the Company has the rights of official use, (iii) the Company has the rights to the legal title of the vehicles at all times and entitles it to change the registered owner to the Company or designated third party at any time, (iv) the Company assumes the risk of loss, damage, penalty and other obligations related to the operation and ownership of the vehicle to the extent that the loss or damages were not caused by the individuals’ improper use of the vehicle, (v) the individuals have no right to sell, lease, lend or pledge the vehicles to any other person or entity, and (vi) the Company is obligated to repay the loans in full, and to bear the costs of the related repairs, maintenance, insurance and taxes. Consequently, the Company has recognized the cost of the vehicles as other assets and the loans as liabilities in its consolidated balance sheet.
 
Vehicle loans-distributors represented loans that were initially obtained by the distributors from banks and financial institutions. The Company and the distributors entered into agreements, pursuant to which the Company would assume the full repayment of the loans on behalf of these distributors in exchange for the distributors agreeing to comply with certain sales conditions (See Note 10). The loans have two or three years terms and are payable in monthly installments. Interest rates on the loans range from 5.40% to 17.24% annually, subject to the change of the base interest rate prescribed by People’s Bank of China.

The aggregate maturities of the long-term loans and payables for each of the five years subsequent to September 30, 2011 are: $2,153,241, $2,111,862, $1,583,896, $4,105, and $0, respectively.

NOTE 12 – OTHER PAYABLES

Other payable as of September 30, 2011 mainly represented payable of $1,209,207 for the construction of the production plant in Yongye Fumin and non-income tax payable of $1,852,719. Other payable as of December 31, 2010 mainly represented consideration payable of approximately $3 million for the acquisition of Customer List (See Note 7), and payable of $1,852,473 for the construction of the production plant in Yongye Fumin.
 
NOTE 13 – SHORT TERM BANK LOAN
 
In April 2011, Yongye Nongfeng obtained two short-term bank loans of RMB 52,500,000 (equivalent to $8,209,282) and RMB 47,500,000 (equivalent to $7,427,446), with fixed annual interest rate of 7.878% and 8.203%, respectively, from China Everbright Bank. These two short-term bank loans are guaranteed by the Company’s Chairman and are due on April 1, 2012 and April 18, 2012, respectively.

NOTE 14 – ACCRUED EXPENSES

As of September 30, 2011 and December 31, 2010, the accrued expenses primarily consisted of accrued advertising and promotion expenses of $14,279,874 and $524,668, respectively, accrued R&D expenses of $3,911,547 and $6,914, respectively, and accrued freight charges of $479,358 and $1,161,333, respectively.
 
NOTE 15 – EQUITY FINANCING

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”) and 1,623,905 warrants (See below) for aggregate gross proceeds equal to $10,000,651 (the “April Offering”). 

 
11

 

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”) and 1,518,253 warrants (See below) 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’s common stock, par value $0.001 per share (the “May Shares”) for aggregate gross proceeds equal to $8,984,595 (the “May Offering”).

On December 17, 2009, the Company entered into an underwriting agreement with Roth Capital Partners, LLC (“Roth”) and Oppenheimer and Company Inc. (the “Underwriters”), pursuant to which the Company agreed to issue and sell 8,000,000 shares of common stock (the “Firm Stock”), par value $0.001 per share, to the Underwriters at a price per share of $7.50 (the ”December Offering”). The sale of the Firm Stock was priced on December 17, 2009 and closed on December 22, 2009. The aggregate proceeds from the offering were $60,000,000. Underwriting discounts and commissions and offering expenses were $3,692,000 and were recorded as a reduction of additional paid-in capital.

The Company also granted the Underwriters an option to purchase up to an additional 1,200,000 shares to cover over-allotments, if any, at the same price as the Firm Stock. On December 31, 2009 the Underwriters agreed to purchase the over-allotment for gross proceeds of $9,000,000, which, after net of commissions and discounts of $450,000, was received on January 4, 2010.

In connection with the acquisition of Customer List (See Note 7) in July 2010, the Company issued 3,600,000 shares of its common stock to the Seller as part of the consideration.

In October 2010, the Company granted 1,183,667 restricted shares to management and independent directors of the Company in accordance with Yongye International, Inc. 2010 Omnibus Securities and Incentive Plan, as an incentive to such individuals to promote the success of the Company’s business. Management was granted 1,137,000 shares on October 8, 2010, and the independent directors were granted 46,667 shares on October 15, 2010 (See below). As of June 30, 2011, all shares have been vested.
 
Redeemable Series A convertible preferred shares

In May 2011, the Company entered into a securities purchase agreement with MSPEA, an affiliate of Morgan Stanley, and Full Alliance, the Company’s largest shareholder. Pursuant to the terms of the agreement, on June 9, 2011 the Company issued 5,681,818 shares of redeemable Series A convertible preferred shares to MSPEA for gross proceeds of $50 million. The redeemable Series A convertible preferred shares are convertible into common stock of the Company at an initial conversion price of $8.80, subject to further adjustments as discussed below.
 
The significant terms of the redeemable Series A convertible preferred shares are as follows:

Liquidation Preference

In the event of liquidation, whether voluntary or involuntary, the holders of the redeemable Series A convertible preferred shares then outstanding shall be entitled to receive, out of the assets of the Company available for distribution to its stockholders before any payment shall be made to the holders of the common stock, with respect to each outstanding share of redeemable Series A convertible preferred shares, an amount equal to the greater of (i) the original issue price, representing $8.80 per share of redeemable Series A convertible preferred shares, plus (a) all accrued but unpaid preferred dividends and (b) other declared but unpaid dividends on redeemable Series A convertible preferred shares, and (ii) such amount per share as would have been payable had all shares of redeemable Series A convertible preferred shares been converted into common stock immediately prior to such liquidation.

 
12

 

If upon liquidation, the assets of the Company available for distribution to its stockholders shall be insufficient to pay the holders of the redeemable Series A convertible preferred shares the full liquidation preference to which they shall be entitled in accordance with the above, the holders of the redeemable Series A convertible preferred shares shall share ratably in any distribution of the assets available for distribution in proportion to the respective amounts which would otherwise be payable in respect of the shares held by them upon such distribution if all amounts payable on or with respect to such shares were paid in full.

Dividends

The holders of the redeemable Series A convertible preferred shares shall be entitled to receive paid-in-kind dividends in additional shares of redeemable Series A convertible preferred shares, on each anniversary of the Issuance Date. The paid-in kind dividends is based on the number of shares of redeemable Series A convertible preferred shares held by such holders on such anniversary multiplied by an annual dividend rate determined on such anniversary in accordance with the formula set forth below (the "Preferred Dividend Rate"), compounded annually:

Preferred Dividend Rate is defined as 7% - [(VWAP – 8.8) x 2 / 310], where VWAP means one-year volume weighted average share price of the Company during the 365-day period immediately prior to the applicable anniversary of Issuance Date, provided that the preferred dividend rate should not exceed 7% per annum and shall not fall below 3% per annum.

In addition, the holders of redeemable Series A convertible preferred shares should also receive, on an as-converted basis, any dividends or distributions that the Company declares to the holders of common stock.

Conversion
 
At any time after issuance, each holder of any shares of redeemable Series A convertible preferred shares then outstanding may, at such holder’s option, elect to convert all or any portion of the shares of redeemable Series A convertible preferred shares held by such holder into a number of fully paid and nonassessable shares of common stock. The initial conversion price is $8.80 per share and is subject to customary anti-dilution adjustments for issuances of shares of common stock as a dividend or distribution on shares of the common stock, or mergers or reorganizations or future issuances of other Company’s securities at a price lower than the then applicable conversion price. Additionally, the conversion price is subject to upward or downward adjustments, depending upon the Actual Net Income (as defined below) being greater than or lower than the Cumulative Net Income Guarantee (as defined below) of the corresponding period, provided that (i) the conversion price, as adjusted, shall not exceed $15.00 per share, and (ii) the sum of all shares of common stock issuable to the holders of redeemable Series A convertible preferred shares as a result of conversions, dividends, or distributions, or common stock acquired shall not exceed 9,869,205, or 19.99% of the total number of shares of common stock outstanding on May 29, 2011, which is the date the Company entered into the securities purchase agreement for the issuance of redeemable Series A convertible preferred shares.
 
 The Actual Net Income means, in respect of any fiscal year or quarter, the consolidated net income of the Company for such fiscal year or quarter (as applicable), after all charges and provisions for taxes and minority interests and adjusted to exclude certain items, as audited (for fiscal years) or reviewed (for fiscal quarters) in accordance with US GAAP.

The Cumulative Net Income Guarantee is defined as: $84 million for fiscal 2011, $210 million for the cumulative period of fiscal 2011 through fiscal 2012, $399 million for the cumulative period of fiscal 2011 through fiscal 2013, and $682.5 million for the cumulative period of fiscal 2011 through fiscal 2014.

Automatic Conversion

On the fifth anniversary of the Issuance Date of the redeemable Series A convertible preferred shares, all redeemable Series A convertible preferred shares will automatically convert into common stock at the then applicable conversion price.

Voting Rights

The holders of the redeemable Series A convertible preferred shares are entitled to vote upon all matters upon which the holders of common stocks have the right to vote, such votes to be counted together with all other shares of stock having general voting powers and not separately as a class. Each holder of the outstanding redeemable Series A convertible preferred shares shall be entitled to cast the number of votes, which is equal to the number of votes that would be attributable to the shares of common stock issuable upon conversion of the redeemable Series A convertible preferred shares.

 
13

 

Redemption

The holders of the redeemable Series A convertible preferred shares have the right to require the Company to redeem all or a portion of the outstanding redeemable Series A convertible preferred shares upon the occurrence of any of the following conditions: (i) a material breach by any of the Company and Full Alliance of any of the key obligations under the securities purchase agreement and related transaction documents, (ii) the failure to remain current in the Company’s securities filings, (iii) the failure to obtain the exploration rights and recover amounts paid for such rights, on or prior to June 30, 2012, and (iv) the discontinuation of Mr. Zishen Wu as CEO of the Company prior to December 31, 2014, unless his cessation of duties results from his death, disability or incapacity. In such cases, the redemption price for the redeemable Series A convertible preferred shares would be equal to an amount that would yield a total internal rate of return of 30% on the purchase price of the redeemable Series A convertible preferred shares.

The holders of the redeemable Series A convertible preferred shares also have the right to redeem all or a portion of their redeemable Series A convertible preferred shares if (i) the quotient of the Company’s aggregate earnings per share in any six rolling consecutive quarters from the first quarter of 2010 onwards divided by the aggregate amount of the earnings per share of the corresponding periods in the prior year is less than 120%, and (ii) net income of any fiscal year between 2011 and 2014 is less than the relevant Income Threshold for such year. In such cases, the redemption price for the redeemable Series A convertible preferred shares would be equal to an amount that would yield a total internal rate of return of 20% on the purchase price of the redeemable Series A convertible preferred shares. The “Income Threshold” is defined as: US$75 million for the fiscal year 2011, US$101 million for the fiscal year 2012, US$121 million for the fiscal year 2013 and US$145 million for the fiscal year 2014, subject to certain adjustments caused by future issuances of the Company’s securities that have a dilutive effect on the holders of the redeemable Series A convertible preferred shares.
 
Based on the historical income level, year to date income and projected net income and earnings per share for the next four years, management believes it is not probable that the Series A convertible preferred shares are redeemable as at September 30, 2011. The Company will further assess the probability of whether the redeemable Series A convertible preferred shares will become redeemable at each reporting period end.
 
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 five-year exercise period with an initial exercise price of $1.848. In addition, 649,562 warrants were issued to 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 five-year 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 executed an irrevocable cashless exercise of its warrants and was issued 686,878 shares of common stock of the Company. 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 as the placement agent, 246,224 warrants (“May Warrants”).  The warrants have a five-year exercise period and an initial exercise price of $1.848. On November 9, 2009, Roth executed an irrevocable cashless exercise of all the “May Warrants”. The Company issued 198,247 shares of common stock of the Company in exchange for the surrender of all the May Warrants.

 
14

 

During the three and nine months ended September 30, 2011, no “April Warrants” and “September Warrants” were exercised by April Investors and September Investors.

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 the May Warrants ($1.848) was not affected but is also subject to potential down-round adjustments in future periods. As of September 30, 2011 and December 31, 2010, there were 148,172 warrants outstanding, of which 48,714 and 99,458 warrants will expire if unexercised by April 2013 and September 2013, respectively.
 
The potential cash payments and the down-round provision preclude the classification of these warrants as equity. Accordingly, the warrants are accounted for as a liability and adjusted to fair value through earnings at each reporting date. The gain resulting from the decrease in fair value of warrants was $119,663 and $533,250 for the three and nine months ended September 30, 2011, respectively. The loss resulting from the increase in fair value of warrants was $12,077 for the three months ended September 30, 2010. The gain resulting from the decrease in fair value of warrants was $157,393 for the nine months ended September 30, 2010.

The estimated fair values of the warrants issued to April Investor and September Investor were determined at September 30, 2011 and December 31, 2010 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 at fair value on a recurring basis as of September 30, 2011 and December 31, 2010.
 
 
Fair Value Measurements Using:
 
       
Quoted Prices in
Active Markets for
Identical Financial
Assets and Liabilities
   
Significant Other
Observable Inputs
   
Significant
Unobservable Inputs
 
September 30, 2011
Total
   
Level 1
   
Level 2
   
Level 3
 
                       
Liabilities at fair value:
                     
Derivative liabilities—warrants
  $ 503,018       -     $ 503,018       -  
 
 
Fair Value Measurements Using:
 
       
Quoted Prices in
Active Markets for
Identical Financial
Assets and Liabilities
   
Significant Other
Observable Inputs
   
Significant
Unobservable Inputs
 
December 31, 2010
Total
   
Level 1
   
Level 2
   
Level 3
 
                       
Liabilities at fair value:
                     
Derivative liabilities—warrants
  $ 1,036,268       -     $ 1,036,268       -  

 
15

 

The fair values of the warrants are summarized as follows:

   
April Warrants
   
September Warrants
 
Fair value of warrant per share (US$) at:
           
Date of issuance
  $ 1.07     $ 2.08  
December 31, 2010
  $ 6.97     $ 7.00  
September 30, 2011
  $ 3.33     $ 3.43  
 
 The fair values of the warrants outstanding as of September 30, 2011 and December 31, 2010 were determined based on the Binominal option pricing model, using the following key assumptions:

   
September 30, 2011
   
December 31, 2010
 
   
April
Warrants
   
September
Warrants
   
April
Warrants
   
September
Warrants
 
                         
Expected volatility
    105.1 %     105.4 %     67.5 %     67.0 %
                                 
Expected dividends yield
    0 %     0 %     0 %     0 %
                                 
Time to maturity
 
1.6 years
   
1.9 years
   
2.3 years
   
2.7 years
 
                                 
Risk-free interest rate per annum
    1.230 %     1.230 %     1.483 %     1.483 %
                                 
Fair value of underlying common shares (per share)
  $ 4.50     $ 4.50     $ 8.40     $ 8.40  

Stock-based compensation

Pursuant to the 2010 Omnibus Securities and Incentive Plan (the “Plan”), which was approved by the stockholders of the Company in the annual meeting held on June 11, 2010, the Company was authorized to issue up to 1,500,000 shares of the Company’s common stock in any calendar to selected executives, key employees and directors. The purpose of the Plan is to provide incentives to such individuals to promote the success of the Company’s business.

In October 2010, the Company granted 1,183,667 restricted shares to management and independent directors of the Company in accordance with the Plan. Management was granted 1,137,000 shares on October 8, 2010, and the independent directors were granted 46,667 shares on October 15, 2010. All of the restricted shares vested in April 2011.
 
A summary of the status of the Company’s shares as of September 30, 2011, and changes during the three and nine months ended September 30, 2011, is presented below: 
 
         
Weighted average
 
         
grant-date
 
Restricted shares
 
Shares
   
fair value
 
Balance at January 1, 2011
    1,183,667     $ 9,261,239  
Granted
    0       0  
Vested
    0       0  
Forfeited
    0       0  
Balance at March 31, 2011
    1,183,667     $ 9,261,239  
Granted
    0       0  
Vested
    (1,183,667 )     (9,261,239 )
Forfeited
    0       0  
Balance at June 30, 2011
    0     $ 0  
Granted
    0       0  
Vested
    0       0  
Forfeited
    0       0  
Balance at September 30, 2011
    0     $ 0  

 
16

 

At September 30, 2011, there was no unrecognized compensation cost related to unvested shares granted under the Plan. The total stock-based compensation cost recognized in the statement of income for the three and nine months ended September 30, 2011 was nil and $4,950,600.

NOTE 16 – STATUTORY RESERVE

Yongye Nongfeng and Yongye Fumin are 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 its registered capital. For the nine months ended September 30, 2011 and 2010, Yongye Nongfeng and Yongye Fumin made appropriations to this statutory reserve of $10,185,918, and $5,051,225, respectively. The accumulated balance of the statutory reserve of Yongye Nongfeng and Yongye Fumin as of September 30, 2011 and December 31, 2010 was $20,100,992 and $9,915,074, respectively.

In accordance with the PRC laws and regulations, Yongye Nongfeng and Yongye Fumin is restricted in its ability to transfer a portion of its net assets to the Company in the form of dividends, which amounted to $19,095,942, representing the amount of accumulated balance of statutory reserve of Yongye Nongfeng and Yongye Fumin attributable to the Company as of September 30, 2011.

NOTE 17 – INCOME TAXES

Yongye Nongfeng is a foreign investment enterprise located in the Western Region of the PRC and was entitled to a preferential income tax rate of 15% for the years ended December 31, 2009 and 2010. During the nine months ended September 30, 2011, Yongye Nongfeng received a High-Tech Enterprise Certificate which entitles it to a preferential tax rate of 15% for three years starting from January 1, 2010.

The Company’s effective income tax rates were 18.10% and 16.66% for the three months ended September 30, 2011 and 2010, respectively, and were 19.19% and 16.16% for the nine months ended September 30, 2011 and 2010, respectively. The effective income tax rate for each of the three and nine months ended September 30, 2011 differs from the PRC statutory income tax rate of 25% primarily due to the effect of the abovementioned Yongye Nongfeng’s preferential tax treatment, and partly offset by the effect of non-deductible expenses.

There has been no change in unrecognized tax benefits during the nine months ended September 30, 2011. In addition, the Company does not expect that the amount of unrecognized tax benefits will change significantly within the next 12 months. No interest and penalties related to unrecognized tax benefits were recorded for each of the three and nine months ended September 30, 2011.
 
NOTE 18 – FAIR VALUE MEASUREMENTS

The fair values of the financial instruments as of September 30, 2011 and December 31, 2010 represent the estimated amounts that would be received to sell those assets or that would be paid to transfer those liabilities in an orderly transaction between market participants at that date. Those fair value measurements maximize the use of observable inputs. However, in situations where there is little, if any, market activity for the asset or liability at the measurement date, the fair value measurement reflects the Company’s own judgments about the assumptions that market participants would use in pricing the asset or liability. Those judgments are developed by the Company based on the best information available in the circumstances, including expected cash flows and appropriately risk-adjusted discount rates, available observable and unobservable inputs.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments:

Cash, restricted cash, accounts receivable, other receivables, long-term loans and payables – current portion, short-term bank loans, accounts payable, accrued expenses and other payables: The carrying amounts approximate fair value because of the short maturity of these instruments.

Derivative liabilities: The method and assumptions used to estimate the fair value of derivative liabilities are set out in Note 15.

 
17

 

Long-term loans and payables: The fair value of the Company’s long-term loans and payables is estimated by discounting future cash flows using current market interest rates offered to the Company and its subsidiaries for debts with substantially the same characteristics and maturities, and approximates to its carrying amount.

NOTE 19 – COMMITMENTS AND CONTINGENCIES

The Company has an operating lease for an office space in Beijing, PRC for the period from January 1, 2011 to December 31, 2013. The lease expense for this office space was $65,040 and $58,428 for the three months ended September 30, 2011 and 2010, respectively, and $192,599 and $174,354 for the nine months ended September 30, 2011 and 2010, respectively. As of September 30, 2011, minimum lease payments for each of twelve months period ended September 30, 2012, 2013 and 2014 under non-cancellable operating lease agreement is $260,891, $260,891 and $65,223, respectively or an aggregated amount of $587,005. There is no minimum lease payment in the next fourth and fifth twelve months period.
 
On May 26, 2011 and June 3, 2011, the Company and certain of its officers and directors were named in putative class action lawsuits filed in the United States Federal District Court for the Southern District of New York alleging, among other things, that the Company and three of its  officers and directors issued false and misleading information to investors about the Company’s financial and business condition. These securities class action complaints generally allege that Yongye’s business was not growing at the rate represented by the defendants and that Yongye’s financial results as reported to the Securities and Exchange Commission were inconsistent with its production capabilities.

On July 19, 2011, the Company and certain of its officers and directors were named in a derivative suit filed in the First Judicial District Court of the State of Nevada (Carson City) alleging, among other things, that the Company’s directors and officers breached their fiduciary duties to the Company, misrepresented the Company’s earnings, wasted corporate assets and unjustly enriched themselves at the expense of the Company. The derivative complaint also alleges that Yongye, at the direction of or with the approval of its directors, failed to implement an adequate system of internal and financial controls.

The litigations are in their early stages. The Company believes the claims contained in the lawsuits to be without merit and intends to defend the Company vigorously.
 
NOTE 20 – RELATED PARTY TRANSACTIONS AND BALANCES
 
On January 4, 2011, the Company entered into an operating lease with Inner Mongolia Yongye for a research and development activity facility in Beijing, PRC for the period from January 4, 2011 to December 31, 2011. The lease expense for the research and development facility paid to Inner Mongolia Yongye was $40,437 and $119,745 for the three and nine months ended September 30, 2011, respectively.

During the nine months ended September 30, 2010, the Company sold three vehicles with net book value of $135,191 and an apartment with net book value of $102,263 to Inner Mongolia Yongye. In addition, the long-term loans and payables of $144,513 that were secured by these assets were assumed by Inner Mongolia Yongye. Upon disposal, no gain or loss was recorded and the Company received cash of $92,941.

In April 2011, Yongye Nongfeng obtained two short-term bank loans of RMB 52,500,000 (equivalent to $8,209,282) and RMB 47,500,000 (equivalent to $7,427,446) from China Everbright Bank. The loans are due on April 1, 2012 and April 18, 2012, respectively, and were guaranteed by the Company’s Chairman.

 
18

 

NOTE 21 – EARNINGS PER SHARE
 
The following table sets forth the computation of basic earnings per share for the periods indicated: 

   
For the three months ended
 
   
September
 30, 2011
   
September
 30, 2010
 
Numerator:
           
Net income attributable to Yongye International, Inc.
 
$
39,124,188
   
$
17,578,267
 
Dividends on redeemable Series A convertible preferred shares
   
(882,192
)
   
-
 
Earnings allocated to participating nonvested shares
     
-
   
-
 
Earnings allocated to participating redeemable Series A convertible preferred shares
   
(3,946,850
)
   
-
 
Net income allocated to common stockholders
 
$
34,295,146
   
$
17,578,267
 
Denominator:
               
Weighted average shares of common stock
   
49,370,711
     
47,130,522
 
Basic earnings per common stock
 
$
0.69
   
$
0.37
 

   
For the nine months ended
 
   
September
 30, 2011
   
September
 30, 2010
 
Numerator:
               
Net income attributable to Yongye International, Inc.
 
$
87,027,380
   
$
46,195,261
 
Dividends on redeemable Series A convertible preferred shares
   
(1,083,562
)
   
-
 
Earnings allocated to participating nonvested shares
   
(700,822
)
   
-
 
Earnings allocated to participating redeemable Series A convertible preferred shares
   
(3,907,852
)
   
-
 
Net income allocated to common stockholders
 
$
81,335,144
   
$
46,195,261
 
Denominator:
               
Weighted average shares of common stock
   
48,948,944
     
45,423,109
 
Basic earnings per common stock
 
$
1.66
   
$
1.02
 
 
The following table sets forth the computation of diluted earnings per share for the periods indicated:
 
   
For the three months ended
 
   
September
 30, 2011
   
September
 30, 2010
 
Numerator:
           
Net income allocated to common stockholders as reported in Basic EPS
 
$
34,295,146
   
$
17,578,267
 
Change in fair value of derivative liabilities
   
(119,663
)
   
12,077
 
Net income allocated to common stockholders
 
$
34,175,483
   
$
17,590,344
 
Denominator:
               
Weighted average shares of common stock as reported in Basic EPS
 
$
49,370,711
   
$
47,130,522
 
Dilutive effect of warrants
   
102,062
     
118,048
 
     
49,472,773
     
47,248,570
 
Diluted earnings per common stock
 
$
0.69
   
$
0.37
 

   
For the nine months ended
 
   
September
30, 2011
   
September
30, 2010
 
Numerator:
               
Net income allocated to common stockholders as reported in Basic EPS
 
$
81,335,144
   
$
46,195,261
 
Change in fair value of derivative liabilities
   
(533,250
)
   
(157,393
)
Net income allocated to common stockholders
 
$
80,801,894
   
$
46,037,868
 
Denominator:
               
Weighted average shares of common stock as reported in Basic EPS
   
48,948,944
     
45,423,109
 
Dilutive effect of warrants
   
108,187
     
118,876
 
     
49,057,131
     
45,541,985
 
Diluted earnings per common stock
 
$
1.65
   
$
1.01
 

 
19

 

NOTE 22 – CONCENTRATIONS AND CREDIT RISKS
 
At September 30, 2011, the Company held cash in banks of approximately $80,298,373 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 36% and 55% of the Company’s total revenues for the three months ended September 30, 2011 and 2010, respectively. Five major customers accounted for 33% and 59% of the Company’s total revenues for the nine months ended September 30, 2011 and 2010, respectively. The Company’s total revenue from five major customers was $50,892,264 and $112,942,050 for the three and nine months ended September 30, 2011, respectively. The Company’s total revenue from five major customers was $39,197,220 and $112,111,148 for the three and nine months ended September 30, 2010, respectively. All of these major customers are distributors in the PRC agriculture industry.
 
For the three months ended September 30, 2011
   
For the nine months ended September 30, 2011
 
Largest
 
Primary
 
Amount of
   
% Total
   
Largest
Primary
 
Amount of
   
% Total
 
Customers
 
Provinces
 
Sales
   
Sales
   
Customers
Provinces
 
Sales
   
Sales
 
Customer A
 
Inner Mongolia
  $ 13,568,265       10 %  
Customer B
Liaoning;
Heilongjiang;
Jilin
  $ 25,953,352       8 %
Customer B
 
Liaoning;
Heilongjiang;
Jilin
    10,841,522       8 %  
Customer F
Shandong
    23,392,184       7 %
Customer C
 
Jiangxi;
Fujian
    8,937,640       6 %  
Customer E
Guangdong;
Hainan
    22,314,319       6 %
Customer D
 
Jiangsu
    8,781,354       6 %  
Customer D
Jiangsu
    20,797,528       6 %
Customer E
 
Guangdong;        Hainan
    8,763,483       6 %  
Customer G
Henan
    20,484,667       6 %
Total
      $ 50,892,264       36 %  
Total
    $ 112,942,050       33 %
 
For the three months ended September 30, 2010
   
For the nine months ended September 30, 2010
 
Largest
 
Primary
 
Amount of
   
% Total
   
Largest
Primary
 
Amount of
   
% Total
 
Customers
 
Provinces
 
Sales
   
Sales
   
Customers
Provinces
 
Sales
   
Sales
 
Customer H
 
Hebei;
Beijing;
Tianjin
  $ 15,313,847       21 %  
Customer J
Hebei;
Beijing;
Tianjin
  $ 32,370,197       17 %
Customer G
 
Henan
    7,214,600       10 %  
Customer E
Guangdong;
Jiangsu;
Henan;
Shanxi
    28,093,886       15 %
Customer F
 
Shandong
    6,888,311       10 %  
Customer F
Shandong
    19,139,975       10 %
Customer I
 
Anhui
    5,060,233       7 %  
Customer K
Inner Mongolia
    17,193,243       9 %
Customer B
 
Liaoning;
Heilongjiang;
Jilin
    4,720,229       7 %  
Customer H
Hebei;
Beijing;
Tianjin
    15,313,847       8 %
Total
      $ 39,197,220       55 %  
Total
    $ 112,111,148       59 %

Three major suppliers accounted for 91% ($52,233,724), of which one major supplier accounted for 46% ($26,327,303), of the Company’s total inventory purchases for the three months ended September 30, 2011. Three major suppliers accounted for 89% ($102,796,350), of which one major supplier accounted for 41% ($47,121,712), of the Company’s total inventory purchases for the nine months ended September 30, 2011. Three major suppliers accounted for 86% ($26,529,521), of which one major supplier accounted for 64% ($19,771,633), of the Company’s total inventory purchases for the three months ended September 30, 2010. Three major suppliers accounted for 87% ($73,219,730), of which one major supplier accounted for 69% ($57,856,688), of the Company’s total inventory purchases for the nine months ended September 30, 2010. If these suppliers terminate their supply relationship with the Company, the Company may be unable to purchase sufficient raw materials on acceptable terms which may adversely affect the Company’s results of operations.

 
20

 

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. In addition, the Company’s business may be influenced by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, rates and methods of taxation, and the extraction of mining resources, among other factors.

NOTE 23 – SUBSEQUENT EVENT

On October 10, 2011, the Company granted 1,166,333 restricted shares to management and independent directors of the Company in accordance with Yongye International, Inc.’s 2010 Omnibus Securities and Incentive Plan which was approved by the stockholders of the Company in the annual meeting held on June 11, 2010, as an incentive to such individuals to promote the success of the Company’s business. Shares vest on the twelve month anniversary of the date of grant.

 
21

 
 
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. (formerly known as 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

We are a leading crop nutrient company in China in term of total sales in 2010. We are primarily engaged in research, development, manufacturing and sales of fulvic acid based crop and animal nutrient products for the agriculture and stock farming industry.  We are headquartered in Beijing with production facilities in Hohhot, Inner Mongolia Autonomous Region of China (“Inner Mongolia”).  Our products are sold nationwide in 30 provinces, autonomous regions and centrally-administered municipalities across China.

Products

Currently, our principal product is liquid crop nutrient, from which we derived substantially all of our sales for the nine months ended September 30, 2011. We also produce powder animal nutrient product which is mainly used for dairy cows. We market both products under the trade name “Shengmingsu” (“生命素” in Chinese which means “Life Essential”). We produce our liquid crop nutrient product based on a patented formula utilizing fulvic acid as the primary compound base which is combined with various micro nutrients such as zinc and boron as well as macro nutrients like nitrogen, phosphorous and potassium ("NPK”) that are essential for the health of crops.  Our product’s core fulvic acid compound improves crop yield by enhancing the absorption of fertilizers and micro nutrients.  In addition, the micro nutrients and NPK included in our product formulation serves as a supplement during key growth stages of crops. We believe that our product is particularly well-suited for use in China, which generally has highly degraded farming soil as a result of over-farming, decades of over-use of chemical fertilizers and less advanced farming practices compared with more developed nations.  After water dilution, our liquid crop nutrient product is most commonly applied through directly spraying onto leaves of crops and typically used at certain critical growth stages of crops in addition to normal fertilizer application.

The efficacy of fulvic acid for enhancing crop yield is well-documented by over 20 global research reports published by universities and institutions in the United States, China, Europe and other countries.  The Inner Mongolia Autonomous Region Scientific and Technology Bureau (“IMARSTB”) conducted an official assessment of our liquid crop nutrient product in 2008 and concluded that our product increases agricultural output, improves the utilization rate of fertilizer, enhances crop resistance to diseases and droughts, and has a lighter weight and higher bio-activity than other products it tested.  In addition, the IMARSTB concluded that large scale experimentation in China has proven that our product can increase overall yields of staple crops, such as wheat and rice by 10-20%, and vegetables and fruits by 15-30%, while also improving product quality. Many other third parties also conducted tests on our product’s efficacy on different crops and geographical locations in China, and they have drawn similar conclusions as documented in the IMARSTB assessment.

 
22

 

Our powder animal product is principally used in the dairy industry as a feed additive for dairy cows and helps decrease inflammation and alleviate pain due to mastitis which occurs as a result of milking.

Sales and Distribution

We employ a multi-tiered distribution model whereby we sell our products to provincial-level distributors who sell to our end-users either directly or indirectly through county-level and village-level distributors. We currently have 25 provincial-level distributors, most of which each covers a single province, while the rest of them cover either multiple provinces or a portion of one province (in the case of Hebei, Inner Mongolia and Xinjiang). We select our provincial-level distributors based on criteria including experience, reputation, network coverage and financial strength, and we usually enter into multi-year distribution contracts with them.  All of our contracts with provincial-level distributors include mutual exclusivity provisions whereby the provincial-level distributors are not allowed to distribute competing products, and we grant the distributor exclusive sales rights in the designated territory. We are careful to ensure that the sales territories of our provincial-level distributors do not overlap.

Our provincial-level distributors sell our products directly to county-level distributors, to key accounts, such as large farms, and farmers through promotional events. County-level distributors sell our products to independently owned Yongye-branded stores, which serve as village-level retailers of our products (“Branded Retailers”), large farms, and farmers through promotional events. Branded Retailers distribute our products directly to farmers in rural villages and towns. Most of them are privately owned individual agriculture stores while some have common ownership or belong to store chains. None of these “Branded Retailers” is owned or controlled by us. They are typically small in size and distribute a variety of agriculture-related products, including fertilizer, seeds and pesticides to farmers in the surrounding areas.

The following chart illustrates our multi-tiered distribution model:


 
23

 

To ensure consistent pricing and channel margins nationwide, Branded Retailers are typically granted exclusive sales rights for our products in their authorized territory at the village/town level. We also provide the Branded Retailers with our distinct signage with the “Yongye Shengmingsu” logo which typically comprises the entire exterior storefront of Branded Retailers. Branded Retailers normally display our products in prominent shelf spaces and they are responsible for providing technical support to farmers and setting up demonstration sites for our products.

As of September 30, 2011, our products were sold in 30 provinces, autonomous regions and centrally-administered municipalities across China through 25 provincial-level distributors, 810 county-level distributors and 29,307 Branded Retailers.  Our multi-tiered distribution model allows us to penetrate the vast and highly fragmented rural area of China by utilizing our internal sales team to manage and leverage thousands of sales personnel at our provincial-level distributors, county-level distributors and Branded Retailers. Our internal sales team actively manages our multi-tier distribution network by participating in major distributor sales activities and providing training presentations and seminars.

Production

Our product’s core compound fulvic acid is extracted from humic acid, which is in turn derived from lignite coal.  Our production process primarily involves the extraction of fulvic acid and then blending it with macro and micro nutrients based on our patented formula. Compared to humic acid, the smaller fulvic acid molecular structure enables it to be more easily absorbed by crop leaves.

We have two production facilities in Hohhot City, Inner Mongolia, with one located in Jinshan Industrial Park (the “Jinshan Facility”) and one in Wuchuan County (the “Wuchuan Facility”).  Prior to the fourth quarter of 2010, the Jinshan Facility was our sole manufacturing facility and it used purchased humic acid as the key raw material to produce our products.  Our Wuchuan Facility was completed in the fourth quarter of 2010 and directly utilizes lignite coal as the key raw material, enabling us to bypass intermediaries from whom we used to purchase humic acid. Our Wuchuan Facility produces our final products and supplies intermediate products for our Jinshan Facility’s production needs.
 
Currently, we procure lignite coal from independent third party suppliers in Inner Mongolia.  In March 2010, we entered into an agreement to acquire a lignite coal resource project in Wuchuan County, Inner Mongolia.  In August 2011, Yongye Fumin, our wholly-owned subsidiary, obtained a Mineral Resource Exploration Permit for this project site in Wuchuan County, Inner Mongolia, which was issued by the Inner Mongolia Ministry of Land and Resources. Such approval granted us exclusive exploration rights for this project site for an initial period of three years beginning August 2, 2011.  We are in the process of applying for the governmental approval for the Mineral Right and are preparing for the relevant reports including but not limited to Geologic Report and Geologic Exploration Report. Upon the granting of the Mineral Right, we will be able to further vertically integrate our operations by using lignite coal extracted from our own mine.

Currently we have 30,000 and 16,000 tons of annual design production capacity at the Wuchuan Facility and the Jinshan Facility, respectively.  The major production processes for liquid crop nutrient product and powder animal nutrient product are identical, and therefore production capacities for the two products are inter-changeable.

Because of the proprietary nature of our products and manufacturing process, we customized the core production components of our manufacturing facilities to enable capacity flexibility.  Our design capacity is calculated by us based on key assumptions, including 300 days of operation in a year and normal manufacturing conditions.  Under actual manufacturing conditions and based on the seasonality in our business, our production facilities have the flexibility to adjust actual production to levels higher than our stated, theoretical design capacities.  For instance, during the past several years, our production outputs during the peak second and third quarters have consistently exceeded the design capacity.

For the nine months ended September 30, 2011, our actual production output for liquid crop nutrient product was 24,689 tons and the actual output for powder animal nutrient was 522 tons.  We may continue to invest in production capacity expansion as required to respond to increasing demand for our products in the future.

 
24

 

R&D and Manufacturing Technologies

Our products are based on a patented formula that combines a fulvic acid base with other macro and micro nutrients.  Our formulations were designed to enhance crop yield by increasing absorption of fertilizer and micro nutrients and providing key micro nutrients and NPK in key growth stages of crops.  In addition, our engineers designed our manufacturing process to overcome technical barriers associated with the extraction of fulvic acid and the blending of our products on an industrial scale so that micro and macro nutrients in our products are water soluble and can be easily absorbed by crops after being sprayed on the leaves.  We were granted two 20 year invention patents by the State Intellectual Property Office in the PRC, effective from October 12, 2006 and October 21, 2005, that cover formulations for both liquid crop nutrient product and powder animal nutrient product, as well as the manufacturing process for extraction and blending of our products.  In addition to seeking patent protection, we maintain proprietary know-how related to extraction and blending as trade secrets.

Marketing and Branding

Our end-customers make their purchase decisions primarily based on actual demonstrations of the efficacy of our product, typically over an entire growing season.  Accordingly, our sales and marketing strategy primarily focuses on local demonstration sites at which locally-grown crops are planted side-by-side with and without our liquid crop nutrient applied.  In executing our marketing strategy, Branded Retailers play a key role in setting up these demonstration sites, marketing our products and providing technical support to farmers.  Branded Retailers are typically trained by our distributors who receive regular and ongoing guidance from our sales and marketing and research and development teams.  In addition, we hold large-scale training programs in various locations annually where we invite Branded Retailers from around China to directly receive product, sales and marketing training.

In addition, our internal sales team frequently organizes presentations and seminars targeted at provincial-level and county-level distributors in order to convey our sales strategy effectively to them.  We also designed a series of incentive programs to motivate our distributors to drive performance and enhance loyalty, including sending selected distributors to a Yongye-sponsored executive training program at Tsinghua University, one of China’s most prestigious academic institutions.

At the national level, we have been conducting a variety of marketing and branding campaigns to enhance our brand recognition among not only end-users but also existing and potential distributors and Branded Retailers. We are amongst the very few players in our industry that actively sponsor CCTV (national TV channel) agricultural programs. We also use local TV stations, agricultural publications and newspapers to carry our advertisements. In addition, we are currently working with a national celebrity, Wang Baoqiang, as our spokesperson, to enhance our product image.

Recent Developments

On May 29, 2011, we entered into a Securities Purchase Agreement with MSPEA Agriculture Holding Limited (“MSPEA”), an affiliate of Morgan Stanley, and Full Alliance International Limited (“Full Alliance”), our largest shareholder, pursuant to which we sold to MSPEA 5,681,818 shares of our redeemable convertible preferred stock for an aggregate purchase price of US$50 million.

On May 26, 2011 and June 3, 2011, we and three of our officers and directors were named in putative class action lawsuits filed in the US Federal District Court for the Southern District of New York alleging, among other things, that we and such officers and directors issued false and misleading information to investors about our financial and business condition. These securities class action complaints generally allege that Yongye’s business was not growing at the rate represented by the defendants and that Yongye’s financial results as reported to the Securities and Exchange Commission were inconsistent with its production capabilities. On July 19, 2011 we and certain of our officers and directors were named in a derivative suit filed in the First Judicial District Court of the State of Nevada and Carson City alleging, among other things, that our directors and officers breached their fiduciary duties to us, misrepresented our earnings, wasted corporate assets and unjustly enriched themselves at the expense of us. The derivative complaint also alleges that Yongye, at the direction of or with the approval of its directors, failed to implement and adequate system of internal and financial controls. The lawsuits are in their early stages. We believe the claims contained in the lawsuits to be without merit and intend to defend ourselves vigorously.

 
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Factors Affecting Our Operating Results

Market Potential for Crop Nutrient Products in China

The long-term market growth of crop nutrient products in China is primarily driven by the need to improve crop yield to ensure sufficient food supply in view of limited and shrinking per capita arable land in China. Currently, with only approximately 10% of the world’s arable land, China needs to feed 1.3 billion people, or approximately 20% of the world’s population. According to the National Population and Family Planning Commission of China, China’s population will reach 1.5 billion by 2030. Therefore, the country faces the challenge of producing additional food to feed the additional 200 million people within the next 20 years. This puts great pressure on China’s agricultural system to increase production output.


Over-farming, decades of overuse of chemical fertilizers and less advanced farming practices have led to degraded soil quality in China. Although China already led the world in fertilizer consumption, applying more fertilizers than the world average on a per hectare basis, the crop yield lags behind most other countries. This creates a huge demand for crop nutrient products that can help improve fertilizer utilization and increase yield. Fulvic acid based crop nutrients are particularly well suited for the market, as it can allow crops to more effectively absorb fertilizers and minerals from the degraded soils.
 
 
The market for our crop nutrient product is large and has attractive long-term growth prospects. China has 1.8 billion mu (each mu is equivalent to approximately 667 square meters) of arable land in total. Typically, each mu of arable land requires at least 300 ml of our liquid crop nutrient product for one growing season. For the year of 2010, our crop nutrient product is estimated to have been used in only less than 5% of the arable land in China, assuming there is only one growing season per annum for all the arable land across China.

Favorable Government Policies on Agriculture

The agriculture industry in China enjoys favorable government policies. In 2010, there was RMB818 billion (US$126 billion) budgeted government spending on agriculture, rural areas and farmers, 14.3% higher than in 2009. According to the 12th Five-Year National Economic and Social Plan (2011-2015) of China, the Chinese government will continue to support the agriculture industry. Increasing the agriculture production capacity and developing high-yield, high-quality and high-efficiency agriculture are the focus of the Chinese government. Given our product’s ability to improve fertilizer utilization, increase crop yield, improve product quality, and enhance crop’s drought-resistance, we expect that we will further benefit from the Chinese government’s agricultural policy.

 
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Distribution Network

The agricultural goods market is very fragmented and spans over 600,000 villages in over 2,000 counties in over 30 provincial regions in China. As farmers in China tend to be less mobile, it is vital to distribute at the village-level in order to address this market. However, due to the scattered nature of China’s villages, it is necessary to work through county-level distributors in order to overcome barriers related to geography, local cultures and business networks. To sell to farmers through village retail stores, crop nutrient manufacturers typically work with provincial-level distributors to manage county-level distributors or work directly with county-level distributors.

In order to more rapidly achieve nationwide coverage, we have adopted a strategy to work with provincial-level distributors rather than directly with county-level distributors. We invest significantly in branding, training and technical support to motivate and maintain the long-term loyalty of our distributors and Branded Retailers, which is critical to successfully selling product through a multi-tier distribution network. Since we enter and expand into provincial regions at different times, our sales in different provincial markets vary due to different market penetration rates.

Our end-customers are comprised of large farms which purchase directly from distributors, and individual farmers who purchase through Branded Retailers or through promotional events held by local distributors. Our Branded Retailer network has been a key driver of our sales. The number of Branded Retailers increased from 24,036 as of December 31, 2010 to 29,307 as of September 30, 2011.  Jiangsu, Heilongjiang, Xinjiang, Yunnan and Henan provinces accounted for the majority of newly recruited Branded Retailers.

 Below is a table setting forth the expansion of our Branded Retailer network.
 
Branded Retailer by Region
 
Year end
2009
   
Q2 End
2010
   
Q3 End
2010
   
Year end
2010
   
Q2 End
2011
   
Q3 End
2011
 
                                     
Hebei/Beijing/Tianjin
    1,894       2,841       3,419       3,532       3,795       3,824  
Inner Mongolia
    660       620       620       501       567       612  
Shandong
    1,216       2,470       2,983       3,198       3,325       3,355  
Guangdong/Hainan
    75       385       499       641       845       879  
Henan
    844       1,573       1,793       1,920       2,208       2,278  
Heilongjiang/Jilin/Liaoning
    315       1,013       1,167       1,231       2,066       2,147  
Xinjiang
    356       816       966       1,395       1,946       1,967  
Hubei/Hunan
    2,082       2,709       2,913       3,040       2,949       2,978  
Gansu/Qinghai
    119       628       821       887       915       920  
Jiangsu
    439       809       1,051       1,186       1,748       1,896  
Shanxi
    167       711       889       1,106       1,288       1,297  
Anhui
    417       1,087       1,122       1,222       1,390       1,420  
Shaanxi
    25       1,096       1,324       1,443       1,480       1,491  
Sichuan/Chongqing
    201       586       624       691       958       1,034  
Jiangxi/Fujian
    100       480       576       666       937       994  
Yunnan/Guizhou
    66       350       495       620       896       1,059  
Zhejiang
    -       85       95       138       191       238  
Guangxi
    -       96       156       184       428       469  
Ningxia
    134       345       404       427       433       441  
Shanghai
    -       -       8       8       8       8  
Total
    9,110       18,700       21,925       24,036       28,373       29,307  
 
 
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The decrease in the number of Branded Retailers in a few provincial regions is primarily the result of our ongoing active management of our retail network. With support from us, our provincial-level and county-level distributors only trade with new retailers that meet certain standards and discontinue working relationships with those that underperform.

Seasonality

Our liquid crop nutrient product is most commonly applied by directly spraying onto leaves of crops in the second and third quarters, which corresponds to the growing seasons for most crops in most parts of China. Accordingly, the sales during the second and third quarters typically represent 70-80% of our annual sales. Our accounts receivable days typically increase in-line with our peak sales seasons and decrease during non-peak seasons. In addition, we typically accumulate higher volumes of finished goods during the non-peak season in preparation for the subsequent peak sales seasons which will result in higher inventory turnover days during non-peak seasons.

Pricing

We principally sell to our provincial-level distributors at an ex-factory price, and they in turn sell to lower level distributors at distributor prices. Branded Retailers sell to farmers at our suggested retail prices. Our pricing policy is consistent across the country, and we require our provincial-level distributors to ensure this policy is followed by county-level distributors and Branded Retailers. Our pricing policy for ex-factory price, different level of distributor prices and suggested retail prices have generally remained stable for the past several years. In 2011, we allowed Branded Retailers to charge a higher retail price for an updated version of our crop nutrient product that is replacing the prior version.

In July 2010, we acquired a list of eight direct customers from our former provincial-level distributor in Hebei.  As a result, we have been able to directly sell products in Hebei province at a county-level distributor price after bypassing the former provincial-level distributor. We expect to maintain the higher selling price to those eight distributors in Hebei in the foreseeable future.

We may adjust our selling prices from time to time in the future based on then market conditions, and any such adjustments may affect our margins, market demand and financial results.

Raw Materials

Our key raw material is lignite coal, and its price is affected by factors such as market demand, lignite coal quality and transportation cost. Prior to 2011, the key raw material for our products was humic acid which was procured from third party suppliers. Upon the completion of our Wuchuan Facility at the end of 2010, we have been able to extract humic acid and fulvic acid in-house from lignite coal and no longer rely on humic acid from intermediaries. Other raw materials used in our products include macro and micro nutrients as well as chemicals used in our extraction and blending processes.

Fluctuations in raw material costs will affect our cost of sales and gross profit margin, and we may not be able to pass such increased costs on to our distributors and then to our end customers.

Competition

While we compete with both nationwide and local manufacturers of humic/fulvic acid crop nutrients, we believe we are a clear market leader. The Chinese agriculture industry and the retail market for agricultural goods are highly fragmented. As of July 2011, there were 3,931 fertilizer products registered in the PRC Ministry of Agriculture’s registry. We mainly compete directly with producers of humic/fulvic acid based products, of which there were 863 registered as of July 2011.

In addition to humic/fulvic acid based crop nutrient products, our nutrient products also compete with other liquid fertilizers applied on plant leaves, such as amino acid-based nutrients and other liquid fertilizers containing NPK or minerals as many farmers view such liquid fertilizers as a single product category.

We believe that with our proven product efficacy, our premium brand and our nation-wide distribution network, we are well positioned to maintain our leadership position in this market.

 
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RESULTS OF OPERATIONS

Summary Statement of Income Data

 in US$, except for
percentages
 
For the Three Months
Ended September 30,
   
For the Nine Months
Ended September 30,
   
For the Three Months 
Ended September 30,
   
For the Nine Months
Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
   
Variance
   
%
   
Variance
   
%
 
                                                 
Sales
    140,593,777       71,752,069       345,519,853       186,101,173       68,841,708       95.9 %     159,418,680       85.7 %
                                                                 
Cost of sales
    55,013,997       29,639,662       140,874,455       80,095,965       25,374,335       85.6 %     60,778,490       75.9 %
                                                                 
Gross profit
    85,579,780       42,112,407       204,645,398       106,005,208       43,467,373       103.2 %     98,640,190       93.1 %
                                                                 
Selling expenses
    25,557,635       15,574,981