10-K 1 v305715_10k.htm FORM 10-K

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-K

 

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

   
  For the fiscal year ended December 31, 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 NO. 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)

 

+86 10 8231 8866

(Issuer’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class   Name of each exchange on which registered
Common Stock, par value US$0.001 per share   NASDAQ Global Select Market

 

Securities Registered Pursuant to Section 12(g) of the Act: None.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes ¨ No x

 

Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.

Yes ¨    No x

 

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 Data 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. £

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer £ Accelerated Filer x Non-Accelerated Filer £ 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

 

The aggregate market value of the 39,573,497 shares of common equity stock held by non-affiliates of the Registrant was approximately US$207,760,859 on the last business day of the Registrant’s most recently completed second fiscal quarter, based on the last sale price of the registrant’s common stock on the most recent date on which a trade in such stock took place prior thereto.

 

There were a total of 50,537,044 shares of the registrant’s Common Stock, par value US$0.001 per share, outstanding as of March 9, 2012.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s Proxy Statement relating to the Registrant’s 2011 Annual Meeting of Shareholders are incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 
 

 

Part I    
     
ITEM 1. Business 5
     
ITEM 1A. Risk Factors 20
     
ITEM 1B. Unresolved Staff Comments 42
     
ITEM 2. Properties 42
     
ITEM 3. Legal Proceedings 42
     
ITEM 4. Mine Safety Disclosures 43
     
Part II    
     
ITEM 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 44
     
ITEM 6. Selected Financial Data 45
     
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 46
     
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk 60
     
ITEM 8. Financial Statements and Supplementary Data 61
     
ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosures 61
     
ITEM 9A. Controls and Procedures 62
     
ITEM 9B. Other Information 64
     
Part III    
     
ITEM 10. Directors, Executive Officers and Corporate Governance 64
     
ITEM 11. Executive Compensation 64
     
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 64
     
ITEM 13. Certain Relationships and Related Transactions, Director Independence 64
     
ITEM 14. Principal Accountant Fees and Services 65
     
Part IV    
     
ITEM 15. Exhibits and Financial Statement Schedules 66
     
Index to Consolidated Financial Statements F-1

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This report contains forward-looking statements and information relating to Yongye International, Inc., that are based on the beliefs of our management as well as assumptions made by and information currently available to us. When used in this report, the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan” and similar expressions, as they relate to us or our management, are intended to identify forward-looking statements. These statements reflect our current view concerning future events and are subject to risks, uncertainties and assumptions, including among many others: a general economic downturn; a downturn in the securities markets; Securities and Exchange Commission regulations which affect trading in the securities of “penny stocks,” and other risks and uncertainties. Should any of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described in this report as anticipated, estimated or expected. Except as required by law, we assume no obligation to update any forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, even if new information becomes available in the future. Important factors that may cause actual results to differ from those projected include the risk factors specified above. Notwithstanding the above, Section 27A of the Securities Act and Section 21E of the Securities Exchange Act expressly state that the safe harbor for forward-looking statements does not apply to companies that issue penny stock. Because we may from time to time be considered as an issuer of penny stock, the safe harbor for forward-looking statements may not apply to us at certain times.

 

All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including statements regarding new and existing products and opportunities; statements regarding market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; uncertainties related to conducting business in China; any statements of belief or intention; any of the factors mentioned in the “Risk Factors” section of this Form 10-K; and any statements or assumptions underlying  any of the foregoing. Also, forward-looking statements represent our estimates and assumptions only as of the date of this report. You should read this report and the documents that we reference in this report, or that we filed as exhibits to this report, completely and with the understanding that our actual future results may be materially different from what we expect.

 

Except as required by law, we assume no obligation to update any forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, even if new information becomes available in the future.

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USE OF CERTAIN DEFINED TERMS

 

Except as otherwise indicated by the context, references in this report to:

 

·“Yongye,” “we,” “us,” “YONG,” “the Company” or “our Company” are references to Yongye International, Inc.;

 

·“Yongye Nongfeng” is a reference to Yongye Nongfeng Biotechnology Co., Ltd.;

 

·“Yongye Fumin” is a reference to Inner Mongolia Yongye Fumin Biotechnology Co., Ltd.;

 

·“Inner Mongolia Yongye” is a reference to Inner Mongolia Yongye Biotechnology Co., Ltd.;

 

·“China” and “PRC” are references to the People’s Republic of China;

 

·“RMB” is a reference to Renminbi, the legal currency of China;

 

·“U.S. dollar,” “$” and “US$” are references to the legal currency of the United States;

 

·“SEC” is a reference to the United States Securities and Exchange Commission;

 

·“Securities Act” is a reference to Securities Act of 1933, as amended; and

 

·“Exchange Act” is a reference to the Securities Exchange Act of 1934, as amended.

 

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Part I

ITEM 1. Business

 

Business Overview

 

We are a leading crop nutrient company in China in terms of total sales in 2011. 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.

 

Currently, our principal product is liquid crop nutrient, from which we derived substantially all of our sales for the year ended December 31, 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.  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.

 

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.

 

Industry and Market Overview

 

China Agriculture Industry

 

Limited and Shrinking Arable Land

 

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. According to a statement given by Vice-President Xi Jinping said when he visited Kimberly farm in the state of Iowa USA on February 16, 2012, China feeds nearly 21% of the world’s population, but its arable land accounts for less than 9% of the world’s arable land. 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. Currently, crop production in China is limited to approximately 301 million acres of arable farm land, which is approximately 14% of China’s land according to a survey conducted by the National Bureau of Statistics of China in 2009, or 0.23 acres of arable farm land per person, which is approximately one-third of the global per capita average and half of the United States’ per capita amount of land devoted to agricultural production.

 

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Moreover, increasing urbanization and desertification in China is encroaching upon farmland, thereby decreasing the amount of land available for crop production. According to the Chinese Academy of Sciences, since 1996, China has lost approximately 6.4% of its arable land to urbanization and China approves approximately 658,667 acres of land for construction each year, which impacts approximately 464,454 acres of farmland, as its urban population continues to increase.

 

A recently released survey by the State Forestry Department showed that more than a quarter of China’s land remained either degraded or lost to sand and gravel due to a combination of a naturally dry climate, centuries of over-cultivation and decades of excessive demand on water and soil from the world’s biggest population and the fastest growing economy. There were small signs of improvement from 2005 to 2010 showing the area of desert shrinking by an annual average of 1,717 square kilometers. This was 40% better than the results from 2000 to 2005, and it is the first time in China’s history to ever show a gain. 

 

Over-farming, decades of overuse of chemical fertilizers and less advanced farming practices have led to degraded soil quality in China. Although, according to Food and Agriculture Organization of the United Nations (“FAO”), China leads the world in fertilizer consumption, applying more fertilizers than the world average on a per hectare basis, the crop yield lags behind most developed countries. This creates a huge demand for crop nutrient products that can help improve fertilizer utilization and increase crop 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. 

 

 

Increasing Wealth is Expected to Increase Spending on Agricultural Products

 

As the economy grows and individual purchasing power expands in China, demand for more food products with higher quality is expected to increase. In China, huge reductions in poverty raised national average food consumption substantially, according to World Agriculture: towards 2015/2030, summary report by FAO of 2002. According to the Asian Development Bank, over 50% of China’s population is comprised of low income rural farmers. The government has pledged to narrow income gaps between urban and rural residents to tackle disparities in wealth levels. With significant 10.3% economic growth in 2010, rural incomes increased the most in over a quarter century with per capita net income for rural residents increased by 10.9% in real terms. Figures released from the National Bureau of Statistics of China show that China’s rural residents outpaced urban dwellers in per capita income growth for the first time since 1997.

 

Government Support for the Agricultural Industry

 

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, which was14.3% 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. The Five-Year Plan will also seek to increase domestic consumption by boosting wages. The main focus of the reforms will be on the lagging wages of rural workers, whose per capita incomes are currently only 30% of those in urban areas. Also, reforms will target tax policies to boost rural purchasing power, measures to broaden rural land ownership, and technology-led programs to raise agricultural productivity. Improvement of agricultural productivity and rural farmers’ living standards will be the focus of government investment. We believe that these government policies and investment will encourage growth in China’s agricultural industry and that we will benefit from such growth.

 

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China Fertilizer Industry

 

The rise of green food industry in China is also increasing demand for environmental friendly fertilizers. According to the China Green Food Development Center, a governmental agency, China’s domestic sales of green food increased at a compound annual growth rate of 21.2% from RMB50 billion in 2001 to RMB282 billion in 2010, and China’s exports of green food increased at a compound annual growth rate of 21.5%, from US$400 million in 2001 to US$2.3 billion in 2010. In March 2011, our crop nutrient product obtained the certificate of production material for green food which was issued by China Green Food Development Center. We believe China’s domestic market for green food will continue to expand as individual purchasing power grows in China and our business will benefit from this growth.

 

 

China’s Dairy Market

 

The growth of China’s economy has led to growth in consumer demand for dairy products and China’s government has attached great importance to the development of this industry, particularly after a food safety incident in China involving milk adulterated with melamine was widely reported in the international media during 2008 and 2010.

 

According to China Dairy Net, China’s dairy sales in 2011 were RMB231.6 billion, representing an increase of 21.6% compared with 2010. China’s dairy sales for the first 11 months of 2011 reached over RMB200 billion. According to China’s 12th Five-Year National Economic and Social Plan (2011-2015) of China, it is anticipated that the output of dairy raw material will be 50 million tons, and the output of dairy products will be 27 million tons by 2015. The Chinese government has increased efforts to regulate the industry and the industry has significantly increased barriers to entry.

 

Competitive Advantages

 

We believe that our competitive advantages include the following.

 

Unique and scalable distribution model. We employ a multi-tiered distribution model whereby we primarily sell our products to provincial-level distributors who sell to our end-customers either directly or indirectly through county-level and village-level distributors. We currently have 25 provincial-level distributors. For the most part, each distributor 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 Branded Retailers, 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.

 

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As of December 31, 2011, we sold our products primarily through 25 provincial-level distributors. There are 810 county-level distributors and 30,086 independently owned Branded Retailers across almost all provinces of China.

 

We believe that our unique distribution model has the following benefits:

 

·We leverage our distributors’ local knowledge and resources to enable quicker entry into new markets, to more efficiently reach potential Branded Retailers and to better communicate with farmers.

 

·We have a highly scalable and replicable distribution model that can be replicated in new markets. We are thus uniquely situated amongst our competitors to take advantage of China’s growing market for agriculture nutrients. The significant expansion of our distribution network since 2008 has paralleled our robust growth in sales during the same period.

 

·Our “Branded Retailer” concept creates a highly synergistic partnership among Yongye, our distributors and our Branded Retailers. We believe Branded Retailer owners embrace the Branded Retailer concept because they typically experience higher customer traffic and generate more sales as their stores become more prominent from the promotional displays and technical support we provide to them. We believe that our advertising campaign also effectively develops sales for distributors by attracting store owners to join our Branded Retailer network. With satisfied distributors and Branded Retailers, we are able to quickly scale up our distribution network and provide better service to our end-customers.

 

Brand name recognition supported by integrated marketing campaign. Both of our crop and animal nutrient products are marketed under the name “Shengmingsu” and we believe that our integrated marketing campaign has led to widespread recognition of our brand name by our end-customers.

 

Our strategy is to build the Yongye brand by getting closer to farmers through both media channels as well as indoor and outdoor displays. We work with our distributors to coordinate advertisements on local television channels and in local newspapers. From 2009, we began running promotional campaign on CCTV-7, which is the national agriculture channel in China. Our Branded Retailers are decorated with our signature color and banners, and prominently display our products alongside promotional display materials that we provide. Working together with our distributors, we create posters with village-specific case studies that demonstrate a farmer’s incremental revenue, original investment and harvesting time saved from using our products. We believe these case studies have been a highly effective manner of marketing as they translate our product efficacy directly into dollar terms and are communicated through real stories which are connected with our end-customers.

 

In addition, we support our distributors and farmers by providing product training courses, conferences and seminars, product demonstrations, and educational pamphlets, magazines and infomercials.

 

Patented formulae and proprietary manufacturing processes for high-quality fulvic acid based nutrients backed by strong research and development platform. Our products are based on patented formulae that combine a fulvic acid base with other macro and micro nutrients.  Our crop nutrient formula was 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 respectively, that cover formulae 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 processes as trade secrets. Both of our crop and animal nutrient products are protected by invention patents in China. They also won the top award for consecutive years at China Yangling Agricultural Hi-Tech Fair, one of the most prestigious agriculture trade fairs in China.

 

In addition to our internal research and development team with extensive experience in the agricultural research fields, we have established project partnerships with certain prestigious national and local agricultural universities and research institutes, including Chinese Academy of Agricultural Sciences, Beijing University of Agriculture, Inner Mongolia Agricultural University, and Inner Mongolia Academy of Agricultural Sciences.

 

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Compelling value proposition of return on investment for farmers. Our patented crop product and animal product formulae are the result of large scale experimentation. Our internal experimentation on our products demonstrates increased production yields, shorter harvest times, extended life cycles, and enhanced crop taste, nutrition and appearance. As mentioned earlier, the IMARSTB concluded that our product can increase overall yields of staple crops, such as wheat and rice, and vegetables by 10 – 20% and 15 – 30%, respectively, while improving product quality.

 

Strength and experience of management team. We believe that our management team collectively has a great deal of experience in our relatively new market for agricultural nutrient products in China. Our chief executive officer, Mr. Zishen Wu, in particular, is considered a very successful entrepreneur in our industry. Additionally, our senior management team has many years of experience and strong education background in the Chinese agricultural industry, marketing and distribution, finance and general management.

 

Growth Strategies

 

Our strategic growth plan for 2012 consists of the following key elements.

 

Geographic expansion and higher penetration of our distribution and Branded Retailer network. We believe that there is significant market potential for our products across China and we plan to continue to enhance our coverage and penetration of the Chinese markets in order to increase our market share and commercial opportunities. We believe this will further expand our immediate and long term revenue base. We believe that we can benefit from the growing market demand resulting from the increased need to boost agricultural productivity. In addition to driving further penetration in our existing markets, we plan to expand our distribution network in new geographic markets. We will also work to ensure continued successful replication of our Branded Retailer model in new markets by continuing to provide our distributors with value-added technical product and sales leadership training, and our integrated marketing campaigns support.

 

Enhance brand recognition on national and local levels. We will invest more resources on marketing efforts to enhance our brand image and increase our exposure in target markets, such as advertisement on national and local media and providing training and technical support to various levels of distributors, Branded Retailers and farmers.

 

Share Exchange

 

We were incorporated in the State of Nevada on December 12, 2006 under the corporate name “Golden Tan, Inc.” At that time, we were engaged in the business of offering sunless tanning services and selling tanning lotions. In 2008, we began to pursue an acquisition strategy, whereby we sought to acquire an undervalued business with a history of operating revenues in markets that provide room for growth.

 

On April 17, 2008, we entered into a share exchange agreement with Fullmax Pacific Limited, a company organized under the laws of the British Virgin Islands (“Fullmax”), the shareholders of Fullmax, who together owned 100% of the equity of Fullmax, and our principal shareholder. Pursuant to the share exchange agreement, the Fullmax shareholders transferred to us 100% of Fullmax’s equity in exchange for 11,444,755 shares of our common stock (the “Share Exchange”). As a result of the Share Exchange, Fullmax became our wholly owned subsidiary.

 

Restructuring

 

At the time we acquired Fullmax, it had acquired certain assets that form the basis of our trading business from Inner Mongolia Yongye Biotechnology Co., Ltd., a company organized under the laws of the PRC (“Inner Mongolia Yongye”), and owned and controlled by Zishen Wu, our chairman, chief executive officer and president. The first step in this process occurred in November 2007, when Fullmax’s wholly-owned subsidiary, Asia Standard Oil Limited, a Hong Kong company (“Asia Standard”) entered into a Sino-foreign cooperative joint venture agreement with Inner Mongolia Yongye (the “CJV Agreement”). The CJV which was formed was Yongye Nongfeng Biotechnology Co., Ltd (“Yongye Nongfeng”).

 

In connection with a September 2008 private placement of our common stock, we agreed with the investors participating in the transaction to complete the remaining steps necessary for acquiring the assets that form the basis of our operations from Inner Mongolia Yongye. We completed these remaining steps, which we refer to as the “Restructuring” in this Annual Report on Form 10-K, in October 2009. Prior to the Restructuring, Inner Mongolia Yongye owned and operated the principle assets of our business and had been in the business of researching, producing and selling its own fulvic acid based crop and animal products since 2003. Until Yongye Nongfeng obtained the required license to produce our products in May 2009, Inner Mongolia Yongye manufactured such products exclusively for us.

 

As part of the Restructuring and pursuant to the CJV Agreement, Inner Mongolia Yongye transferred to Yongye Nongfeng its management and other personnel, and the land, buildings and equipment comprising its manufacturing facility. In addition, Inner Mongolia Yongye assisted with obtaining the necessary governmental approvals required for these transfers, as well as with the issuance in May 2009 by the PRC Ministry of Agriculture of a fertilizer license, the patented technology under which was formerly held in the name of Inner Mongolia Yongye, to Yongye Nongfeng.

 

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All of our operations are conducted through Yongye Nongfeng, and its 100% owned subsidiary Yongye Fumin. Pursuant to the terms of the CJV Agreement, we are entitled to 95% of the profits of Yongye Nongfeng and Inner Mongolia Yongye is entitled to 5%.  Zishen Wu, our chairman, president and chief executive officer, owns 95.0% of the outstanding equity interests of Inner Mongolia Yongye and, therefore, is entitled to a portion of the profits of Yongye Nongfeng that are payable to Inner Mongolia Yongye. In addition, Mr. Wu and Inner Mongolia Yongye are parties to an employment agreement, pursuant to which Mr. Wu is employed as chairman and chief executive officer of Inner Mongolia Yongye.

 

The following chart reflects our current organizational structure as of the date hereof. The ownership percentages of Yongye Nongfeng are approximations.

 

 

*Pursuant to the terms of the CJV Agreement, as amended, we are entitled to 95% of the profits distributions of Yongye Nongfeng and Inner Mongolia Yongye is entitled to 5%. In preparing the consolidated financial statements, Inner Mongolia Yongye was noncontrolling interest as of December 31, 2009, 2010 and 2011.

 

On July 20, 2010, Yongye Nongfeng set up a wholly-owned subsidiary, Inner Mongolia Yongye Fumin Biotechnology Co., Ltd. (“Yongye Fumin”), with the paid in capital of US$14,731,880 (equivalent to RMB100 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. Yongye Fumin became fully operational since the first quarter of 2011.

 

Our Principal Products and Services

 

The base of our products is our own patented fulvic acid base compound, which is extracted from humic acid. Fulvic acid binds itself to and strengthens the cell walls of crop and cell membranes of animals, thereby increasing the ability of cells to retain vitamins and minerals and to fight sickness and disease. Fulvic acid also acts as a transport agent by delivering nutrients that stimulate cell growth, increasing oxygen intake into cells, and binding with and removing toxins such as heavy metals and other pollutants. These help with better nutrient uptake in crop and digestion in animals.

 

Liquid Crop Nutrient Product

 

Our liquid crop nutrient product consists of our fulvic acid compound base and nutrients that crops need to grow, and can be applied to various types of crops by spraying the liquid product directly on the crops after dilution with water, typically in conjunction with fertilizers and pesticides. We primarily sell our crop product by 100 milliliter bottle and 10 liter container.

 

We believe that when used correctly, our product can help farmers more efficiently use fertilizers and pesticides, which may reduce the farmers’ overall input costs and environmental damage to the farmers’ land. While each crop varies in response to our product, based on our internal studies, crops are expected to experience yield increases on par with the following results when our crop product is properly used along with sufficient amounts of fertilizer and water:

 

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Crop   Yield
Capsicum (green pepper)   increases yield by up to 22.7%
Carrot:   increases yield by up to 26.5%
Celery:   increases yield by up to 26.3%
Cucumbers:   increases yield by up to 21.7%, and the leaves are greener, the crops are higher by 3.0 cm, and earlier to market by 11 days
Grapes:   increases weight of individual grape by 0.4 g, or 18.2%, increases sugar content by 37.5%
Potatoes:   increases yield by up to 17.3%, and the leaves are thicker and blossom 7 to 10 days earlier
Watermelon:   increases yield by up to 16.9%, increases sugar content 0.8%-1.8%
 By Wheat:   increases yield by up to 10.7%

 

Source: Company research

 

Powder Animal Product

 

Our animal nutrient product is a powder which consists of our fulvic acid compound base and additional nutrients and Chinese herbs that reduce inflammation. Our animal products are currently targeted at and administered to dairy cows through mixture with cow feed. We sell our animal product, which are mainly packaged in bags, with each bag containing twenty, 300 gram packets.

 

Our animal product’s ability to reduce inflammation makes it attractive to Chinese farmers because of the prevalence of mastitis among the dairy cows, an inflammation of the teats that slows down milk production, which is common in the global dairy industry. The Chinese Journal of Veterinary Medicine has reported that, in China, 50-80% of the cows have some form of mastitis, which is typically treated with antibiotics according to the “Handbook of Organic Food Safety and Quality” (International Standard Book Number 0849391547). Although antibiotics can clear up bacterial infections when used correctly, overuse of antibiotics can lead to drug-resistant strains of bacteria and antibiotics kill healthy gut bacteria which is vital to a healthy immune system. Our animal product can help Chinese farmers reduce costs and problems associated with the use of antibiotics to treat mastitis.

 

Our internal studies show that administration of our animal product to cows increases milk production and milk quality, improves cows’ immunity, reduces mastitis, decreases the need for antibiotics, and improves cows’ digestion and growth rate.

 

New Products

 

We are evaluating the prospects for introducing animal products designed for pigs, chickens and sheep.

 

We did not launch any new crop nutrient products in 2011, but we plan to officially introduce two new products to the market in 2012. One new product is to help the crop seeds to sprout and grow, and the other is to improve the crop roots’ ability to absorb the water and fertilizers and to enhance the crop’s resistance against drought, freeze, diseases, and stalk leaning. We are also examining market opportunities for introducing diversified crop nutrient products targeted at corn, peppers, wheat, rice, cucumbers, tomatoes, cotton, potatoes, sunflowers, grapes, tropical fruits and flowers.

 

Production

 

Raw Materials

 

The principal raw material used in the manufacture of fulvic acid is humic acid. Humic acid is formed by biodegradation of dead organic matter which is buried and compressed under soil, and humic acid is mostly contained in peat, lignite coal, leonardite coal, and etc..

 

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Currently, our key raw material for humic acid is lignite coal, and the price of lignite coal is affected by factors such as market demand, quality and transportation cost. The humic acid we use comes from top grade lignite coal which is mined in Inner Mongolia and is typically sold on a per ton basis. We currently procure lignite coal from independent third party suppliers in Inner Mongolia to extract humic acid for our manufacturing needs. 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 chemicals used in our extraction and blending processes as well as macro and micro nutrients.

 

Fluctuations in raw material purchase prices 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.

 

Manufacturing Process

 

Our products are based on patented formulae that combine a fulvic acid base with other macro and micro nutrients.  Our crop nutrient product formula was 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 respectively, that cover formulae for both crop and animal nutrient products, as well as the manufacturing processes for extraction and blending of our products.  In addition to seeking patent protection, we maintain proprietary know-how related to extraction and blending processes as trade secrets.

 

Packaging and Shipment

 

Our liquid crop product is primarily packaged in 100 milliliter bottles and 10 liter container. Our powder animal product is mainly packaged in bags, with each bag containing twenty, 300 gram packets. Each type of packaging material, along with packaging labels, are purchased from two to three separate manufacturers as these packaging materials are readily available in the market.

 

After packaging our products at our manufacturing facility, we engage third parties to ship them to our distributors and we bear the risk of loss until our products are received by our distributors.

 

Quality Control

 

We have implemented and maintain strict quality control procedures. In July 2007, Inner Mongolia Yongye received ISO 9001:2000 accreditation after a third party audit of its quality control procedures at its manufacturing facility. In the Restructuring, Inner Mongolia Yongye transferred its manufacturing facility and personnel to Yongye Nongfeng and Yongye Nongfeng also received ISO 9001:2000 accreditation following a similar third party audit.

 

Production Facility

 

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. The molecular structure of fulvic acid is smaller than humic acid, which enables fulvic acid 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 to extract humic acid for our manufacturing needs.  In March 2010, to secure long-term supply of humic acid, we entered into an agreement to acquire a mineral 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 a Geological Report and Geological Exploration Report. Upon the granting of the Mineral Right, we will be able to further vertically integrate our operations.

 

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Currently we have a total of 46,000 tons of combined annual design production capacity at the Wuchuan Facility and the Jinshan Facility.  The major production processes for our crop and animal nutrient products are identical, and therefore production capacities for the two products to a large extent are inter-changeable.

 

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Because of the proprietary nature of our products and manufacturing processes, 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 year ended December 31, 2011, our actual production output for liquid crop nutrient product was 38,809 tons and the actual output for powder animal nutrient was 965 tons.  We may continue to invest in production capacity expansion as required to respond to increasing demand for our products in the future.

 

Marketing and Sales Support

 

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 strategies primarily focus 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 their loyalty to our Company, 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 our end-customers but also our existing and potential distributors and Branded Retailers. We are amongst the very few companies in our industry that actively sponsor CCTV (China 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.

 

Distribution & Sales Network

 

We employ a multi-tiered distribution model whereby we primarily sell our products to provincial-level distributors who sell to our end-customers either directly or indirectly through county-level distributors and independently owned Branded Retailers (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 Branded Retailers, which serve as village-level retailers of our products, 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.

 

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The following chart illustrates our multi-tiered distribution model:

 

 

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 or 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 December 31, 2011, our products were sold in 30 provinces, autonomous regions and centrally-administered municipalities across China to 25 provincial-level distributors, who then sell our products to 810 county-level distributors and 30,086 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.

 

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 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
   Q4 End
2011
 
                             
Hebei/Beijing/Tianjin   1,894    2,841    3,419    3,532    3,795    3,824    3,935 
Inner Mongolia   660    620    620    501    567    612    765 
Shandong   1,216    2,470    2,983    3,198    3,325    3,355    3,358 
Guangdong/Hainan   75    385    499    641    845    879    941 
Henan   844    1,573    1,793    1,920    2,208    2,278    2,456 
Heilongjiang/Jilin/Liaoning   315    1,013    1,167    1,231    2,066    2,147    2,180 
Xinjiang   356    816    966    1,395    1,946    1,967    2,097 
Hubei/Hunan   2,082    2,709    2,913    3,040    2,949    2,978    2,978 
Gansu/Qinghai   119    628    821    887    915    920    920 
Jiangsu   439    809    1,051    1,186    1,748    1,896    1,936 
Shanxi   167    711    889    1,106    1,288    1,297    1,310 
Anhui   417    1,087    1,122    1,222    1,390    1,420    1,420 
Shaanxi   25    1,096    1,324    1,443    1,480    1,491    1,491 
Sichuan/Chongqing   201    586    624    691    958    1,034    1,044 
Jiangxi/Fujian   100    480    576    666    937    994    1,006 
Yunnan/Guizhou   66    350    495    620    896    1,059    1,076 
Zhejiang   -    85    95    138    191    238    252 
Guangxi   -    96    156    184    428    469    472 
Ningxia   134    345    404    427    433    441    441 
Shanghai   -    -    8    8    8    8    8 
Total   9,110    18,700    21,925    24,036    28,373    29,307    30,086 

 

Customers

 

Since our inception, we have worked to build and maintain our sales and distribution networks. We have established good relationships with capable agricultural products distributors.

 

We usually sign three year contracts with distributors that we identify and choose based upon their overall business strength, credit worthiness and proven ability to develop their local markets.

 

Competition

 

While we compete with both nationwide and local manufacturers of humic or fulvic acid crop nutrients, we believe that we are a clear market leader. The Chinese agriculture industry and the retail market for agricultural goods are highly fragmented. As of the end of February 2012, there were more than 4,000 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 around 1,000 registered as of the end of February 2012.

 

In addition to humic or fulvic acid based crop nutrient products, our nutrient products also compete with other liquid fertilizers applied on crop 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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 Research and Development

 

Our research and development process begins with an internal evaluation of market demand for new types of products. After we initially identify market opportunities for new products, we will, either alone or in cooperation with our research partners, conduct research activities and develop new products. Once our research and development activities are complete, we make a final judgment regarding whether and when to bring the new product to market based upon a second evaluation of market demand, an estimate of the time and expense that will be required to obtain any necessary governmental approvals, the desirability for obtaining patents or feasibility of protecting our intellectual property by other means, and the results of test marketing. The entire process normally takes anywhere from one to five years, depending on the product.

 

We are currently researching and market testing various customized products for crop and animals. We plan to officially introduce two new products to the market in 2012. One new product is to help crop seeds to sprout and grow, and the other is to improve crop roots’ ability to absorb water and fertilizers and to enhance the crop resistance against drought, freeze, diseases, and stalk leaning. We are also examining market opportunities for introducing crop products specifically targeted at corn, peppers, wheat, rice, cucumbers, tomatoes, cotton, potatoes, sunflowers, grapes, tropical fruits and flowers, though no assurance can be given that we will ultimately bring to market the products we are currently researching or the product we are currently market testing. As to animal products, we are market testing the products used for pig, chickens and sheep.

 

Intellectual Property

 

Our products are based on patented formulae that combine 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 respectively, that cover formulae for our liquid crop nutrient product and powder animal nutrient product, as well as the manufacturing processes for extraction and blending of our products.  In addition to seeking patent protection, we maintain proprietary know-how related to extraction and blending processes as trade secrets.

 

On December 6, 2008, the IMARSTB thoroughly reviewed scientific and economic data provided by us and reached the opinion that our liquid crop nutrient product effectively increases agricultural output, improves the utilization rate of fertilizer, enhances a crop’s resistance to disease. In addition, the IMARSTB concluded that large scale experimentation has proven that our product can increase overall yields of staple crops, such as wheat and rice, and vegetables by 10-20% and 15-30%, respectively, while improving product quality. 

 

We have obtained a registered trademark for “Yongye” from the Trademark Bureau of the State Administration of Industry and Commerce of the PRC (“CTMO”), which is valid until October 2017. We have not obtained CTMO approval for the trademark “Shengmingsu” yet. Our cooperative joint venture partner, Inner Mongolia Yongye filed a trademark application for “Shengmingsu” with the CTMO in December 2007, prior to Yongye Nongfeng’s establishment. Inner Mongolia Yongye will transfer this trademark to Yongye Nongfeng upon procurement of trademark registration with the CTMO.

 

In addition to trademark and patent protection law in China, we rely on contractual confidentiality and non-competition provisions to protect our intellectual property rights and brand. We also take further steps to limit the number of people involved in the production process and refer to each ingredient by number rather than name when collecting and preparing them for mixture.

 

Employees

 

The table below presents the number of our employees as of the end of the periods indicated.

 

Category  2011   2010   2009 
             
Administration   86    74    63 
Manufacturing   302    189    207 
Research & Development   43    35    29 
Sales & Supporting   140    114    100 
Total   571    412    399 

 

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The number of manufacturing staff from 2010 to 2011 increased by 113 primarily due to the fact that we hired more manufacturing staff for Yongye Fumin, our new operating entity, which became fully operational in 2011. We usually hire a significant number of temporary workers in the second and third quarters which are our peak seasons to help meet high levels of demand for our products. Those temporary workers were not counted in the disclosed number of our manufacturing employees in our annual reports. In addition, in 2010, in order to increase operational efficiency during our non-peak season, we restructured our manufacturing workforce and reclassified some full-time employees as temporary workers. Due to the factors discussed above, the full-time manufacturing employee count in our payroll at the end of the year 2010 actually decreased by 18 employees compared to 2009. Since we expect further business growth in the future, the number of our employees may increase accordingly.

 

Governmental Regulation

 

Our products and services are subject to regulation by central and provincial governmental agencies in the PRC, which require us to obtain licenses and certifications. We are required to renew, pass an examination or make a filing in connection with these licenses and certifications on a regular basis.

 

Business License

 

Yongye Nongfeng’s business license enables it to research, develop, process, manufacture, market and sell fulvic acid based crop and animal nutrient products. The business license is valid till January 4, 2018 and is subject to annual examination. In September 2011, Yongye Nongfeng increased its registered capital to US$123,200,000. Yongye Fumin’s business license enables it to research, develop, process, manufacture, market and sell fulvic acid based crop and animal nutrient products, and soil conditioner. The business license is valid till July 19, 2020 and is subject to annual examination.

 

Fertilizer Registration

 

All fertilizers produced in the PRC must be registered with the PRC Ministry of Agriculture or its local branches at a provincial level. No fertilizer can be manufactured without such registration. As part of the Restructuring process, Yongye Nongfeng applied for its initial fertilizer registration certificate in May 2009 and received it on June 1, 2009. On November 4, 2009, the long-term certificate with a five-year term was issued to Yongye Nongfeng.

 

Additive Pre-mixed Feed Certificate

 

With respect to manufacturing of our animal nutrient products by Yongye Nongfeng in the PRC, it is required to obtain an Additive Pre-mixed Feed Certificate. Yongye Nongfeng was granted this certificate in April 2010 by the Ministry of Agriculture, which is valid for a period of five years.

 

Environmental, Health and Safety Laws

 

We are in compliance in all material respects with the various laws, regulations, rules, specifications and permits, approvals and registrations relating to human health and safety and the environment, except where noncompliance would not have a material adverse effect on our business, financial condition and results of operations.

 

Legal Proceedings

 

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 December 12, 2011, the securities class actions were consolidated and a consolidated class action complaint was filed alleging we and our officers and directors issued false and misleading information to investors about our financial and business conditions. On March 5, 2012, the plaintiffs voluntarily dismissed this action with prejudice as to themselves as named plaintiffs.

 

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 such 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. This lawsuit is in its early stage. We believe the claims contained in the lawsuit to be without merit and intend to defend ourselves vigorously.

 

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Property

 

Our principal executive offices is located at 6th floor, Xue Yuan International Tower, No. 1 Zhichun Road, Haidian District, Beijing PRC and the telephone number is 86-10-8232-8866. The office space is approximately 1,000 square meters in area.  Our manufacturing facilities and the adjacent greenhouses and open field, which serve as a research and product demonstration sites, are in the High Tech Economic Development Zone in Hohhot, Inner Mongolia and Economic Development Zone in Wuchuan County, Inner Mongolia.

 

There is no private ownership of land in China. All land ownership is held by the government of the PRC, its agencies and collectives. Land use rights can be transferred upon approval by the land administrative authorities of the PRC (the State Land Administration Bureau) upon payment of the required land transfer fee. Yongye Nongfeng owns the land use rights for the land on which our manufacturing facilities, greenhouses and open field are situated, which have a term of 50 years that expires in 2057. We lease our principal executive offices under a lease that provides for a three year term.

 

Executive Office

 

Our principal executive office is located on the 6th Floor, Suite 608, at Xue Yuan International Tower, No. 1 Zhichun Road, Haidian District, Beijing, PRC. Our telephone number at that address is 86-10-8232-8866. Our corporate website is www.yongyeintl.com.

 

Executive Officers of Our Company

 

Because the Proxy Statement for our Annual Meeting of Shareholders will not contain information with respect to all executive officers of Yongye, set forth below is the information with respect to our executive officers:

 

Name   Age   Position
Zishen Wu   43   Chief Executive Officer, President and Chairman
Sam (Yue) Yu   36   Chief Financial Officer
Nan Xu   35   Chief Operating Officer

 

Zishen Wu, Chief Executive Officer, President and Chairman

 

Mr. Wu is CEO and Chairman of the Board of Directors of our Company and Yongye Nongfeng. Mr. Wu began his career as an official at the State Planning Department in Inner Mongolia from 1984 to 1988. From 1989 to 2000, Mr. Wu worked at Inner Mongolia Constructional Consulting and Investment Co., Ltd., a business entity managing state-owned assets in Inner Mongolia. He also served as directors on the boards of several state-owned companies in textile, dairy and agriculture industries. In 2001, Mr. Wu founded Yongye Technology Company in Inner Mongolia, an entity that distributed consumer electronics. In 2003, Mr. Wu founded Inner Mongolia Yongye Biotechnology Co., Ltd, an entity that engages in business in agriculture industry. Mr. Wu was General Manager of Inner Mongolia Yongye Biotechnology Co., Ltd. from January 2003 to December 2007.  Mr. Wu currently is a member of executive committee for Industry and Commerce Association in Inner Mongolia. Mr. Wu has an EMBA degree from School of Management of Fudan University.

 

Sam Yu, Chief Financial Officer

 

Mr. Sam (Yue) Yu joined our Company as Chief Financial Officer on March 25, 2009.  Before joining our Company, Mr. Yu provided capital market consulting services for Chinese companies listed on NASDAQ.  Prior to that, Mr. Yu had served as Chief Operating Officer of Lionax International Investment Holding Ltd., a Chinese company listed on NYSE Euronext, from 2007 to 2008.  Mr. Yu also previously held positions with Underwriters Laboratories Inc. in Asia and its Chicago headquarters from 2002 to 2007, including General Manager, Fire and Security Sector, Asia Pacific; General Manager, Suzhou Branch; Business Development Manager; and Manager of Financial Analysis. Mr. Yu also worked at Shenzhen Development Bank. Mr. Yu was awarded a B.S. in Accounting at the University of International Business and Economics in China. He then earned an M.B.A. in General Management from the Stanford Graduate School of Business.

 

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Xu Nan, Chief Operating Officer

 

Mr. Nan Xu is Chief Operating Officer of Yongye International, Inc.. Prior to joining Yongye in 2007, Mr. Nan Xu was responsible for regional sales and channel management in Liaoning province for Hanvon, a leading Chinese technology company. In 2003, Mr. Xu founded Dongfang Xinqidian, a consumer technology company. From 1999 to 2003, Mr. Wu was general manager for the Northern China region of Hi-Tech Wealth. Prior to that, he was responsible for channel management in Hebei province for LG. Mr. Xu is a recipient of the "Jin Ding Award" in 2011, the top recognition in the Chinese sales and marketing profession.

 

ITEM 1A Risk Factors

 

An investment in our Common Stock is speculative and involves a high degree of risk and uncertainty. You should carefully consider the risks described below, together with the other information contained in this report, including the consolidated financial statements and notes thereto, before deciding to invest in our Common Stock. The risks described below are not the only ones facing our Company. Additional risks not presently known to us or that we presently consider immaterial may also adversely affect our Company. If any of the following risks occur, our business, financial condition and results of operations and the value of our Common Stock could be materially and adversely affected.

 

Risks Related to Our Business

 

We rely on a single product for a substantial portion of our sales and any changes in the market for this product could have a material adverse effect on our business, financial condition and results of operations.

 

In 2011, 2010 and 2009, sales of our liquid crop nutrient product represented 99%, 97% and 93% of our total sales, respectively. If there is any disruption in the demand for our liquid crop nutrient product, whether as a result of alternative nutrient or fertilizer products being developed, the entry of significant competitors to the marketplace or otherwise, our business, financial condition and results of operations could be materially and adversely affected.

 

The limited operating history and early stage development of Yongye Nongfeng, and Yongye Fumin may make it difficult to evaluate our business and future prospects.

 

We established our cooperative joint venture, Yongye Nongfeng, on January 4, 2008, with the intention of carrying out the business of marketing and distributing, and the ultimate goal of manufacturing of our fulvic acid based crop and animal nutrient products. In October 2009, we completed the transfer of manufacturing business of our products from Inner Mongolia Yongye (which is under the control of Mr. Zishen Wu), to Yongye Nongfeng (Mr. Wu is also the CEO of Yongye Nongfeng), including all assets related to the manufacturing, distribution and sales as well as all applicable licenses and titles (the “Restructuring”). On October 10, 2009 the cooperative joint venture contract and Yongye Nongfeng’s articles of association were revised, and the profit distribution percentage and the post-dissolution remaining asset distribution percentage of Inner Mongolia Yongye in Yongye Nongfeng increased to 5% from the previous 0.5%. On July 20, 2010, Yongye Nongfeng set up a wholly-owned subsidiary, Yongye Fumin to expand the production capacity for fulvic acid based liquid and powder nutrient compounds.

 

The limited operating history and the early stage of development of Yongye Nongfeng and Yongye Fumin may make it difficult to evaluate our business and future prospects. We cannot assure you that Yongye Nongfeng and Yongye Fumin will continue to maintain such profitability or that they will not incur net losses in the future. We expect that our operating expenses will increase as we pursue our growth strategies.

 

Failure to manage our recent dramatic growth could strain our management, operational and other resources, which could materially and adversely affect our business and prospects.

 

We have been expanding our operations dramatically and believe we will continue to do so. To meet the demand of our customers, we expect to expand our distribution network in terms of numbers and locations. The rapid growth of our business has resulted in, and if we continue to grow at this rate, will continue to result in, substantial demands on our management, operational and other resources. In particular, the management of our growth will require, among other things:

 

·sufficient working capital and stringent cost controls;

 

·increased sales and sales support activities;

 

·improved administrative and operational systems;

 

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·continued responsibility for disclosure of material facts relating to our business;

 

·strengthening of financial and management controls; and

 

·hiring and training of new personnel.

 

As we continue this effort, we may incur substantial costs and expend substantial resources. We may not be able to manage our current or future operations effectively and efficiently or compete effectively in new markets we enter. If we are not able to manage our growth successfully, our business and prospects may be materially and adversely affected.

 

We do not own 100% of the equity interests in Yongye Nongfeng, which may not be as stable and effective in providing operational control as 100% ownership and we may have conflicts of interests with our joint venture partner.

 

We operate our business through Yongye Nongfeng. If there are disagreements between us and our cooperative joint venture partner, Inner Mongolia Yongye, regarding the business and operations of Yongye Nongfeng, we cannot assure you that we will be able to resolve them in a manner that will be in our best interests. In addition, our joint venture partner may (i) have economic or business interests or goals that are inconsistent with ours; (ii) take actions contrary to our instructions, requests, policies or objectives; (iii) be unable or unwilling to fulfill their obligations; (iv) have financial difficulties; or (v) have disputes with us as to the scope of their responsibilities and obligations. Any of these and other factors may materially and adversely affect the performance of Yongye Nongfeng, which may in turn materially and adversely affect our financial condition and results of operations.

 

We rely on the cooperative joint venture contract with Inner Mongolia Yongye to operate our business. If Inner Mongolia Yongye fails to perform its obligations under the cooperative joint venture contract, we may have to incur substantial costs and resources to enforce such arrangements and rely on legal remedies under PRC laws, including seeking specific performance or injunctive relief and damages, and we cannot assure you that such remedies would be effective. Accordingly, it may be difficult for us to change our corporate structure or to bring claims against Inner Mongolia Yongye if it does not perform its obligations under the cooperative joint venture contract.

 

The cooperative joint venture contract is governed under PRC law. Accordingly, this agreement would be interpreted in accordance with PRC laws and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in the PRC is not as developed as in other jurisdictions, such as the United States.  As a result, uncertainties in the PRC legal system could limit our ability to enforce the cooperative joint venture contract. In the event we are unable to enforce the cooperative joint venture contract, we may not be able to exert effective control over our operating entities, and our ability to conduct our business may be negatively affected.

 

Mr Zishen Wu, our president and CEO, owns a controlling interest in Inner Mongolia Yongye. There could be conflicts of interests between his duties to us and his ownership interests in Inner Mongolia Yongye. We can provide no assurance that if conflicts of interests arise, these conflicts will not result in a significant loss in corporate opportunities for us or a diversion of our resources to Inner Mongolia Yongye, which may not be in our best interest.

 

We may experience difficulty in collecting our accounts receivables, which could have a material and adverse effect on our liquidity, financial condition and results of operations.

 

We derive our revenues from the sale of products through our distributors or and are subject to counterparty risks such as our distributors’ inability to pay. We offer various payment terms to our distributors. The credit period we grant and our credit policies are generally in line with market practice. Under our payment terms, we typically allow our distributors to pay the total purchase price within six months after the receipt of our products. Our peak selling seasons are normally the second quarter and the third quarter, accounting for 70%-80% of our full year sales. Payments for most of our sales made during peak seasons are generally collected in the fourth quarter and the first quarter of the following year. As of December 31, 2011 and 2010, our accounts receivable amounted to US$153.6 million and US$26.1 million, respectively.

 

The accounts receivable increased by US$127.5 million in 2011 as compared to 2010, representing an increase of 488.4%. This significant increase in accounts receivable is attributable to (i) our substantial sales increase by US$176.3 million from approximately US$214.1 million in 2010 to approximately US$390.4 million in 2011, which represents an increase of 82.3%; (ii) in 2011, we experienced significantly more sales in September, October and November than the corresponding months in 2010 amounting to US$45.2 million, which were usually non-peak season months in the past and which are to be collected in the first quarter and second quarter of 2012; and (iii) the significant increase of our accounts receivable turnover days from 27 days in 2010 to 90 days in 2011. The significant increase of our accounts receivable turnover days in 2011 was primarily due to the delayed payments by certain of our distributors which also conduct business in distribution of nitrogen, potash and phosphorus (“NPK”) fertilizers, in addition to our nutrient products. Since the NPK fertilizer suppliers typically have a substantially lower profit margin, the NPK fertilizer suppliers normally require distributors to pay deposit upfront at year end to guarantee the normal supply next year. In 2011, China tightened its monetary policy and it became very difficult to obtain financing from financial institutions. Thus our distributors were under greater liquidity pressure than before. In order to respond to the cash flow shortage caused by the tightened financing, such distributors took full advantage of our six month credit term to pay deposit for NPK fertilizer.

 

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There can be no assurance that we will be able to improve our collection of accounts receivable from such distributors. The significant amount of accounts receivable and the increased accounts receivable turnover days may expose us to increasing risks associated with shortage of working capital, which may result in delay or difficulty in the delivery of our products and services and, in turn, our liquidity, financial condition and results of operations could be materially and adversely affected.

 

In addition, the increased accounts receivable balance and turnover days increase our exposure to bad debt. Of the US$168.9 million of our gross accounts receivable as of December 31, 2011, US$11.6 million were past due, while we did not have any accounts receivable past due as of December 31, 2010 and 2009. All of those past due accounts receivable were subsequently collected in January 2012. We do not hold any collateral over our accounts receivable. Accounts receivable represents those receivables derived in the ordinary course of business. Accounts receivable is reported net of an allowance for doubtful accounts. We establish an allowance for doubtful accounts based on estimates of market condition and distributors’ financial status, aging analyses of accounts receivable balances, historical experience and other factors surrounding the credit risk of specific distributors. Past due balances of accounts receivable are reviewed individually for collectability. We recorded an allowance for doubtful receivables in the amount US$15.2 million as of December 31, 2011. Although we are taking measures, such as increasing collection efforts and closely monitoring distributor credit status to minimize the bad debt risk, we cannot assure you that such measures will be effective and the significant increase in bad debt may result in losses that could have a material adverse effect on our business, financial condition and results of operations.

 

Furthermore, the payment ability of our distributors, in turn, directly affects our revenue recognition. One of the criteria to recognize revenues is that the collectability of outstanding accounts receivable is reasonably assured. As such, deteriorating payment ability of our distributors will result in delay revenue recognition, until collectability can be reasonably assured which is generally upon cash receipt and, thus, have a material and adverse effect on our financial condition and results of operations.

 

One or more of our distributors and retailers could engage in activities that are harmful to our brand and to our business.

 

Due to our reliance on a distribution network that is comprised of provincial-level distributors, country-level distributors and Branded Retailers to sell our products, we are susceptible to our distributors and Branded Retailers engaging in activities that are harmful to our brand and business. If our distributors or Branded Retailers do not implement our branding strategy properly, including failure to use appropriate signage at Branded Retailers, our brand name may be damaged. In addition, if our distributors or Branded Retailers sell our products under another brand, purchasers will not be aware of our brand name. Moreover, our ability to provide appropriate customer service to these purchasers will be negatively affected, and we may be unable to develop our local knowledge of the needs of these customers. Furthermore, if any of our distributors or Branded Retailers sell inferior products produced by other companies under our brand name, our brand and reputation could be harmed, which could make marketing of our products more difficult.

 

If we are not able to obtain the requisite government approval to complete the mineral resources project or if the project renders fewer resources than expected, our vertical integration strategy could fail.

 

In 2010, we entered into an agreement with Wuchuan Shuntong to acquire the permit for the rights to explore, develop and produce mineral resources in a certain area of Wuchuan County. The cash consideration of the permit was approximately RMB240 million or US$35 million. The permit allows us to complete all necessary administrative procedures and obtain government approvals to acquire the permit for the rights to explore, develop and produce humic acid bearing resources (“Mineral Rights”). We believe that the Mineral Rights will allow us to secure a long term supply of humic acid, which is a major raw material used in the manufacture of our products. 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 Rights to develop and produce the mineral resources and are preparing for the relevant reports, including but not limited to a Geological Report and Geological Exploration Report. However, we cannot assure you that we can obtain the Mineral Rights to develop and produce the mineral resources in a timely manner, if at all. Furthermore, the nature and amount of the mineral resources in the Wuchuan project may not be the same as analyzed in the third-party preliminary reports obtained by us in 2009, and our supply of humic acid will be dependent upon market availability. If we are unable to obtain adequate quantities of raw materials at economically viable prices which meet our specifications, our financial condition and results of operation could be adversely affected.

 

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If we cannot renew our fertilizer registration certificate, we will be unable to sell our products which will cause our sales revenues to significantly decrease.

 

All fertilizers produced in the PRC must be registered with the PRC Ministry of Agriculture or its local branches at a provincial level. No fertilizer can be manufactured without such registration. As part of the Restructuring process, Yongye Nongfeng applied for its initial fertilizer registration certificate in May 2009 and received it on June 1, 2009. On November 4, 2009, the long-term certificate with a five-year term was issued to Yongye Nongfeng.

 

However, there is no guarantee that the PRC Ministry of Agriculture will further renew our fertilizer registration certificate. If we cannot obtain the necessary renewal, we will not be able to manufacture and sell our fertilizer products in China, which will cause the termination of our commercial operations.

 

Our patent protected formulae, fulvic acid extraction and blending processes may become obsolete which could materially and adversely affect the competitiveness of our  products.

 

The production of our crop and animal nutrient products is based on our patented crop and animal product mixture processes and nutrient formulae. Our future success will depend upon our ability to address the increasingly sophisticated needs of our customers by supporting existing and emerging fulvic acid products and by developing and introducing new products and enhancements to our existing products on a timely basis that keep pace with evolving industry standards and changing customer requirements. If our patented crop and animal nutrient product mixture processes and formulae become obsolete as our competitors develop better products, our future business and financial results could be adversely affected. In addition, although we entered into confidentiality agreements with our key employees, we cannot assure you if there would not be any breach of such agreement in which case our rights over such patented formulae would be adversely affected.

 

We may not possess all the licenses required to operate our business, or may fail to maintain the licenses we currently hold. This could subject us to fines and other penalties, which could have a material adverse effect on our results of operations.

 

In addition to a fertilizer registration certificate, we are required to hold a variety of other permits, licenses and certificates to conduct our business in China, including relevant construction and environmental permits and certificates in connection with the commencement of operations at Yongye Fumin. We may not possess or receive all the permits, licenses and certificates required for our business or for which application has been made. In addition, there may be circumstances under which the approvals, permits, licenses or certificates granted by the governmental agencies are subject to change without substantial advance notice, and it is possible that we could fail to obtain the approvals, permits, licenses or certificates that are required to expand our business as we intend. If we fail to obtain or to maintain such permits, licenses or certificates or renewals are granted with onerous conditions, we could be subject to fines and other penalties and be limited in the number or the quality of the products that we would be able to offer. As a result, our business, result of operations and financial condition could be materially and adversely affected.

 

Zishen Wu, our chairman, chief executive officer and president, has played an important role in the growth and development of our business since its inception, and a loss of his services in the future could severely disrupt our business and negatively affect investor confidence in us, which may also cause the market price of our common stock to go down.

 

To date, we have relied heavily on Mr. Wu’s expertise in, and familiarity with, our business operations, his relationships within the industries in which we operate, his reputation and experience. In addition, Mr. Wu has been primarily responsible for formulating our overall business strategies and spearheading the growth of our operations. If Mr. Wu were unable or unwilling to continue in his present positions, we may not be able to easily replace him and may incur additional expenses to identify and train his successor. In addition, if Mr. Wu were to join a competitor or form a competing business, it could severely disrupt our business and negatively affect our financial condition and results of operations. Although Mr. Wu is subject to certain noncompetition restrictions during and after termination of his employment with us, we cannot assure you that such non-competition restrictions will be effective or enforceable under PRC law. Moreover, even if the departure of Mr. Wu from our Company would not have any actual impact on our operations and the growth of our business, it could create the perception among investors or the marketplace that his departure could severely damage our business and operations and could negatively affect investor confidence in us, which may cause the market price of our common stock to go down. In the event Mr. Wu ceases to be our chief executive officer or ceases to be engaged or to perform his duties on a full-time basis prior to December 31, 2014 (unless as a result of his death, disability or incapacity or events beyond our control or is approved by the holders of a majority of the shares of the convertible preferred stock then outstanding), the holders of our convertible preferred stock will be able to redeem all or a portion of the outstanding shares of convertible preferred stock at a redemption price equal to the original purchase price thereof, plus a premium designed to generate a 30% internal rate of return to such holders. We do not maintain key man insurance for Mr. Wu.

 

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We depend heavily on our skilled personnel, and any loss of such personnel or the failure to continue to attract such personnel in the future could harm our business.

 

Our business is specialized and requires the employment of personnel with significant scientific and operational experience in the industry. Accordingly, we must attract, recruit and retain a workforce of technically and scientifically competent employees. Due to the intense market competition for highly skilled workers and experienced senior management, we have faced difficulties locating personnel that have the necessary scientific, technical and operational skills and experience with the fertilizer industry. Our ability to effectively implement our business strategy will depend upon, among other factors, the successful recruitment and retention of qualified management and our key personnel. These individuals are difficult to find in the PRC and we may not be able to retain such skilled employees and replace them within a reasonable period of time, or at all. Our business may be severely disrupted, our financial condition and results of operations may be materially and adversely affected, and we may incur additional expenses in recruiting and training additional personnel. Although our employees and senior management members are subject to certain non-competition restrictions during and after termination of their employment, we cannot assure you that such non-competition restrictions will be effective or enforceable under PRC law. If any of our key personnel joins a competitor or forms a competing business, our business may be severely disrupted. We have no key man insurance with respect to our key personnel that would provide insurance coverage payable to us for loss of their employment due to death or other reasons.

 

The markets in which we operate are highly competitive and fragmented and we may not be able to maintain market share.

 

We operate in highly competitive markets and compete with numerous local PRC humic or fulvic acid crop nutrient manufacturers, as well as other foliar-applied liquid fertilizer manufacturers and we expect competition to persist and intensify in the future. Our competitors are mainly local fertilizer companies who may have better access in certain local markets, stronger ability to customize products to a particular region or locality and more established local distribution channels within a specific region. In the future, we may also compete with large PRC state-owned enterprise national competitors, and they may have competitive advantages over us in certain areas such as access to capital, technology, product quality, economies of scale and brand recognition and may also be better positioned than us to develop superior product features and technological innovations and to exploit and adapt to market trends. Additionally, we may not be able to conduct in-depth research and analysis on our current or new markets due to the lack of enough public or third-party sources of information on our industry and competitors. Therefore, we may not have a clear estimate of the current number of our direct competitors or such competitors' revenues or market share.

 

In addition, China’s entry into the World Trade Organization may lead to increased foreign competition for us. If our international competitors are localized and establish their market recognition in China, we may face additional competition. If we are not successful in our marketing and advertising efforts to increase awareness of our brands, our revenues could decline, which could have a material adverse effect on our business, financial condition, results of operations and share price. We cannot assure you that additional competitors will not enter our existing markets, or that we will be able to compete successfully against existing or new competition.

 

MSPEA Agriculture Holding Limited (“MSPEA”) has significant influence over our affairs.

 

MSPEA currently owns 100% of the outstanding convertible preferred stock and approximately 10.3% of our common stock on an as converted basis. In addition, pursuant to certain rights granted to it under the Certificate of Designation, so long as MSPEA and its affiliates continue to own 25% of the convertible preferred stock initially issued to it, the holders of at least a majority of the shares of the convertible preferred stock have the right to designate one of the directors on our board of directors and have the ability to veto certain of our corporate actions or material transactions under some circumstances. As a result, MSPEA has significant influence over our business.

 

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If we do not meet performance targets specified in the securities purchase agreement with MSPEA or if we issue equity securities at a price per share less than the then-applicable conversion price, the conversion price of the convertible preferred stock would decrease.

 

Pursuant to the terms of the convertible preferred stock, if our net income for the period from fiscal year 2011 (inclusive) to the latest fiscal year with respect to which audited consolidated financial statements are available is below the net income targets of US$84 million for fiscal year 2011, US$210 million for the cumulative period of fiscal year 2011 through fiscal year 2012, US$399 million for the cumulative period of fiscal year 2011 through fiscal year 2013 and US$682.5 million for the cumulative period of fiscal year 2011 through fiscal year 2014 (the “Income Targets,” which Income Targets may be adjusted upwards in the event we issue any equity securities in the future without the prior written approval of the holders of the convertible preferred stock), the conversion price for the convertible preferred stock will decrease and the holders of our common stock could suffer significant dilution in the event of a conversion of any shares of convertible preferred stock. In addition, if we have not achieved any such Income Target and have engaged in certain additional issuances of our equity securities that are not approved in writing by holders of a majority of the convertible preferred stock then outstanding (subject to certain exceptions) but for which no adjustment was made to the Income Targets, Full Alliance has agreed to transfer to MSPEA or its affiliates for total consideration of US$1.00 an amount of shares of our common stock held by Full Alliance that MSPEA would otherwise receive upon conversion of the purchased shares, had the Income Target been so increased. As a result, MSPEA could acquire up to an additional 5,600,000 shares of our common stock currently held by Full Alliance, which shares have been pledged by Full Alliance to support the foregoing obligation. Additionally, as a result of a “full ratchet” anti-dilution provision in favor of holders of our convertible preferred stock, any future issuances of equity securities at a price per share less than the then-applicable conversion price that are not approved by a majority of such holders (subject to certain exceptions) will result in the conversion price being adjusted to the price at which such equity securities are issued.

 

Upon the occurrence of certain events, we may be required to redeem all or a portion of the convertible preferred stock.

 

Upon the occurrence of certain events, including, but not limited to, (i) a breach by us or Full Alliance of certain provisions of the financing documents, which breach gives rise to a material adverse effect on us or which materially diminishes the value of the convertible preferred stock, (ii) our failure to timely file our annual and quarterly reports on Forms 10-K and 10-Q, (iii) our failure to obtain certain mineral exploration rights without any additional material consideration, following which we fail to recover all of the proceeds for the original purchase of such mining rights on or prior to June 30, 2012 and (iv) Mr. Zishen Wu ceasing to be our chief executive officer or ceasing to be engaged or to perform his duties on a full time basis in that capacity prior to December 31, 2014 (unless as a result of his death, disability or incapacity or events beyond our control or is approved by the holders of a majority of the shares of the convertible preferred stock then outstanding), the holders of the convertible preferred stock have the right to require us to redeem all or a portion of their convertible preferred stock at a redemption price equal to the original purchase price, plus a premium designed to generate a 30% internal rate of return to the holders thereof.

 

In addition, the holders of the convertible preferred stock have the right to require us to redeem all or a portion of their convertible preferred stock if (i) the quotient of the aggregate amount of the earnings per share of any six (6) rolling consecutive quarters commencing from the first quarter of the fiscal year 2010 onwards divided by the aggregate amount of the earnings per share of the corresponding six (6) quarter period one year preceding thereto is less than one hundred and twenty percent (120%), and (ii) the actual net income of any fiscal year from 2011 to 2014 (both inclusive) is lower than US$75 million in fiscal year 2011, US$101 million in fiscal year 2012, US$121 million in fiscal year 2013 and US$145 million in fiscal year 2014, in each case at a redemption price equal to the original purchase price, plus a premium designed to generate a 20% internal rate of return to the holders thereof. The foregoing earnings targets are subject to adjustment in certain circumstances including if we have engaged in certain additional issuances of our equity securities that are not approved in writing by holders of a majority of the convertible preferred stock then outstanding (subject to certain exceptions).

 

If we are required to redeem the convertible preferred stock, we would need cash available, and to the extent that we do not have sufficient cash available and do not have access to bank debt, might have to liquidate assets to fund such redemptions. Any such liquidation may yield proceeds lower than might otherwise be the case.

 

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If we need additional financing, we may not be able to find such financing on satisfactory terms or at all.

 

Our capital requirements may be accelerated as a result of many factors, including the growth and timing of our business development activities, budget shortfalls, unanticipated expenses or capital expenditures, future product opportunities, future licensing opportunities and future business combinations. Consequently, we may need to seek additional debt or equity financing, which may not be available on favorable terms, or at all, and which may be dilutive to our stockholders.

 

We may seek to raise additional capital through public or private equity offerings, debt financings or additional corporate collaboration and licensing arrangements. To the extent we raise additional capital by issuing equity securities, our stockholders may experience dilution and, so long as MSPEA and its affiliates hold at least 1,420,455 shares of convertible preferred stock, we would need to obtain the approval of a majority of the shares of convertible preferred stock then outstanding (subject to certain exceptions). To the extent that we raise additional capital by issuing debt securities, we may incur substantial interest obligations, may be required to pledge assets as security for the debt and may be constrained by restrictive financial and/or operational covenants. Any provider of debt financing would also be superior to our stockholders’ interest in bankruptcy or liquidation. To the extent we raise additional funds through collaboration and licensing arrangements, it may be necessary to relinquish some rights to our technologies or product candidates, or grant licenses on unfavorable terms.

 

If we fail to adequately protect or enforce our intellectual property rights, the value of our intellectual property rights could diminish.

 

Our success, competitive position and future revenues will depend in part on our ability to obtain and maintain patent protection for our products, methods, processes and other technologies, to preserve our trade secrets, to prevent third parties from infringing on our proprietary rights and to operate without infringing the proprietary rights of third parties.

 

To date, we have received two patents for our crop and animal products with the State Intellectual Property Office of the PRC. We have obtained a registered trademark for “Yongye” from the Trademark Office of the State Administration of Industry and Commerce of the PRC (“CTMO”). We have not obtained CTMO approval for the trademark “Shengmingsu” yet. Our cooperative joint venture partner, Inner Mongolia Yongye filed a trademark application for “Shengmingsu” with the CTMO in December 2007, prior to Yongye Nongfeng’s establishment. Inner Mongolia Yongye will transfer this trademark to Yongye Nongfeng upon procurement of trademark registration with the CTMO. In addition, we rely on trade secret protection for our proprietary process of extracting fulvic acid from humic acid and creating the base fulvic acid compound used in both our crop (liquid form) and animal nutrient (powder form) products. However, we cannot predict the degree and range of protection patents, trademarks and trade secrets will afford us against competitors. Third parties may find ways to invalidate or otherwise circumvent our patents, proprietary technology and trademark. Third parties may attempt to obtain patents claiming aspects similar to our patent and trademark applications. If we need to initiate litigation or administrative proceedings to protect our rights, such actions may be costly and may divert management attention as well as expend other resources which could otherwise have been devoted to our business. An adverse determination in any such litigation will impair our intellectual property rights and may harm our business, prospects and reputation. In addition, historically, implementation of PRC intellectual property-related laws has been lacking, primarily because of ambiguities in the PRC laws and difficulties in enforcement. Accordingly, intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other countries, which increases the risk that we may not be able to adequately protect our intellectual property rights.

 

If we infringe upon the rights of third parties, we could be subject to disputes or lawsuits and we could be prevented from selling products, forced to pay damages and compelled to defend against litigation.

 

If our products, formulae, methods, processes and other technologies infringe upon proprietary rights of other parties, we could be subject to disputes and lawsuits and could incur substantial costs, and may have to obtain licenses (which may not be available on commercially reasonable terms, if at all), redesign our products or processes, stop using the subject matter claimed in the asserted patents, pay damages, or defend litigation or administrative proceedings, which may be costly whether we win or lose. All of the above could result in a substantial diversion of valuable management resources.

 

We have taken reasonable steps, including comprehensive internal and external prior intellectual property right searches, to ensure we have freedom to operate and that our development and commercialization efforts can be carried out as planned without infringing others’ proprietary rights. However, we cannot guarantee that we will infringe upon no third-party intellectual property right, and we may be subject to a third-party infringement claim. Resolving such issues has traditionally resulted, and could in our case result, in lengthy and costly legal proceedings, the outcome of which cannot be predicted accurately.

 

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A severe or prolonged downturn in the global economy could materially and adversely affect our business and results of operations.

 

The global market and economic conditions during the years 2008 through 2011 were unprecedented and challenging, with recessions occurring in most major economies. Continued concerns about the systemic impact of potential long-term and wide-spread recession, energy costs, geopolitical issues, and the availability and cost of credit have contributed to increased market volatility and diminished expectations for economic growth around the world. The difficult economic outlook has negatively affected businesses and consumer confidence and contributed to volatility of unprecedented levels.

 

The PRC economy also faces challenges. The PRC government has implemented various measures recently to curb inflation. If economic growth slows or an economic downturn occurs, our business and results of operations may be materially and adversely affected.

 

We currently rely upon third-party suppliers for raw materials.

 

We currently are dependent upon third parties for our supply of lignite coal, chemical components and other raw materials. Should any of our suppliers terminate their supply relationships with us, or if our suppliers have inadequate amounts of lignite coal or any such other raw materials to meet our needs, we may be unable to procure sufficient amounts of lignite coal or any such other raw materials on acceptable terms in a timely manner that meet our specifications or that meet the demands of our customers and our profitability may be limited. In addition, these suppliers may not perform their obligations, and it may not be possible to specifically enforce the relationships we have formed with such suppliers. If we are unable to obtain adequate quantities of lignite coal or any such other raw materials at economically viable prices which meet our specifications, our financial condition and results of operations could be adversely affected.

 

Any significant fluctuation in our production costs may have a material adverse effect on our operating results.

 

The prices for the raw materials and other inputs to manufacture our products are subject to market factors largely beyond our control, including the price of lignite coal, chemical components, our energy costs and freight costs. The costs for these inputs may fluctuate significantly based upon changes in the economy and markets. We may not be able to pass any increase of such costs through to our customers and we could incur significant losses.

 

Disruptions in the supply of raw materials used in our products could cause us to be unable to meet customer demand, which could result in the loss of customers and sales.

 

Currently, the lignite coal is the primary raw material that we use to manufacture our products. If there are any business interruptions at our key suppliers and we are unable to locate alternative supply in a timely manner, we may not be able to meet customer demand, which could result in the loss of customers and sales.

 

We may be subject to more stringent governmental regulation on our products.

 

The manufacture and sale of our products in the PRC is regulated by the PRC and the provincial government. The legal and regulatory regime governing our industry is evolving, and we may become subject to different, including more stringent, requirements than those currently applicable to us. While we believe a more stringent standard will have a bigger impact on those manufacturers with poor quality products, we cannot assure you any regulatory change will not adversely affect our business.

 

We have limited insurance coverage and may incur losses due to business interruptions resulting from natural and man-made disasters, and our insurance may not be adequate to cover liabilities resulting from accidents or injuries that may occur.

 

The insurance industry in China is still at an early stage of development. Insurance companies in China offer limited commercial insurance products. While we carry property insurance on our office building, production facility, raw materials and inventories in our Hohhot facilities, and carry auto insurance on our vehicles and maintain workers compensation insurance for our full-time workers, we do not carry any product liability insurance. We believe that current facilities are adequate for our current and immediately foreseeable operating needs. We have determined that balancing the risks of disruption or liability from our business, the cost of insuring for these risks on the one hand, and the difficulties associated with acquiring such insurance on commercially reasonable terms on the other hand, it is not economically practical for us to have such insurance.

 

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Should any natural catastrophes such as earthquakes, floods, or any acts of terrorism occur in Inner Mongolia, where our primary operations are located and most of our employees are based, or elsewhere, we might suffer not only significant property damage, but also loss of revenues due to interruptions in our business operations.

 

The occurrence of a significant event for which we are not fully insured or indemnified, and/or the failure of a party to meet its underwriting or indemnification obligations, could materially and adversely affect our operations and financial condition. Moreover, no assurance can be given that we will be able to maintain adequate insurance in the future at rates we consider reasonable.

 

Any disruption of the operations in our production facility would damage our business.

 

All of our crop and animal nutrient products are currently manufactured in our production facility in Inner Mongolia, China. Our operations could be interrupted by fire, drought, flood, earthquake and other events beyond our control. In addition, in recent months there has been increasing social unrest in Inner Mongolia. This social unrest has led to protests, demonstrations and violence. Any disruption of the operations in our production facility, due to either environmental causes, social unrest or other events beyond our control, would have a significant negative impact on our ability to manufacture and deliver products. We could be unable to outsource our production on terms favorable to us, if at all. Failure to replace any lost production capability would cause a potential diminution in sales, the cancellation of orders, loss of valuable employees, damage to our reputation and potential lawsuits.

 

The crop and animal nutrient products that we manufacture pose safety risks and could expose us to product liability claims.

 

Defects in, or unknown harmful effects caused by, organic and inorganic chemicals and elements in our products could subject us to potential product liability claims that our products cause some harm to the human body or the crop and animals. Although we have adopted safety measures, which we believe meet industry standards, in our research, development and manufacturing processes, accidents may still occur. We do not carry any product liability insurance and any accident, either at the manufacturing phase or during the use of our products, may subject us to significant liabilities. Negative publicity about the safety of our products, whether justified or not, could damage our reputation, involve us in litigation, and damage our brand name and our business. As of the date of this report, no product liability claim has ever been brought against us. However, if we are involved in litigation in the future, our business, financial conditions and results of operations could be materially and adversely affected.

 

An outbreak of food scares in China would materially and adversely affect our business.

 

Any major outbreak of food scares, such as the milk contamination scandal in the PRC in 2008, may result in significant disruptions to our business operations. A major food scare could result in considerable decreases in the demand for the products in which our products are used, which would materially and adversely affect our business and our profitability. Adverse publicity and concerns resulting from such a food scare may discourage consumers from purchasing products in which our products are used. Such a reduction in demand would adversely impact our financial performance and results of operations.

 

Because we may rely on dividends and other distributions on equity paid by our current and future Chinese subsidiaries for our cash requirements, restrictions under Chinese law on their ability to make such payments could materially and adversely affect our ability to grow, make investments or acquisitions, pay dividends to our investors, and otherwise fund and conduct our businesses.

 

We have adopted a holding company structure, and we rely on dividends and other distributions on equity paid by our current and future PRC subsidiaries for their cash requirements, including the funds necessary to service any debt we may incur or financing we may need for operations other than through our PRC subsidiaries. PRC legal restrictions permit payments of dividends by our PRC subsidiaries only out of their accumulated after-tax profits, if any, determined in accordance with PRC GAAP. Our PRC subsidiaries are also required under PRC laws and regulations to allocate at least 10% of their after-tax profits determined in accordance with PRC GAAP to statutory reserves until such reserves reach 50% of the company’s registered capital. Allocations to these statutory reserves and funds can only be used for specific purposes and are not transferable to us in the form of loans, advances or cash dividends. Any limitation on the ability of our current or future PRC subsidiaries to transfer funds to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.

 

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If we are unable to establish appropriate internal financial reporting controls and procedures, it could cause us to fail to meet our reporting obligations, result in the restatement of our financial statements, harm our operating results, subject us to regulatory scrutiny and sanction, cause investors to lose confidence in our reported financial information and have a negative effect on the market price for shares of our common stock.

 

Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. We maintain a system of internal control over financial reporting, which is defined as a process designed by, or under the supervision of, our principal executive officer and principal financial officer, or persons performing similar functions, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

 

As a public company, we have significant additional requirements for enhanced financial reporting and internal controls. We are required to document and test our internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, which requires annual management assessments of the effectiveness of our internal controls over financial reporting. The process of designing and implementing effective internal controls is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to expend significant resources to maintain a system of internal controls that is adequate to satisfy our reporting obligations as a public company. We cannot assure you that we will not, in the future, identify areas requiring improvement in our internal control over financial reporting. We cannot assure you that the measures we will take to remediate any areas in need of improvement will be successful or that we will implement and maintain adequate controls over our financial processes and reporting in the future as we continue our growth. If we are unable to establish appropriate internal financial reporting controls and procedures, it could cause us to fail to meet our reporting obligations, result in the restatement of our financial statements, harm our operating results, subject us to regulatory scrutiny and sanction, cause investors to lose confidence in our reported financial information and have a negative effect on the market price for shares of our common stock.

 

Lack of experience as officers of publicly traded companies of our management team may hinder our ability to comply with the Sarbanes-Oxley Act.

 

It may be time consuming, difficult and costly for us to develop and implement the appropriate internal controls and reporting procedures required by the Sarbanes-Oxley Act of 2002. We may need to hire additional financial reporting, internal controls and other finance staff in order to develop and implement appropriate internal controls and reporting procedures. If we are unable to comply with the Sarbanes-Oxley Act’s internal controls requirements, our auditor could not issue an unqualified opinion of our internal control over financial reporting.

 

We have incurred increased costs as a result of being a public company.

 

As a public company, we have incurred significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as the related rules and regulations subsequently implemented by the SEC, has required changes in corporate governance practices of public companies. These rules and regulations have increased our legal, accounting and financial compliance costs and made certain corporate activities more time-consuming and costly.

 

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Risks Associated With Doing Business in China

 

Adverse changes in PRC economic and political policies could have a material adverse effect on the overall economic growth of China, which could reduce the demand for our products and materially and adversely affect our business.

 

Substantially all of our assets are located in China. Substantially all of our revenue is derived from our operations in China and we anticipate that sales of our products in the PRC will continue to represent a substantial proportion of our total sales in the near future. Accordingly, our results of operations and prospects are subject, to a significant extent, to the economic, political and legal developments in China. The PRC economy differs from the economies of most developed countries in many aspects, including:

 

·the level of government involvement;

 

·the level of development;

 

·the growth rate;

 

·the level and control of capital investment;

 

·the control of foreign exchange; and

 

·the allocation of resources.

 

While the Chinese economy has grown significantly in the past two decades, the growth has been uneven geographically, among various sectors of the economy and during different periods. We cannot assure you that the Chinese economy will continue to grow or at the pace that has prevailed in recent years, or that if there is growth, such growth will be steady and uniform. Any measures taken by the PRC government, even if they benefit the overall Chinese economy in the long-term, may have a negative effect on us. For example, our financial condition and results of operations may be materially and adversely affected by government control over capital investments. Although the Chinese economy has been transitioning from a planned economy to a more market-oriented economy, a substantial portion of the productive assets in China is still owned by the PRC government. The continued control of these assets and other aspects of the national economy by the PRC government could materially and adversely affect our business. The PRC government also exercises significant control over Chinese economic growth through allocating resources, controlling payment of foreign currency denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Any adverse change in the economic conditions or government policies in China could have a material adverse effect on the overall economic growth and the level of investments and expenditures in China, which in turn could lead to a reduction in consumer demand for our products and consequently have a material adverse effect on our business and financial condition.

 

The PRC legal system embodies uncertainties that could limit the legal protections available to us.

 

Unlike common law systems, the PRC legal system is based on written statutes and decided legal cases have little precedential value. In 1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing economic matters in general. Our PRC operating subsidiary is subject to laws and regulations applicable to foreign investment in China. Yongye Nongfeng is subject to laws and regulations governing the formation and conduct of domestic PRC companies. Relevant PRC laws, regulations and legal requirements may change frequently, and their interpretation and enforcement involve uncertainties. For example, we may have to resort to administrative and court proceedings to enforce the legal protection that we enjoy either by law or contract. However, since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory and contractual terms, it may be more difficult to evaluate the outcome of administrative and court proceedings. Such uncertainties, including the inability to enforce our contracts and intellectual property rights, could materially and adversely affect our business and operations. Accordingly, we cannot predict the effect of future developments in the PRC legal system, particularly with respect to the fertilizer and feed sector, including the promulgation of new laws, changes to existing laws or the interpretation or enforcement thereof, or the preemption of local regulations by national laws. These uncertainties could limit the legal protections available to us.

 

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Currency fluctuations may adversely affect our business.

 

Our reporting currency is the U.S. dollar and our operating subsidiaries in China use RMB as their functional currency. Substantially all of our revenue and expenses are in Renminbi. We are subject to the effects of exchange rate fluctuations with respect to any of these currencies. For example, the value of the Renminbi depends to a large extent on Chinese government policies and China’s domestic and international economic and political developments, as well as supply and demand in the local market. From 1994 to 2005, the official exchange rate for the conversion of Renminbi to the U.S. dollar had generally been stable and the Renminbi had appreciated slightly against the U.S. dollar. However, on July 21, 2005, the PRC Government changed its policy of pegging the value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi may fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an approximately 31% appreciation of the Renminbi against the U.S. dollar between July 21, 2005 and December 31, 2011.

 

It is possible that the PRC Government could adopt a more flexible currency policy, which could result in more significant fluctuations of the Renminbi against the U.S. dollar. We can offer no assurance that the Renminbi will be stable against the U.S. dollar or any other foreign currency.

 

To the extent the U.S. dollar strengthens against the Renminbi, the translation of foreign currency denominated transactions will result in reduced revenue, operating expenses and net income for our PRC operations. Similarly, to the extent the U.S. dollar weakens against the Renminbi, the translation of the foreign currency denominated transactions will result in increased revenue, operating expenses and net income for our PRC operations. We are also exposed to foreign exchange rate fluctuations as we translate the financial statements of Yongye Nongfeng and Yongye Fumin into U.S. dollars in consolidation. If there is a change in foreign currency exchange rates, the translation of our foreign subsidiaries’ financial statements into U.S. dollars will lead to a translation gain or loss which is recorded as a component of other comprehensive income. In addition, we may have certain monetary assets and liabilities that are denominated in currencies other than the relevant entity’s functional currency. Changes in the functional currency value of these assets and liabilities result in foreign exchange gain or loss. We have not entered into agreements or purchased instruments to hedge our exchange rate risks, although we may do so in the future. The availability and effectiveness of any hedging transaction may be limited and we may not be able to successfully hedge our exchange rate risks.

 

We must comply with the Foreign Corrupt Practices Act.

 

We are required to comply with the United States Foreign Corrupt Practices Act, which prohibits U.S. companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Foreign companies, including some of our competitors, are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in mainland China. If our competitors engage in these practices, they may receive preferential treatment from personnel of some companies, giving our competitors an advantage in securing business or from government officials who might give them priority in obtaining new licenses, which would put us at a disadvantage. Although we inform our personnel and other agents that such practices are illegal, we cannot assure you that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations.

 

Changes in foreign exchange regulations in the PRC may affect our ability to pay dividends in foreign currency or conduct other foreign exchange business.

 

The Renminbi is not currently a freely convertible currency, and the restrictions on currency exchanges may limit our ability to use revenues generated in Renminbi to fund our business activities outside the PRC or to make dividends or other payments in U.S. dollars. The PRC government strictly regulates conversion of Renminbi into foreign currencies. Over the years, foreign exchange regulations in the PRC have significantly reduced the government’s control over routine foreign exchange transactions under current accounts. In the PRC, the State Administration for Foreign Exchange, or the SAFE, regulates the conversion of the Renminbi into foreign currencies. Pursuant to applicable PRC laws and regulations, foreign invested enterprises incorporated in the PRC are required to apply for “Foreign Exchange Registration Certificates”. Currently, conversion within the scope of the “current account” (e.g. remittance of foreign currencies for payment of dividends, etc.) can be effected without requiring the approval of SAFE. However, conversion of currency in the “capital account” (e.g. for capital items such as direct investments, loans, securities, etc.) still requires the approval of SAFE.

 

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In addition, on October 21, 2005, SAFE issued the Notice on Issues Relating to the Administration of Foreign Exchange in Fundraising and Reverse Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies (“Notice 75”), which became effective as of November 1, 2005. Notice 75 replaced the two rules issued by SAFE in January and April 2005. According to Notice 75:

 

·prior to establishing or assuming control of an offshore company for the purpose of obtaining overseas equity financing with assets or equity interests in an onshore enterprise in the PRC, each PRC resident, whether a natural or legal person, must complete the overseas investment foreign exchange registration procedures with the relevant local SAFE branch;

 

·an amendment to the registration with the local SAFE branch is required to be filed by any PRC resident that directly or indirectly holds interests in that offshore company upon either (1) the injection of equity interests or assets of an onshore enterprise to the offshore company, or (2) the completion of any overseas fund raising by such offshore company; and

 

·an amendment to the registration with the local SAFE branch is also required to be filed by such PRC resident when there is any material change in the capital of the offshore company that does not involve any return investment, such as (1) an increase or decrease in its capital, (2) a transfer or swap of shares, (3) a merger or division, (4) a long term equity or debt investment, or (5) the creation of any security interests.

 

Moreover, Notice 75 applies retroactively. As a result, PRC residents who have established or acquired control of offshore companies that have made onshore investments in the PRC in the past are required to complete the relevant overseas investment foreign exchange registration procedures by March 31, 2006. Under the relevant rules, failure to comply with the registration procedures set forth in Notice 75 may result in restrictions being imposed on the foreign exchange activities of the relevant onshore company, including the payment of dividends and other distributions to its offshore parent or affiliate and the capital inflow from the offshore entity, and may also subject relevant PRC residents to penalties under PRC foreign exchange administration regulations.

 

In addition, SAFE has, from time to time, issued updated internal implementing rules, or Implementing Rules, in relation to Notice 75. New Implementing Rules became effective on July I, 2011. Such Implementing Rules provide more detailed provisions and requirements regarding the overseas investment foreign exchange registration procedures. However, even with the promulgation of the new Implementing Rules there still exist uncertainties regarding the SAFE registration for PRC residents’ interests in overseas companies.

 

On December 25, 2006, the People’s Bank of China promulgated the Administrative Measures for Individual Foreign Exchange. On January 5, 2007, SAFE issued the Implementation Rules of the Administrative Measures for Individual Foreign Exchange, or the Individual Foreign Exchange Rules, which, among other things, specify approval requirements for a PRC citizen’s participation in the employee stock ownership plans or stock option plans of an overseas publicly-listed company. In February 2012, SAFE promulgated the Notice on Issues concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly-Listed Company, or the Stock Option Rules, which replaced and substituted the Application Procedures of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Ownership Plan or Stock Option Plan of Overseas Publicly-Listed Company issued by SAFE in March 2007. According to the Stock Option Rules, if a PRC resident participates in any stock incentive plan of an overseas publicly-listed company, a qualified PRC domestic agent must, among other things, file on behalf of such participant an application with SAFE to conduct the SAFE registration with respect to such stock incentive plan and obtain approval for an annual allowance with respect to the purchase of foreign exchange in connection with the exercise or sale of stock options or stock such participant holds. Such participating PRC resident’s foreign exchange income received from the sale of stock and dividends distributed by the overseas publicly-listed company must be fully remitted into a specific domestic foreign currency account opened and managed by such PRC agent first, before distribution to such participants. We are an offshore listed company and, as a result, any Chinese employee, or foreign employee who resides in PRC more than one year consecutively, of Yongye Nongfeng or Yongye Fumin, including without limitation, directors, supervisors and other senior management staffs of Yongye Nongfeng or Yongye Fumin, who have been granted share options or shares under our 2010 Omnibus Securities and Incentive Plan are subject to the Stock Option Rules. If Yongye Nongfeng, Yongye Fumin or their qualified employees fail to comply with these regulations, they may be subject to fines or other legal sanctions imposed by SAFE or other Chinese government authorities.

 

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PRC regulations relating to mergers and acquisitions of domestic enterprises by foreign investors may increase the administrative burden we face and create regulatory uncertainties.

 

On August 8, 2006, six PRC regulatory agencies, namely, the PRC Ministry of Commerce, or MOFCOM, the State Assets Supervision and Administration Commission, or SASAC, the State Administration for Taxation, the State Administration for Industry and Commerce, the China Securities Regulatory Commission, or CSRC, and SAFE, jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or New M&A Rule, which became effective on September 8, 2006 and was amended on June 22, 2009. The New M&A Rule purports, among other things, to require offshore special purpose vehicles, or SPVs, formed for overseas listing purposes through acquisitions of PRC domestic companies and controlled by PRC companies or individuals, to obtain the approval of the CSRC prior to publicly listing their securities on an overseas stock exchange.

 

On September 21, 2006, pursuant to the New M&A Rule and other PRC laws and regulations, the CSRC, in its official website, promulgated relevant guidance with respect to the issues of listing and trading of domestic enterprises’ securities on overseas stock exchanges (the “Related Clarifications”), including a list of application materials with respect to the listing on overseas stock exchanges by SPVs.

 

There are substantial uncertainties regarding the interpretation and application of the above rules, and CSRC has yet to promulgate any written provisions or formally to declare or state whether the overseas listing of PRC related company similar to the case of us shall be subject to the approval of CSRC. If CSRC approval is required in connection with our listing, our failure to obtain or delay in obtaining such approval could result in penalties imposed by CSRC and other PRC regulatory agencies. These penalties could include fines and penalties on our operations in China, restriction or limitation on remitting dividends outside of China, and other forms of sanctions that may cause a material and adverse effect to our business, operations and financial conditions.

 

Notwithstanding those provisions, we are advised by our PRC counsel, Han Kun Law Offices, that CSRC approval is not required in the context of our listing because (i) we are not a special purpose vehicle formed or controlled by PRC companies or PRC individuals, (ii) we are owned or substantively controlled by foreigners, and (iii) establishment of Yongye Nongfeng is not subject to the New M&A rules because its establishment is through incorporation of a cooperative joint venture with Inner Mongolia Yongye, rather than through merger or acquisition. However, we cannot assure that the relevant PRC government agencies, including the CSRC, would reach the same conclusion, and we still cannot rule out the possibility that CSRC may deem our listing structure circumvents the New M&A rules, Related Clarifications and PRC Securities Law.

 

Though the New M&A rules do not have express provisions in terms of penalties against non-procurement of CSRC approval, there are some other penalty provisions in other PRC laws and regulations regulating offshore listing, which can be cited as a reference:

 

(i) Pursuant to Article 188 of the PRC Securities Law, any entity that issues securities or issues securities in disguised form without verification or examination and approval by the statutory authority shall be ordered to cease issuance and refund the funds thus raised, together with bank deposit interest for the same period, and shall also be fined not less than one percent but not more than five percent of the amount of the proceeds illegally raised. The persons directly in charge and the other persons directly responsible shall be given a disciplinary warning and also be fined not less than RMB30,000 but not more than RMB300,000.  However, we believe that this penalty is mainly designed for and targeted at domestic listing because the PRC Securities Law mainly regulate domestic listings, and listing or de-listing of a company’s stock in the US stock market should be subject to the SEC’s regulation, which is beyond the CSRC’s jurisdiction.

 

(ii) Pursuant to the Circular of the State Council Concerning Further Strengthening the Administration of Overseas Issuance and Listing of Securities, the overseas listing of securities of a PRC related company which violates this Circular shall be deemed an issuance of shares without authorization or approval. Persons in charge of the competent departments responsible for approval of such an overseas issuance could be subject to administrative sanctions if such person in charge is liable for such violation. People heading the issuing entity and other people directly responsible for issuance shall be penalized, including degraded to a lower lever position and termination of employment by the upper level department. If the violation constitutes a crime, criminal liability shall be claimed against relevant responsible persons according to applicable laws. The issuing entity, relevant agencies involved and the responsible people thereof shall be penalized by the CSRC in accordance with the provisions of the Interim Regulations on the Administration of Issuance and Trading of Securities and other relevant provisions.

 

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Government regulations on environmental matters in China may adversely impact on our business.

 

Our manufacturing operations are subject to numerous laws, regulations, rules and specifications relating to human health and safety and the environment. These laws and regulations address and regulate, among other matters, wastewater discharge, air quality and the generation, handling, storage, treatment, disposal and transportation of solid and hazardous wastes and releases of hazardous substances into the environment. In addition, third parties and governmental agencies in some cases have the power under such laws and regulations to require remediation of environmental conditions and, in the case of governmental agencies, to impose fines and penalties. We make capital expenditures from time to time to stay in compliance with applicable laws and regulations.

 

We believe that we have obtained all permits and approvals and filed all registrations required for the conduct of our business, except where the failure to obtain any permit or approval or file any registration would not have a material adverse effect on our business, financial condition and results of operations. We believe that we are in compliance in all material respects with the numerous laws, regulations, rules, specifications and permits, approvals and registrations relating to human health and safety and the environment except where noncompliance would not have a material adverse effect on our business, financial condition and results of operations.

 

The PRC governmental authorities have not revealed any material environmental liability that would have a material adverse effect on us. We have not been notified by any governmental authority of any continuing noncompliance, liability or other claim in connection with any of our properties or business operations, nor are we aware of any other material environmental condition with respect to any of our properties or arising out of our business operations at any other location. However, in connection with the ownership and operation of our properties (including locations to which we may have sent waste in the past) and the conduct of our business, we potentially may be liable for damages or cleanup, investigation or remediation costs. In addition, in connection with environmental certification applications we have filed regarding our existing operations, the PRC governmental authorities could impose significant additional obligations prior to approving such applications, or could determine not to approve such applications. Any such additional obligation, or the denial of such applications could have a material adverse effect on our business, financial conditions and results of operations.

 

No assurance can be given that all potential environmental liabilities have been identified or properly quantified or that any prior owner, operator, or tenant has not created an environmental condition unknown to us. Moreover, no assurance can be given that (i) future laws, ordinances or regulations will not impose any material environmental liability or (ii) the current environmental condition of the properties will not be affected by the condition of land or operations in the vicinity of the properties (such as the presence of underground storage tanks), or by third parties unrelated to us. State and local environmental regulatory requirements change often.

 

It is possible that compliance with a new regulatory requirement could impose significant compliance costs on us. Such costs could have a material adverse effect on our business, financial condition and results of operations.

 

We may have difficulty managing the risk associated with doing business in the Chinese fertilizer and feed sector.

 

In general, the fertilizer and feed sector in China is affected by a series of factors, including, but not limited to, natural, economic and social such as climate, market, technology, regulation, and globalization, which makes risk management difficult. Fertilizer and feed operations in China face similar risks as present in other countries, however, these can either be mitigated or exacerbated due to governmental intervention through policy promulgation and implementation either in the fertilizer and feed sector itself or sectors which provide critical inputs to fertilizer and feed such as energy or outputs such as transportation. While not an exhaustive list, the following factors could significantly affect our ability to do business:

 

·food, feed, and energy demand including liquid fuels and crude oil;

 

·agricultural, financial, energy and renewable energy and trade policies;

 

·input and output pricing due to market factors and regulatory policies;

 

·production and crop progress due to adverse weather conditions, equipment deliveries, and water and irrigation conditions; and

 

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·infrastructure conditions and policies.

 

Currently, we do not and do not intend to carry insurance to protect revenue which could be lost caused by any of the above factors.

 

We may have difficulty establishing adequate management, legal and financial controls in the PRC.

 

The PRC historically has been unaccustomed to and lacking in management and financial reporting concepts and practices as in the United States and other developed countries, as well as in modern banking, computer and other control systems. We may have difficulty in hiring and retaining a sufficient number of qualified employees to work in the PRC. As a result of these factors, we may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that as used in United States and other developed countries. We may have difficulty in establishing adequate management, legal and financial controls in the PRC.

 

We face risks related to health epidemics and other outbreaks.

 

Our business could be adversely affected by the effects of swine flu, avian flu, severe acute respiratory syndrome, or SARS, or other epidemics or outbreaks. From 2005 to 2009, there have been reports on the occurrences of avian flu and swine flu in various parts of China and elsewhere in Asia, including a few confirmed human cases and deaths. Any prolonged recurrence of swine flu, avian flu, SARS or other adverse public health developments in China may have a material adverse effect on our business operations. Our operations may be impacted by a number of health-related factors, including, among other things, quarantines or closures of our factories and the facilities of our supplier and customers which could severely disrupt our operations. Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect our business and results of operations. We have not adopted any written preventive measures or contingency plans to combat any future outbreak of swine flu, avian flu, SARS or any other epidemics.

 

Inflation in the PRC could negatively affect our profitability and growth.

 

While the PRC economy has experienced rapid growth, it has been uneven among various sectors of the economy and in different geographical areas of the country. Rapid economic growth can lead to growth in the money supply and rising inflation. If prices for our products do not rise at a rate that is sufficient to fully absorb inflation-driven increases in our costs of supplies, our profitability can be adversely affected.

 

During the past ten years, the rate of inflation in China has been fluctuating quite significantly. The Chinese government, from time to time, has adopted various corrective measures designed to restrict the availability of credit, regulate growth and contain inflation. In order to control inflation, the PRC government has imposed controls on bank credits, limits on loans for fixed assets and restrictions on state bank lending. The implementation of these and other similar policies can impede economic growth and thereby harm the market for our products and our business.

 

Because our assets and operations are located in PRC, you may have difficulty enforcing civil liabilities against us under the securities and other laws of the United States or any state.

 

We are a holding company, and most of our assets are located in the PRC. In addition, substantially all of our directors and officers are non-residents of the United States, and all or a substantial portion of the assets of these non-residents are located outside the United States, As a result, it may be difficult for investors to effect service of process within the United States upon these non-residents, or to enforce against them judgments obtained in United States courts, including judgments based upon the civil liability provisions of the securities laws of the United States or any state. There is uncertainty as to whether courts of the PRC would enforce:

 

·judgments of United States courts obtained against us or these non-residents based on the civil liability provisions of the securities laws of the United States or any state; or

 

·in original actions brought in the PRC, liabilities against us or non-residents predicated upon the securities laws of the United States or any state.

 

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Enforcement of a foreign judgment in the PRC also may be limited or otherwise affected by applicable bankruptcy, insolvency, liquidation, arrangement, moratorium or similar laws relating to or affecting creditors’ rights generally and will be subject to a statutory limitation of time within which proceedings may be brought.

 

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We may not receive the preferential tax treatment we previously enjoyed under PRC laws, and our global income and dividends paid to us from our operations in China may become subject to income tax under PRC law.

 

The rate of income tax on companies in China may vary depending on the availability of preferential tax treatment or subsidies based on their industry or location. The PRC government promulgated on March 16, 2007 the new Enterprise Income Tax Law, (“EIT Law”), and it’s implementing rules, which became effective January 1, 2008. Pursuant to the new law, the enterprise income tax of 25% shall be applied to any enterprise. However, 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. There is no assurance we can renew our High-Tech Enterprise Certificate after it expires or if any new law may change the preferential treatment granted to us. Any loss or substantial reduction of the tax benefits enjoyed by us would reduce our net profit and have a material adverse effect on our financial condition and results of operations.

 

Notwithstanding the foregoing provision, the new EIT Law also provides that dividends paid between “qualified resident enterprises” are exempt from enterprise income tax. Under the new EIT Law and its implementing rules, an enterprise established outside the PRC with its “de facto management body” within the PRC is considered a “resident enterprise” and will be subject to the enterprise income tax at the rate of 25% on its worldwide income. The “de facto management body” is defined as the organizational body that effectively exercises overall management and control over production and business operations, personnel, finance and accounting, and properties of the enterprise. It remains unclear how the PRC tax authorities will interpret such a broad definition. Substantially most of our management members or business operations are based in the PRC. If the PRC tax authorities subsequently determine that we should be classified as a resident enterprise, then it is possible that our worldwide income will be subject to income tax at a uniform rate of 25%.

 

In addition, under the new EIT law and its implementing rules, dividends paid by a foreign invested enterprise in the PRC to its foreign investor who is a non-resident enterprise will be subject to a 10% PRC withholding income tax (5% for a qualified Hong Kong beneficial owner), unless such tax is eliminated or reduced under an applicable tax treaty. Asia Standard Oil Limited (“ASO”), the 95% shareholder of Yongye Nongfeng, is incorporated in Hong Kong. Therefore, if ASO is considered a non-resident enterprise for purposes of the new EIT law, this new withholding income tax imposed on dividends paid to us by Yongye Nongfeng would reduce our net income in the event we decide to declare a dividend, which may have an adverse effect on our operating results.

 

It is unclear whether the dividends we receive from Yongye Nongfeng will constitute dividends between “qualified resident enterprises” and would therefore qualify for the tax exemption because it is unclear as to (i) the detailed qualification requirements for such exemption and (ii) whether dividend payments by our PRC subsidiary and investee company to us will meet such qualification requirements, even if we are considered a PRC resident enterprise for tax purposes.

 

Moreover, since ASO, the 95% shareholder of Yongye Nongfeng, is incorporated in Hong Kong, even if ASO is considered a non-resident enterprise, it is also unclear whether ASO should be considered as a Hong Kong beneficial owner. The beneficial owner means persons who possess ownership and right of control on their proceeds or rights or properties generated from such proceeds. The beneficial owner generally engages in substantive operation activities and may be individuals, companies or any other associations. Agents and companies for tax evasion purposes are not beneficial owner. If ASO is not considered Hong Kong beneficial owner, it will be subject to a 10% PRC withholding income tax.

 

Dividends payable to our non-PRC investors and any gain on the sale of our shares may be subject to taxes under PRC tax laws.

 

If our dividends payable to our shareholders are treated as income derived from sources within China, then those dividends, and any gain on the sale or transfer of our shares, may be subject to taxes under PRC tax laws.

 

Under the EIT Law and its implementing rules, a withholding income tax at the rate of 10% is applicable to dividends paid by us to our investors that are non-resident enterprises so long as (i) any such non-resident enterprise investor does not have an establishment or place of business in China, or (ii) despite the existence of an establishment or place of business in China, the relevant income is not effectively connected with such an establishment or place of business in China and (iii) such dividends are derived from sources within PRC. Similarly, any gain realized on the transfer of our shares by such investors is also subject to a 10% income tax if such gain is regarded as income derived from sources within China and we are considered a resident enterprise domiciled in China for tax purposes. If we are required under the EIT Law to withhold PRC income tax on our dividends paid to our foreign shareholders or investors who are non-resident enterprises, or if you are required to pay PRC income tax on the transfer of our shares under the circumstances mentioned above, the value of your investment in our shares may be materially and adversely affected.

 

37
 

 

In January 2009, the State Administration of Taxation promulgated the Provisional Measures for the Administration of Withholding of Enterprise Income Tax for Non-resident Enterprises (“Measures”). Entities which have the direct obligation to make the following types of payments to a non-resident enterprise will be the relevant tax withholders for such a non-resident enterprise: income from equity investment (including dividends and other return on investment), interest, rent, royalties, and income from assignment of property as well as other income subject to enterprise income taxes received by non-resident enterprises in China. Further, the Measures provide that in the case of an equity transfer of a PRC company’s equity interest between two non-resident enterprises outside of the PRC, the non-resident enterprise which receives the equity transfer payment shall file a tax declaration with the PRC tax authority located at the place of the PRC company whose equity has been transferred, and the PRC company whose equity has been transferred shall assist the tax authorities to collect taxes from the relevant non-resident enterprise.

 

Moreover, the State Administration of Taxation released Circular Guoshuihan No. 698 (“Circular 698”) on December 10, 2009 that reinforces the taxation of certain equity transfers by non-resident investors through overseas holding vehicles. Circular 698 is retroactively effective from January 1, 2008. Circular 698 addresses indirect equity transfers as well as other issues. According to Circular 698, where a non-resident investor that indirectly holds an equity interest in a PRC resident enterprise through a non-PRC offshore holding company indirectly transfers an equity interest in the PRC resident enterprise by selling an equity interest in the offshore holding company, and the latter is located in a country or jurisdiction where the actual tax burden is less than 12.5% or where the offshore income of its residents is not taxable, the non-resident investor is required to provide the PRC tax authority in charge of that PRC resident enterprise with certain relevant information within 30 days of the execution of the equity transfer agreement. The tax authorities in charge will evaluate the offshore transaction for tax purposes. In the event that the tax authorities determine that such transfer is abusing forms of business organization and a reasonable commercial purpose for the offshore holding company other than the avoidance of PRC income tax liability is lacking, the PRC tax authorities will have the power to re-assess the nature of the equity transfer under the doctrine of substance over form. If challenge of a transfer from the State Administration of Taxation is successful, it may deny the existence of the offshore holding company that is used for tax planning purposes and subject the non-resident investor to PRC tax on the capital gain from such transfer. Since Circular 698 has a short history, there is uncertainty as to its application. We may become at risk of being taxed under Circular 698 and may be required to expend valuable resources to comply with Circular 698 or to establish that we should not be taxed under Circular 698, which could have a material adverse effect on its financial condition and results of operations. If the PRC tax authority determines that Circular 698 applies to us (or a non-resident investor), we (or a non-resident investor) will be obligated to make a tax return filing with the relevant PRC tax authority in accordance with PRC tax laws and regulations.

 

PRC regulation of direct investment and loans by offshore holding companies to PRC entities may delay or limit our ability to use the proceeds of any offering of securities to make additional capital contributions or loans to our PRC operating business.

 

Any capital contributions or loans that we, as an offshore company, make to our PRC operating business are subject to PRC regulations. For example, any of our loans to our PRC operating business cannot exceed the difference between the total amount of investment our PRC operating business are approved to make under relevant PRC laws and their respective registered capital, and must be registered with the local branch of SAFE as a procedural matter. In addition, our capital contributions to Yongye Nongfeng must be approved by MOFCOM or its local counterpart and registered with the SAIC or its local counterpart. We cannot assure you that we will be able to obtain these approvals on a timely basis, or at all. If we fail to obtain such approvals, our ability to make equity contributions or provide loans to our PRC operating business or to fund its operations may be negatively affected, which could adversely affect its liquidity and its ability to fund its working capital and expansion projects and meet its obligations and commitments. Furthermore, SAFE promulgated a circular in August 2008 with respect to the administration of conversion of foreign exchange capital contribution of foreign invested enterprises into RMB. Pursuant to that circular, RMB converted from foreign exchange capital contribution can only be used for the activities within the approved business scope of such foreign invested enterprise and cannot be used for domestic equity investment unless otherwise allowed by PRC laws or regulations. As a result, we may not be able to convert Yongye Nongfeng’s newly increased capital contribution into RMB for equity investment in China.

 

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PRC labor law restricts our ability to reduce our workforce in the PRC in the event of an economic downturn and may increase our labor costs.

 

In June 2007, the National People’s Congress of the PRC enacted the Labor Contract Law, which became effective on January 1, 2008. To clarify certain details in connection with the implementation of the Labor Contract Law, the State Council promulgated the Implementing Rules for the Labor Contract Law, or the implementing Rules, on September 18, 2008 which came into effect immediately. The Labor Contract Law provides various rules regarding employment contracts that will likely have a substantial impact on employment practices in China. The Labor Contract Law imposes severe penalties on employers that fail to timely enter into employment contracts with employees. The employer is required to pay a double salary to the employee if it does not enter into a written contract with the employee within one month of the employment, and a non-fixed-term contract is assumed if a written contract is not executed after one year of the employment. Additionally, the Labor Contract Law sets a limit of two fixed-term contracts regardless of the length of each term, after which the contract must be renewed on a non-fixed-term basis should the parties agree to a further renewal unless otherwise required by the respective employee. This requirement curtails the common practice of continuously renewing short-term employment contracts. The Implementing Rules appear to further tighten this rule by suggesting that an employee has the right to demand a non-fixed-term contract upon the completion of the second fixed term regardless of whether the employer agrees to a contract renewal. A non-fixed-term contract does not have a termination date and it is generally difficult to terminate such a contract because termination must be based on limited statutory grounds. The employer can no longer supplement such statutory grounds through an agreement with the employee. In addition, the Labor Contract Law requires the payment of statutory severance upon the termination of an employment contract in most circumstances, including the expiration of a fixed-term employment contract.

 

Under the Labor Contract Law, employers can only impose a post-termination non-competition provision on employees for a maximum period of two years. If an employer intends to maintain the enforceability of a post-termination non-competition provision, the employer has to pay the employee compensation on a monthly basis post-termination of the employment. Under the Labor Contract Law, a “mass layoff” is defined as termination of more than 20 employees or more than 10% of the workforce. The Labor Contract Law expands the circumstances under which a mass layoff can be conducted, such as when a company undertakes a restructuring pursuant to the PRC Enterprise Bankruptcy Law, suffers serious difficulties in business operations, changes its line of business, performs significant technology improvements, changes operating methods, or where there has been a material change in the objective economic circumstances relied upon by the parties at the time of the conclusion of the employment contract, thereby making the performance of such employment contract impractical. The employer must follow specific procedures in conducting a mass layoff. There is little guidance on what penalties an employer will suffer if it fails to follow the procedural requirements in conducting the mass layoff. Finally, the Labor Contract Law requires that the employer discuss the company’s internal rules and regulations that directly affect the employees’ material interests (such as employees’ salary, work hours, leave, benefits, and training, etc.) with all employees or employee representative assemblies and consult with the trade union or employee representatives on such matters before making a final decision.

 

All of our employees based exclusively within the PRC are covered by these laws. As there has been little guidance and precedents as to how the Labor Contract Law and its Implementing Rules shall be enforced by the relevant PRC authorities, there remains uncertainty as to their potential impact on our business and results of operations. The compliance with the Labor Contract Law and its implementing Rules may increase our operating expenses, in particular our personnel expenses and labor service expenses. If we want to maintain the enforceability of any of our employees’ post-termination non-competition provisions, the compensation and procedures required under the Labor Contract Law may add substantial costs and cause logistical burdens to us. Prior to the Labor Contract Law such compensation was often structured as part of the employee’s salary during employment, and was not an additional compensation cost. In the event that we decide to terminate employees or otherwise change our employment or labor practices, the Labor Contract Law and its Implementing Rules may also limit our ability to effect these changes in a manner that we believe to be cost-effective or desirable, which could adversely affect our business and results of operations. In particular, our ability to adjust the size of our operations when necessary in periods of recession or less severe economic downturns such as the recent financial turmoil may be affected. In addition, during periods of economic decline when mass layoffs become more common, local regulations may tighten the procedures by, among other things, requiring the employer to obtain approval from the relevant local authority before conducting any mass layoff. Such regulations can be expected to exacerbate the adverse effect of the economic environment on our results of operations and financial condition.

 

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Failure to fully comply with PRC labor laws may expose us to potential liability.

 

Companies operating in China must comply with a variety of labor laws, including certain social insurance, housing fund and other staff welfare-oriented payment obligations. While we believe we have complied with such obligations, there exist uncertainties as to the interpretation, implementation and enforcement of such obligations. If relevant governmental authorities determine that we have not complied fully with such obligations, we may be in violation of applicable PRC labor laws and we cannot assure you that PRC governmental authorities will not impose penalties on us for any failure to comply. In addition, in the event that any current or former employee files a complaint with relevant governmental authorities, we may be subject to making up such staff-welfare oriented obligations as well as paying administrative fines.

 

Risks Related to our Securities

 

Our common stock may be affected by limited trading volume and may fluctuate significantly.

 

Our common stock is traded on the Nasdaq Global Select Market. Although an active trading market has developed for our common stock, there can be no assurance that an active trading market for our common stock will be sustained. Failure to maintain an active trailing market for our common stock may adversely affect our shareholders’ ability to sell our common stock in short time periods, or at all. In addition, sales of substantial amounts of our common stock in the public market could harm the market price of our common stock. Our common stock has experienced, and may experience in the future, significant price and volume fluctuations. Some of the factors that may materially affect the market price of our common stock are beyond our control, such as changes in financial estimates by industry and securities analysts, conditions or trends in the industry in which we operate or sales or our common stock. These factors may materially adversely affect the market price of our common stock, regardless of our performance. These broad market fluctuations may adversely affect the market price of our common stock.

 

Shares eligible for future sale may adversely affect the market price of our common stock, as the future sale of a substantial amount of our restricted stock in the public marketplace could reduce the price of our common stock.

 

From time to time, certain of our stockholders may be eligible to sell all or some of their shares of common stock by means of ordinary brokerage transactions in the open market pursuant to Rule 144, promulgated under the Securities Act (“Rule 144”), subject to certain limitations. In general, pursuant to Rule 144, a stockholder (or stockholders whose shares are aggregated) who has satisfied a six-month holding period may, under certain circumstances, sell within any three-month period a number of securities which does not exceed the greater of 1% of the then outstanding shares of common stock or the average weekly trading-volume of the class during the four calendar weeks prior to such sale. Rule 144 also permits, under certain circumstances, the sale of securities, without any limitations, by a non-affiliate of our Company that has satisfied a one-year holding period. We have granted MSPEA and any other holders of the convertible preferred stock certain registration rights with respect to the common stock underlying the convertible preferred stock and any other shares of common stock they may otherwise own or acquire in the future. Any substantial sale of common stock pursuant to Rule 144 or pursuant to any resale prospectus, including a resale prospectus used to register the common stock underlying the convertible preferred stock, may have an adverse effect on the market price of our securities.

 

There is a significant number of our common stock eligible for sale, which could depress the market price of such stock.

 

Since September 23, 2011, the effective date of the registration statement that registered the common stock underlying our convertible preferred stock, a large number of our common stock has become available for sale in the public market, which could harm the market price of the stock. Further, shares may be offered from time to time in the open market pursuant to Rule 144, and these sales may have a depressive effect as well. In general, a person who has held restricted shares for a period of six months may, upon filing a notification with the SEC on Form 144, sell common stock into the market in an amount equal to the greater of one percent of the outstanding shares or the average weekly trading volume during the last four weeks prior to such sale.

 

Your percentage ownership in us may be diluted by future issuances of capital stock and by the conversion of the convertible preferred stock, which could reduce your influence over matters on which stockholders vote.

 

Subject only to any applicable stockholder approval requirements imposed by the Nasdaq Global Select Market, our board of directors has the authority to issue all or any part of our authorized but unissued shares of common stock. Issuances of common stock would reduce your influence over matters on which our stockholders vote. The conversion of the convertible preferred stock will dilute your percentage ownership.

 

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Stockholders should have no expectation of any dividends.

 

To date, we have not declared nor paid any cash dividends. The Board of Directors does not intend to declare any dividends on our common stock in the near future, but instead intends to retain all earnings, if any, for use in the operation and expansion of our business. If we decide to pay dividends, foreign exchange and other regulations in China may restrict our ability to distribute retained earnings from China or convert those payments from Renminbi into foreign currencies.

 

Techniques employed by manipulative short sellers in Chinese small cap stocks may drive down the market price of our common stock.

 

Short selling is the practice of selling securities that the seller does not own but rather has, supposedly, borrowed from a third party with the intention of buying identical securities back at a later date to return to the lender. The short seller hopes to profit from a decline in the value of the securities between the sale of the borrowed securities and the purchase of the replacement shares, as the short seller expects to pay less in that purchase than it received in the sale. As it is therefore in the short seller’s best interests for the price of the stock to decline, many short sellers (sometime known as “disclosed shorts”) publish, or arrange for the publication of, negative opinions regarding the relevant issuer and its business prospects in order to create negative market momentum and generate profits for themselves after selling a stock short. While traditionally these disclosed shorts were limited in their ability to access mainstream business media or to otherwise create negative market rumors, the rise of the Internet and technological advancements regarding document creation, videotaping and publication by weblog (“blogging”) have allowed many disclosed shorts to publicly attack a company’s credibility, strategy and veracity by means of so-called research reports that mimic the type of investment analysis performed by large Wall Street firm and independent research analysts.  These short attacks have, in the past, led to selling of shares in the market, on occasion in large scale and broad base. Issuers with business operations based in China and who have limited trading volumes and are susceptible to higher volatility levels than U.S. domestic large-cap stock, and can be particularly vulnerable to such short attacks. 

 

These short seller publications are not regulated by any governmental, self-regulatory organization or other official authority in the U.S., are not subject to the certification requirements imposed by the Securities and Exchange Commission in Regulation AC (Regulation Analyst Certification) and, accordingly, the opinions they express may be based on distortions of actual facts or, in some cases, fabrications of facts. In light of limited risks involved in publishing such information, and the enormous profit that can be made from running just one successful short attack, unless the short sellers become subject to significant penalties, it is more likely than not that disclosed shorts will continue to issue such reports.

 

While we intend to strongly defend our public filings against any such short seller attacks, often times we are constrained, either by principles of freedom of speech, applicable state law (often called “Anti-SLAPP statutes”), or issues of commercial confidentiality, in the manner in which we can proceed against the relevant short seller. You should be aware that in light of the relative freedom to operate that such persons enjoy — oftentimes blogging from outside the U.S. with little or no assets or identity requirements — should we be targeted for such an attack, our stock will likely suffer from a temporary, or possibly long term, decline in market price should the rumors created not be dismissed by market participants.

 

In February, March, May and December of 2011, and January of 2012, there were reports published by the Seeking Alpha website, analysts, and other web-based publishers that contained misleading statements about us. Although we have responded to each of these reports in press releases dated February 7, 2011, March 24, 2011, May 19, 2011 and December 15, 2011, there are predictions that there will continue to be more short seller attacks against Chinese companies. As a result, the price of our stock remains vulnerable to any further attacks in this regard.

 

We are the subject of pending class action lawsuits, which could require us to pay substantial damages or could otherwise have a material adverse effect on us.

 

Following the publishing of certain reports on the Seeking Alpha website, analyst reports and other web-based articles, we and certain of our officers and directors were named in a number of class action lawsuits alleging, among other things, that we and such officers and directors issued false and misleading information to investors about our financial and business condition. On March 5, 2012, the plaintiffs voluntarily dismissed this action with prejudice as to themselves as named plaintiffs. We and certain of our officers and directors were named in a derivative lawsuit alleging that such officers and directors breached their fiduciary duties, wasted corporate assets and were unjustly enriched at expenses of our Company. While we believe the claims contained in these lawsuits to be without merit and intend to defend these cases vigorously, these efforts will be both expensive and time consuming and ultimately, due to the nature of the litigation, there can be no assurance that these efforts will be successful. In addition, our bylaws, our amended articles of incorporation and an agreement we entered into in favor of MSPEA’s director in connection with the May 2011 financing require us to indemnify our directors for breaches of fiduciary duties, subject to certain limited exceptions. According to such documents, we are obligated to pay for certain costs and expenses of our directors and may be liable for substantial damages, costs and expenses if the plaintiffs prevail. Such litigation could also divert the attention of our management and our resources in general from day-to-day operations.

 

41
 

 

An SEC investor bulletin regarding reverse mergers may drive down the market price of our common stock.

 

On June 9, 2011, the SEC issued an investor bulletin in which it explained the process by which a company becomes a public company by means of a reverse merger, described the potential risks of investing in a reverse merger company and detailed recent enforcement actions taken by it against certain reverse merger companies. In particular the investor bulletin raised specific concerns with respect to foreign companies that access the U.S. markets through the reverse merger process, as we did. The SEC investor bulletin could cause investors in our common stock to sell their shares and may cause other investors not to invest in us, thus driving down the market price of our common stock or making it more difficult for us to raise funds in the future. 

 

If our common stocks were delisted and determined to be “penny stocks,” a broker-dealer may find it more difficult to trade our common stocks and an investor may find it more difficult to acquire or dispose of our common stocks in the secondary market.

 

If our common stocks were removed from listing with the Nasdaq Global Select Market, we may be subject to the so-called “penny stock” rules. The SEC has adopted regulations that define a “penny stock” to be any equity security that has a market price per share of less than US$5.00, subject to certain exceptions, such as any securities listed on a national securities exchange. For any transaction involving a “penny stock,” unless exempt, the rules impose additional sales practice requirements on broker-dealers, subject to certain exceptions. If our common stocks were delisted and determined to be “penny stocks,” a broker-dealer may find it more difficult to trade our common stocks and an investor may find it more difficult to acquire or dispose of our common stocks on the secondary market. Investors in penny stocks should be prepared for the possibility that they may lose their whole investment.

 

ITEM 1B. Unresolved Staff Comments

 

None.

 

ITEM 2. Properties

 

Our principal executive office is located at 6th floor, Xue Yuan International Tower, No. 1 Zhichun Road, Haidian District, Beijing PRC and the telephone number is +86-10-8232-8626. The office space is approximately 1,000 square meters in area.  Yongye Nongfeng main production plant is in the High Tech Economic Development Zone in Hohhot City in Inner Mongolia, and Yongye Fumin’s production plant is in the Economic Development Zone in Wuchuan County, Hohhot City, Inner Mongolia.

 

There is no private ownership of land in China. All land ownership is held by the government of the PRC, its agencies and collectives. Land use rights can be transferred upon approval by the land administrative authorities of the PRC (State Land Administration Bureau) upon payment of the required land transfer fee. Yongye Nongfeng and Yongye Fumin own the land use rights for the land on which their manufacturing facilities are situated, which have a term of 50 years.

 

ITEM 3. Legal Proceedings

 

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 December 12, 2011, the securities class actions were consolidated and a consolidated class action complaint was filed alleging we and our officers and directors issued false and misleading information to investors about our financial and business conditions. On March 5, 2012, the plaintiffs voluntarily dismissed this action with prejudice as to themselves as named plaintiffs.

 

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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 such 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. This lawsuit is in its early stage. We believe the claims contained in the lawsuit to be without merit and intend to defend ourselves vigorously.

 

ITEM 4. Mine Safety Disclosures

 

Not applicable. 

 

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Part II

 

ITEM 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Market Information

 

Our common stock is quoted on The NASDAQ Global Select Market (“NASDAQ”) under the trading symbol “YONG”. Between April 30, 2008 and September 3, 2009, our common stock was quoted on the OTC Bulletin Board (“OTCBB”) under the trading symbol “YGII.OB”. Until April 29, 2008, our common stock was traded under the symbol “GDTN.OB”. The closing price for our common stock on NASDAQ on March 9, 2012 was US$3.61 per share.

 

The following table sets forth the high and low sales prices for our common stock in the last two fiscal years, as reported by NASDAQ for the periods indicated.

 

Year  Period   High   Low 
             
2010   First Quarter   US$9.21   US$6.87 
                
    Second Quarter    8.47    6.86 
                
    Third Quarter    8.87    5.90 
                
    Fourth Quarter    9.09    7.05 
                
2011   First Quarter   US$8.58   US$5.70 
                
    Second Quarter    6.11    3.52 
                
    Third Quarter    6.13    4.01 
                
    Fourth Quarter    5.67    3.52 

 

Holders

 

As of March 9, 2012, there were  12 record holders of our common stock. 

 

Dividends

 

We have not paid any cash dividends on shares of our common stock and do not plan to do so in the near future. We currently plan to retain future earnings to fund the development and growth of our business. Any future determination related to our dividend policy will be made at the discretion of our Board of Directors. 

 

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Equity Compensation Plan Information

 

The following table sets forth aggregate information regarding our equity compensation plans in effect as of December 31, 2011:

 

   Number of
securities to be
issued upon
exercise of
outstanding options,
warrants
and rights
   Weighted-average
exercise price of
outstanding
options, warrants
and rights
   Number of
securities
remaining
available for
future issuance
under equity
compensation
plans (excluding
securities reflected
in column (a))
 
Plan category  (a)   (b)   (c) 
Equity compensation plans approved by security holders   2,350,000   US$    -0- 
Equity compensation plans not approved by security holders   -0-    -0-    -0- 
Total   2,350,000   US$    -0- 

  

(a)           Includes restricted shares issued pursuant to our 2010 Equity Incentive Plan (the “2010 Plan”), which was approved by our stockholders, and which are subject to a vesting schedule pursuant to the terms of the relevant award agreement.

 

Purchases of Equity Securities by Our Company and Affiliated Purchasers

 

During the fourth quarter of our fiscal year ended December 31, 2011, neither we nor any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act) purchased any shares of our common stock, the only class of our equity securities registered pursuant to section 12 of the Exchange Act.

 

Recent Sales of Unregistered Securities

 

We have reported all sales of our unregistered equity securities that occurred during 2011 in our Reports on Form 10-Q or Form 8-K, as applicable.

 

ITEM 6. Selected Financial Data

 

The following table sets forth selected financial data as of and for the years ended December 31, 2011, 2010, 2009, 2008, and 2007. We derived the selected financial data from our financial statements for those periods. The following selected financial data should be read in conjunction with our consolidated financial statements and related notes and the information contained in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

 

 

   As of and For the year ended 
   December 31,
2011
   December 31,
2010
   December 31,
2009
   December 31, 
2008
   December 31, 
2007
 
                   The predecessor Inner
Mongolia Yongye
 
Income Statement Data:                         
Sales  US$390,379,489   US$214,091,716   US$98,092,842   US$48,092,271   US$13,137,406 
Cost of sales   162,078,410    94,833,834    45,989,386    23,165,684    7,274,710 
Selling expenses   73,886,542    40,612,300    14,720,657    8,665,755    449,168 
General and administrative expenses   35,694,045    13,994,936    4,289,488    2,573,017    476,828 
Earnings before income tax expenses   108,199,751    62,199,838    7,497,312    15,277,438    4,358,554 
Income tax expenses   18,407,554    10,867,857    4,997,105    864,292    - 
Net income   89,792,197    51,331,981    2,500,207    14,413,146    4,358,554 
                          
Earnings per share:                         
Basic  US$1.57   US$1.05   US$0.07   US$0.68   US$0.38 
Diluted  US$1.55   US$1.05   US$0.07   US$0.56   US$0.38 
                          
Weighted average shares:                         
Basic   49,055,252    46,119,772    31,324,830    19,599,054    11,444,775 
Diluted   49,161,073    46,308,924    31,324,830    20,106,433    11,444,775 
Balance Sheet Data:                         
Total assets  US$458,764,878   US$247,626,036   US$145,805,688   US$34,504,261   US$23,131,656 
Total equity attributable to Yongye International, Inc.   316,587,975    215,215,203    125,913,424    27,300,603    12,911,472 
Total equity   331,887,992    225,088,285    132,590,822    28,504,646    12,911,472 

 

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ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Except for the historical information contained herein, the matters discussed in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report are forward-looking statements that involve risks and uncertainties. The factors listed in the section captioned “Risk Factors” as well as any cautionary language in this report, provided examples of risks, uncertainties and events that may cause our actual results to differ materially from those projected. Except as may be required by law, we undertake no obligation to update any forward-looking statement to reflect events after the date of this annual filing.

 

Overview

 

We are a leading crop nutrient company in China in term of total sales in 2011. 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.

 

Currently, our principal product is liquid crop nutrient, from which we derived substantially all of our sales for the year ended December 31, 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.

 

In 2011, we sold approximately 33,179 tons of our liquid crop nutrient product, the revenue from which represented 99% of our total revenue, and 683 tons of our animal nutrient product, the revenue from which represented 1% of our total revenue.

 

Recent Developments

 

On May 29, 2011, we entered into a Securities Purchase Agreement with MSPEA, an affiliate of Morgan Stanley, and 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 December 12, 2011, the securities class actions were consolidated and a consolidated class action complaint was filed alleging we and our officers and directors issued false and misleading information to investors about our financial and business conditions. On March 5, 2012, the plaintiffs voluntarily dismissed this action with prejudice as to themselves as named plaintiffs.

 

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 such 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. This lawsuit is in its early stage. We believe the claims contained in the lawsuit 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 9% of the world’s arable land, China needs to feed 1.3 billion people, or approximately 21% 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, according to FAO, China leads the world in fertilizer consumption, applying more fertilizers than the world average on a per hectare basis, the crop yield lags behind most developed countries. This creates a huge demand for crop nutrient products that can help improve fertilizer utilization and increase crop 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 2011, our crop nutrient product is estimated to have been used in only less than 5% of the arable land in China, assuming there is one and half growing season per annum on average for all the arable land across China.

 

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 which in turn sell our products to county-level distributors, Branded Retailers and end-customers. 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 30,086 as of December 31, 2011.  Jiangsu, Xinjiang, Heilongjiang, Henan, Yunnan and Hebei provinces accounted for the majority of newly recruited Branded Retailers.

 

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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. 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.

 

48
 

 

Agriculture Sector

 

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.

 

In addition, agriculture continues to be a heavily invested sector in China. Brand name investors continue to invest into China’s agriculture industry because they have confidence in China’s long term outlook. The market volume for agriculture products is large, both for domestic sales and export. This is driven by the growing demand for higher quality food products domestically and international reliance on food products from China. Currently, China is the world’s biggest grower and consumer of grains and yet must boost crop yields by at least 1% a year to ensure the country has enough food to feed its 1.3 billion people, according to the former Minister of Agriculture, Sun Zhengcai (China Economic Net, July 21, 2008). Additional policy changes are expected to include protecting farmland and increasing rural incomes to retain farming interest.

 

The goal of government policies is to maintain self-sufficiency in food production because no other country can feed the world’s biggest population, according to Sun. “Our strategy must be based on stable farmland, and seeking ways to improve yields,” Sun said in a speech to local officials, outlining the government’s near- and long-term agriculture policy and objectives. China, which harvested more summer crops, aims also to boost grain and oilseed output this year, Sun said. To ensure next year’s crops production, officials must “stabilize” area planted with winter wheat and use idle land in the off season to grow rapeseed, Sun said.

 

New Land Reform Policy

 

Farmland in China is owned by the local government, but given to local farmers for cultivation under 30 year use contracts. With the allure of higher incomes and better living conditions in the city, in some places, farmers have abandoned the land and no other farmers have stepped in to bring it back into production. This has created a shortage of productive agricultural land. The government has acknowledged this issue and recently enacted a new land use reform policy which liberalizes the exchange of land among the nation’s farmers. This creates a new model for China’s 730 million farmers with the idea being to create more stable farmland by shifting the country away from the single household farm plot model to the amalgamation of larger-scale operations which should be more productive due to technology and economies of scale. Farmers will be able to transfer their land-use rights to others through a new market system for rural land-use rights. Chinese authorities commented that, “Without modernizing agriculture, China cannot modernize; without stability and prosperity in rural areas, China cannot have stability and prosperity. These changes are enacted to “ensure national food security and the supply of major agricultural products, and promote increases in agricultural production, farm incomes and rural prosperity.” (China’s Ongoing Agriculture Modernization, USDA, April 2009). 

 

Drought

 

Many regions in China have experienced drought in the past several years and our Company’s growth to date was partly due to the anti-natural disaster feature of its Shengmingsu product. We believe one important benefit of our "Shengmingsu" branded crop nutrient product is to help crop counteract the effects of water deprivation. Crops sprayed with Shengmingsu are able to better withstand the effects of drought and continue to flourish alongside withering crops which received only traditional fertilizer. Our crop nutrient product has been used in a number of drought-affected areas to assist local farmers in combating the conditions.

 

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FINANCIAL HIGHLIGHTS

 

YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

   For the Years Ended 
   December 31, 2011   December 31, 2010   December 31, 2009 
             
Sales               
External customers  US$390,379,489   US$214,091,716   US$95,870,906 
Related party   -    -    2,221,936 
                
Total sales   390,379,489    214,091,716    98,092,842 
                
Cost of sales               
External customers   162,078,410    94,833,834    44,966,126 
Related party   -    -    1,023,260 
                
Cost of sales   162,078,410    94,833,834    45,989,386 
                
Gross profit   228,301,079    119,257,882    52,103,456 
                
Selling expenses   73,886,542    40,612,300    14,720,657 
                
Research and development expenses   13,130,627    4,852,004    1,690,248 
                
General and administrative expenses   35,694,045    13,994,936    4,289,488 
                
Income from operations   105,589,865    59,798,642    31,403,063 
                
Other income/(expenses)               
Interest expense   (1,429,111)   (86,440)   (81,966)
Interest income   123,054    60,904    11,865 
Subsidy income   2,973,362    3,081,049    237,364 
Other income/(expenses),net   223,496    (613,105)   (63,212)
Change in fair value of derivative liabilities   719,085    (41,212)   (24,009,802)
                
Total other income/(expenses), net   2,609,886    2,401,196    (23,905,751)
                
Earnings before income tax expense   108,199,751    62,199,838    7,497,312 
                
Income tax expense   18,407,554    10,867,857    4,997,105 
                
Net income   89,792,197    51,331,981    2,500,207 
                
Less: Net income attributable to the noncontrolling interest   4,930,571    2,895,055    304,556 
                
Net income attributable to Yongye International, Inc.   84,861,626    48,436,926    2,195,651 
                
Earnings per share:               
Basic earnings per common stock  US$1.57   US$1.05   US$0.07 
Diluted earnings per common stock  US$1.55   US$1.05   US$0.07 
                
Weighted average shares used in computation:               
Basic earnings per common stock   49,055,252    46,119,772    31,324,830 
Diluted earnings per common stock   49,161,073    46,308,924    31,324,830 
                
Net income   89,792,197    51,331,981    2,500,207 
Other comprehensive income               
Foreign currency translation adjustment, net of nil income taxes   10,951,316    6,595,296    (309)
                
Comprehensive income   100,743,513    57,927,277    2,499,898 
Less: Comprehensive income attributable to the noncontrolling interest   5,426,935    3,195,684    304,553 
Comprehensive income attributable to Yongye International, Inc.  US$95,316,578   US$54,731,593   US$2,195,345 

 

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RESULTS OF OPERATIONS

 

Fiscal year ended December 31, 2011 compared with Fiscal year ended December 31, 2010 and 2009

 

Our business for the year ended December 31, 2011 grew at a rate of 82.3% in net sales or a US$176.3 million increase over the same period in 2010, and for the year ended December 31, 2010, our net sales grew at a rate of 118.3% or a $116.0 million increase over the same period in 2009. This increase was driven by higher penetration in our traditional markets, leading to increases in sales volume, and the growth of several new markets.

 

The following table shows, for the periods indicated, information derived from our consolidated statements of comprehensive income.

 

   Yongye   Yongye   Yongye   Changes in % 
   International, Inc.   International, Inc.   International, Inc.   2011 vs.   2010 vs. 
   2011   2010   2009   2010   2009 
Net Sales  US$390,379,489   US$214,091,716   US$98,092,842    82%   118%
Gross Profit   228,301,079    119,257,882    52,103,456    91%   129%
Income from Operations   105,589,865    59,798,642    31,403,063    77%   90%
Net Income   89,792,197    51,331,981    2,500,207    75%   1953%
                          
Gross Margins   58%   56%   53%   4%   6%
Net Margins   23%   24%   3%   4%   700%
                          
EPS- Basic  US$1.57   US$1.05   US$0.07    50%   1400%
EPS- Diluted  US$1.55   US$1.05   US$0.07    48%   1400%

 

Our financial position at December 31, 2011 and 2010:

 

   Yongye   Yongye     
   International, Inc.   International, Inc.     
   December 31, 2011   December 31, 2010   Changes in % 
Cash and restricted cash  US$81,194,880   US$41,953,469    94%
Accounts receivable, net of allowance for doubtful accounts   153,629,522    26,110,813    488%
Inventories   86,117,000    65,878,047    31%
Property, plant and equipment, net   21,929,444    21,547,152    2%
Prepayment for mining project   35,511,520    34,151,063    4%
Total assets   458,764,878    247,626,036    85%
Short term bank loan   28,308,563    -    - 
Long-term loans and payables - current portion   4,279,234    457,880    835%
Income tax payable   3,161,538    6,137,119    (48)%
Accrued expenses   4,437,220    3,024,235    47%
Other payables   3,159,070    5,310,517    (41)%
Total current liabilities   60,856,571    22,154,466    175%
Long-term loans and payables   7,464,683    383,285    1848%
Other non-current liability   4,297,842    -    N A 
                
Total equity attributable to Yongye International, Inc.   316,587,975    215,215,203    47%
Total equity   331,887,992    225,088,285    47%

 

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Our accounts receivable increased by US$127.5 million in 2011 as compared to 2010, representing an increase of 488.4%. This significant increase in accounts receivable was attributable to (i) our substantial sales increase by US$176.3 million from US$214.1 million in 2010 to US$390.4 million in 2011 which represents an increase of 82.3%; (ii) in 2011, we experienced significantly more sales in September, October and November than the corresponding months in 2010 amounting to US$45.2 million, which have historically been non-peak season months and which were to be collected in the first and second quarters of 2012; and (iii) the significant increase of our accounts receivable turnover days from 27 days in 2010 to 90 days in 2011. The significant increase of our accounts receivable turnover days in 2011 was primarily due to the delayed payments by certain of our distributors which also conduct business in distribution of nitrogen, potash and phosphorus (“NPK”) fertilizers, in addition to our nutrient products. Since the NPK fertilizer suppliers typically have a substantially lower profit margin, the NPK fertilizer suppliers normally require distributors to pay deposit upfront at year end to guarantee the normal supply in next year. In 2011, China tightened its monetary policy and it became very difficult to obtain financing from financial institutions. Thus our distributors were under greater liquidity pressure than before. In order to respond to the cash flow shortage caused by the tightened financing, such distributors took full advantage of our six month credit term to pay deposit for NPK fertilizer. The delay in payments from the distributors was not due to excessive inventories held by such distributors, which could not be sold. The shipments and sales of our products are based on the orders initiated by our distributors. Their orders are based on the demand of the end customers or county-level distributors. In addition, none of our distributors has any dispute on any outstanding account receivables.

 

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

 

   December 31, 2011   December 31, 2010 
         
Accounts receivable  US$168,852,106   US$26,110,813 
Less: allowance for doubtful accounts   (15,222,584)   - 
Total  US$153,629,522   US$26,110,813 

 

Of the US$168.9 million of our gross accounts receivables as of December 31, 2011, US$11.6 million of our account receivables were past our six month credit term, representing 6.8% of total year-end gross account receivable balance and 3.0% of our full year sales in 2011. In January 2012, we collected all the overdue amount of US$11.6 million. As of March 15, 2012, we have collected approximately US$73 million of the US$168.9 million of the year-end balance of gross accounts receivables. For the gross accounts receivables balance as of the end of 2011, our top three customers accounted for $47.4 million or 28.1% and our top five customers accounted for $73.9 million or 43.8% of the total amount of accounts receivable.

 

The ageing of gross accounts receivables as of December 31, 2011 and 2010 was:

 

Receivable Ageing  December 31, 2011   %   December 31, 2010   % 
                     
Current:                    
0-3 months  US$39,960,713    23.7%  US$16,932,794    64.8%
3-6 months   117,318,791    69.5%   9,178,019    35.2%
Subtotal   157,279,504    93.2%   26,110,813    100%
                     
Past due:                    
Past due 0-30 days   11,572,602    6.8%   -    - 
Past due over 30 days   -    -    -    - 
Subtotal   11,572,602    6.8%   -    - 
                     
Total   168,852,106    100%   26,110,813    100%

 

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Consistent with industry practice, we provide credit term up to six months to our distributors with well-established trading records. Accounts receivable represents those receivables derived in the ordinary course of business. Accounts receivable is reported net of an allowance for doubtful accounts. We establish an allowance for doubtful accounts based on estimates of market condition and distributors’ financial status, aging analyses of accounts receivable balances, historical experience and other factors surrounding the credit risk of specific distributors. Past due balances of accounts receivable are reviewed individually for collectability. As of December 31, 2011, there were past due balances of accounts receivable due from certain distributors. In addition, as of February 29, 2012, these distributors also had past due balances. Although we have the enforceable right for collection and intend to pursue collection, we believe that the collectability of these past due balances are doubtful, and we recorded an allowance for doubtful receivables in the amount US$15.2 million as of December 31, 2011.

 

After our Wuchuan Facility was put into operation, we have significantly increased production capacity. In addition, we improved inventory management and reduced inventory turnover days to 171 days for the year ended December 31, 2011 compared to 208 days for the same period of 2010.

 

The cash consideration for the resource project is RMB240 million or approximately US$35 million, of which RMB 2.5 million or approximately US$0.4 million remains to be paid. According to preliminary third party analysis, the mineral resource of the project we acquired is at surface level and the “open pit” mining method is recommended. Also, our Wuchuan Facility was built near the mineral resource project to minimize future shipping expense.

 

In December 2011, Yongye Nongfeng obtained two short-term bank loans of RMB60,000,000 (equivalent to US$9,436,188) and RMB120,000,000 (equivalent to US$18,872,375), each with a fixed annual interest rate of 7.93%, from China Citic Bank. These two short-term bank loans are pledged by the inventory, land use right and buildings of Yongye Nongfeng. These two short-term loans are due on June 22, 2012.

 

Total equity increased by US$106.8 million from US$225.1 million as of December 31, 2010 to US$331.9 million as of December 31, 2011. The increase in our total equity was mainly due to an increase in retained earnings of US$84.9 million for the net income attributable to Yongye International, Inc. during the year and an increase in common stock and additional paid in capital of US$6.1 million, as a result of the 1,183,667 and 1,166,333 restricted shares granted to management and independent directors.

 

Net Sales

 

               Changes in % 
               2011 vs.   2010 vs. 
   2011   2010   2009   2010   2009 
Sales  US$390,379,489   US$214,091,716   US$98,092,842    82%   118%
Gross Profit   228,301,079    119,257,882    52,103,456    91%   129%
Gross Margins   58%   56%   53%          

 

Our sales increased by US$176.3 million from US$214.1 million in 2010 to US$390.4 million in 2011, representing an increase of 82.3%. Sales increased by US$116.0 from US$98.1 in 2009 to US$214.1 million in 2010, representing an increase of 118.3%.

 

For the year ended December 31, 2011, we derived US$286.8 million, or 73.5% of our total sales, from existing provincial markets, and we derived US$103.6 million, or 26.5% of our total sales, from the newly developed provincial markets, where we started to actively manage after the second fiscal quarter of 2010. The newly developed provincial markets primarily included Yunnan, Jiangxi, Sichuan, Shaanxi and Anhui.

 

Of the US$176.3 million increase of sales for the year ended December 31, 2011, US$87.4 million, or 49.6%, were derived from existing provincial markets, primarily due to higher penetration rate, more effective channel management and continued retail network development in provinces such as Jiangsu, Heilongjiang/Jilin/Liaoning, Hebei, Inner Mongolia, Henan and Guangdong. In Jiangsu and Hebei, our sales continued to grow as our distributors effectively executed our marketing programs. In Heilongjiang/Jilin/Liaoning and Inner Mongolia, demand from large farms increased significantly. We also achieved significant growth in newly developed provincial markets including Yunnan, Jiangxi, Sichuan, Shaanxi and Anhui. For example, farmers in Yunnan province increased usage of our liquid nutrient product for tobacco and flowers.

 

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For the year ended December 31, 2011, the average selling price (“ASP”) of our liquid crop nutrient product was US$11,639 per ton, as compared to US$11,038 per ton for the same period of 2010. The small increase in our ASP is primarily the result of the effect of currency rate fluctuations.

 

These increases of our sales from the year of 2009 to 2010 were driven by higher demand for our liquid crop nutrient product throughout our market area, including our traditional markets with higher penetration of, and the new markets with significant growth. The growth was mainly due to the great increase in the quantity of product sold while our prices remained relatively stable in most region market except Hebei. Additionally, after the acquisition of Hebei customer list, we are selling at a higher price directly to lower level distributors in Hebei, which is Yongye’s largest regional market in China, representing approximately 29% of sales in 2010.

 

The following table set forth the sales breakdown by region for the year ended December 31, 2011, 2010 and 2009:

 

               2011 vs 2010       2010 vs 2009     
Sales By Region (US$
mm)
  2011   2010   2009   Change in
US$
   2011 vs 2010
Change in %
   Change in
US$
   2010 vs 2009
Change in %
 
Hebei/Beijing/Tianjin   73.7    61.7    29.1    12.0    19.4%   32.6    112.0%
Inner Mongolia   33.5    24.0    18.5    9.5    39.6%   5.5    29.7%
Shandong   28.1    20.1    5.5    8.0    39.8%   14.6    265.5%
Guangdong/Hainan   25.9    18.5    7.4    7.4    40.0%   11.1    150.0%
Henan   23.6    14.6    2.2    9.0    61.6%   12.4    563.6%
Heilongjiang/Jilin/Liaoning   29.4    15.4    2.2    14.0    90.9%   13.2    600.0%
Xinjiang   10.7    10.2    16.0    0.5    4.9%   (5.8)   -36.3%
Hubei/Hunan   13.2    9.1    6.0    4.1    45.1%   3.1    51.7%
Gansu/Qinhai   13.1    8.2    4.2    4.9    59.8%   4.0    95.2%
Jiangsu   23.8    6.7    2.9    17.1    255.2%   3.8    131.0%
Shanxi   11.8    6.0    2.6    5.8    96.7%   3.4    130.8%
Anhui   17.3    6.9    0.5    10.4    150.7%   6.4    12.8x
Shaanxi   20.0    3.6    0.3    16.4    455.6%   3.3    11.0x
Sichuan/Chongqin   21.3    3.6    0.2    17.7    491.7%   3.4    17.0x
Jiangxi/Fujian   21.9    2.1    0.1    19.8    942.9%   2.0    20.0x
Yunnan/Guizhou   22.2    2.3    0.1    19.9    865.2%   2.2    22.0x
Zhejiang   *    0.3    *    (0.3)   -100.0%   0.3    NA 
Guangxi   0.5    0.6    *    (0.1)   -16.7%   0.6    NA 
Ningxia   0.1    0.1    0.1    -    -    -    - 
Shanghai   *    *    *    -    -    -    NA 
Others   0.3    0.1    0.2    0.2    200.0%   (0.1)   -50.0%
Total   390.4    214.1    98.1    176.3    82.3%   116.0    118.2%

 

* Less than US$50,000

 

Our gross profit increased by US$109.0 million from US$119.3 million in 2010 to US$228.3 million in 2011, representing an increase of 91.4%. Gross profit increased by US$67.2 million from US$52.1 million in 2009 to US$119.3 million in 2010, representing an increase of 128.9%.

 

Gross margin increased by 2.8% from 55.7% in 2010 to 58.5% in 2011, and increased by 2.6% from 53.1% in 2009 to 55.7% in 2010. The gross margin increase from the year of 2010 to 2011 was mainly due to that our Wuchuan Facility was put into operation, which enabled us to start using lignite coal as the key raw material and to bypass intermediaries from whom we used to purchase humic acid. The gross margin increase from 2009 to 2010 was mainly due to the benefits from economics of scale. Moreover, after the acquisition of Hebei customer list in July 2010, our increased margin for the sales made in Hebei province also contributed to the increase of gross profit ratio.

 

The number of independently owned Branded Retailers reached 30,086 as of December 31, 2011, compared to 24,036 as of December 31, 2010. 

 

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Sales by Product Line

 

   2011    % of Total   2010   % of Total    2009   % of Total  
   Total sales   Sales   Total sales   Sales   Total sales   Sales 
Crop  US$386,166,674    99%  US$207,514,478    97%  US$91,172,988    93%
Animals   4,212,815    1%   6,577,238    3%   6,919,854    7%
Total   390,379,489    100%   214,091,716    100%   98,092,842    100%

 

During the year ended December 30, 2011, we sold 33,179 tons of liquid crop nutrient products, which represented 99% of our total sales. We also sold approximately 683 tons of our animal nutrient products, which represented 1% of our total sales.

 

Distributors

 

   2011   2010   2009 
   % of Sales   Sales   % of Sales   Sales   % of Sales   Sales 
5 Major Distributors   33%  US$130,621,380    56%  US$119,771,911    82%  US$80,274,006 
3 Major Distributors   21%   83,123,963    40%   85,875,610    66%   64,284,474 
1 Major Distributor   8%   29,392,316    16%   33,173,293    30%   29,004,998 

 

Five major distributors accounted for 33% and one major distributor accounted for 8% of our total revenue for the year ended December 31, 2011. Five major distributors accounted for 56% and one major distributor accounted for 16% of our total revenue for the year ended December 31, 2010. Five major distributors accounted for 82% and one major distributor accounted for 30% of total revenue for the year ended December 31, 2009. Our total sales to five major distributors were US$130.6 million, US$119.8 million and US$80.3 million for the years ended December 31, 2011, 2010 and 2009, respectively.

 

Cost of Goods Sold

 

   2011   2010   2009 
             
Cost of Sales  US$162,078,410   US$94,833,834   US$45,989,386 
Percentage of Sales   42%   44%   47%

 

Cost of goods sold for the year ended December 31, 2011 was US$162.1 million, or 41.5% of our net sales. This represents an increase of US$67.2 million over the previous period and represents a 70.9% increase compared with 2010. Cost of goods sold for the year ended December 31, 2010 was US$94.8 million, representing an increase of US$48.8 million over the previous period of US$46.0 million in 2009, or an increase of 106.2% compared with 2009. The decrease in cost of goods sold as a percentage of our net sales from 44.3% for the year of 2010 to 41.5% for the year of 2011 was mainly due to the fact that our Wuchuan Facility was put into operation, which enabled us to start using lignite coal as the key raw material and to bypass intermediaries from whom we used to purchase humic acid.

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Selling, General & Administrative and Research & Development expenses

 

       % of Total       % of Total       % of Total 
   2011   Sales   2010   Sales   2009   Sales 
Selling Expenses  US$73,886,542    19%  US$40,612,300    19%  US$14,720,657    15%
General & Administrative Expenses   35,694,045    9%   13,994,936    7%   4,289,488    4%
Research & Development Expenses   13,130,627    3%   4,852,004    2%   1,690,248    2%

 

Selling expenses increased by US$33.3 million to US$73.9 million for the year ended December 31, 2011 as compared with the year ended December 31, 2010. Selling expenses increased by US$25.9 million for the year ended December 31, 2010 from US$14.7 million in the corresponding period in 2009. As a percentage of sales for the year ended December 31, 2011, selling expenses decreased slightly by 0.1% to 18.9% as compared to 19.0% of sales in the year ended December 31, 2010. The increase in selling expenses was primarily due to (i) an increase of US$30.7 million in advertising and promotion expense, and distributors’ seminar expenditures, and (ii) an increase of US$2.7 million in transportation expenses due to increased sales. As a percentage of sales for the year ended December 31, 2010, selling expenses increased by 4.0% to 19.0% as compared to 15.0% of sales in the year ended December 31, 2009, due to an increase of US$16.9 million in advertising expenses mainly resulting from more promotional activities in 2010, as we entered into more geographic markets and conducted several nation-wide joint programs with China Central Television Station (CCTV). 

 

General & administrative expenses increased by US$21.7 million to US$35.7 million for the year ended December 31, 2011 from US$14.0 million in 2010, and increased by US$9.7 million for the year ended December 31, 2010 from US $4.3 million in 2009. As a percentage of sales for the year ended December 31, 2011, general & administrative expenses increased by 2.6% to 9.1% as compared to 6.5% of sales in the year ended December 31, 2010, mainly due to the impact of bad debt expenses amounting to US$15.0 million, the implementation of the management equity compensation plan, which resulted in an increase in compensation expenses amounting to US$1.7 million, an increase in employee salaries of 1.5 million, as well as an increase in meeting expenditure, staff training expenses and general maintenance expenses. As a percentage of sales for the year ended December 31, 2010, general & administrative expenses increased by 2.1% to 6.5% as compared to 4.4% of sales in the year ended December 31, 2009, due to an increase of US$4.3 million in management compensation expenses resulted from restricted stock grant to management in October 2010, as well as an increase in staff salaries of US$1.1 million.

 

We incurred US$13.1 million of research and development expenses in the year ended December 31, 2011 as compared to US$4.9 million and US$1.7 million in the years ended December 31, 2010 and 2009, respectively. Our research and development expenses mainly consist of field test expenses for new crops and newly developed provincial markets as well as new product development expenses.

 

Loss on Change in Fair Value of Derivative Liabilities

 

The warrants issued in our private financings in 2008 and 2009 are accounted for as derivative liabilities and measured at fair value at each reporting date. The decrease in fair value during the year ended December 31, 2011 resulted in a gain of US$719,085. The decrease in fair value of the warrants was primarily due to the decrease in our stock price from US$8.35 per share at January 3, 2011 to US$3.52 at December 30, 2011. The change in fair value of the warrants for the year ended December 31, 2010 resulted in a loss of US$41,212 as compared with a loss of US$24,009,802 for the year ended December 31, 2009.

 

Corporate Income Taxes

 

We did not carry on any business and did not maintain any branch office in the United States during the years ended December 31, 2011, 2010, 2009 and 2008 and do not intend to repatriate any earnings from the Chinese operations. Therefore, no provision for withholding taxes for the undistributed earnings of foreign subsidiaries, U.S. federal income taxes, or deferred income tax benefits has been made.

 

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Effective from January 1, 2008, the PRC’s statutory income tax rate is 25%. Our PRC subsidiaries are subject to PRC income tax at 25%, unless otherwise specified. Yongye Nongfeng was entitled to a preferential income tax rate of 15% for the years ended December 31, 2009 and 2010. During the year ended December 31, 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. Our Company’s effective income tax rate was 17.01%, 17.47% and 66.65% for the years ended December 31, 2011, 2010 and 2009, respectively. The difference between effective tax rate and statutory tax rate primarily represented the tax effects of certain non-taxable income, non-deductible expenses and preferential tax rate.

 

For the year ended December 31, 2011, our Company’s income tax expense was US$18.4 million as compared to US$10.9 million and US$5.0 million for the years ended December 31, 2010 and 2009, respectively.

  

Net Income

 

Net income for the year ended December 31, 2011 was US$89.8 million (representing a net profit margin of 23%) compared to US$51.3 (representing a net profit margin of 24%) and US$2.5 million (representing a net profit margin of 3%) in the years ended December 31, 2010 and 2009, respectively. The fluctuation in our net profit margin is primarily due to the increase of the gross profit margin as Wuchuan Facility became operational, and increased bad debt expense in the year ended December 31, 2011 as compared to 2010 and 2009.

 

Foreign Currency Translation Gains

 

The financial position and results of operations of our Company’s subsidiaries in the PRC are measured using the Renminbi as the functional currency, while our Company’s reporting currency is the US dollar. Assets and liabilities of the subsidiaries are translated at the prevailing exchange rate in effect at each period end. The income statement is translated at the average rate of exchange during the period. Translation adjustments are included in the cumulative translation adjustment account in the consolidated statements of stockholders’ equity and comprehensive income. 

 

Liquidity and Capital Resources

 

Our Company has historically financed its operations and capital expenditures principally through issuance of common shares and bank loans. As is customary in the industry, we provide credit terms to all of our distributors which typically exceed the terms that we receive from our suppliers. Currently, we provide credit terms of up to six months to distributors with well-established trading records. Therefore, our liquidity needs have generally consisted of working capital necessary to finance receivables and raw material and finished goods inventory. We believe that our existing cash and cash equivalents will be sufficient to meet our anticipated future cash needs for the coming growing season. We may, however, require additional cash resources due to changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue. Therefore, there can be no assurance that such additional investment will be available to us, or if available, that it will be available on terms acceptable to us.

 

Financial Cash Flow Highlights

 

   2011   2010   2009 
Net cash (used in)/ provided by operating activities  US$(31,203,441)   US$15,891,251   US$(2,190,379 ) 
Net cash used in investing activities   (7,072,060)   (45,962,286)   (4,382,838)
Net cash provided by financing activities   75,506,515    4,971,610    67,694,200 
Effect of exchange rate change on cash and cash equivalents   2,010,397    1,494,713    (80,279)
Net increase/(decrease) in cash and cash equivalents   39,241,411    (23,604,712)   61,040,704 
Cash and cash equivalents at beginning of period   41,913,469    65,518,181    4,477,477 
Cash and cash equivalents at end of period   81,154,880    41,913,469    65,518,181 

 

Net cash used in operating activities in the year ended December 31, 2011 was US$31.2 million, and net cash provided by operating activities in the year ended December 31, 2010 was US$15.9 million and the net cash used in operating activities in the year ended December 31, 2009 was US$2.2 million, respectively. The changes were primarily due to the increase of US$103.7 million in working capital employed, which was primarily driven by higher accounts receivables, but was partially offset by utilization of deposits to raw material suppliers for the year ended December 31, 2011 as compared to 2010 when the deposits were made to the suppliers. Other factors include an increase of US$38.5 million in earnings and a non-cash expense of US$6.1 million for management stock compensation. For the year ended December 31, 2010, the change was mainly due to more efficient controls on working capital, effective collection on receivables, as well as the significant growth of sales compared with the same period of 2009.

 

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Our accounts receivable increased by US$127.5 million in 2011 as compared to 2010, representing an increase of 488.4%. This significant increase in accounts receivable was attributable to (i) our substantial sales increase by US$176.3 million from US$214.1 million in 2010 to US$390.4 million in 2011 which represents an increase of 82.3%; (ii) in 2011, we experienced significantly more sales in September, October and November than the corresponding months in 2010 amounting to US$45.2 million, which were usually non-peak season in the past and which were to be collected in the first and second quarter of 2012; and (iii) the significant increase of our accounts receivable turnover days from 27 days in 2010 to 90 days in 2011. The significant increase of our accounts receivable turnover days in 2011 was primarily due to the delayed payments by certain of our distributors which also conduct business in distribution of nitrogen, potash and phosphorus (“NPK”) fertilizers, in addition to our nutrient products. Since the NPK fertilizer suppliers typically have a substantially lower profit margin, the NPK fertilizer suppliers normally require distributors to pay deposit upfront at year end to guarantee the normal supply in next year. In 2011, China tightened its monetary policy and it became very difficult to obtain financing from financial institutions. Thus our distributors were under greater liquidity pressure than before. In order to respond to the cash flow shortage caused by the tightened financing, such distributors took full advantage of our six month credit term to pay deposit for NPK fertilizer. None of our distributors has any dispute on any outstanding account receivables.

 

Net cash used in investing activities were US$7.1 million, US$46.0 million and US$4.4 million for the years ended December 31, 2011, 2010 and 2009, respectively. The changes were primarily due to the prepayment of US$33.3 million for the acquisition of the mineral resource project in Wuchuan area during the year ended December 31, 2010. Total consideration of this acquisition is approximately US$35 million.

 

Net cash provided by financing activities were US$75.5 million, US$5.0 million and US$67.7 million for the years ended December 31, 2011, 2010 and 2009, respectively. For the year end December 31, 2011 as compared with the same period in 2010, these changes were mainly due to the fact that we sold to MSPEA, an affiliate of Morgan Stanley, 5,681,818 shares of our redeemable convertible preferred stock. Net proceeds we received from this sale of shares were in the amount of US$49.4 million. In December 2011, we entered into two short-term bank loan agreements with China Citic Bank for an aggregate loan amount of US$28.3 million. For the year ended December 31, 2010 as compared with the same period in 2009, the changes were mainly due to that we received cash from our offerings in May and December 2009 amounting to US$69.5 million, which was offset by expenses incurred in stock issuance costs of US$4.5 million, as well as the repayment of loans and payables of US$3.5 million during the year ended December 31, 2010.

 

Net current assets at December 31, 2011 increased by US$146.0 million to US$270.4 million from US$124.3 million, or 117%, over December 31, 2010. 

 

Impact of Inflation

 

We are subject to commodity price risks arising from price fluctuations in the market prices of the raw materials. We have generally been able to pass on cost increases through price adjustments. However, the ability to pass on these increases depends on market conditions influenced by the overall economic conditions in China. We manage our price risks through productivity improvements and cost-containment measures. We do not believe that inflation risk is material to our business or our financial position, results of operations or cash flows at this time.

 

Off Balance Sheet Arrangements

 

We do not have any significant off-balance sheet arrangements and accordingly, no such arrangements are likely to have a current or future effect on our financial position, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. 

 

Critical Accounting Policies

 

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions, and estimates that affect the amounts reported in the consolidated financial statements. The footnote 2 to our Company’s financial statements (Summary of Significant Accounting Policies) describes the major accounting policies and methods used in the preparation of the financial statements.

 

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The following are considered to be the Company’s critical accounting policies: 

 

Accounts Receivable and Allowance for Doubtful Accounts

 

Accounts receivable are recognized and carried at the original invoiced amount less an allowance for any uncollectible accounts.

 

We perform ongoing credit evaluations of our customers and review the composition of accounts receivable, analyze historical bad debts, customer concentration, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate if allowance for doubtful accounts is needed. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We primarily determine the allowance by (1) analyzing specific customer accounts that have known or potential collection issues and (2) applying an estimated loss rate on the customer accounts with consideration of the aging of the receivable balances, customer payment patterns during the year and subsequent to year-end. If circumstances related to specific customers change, our estimates of the recoverability of receivables could be further adjusted. In the event that we believe an account receivable will become uncollectible, we record additional provision to increase the allowance for doubtful accounts. The accounting effect of this entry is a charge to income. As of December 31, 2011, we recorded an allowance for doubtful accounts in the amount of US$15.2 million. If the financial condition of our distributors deteriorates in future, we would make further allowance for doubtful accounts, which could be significant. Furthermore, the financial condition deterioration of our distributors, in turn, directly affects our revenue recognition. One of the criteria to recognize revenues is that the collectability of the receivable is reasonably assured. As such, deteriorating payment ability of our distributors will result in revenue recognition of our product sales being delayed, generally until the receipt of cash.

 

Inventory

 

We value our finished goods inventory at the lower of cost or market value. Cost includes cost of direct labor and raw materials, as well as allocation of variable and fixed production overhead. Variable production overheads are allocated to each unit of production based on the actual use of the production facilities. Fixed production overheads are allocated to the cost of conversion based on the normal capacity of the production facilities. We define normal production capacity as being a reasonable level of production volume supported by sufficient customer demand without any abnormal equipment downtime due to shortages of materials and labor, taking into consideration the loss of production capacity resulting from planned maintenances.

 

We would write down the cost of excessive inventory. The factors considered in evaluating whether excessive inventory exists are:

 

· our forecast of future demand, including existing customers’ order and forecasted orders; and
   
· the expiration date for the specific products.

 

Inventory write-downs are recorded in the period in which the impairment occurs. If our current assumptions about future production, inventory levels or demand were to change or if actual market conditions are less favorable than those we have projected, additional inventory write-downs would be required, which could negatively impact our financial condition and results of operations. 

 

Fair Value of Warrants

 

The fair values of the warrants are summarized as follows:

 

   April Warrants   September Warrants   May Warrants 
Fair value of Warrant per share (US$) at:               
Date of issuance   1.07    2.08    0.95 
December 31, 2010   6.97    7.00    N/A 
December 31, 2011   2.11    2.16    N/A 

 

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The fair values of the warrants outstanding as of December 31, 2011 and 2010 were determined based on the Binominal option pricing model, using the following key assumptions:

 

   December 31, 2011   December 31, 2010 
   April
Warrants
   September
Warrants
   April
Warrants
   September
Warrants
 
                 
Expected volatility   65.5%   64.1%   67.5%   67.0%
                     
Expected dividends yield   0%   0%   0%   0%
                     
Time to maturity   1.3 years    1.7 years    2.3 years    2.7 years 
                     
Risk-free interest rate per annum   1.202%   1.202%   1.483%   1.483%
                     
Fair value of underlying common shares (per share)   3.52    3.52    8.40    8.40 

 

Stock Based Compensation

 

We measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award and recognize the cost over the period the employee is required to provide service in exchange for the award, which generally is the vesting period. We have elected to recognize the compensation cost for an award with only service conditions and a graded vesting schedule on a straight-line basis over the requisite service period for the entire award. However, the cumulative amount of compensation cost recognized at any date equals at least the portion of the grant date value of such award that is vested at that date.

 

In October 2010, we granted 1,183,667 restricted shares to management and independent directors of our Company in accordance with the Yongye International, Inc. 2010 Omnibus Securities and Incentive Plan (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. The restricted shares vested in April 2011.

 

In October 2011, we granted 1,166,333 restricted shares to management and independent directors of our in accordance with the Plan. Management was granted 1,073,000 shares, and the independent directors were granted 93,333 shares on October 10, 2010. The restricted shares are scheduled to vest in October 2012. We estimated the fair value of our non-vested shares granted by us to management and independent directors by using the market prices of our shares at the respective grant dates.

 

ITEM 7A.  Quantitative and Qualitative Disclosures about Market Risk

 

Foreign Exchange Risk

 

All of our net sales, and majority of costs and expenses are denominated in RMB. Although the conversion of the RMB is highly regulated in China, the value of the RMB against the value of the U.S. dollar or any other currency nonetheless may fluctuate and be affected by, among other things, changes in China’s political and economic conditions. Under current policy, the value of the RMB is permitted to fluctuate within a narrow band against a basket of certain foreign currencies. China is currently under significant international pressures to liberalize this government currency policy, and if such liberalization were to occur, the value of the RMB could appreciate or depreciate against the U.S. dollar.

 

Because substantially all of our earnings and majority of our cash assets are denominated in RMB, other than certain cash deposits we keep in a bank in Hong Kong and U.S., appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue in future that will be exchanged into U.S. dollars and earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.

 

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Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedging transactions may be limited and we may not be able to successfully hedge our exposure at all. In addition, our currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currency.

 

Interest Rate Risk

 

We have not been, nor does it anticipate being, exposed to material risks due to changes in interest rates. Our risk exposure to changes in interest rates relates primarily to the interest income generated by cash deposited in interest-bearing savings accounts. We have not used, and do not expect to use in the future, any derivative financial instruments to hedge its interest risk exposure. However, our future interest income may fall short of its expectation due to changes in interest rates in the market.

 

Credit Risk

 

We are exposed to credit risk from its cash in bank and accounts receivable. The credit risk on cash in bank and fixed deposits is limited because the counterparties are recognized financial institutions. Accounts receivable are subjected to credit evaluations. An allowance would be made, if necessary, for estimated irrecoverable amounts by reference to past default experience, if any, and by reference to the current economic environment.

 

Inflation

 

Inflationary factors, such as increases in the cost of our products and overhead costs, could impair our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of sales revenue if the selling prices of our products do not increase with these increased costs. 

 

Company’s Operations are Substantially in Foreign Countries

 

Substantially all of our operations are conducted in China and are subject to various political, economic, and other risks and uncertainties inherent in conducting business in China. Among other risks, our Company and our subsidiaries’ operations are subject to the risks of restrictions on transfer of funds; export duties, quotas, and embargoes; domestic and international customs and tariffs; changing taxation policies; foreign exchange restrictions; and political conditions and governmental regulations. Additional information regarding such risks can be found under the heading “Risk Factors” in this Form 10-K.

 

ITEM 8. Financial Statements and Supplementary Data

 

Consolidated Financial Statements

 

The information required by Item 8 appears after the signature page to this report.

 

ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosures

 

Not applicable.

 

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ITEM 9A. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in reports filed by us under the Securities Exchange Act of 1934 (“the Exchange Act”), as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. Our Chief Executive Officer and Chief Financial Officer evaluated, with the participation of other members of management, the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e) and 15d-15(e)), as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our Company’s disclosure controls and procedures were effective as of December 31, 2011.

 

Although our management, including the Chief Executive Officer and the Chief Financial Officer, believes that our disclosure controls and internal controls currently provide reasonable assurance that our desired control objectives have been met, management does not expect that our disclosure controls or internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

Management’s Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and/or Board; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Under the supervision of our Chief Executive Officer and our Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, management has concluded that our Company maintained effective internal control over financial reporting as of December 31, 2011.

 

KPMG, an independent registered public accounting firm, has audited the effectiveness of our internal control over financial reporting as of December 31, 2011 as stated in their report which is included below.

 

62
 

 

 Report of Independent Registered Public Accounting Firm

 

 

The Board of Directors and Stockholders

Yongye International, Inc.:

 

We have audited Yongye International, Inc.’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Yongye International, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, Yongye International, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Yongye International, Inc. and subsidiaries as of December 31, 2011 and 2010, and the related consolidated statements of comprehensive income, changes in equity, and cash flows for each of the years in the three-year period ended December 31, 2011, and our report dated March 15, 2012 expressed an unqualified opinion on those consolidated financial statements.

 

/s/ KPMG

Hong Kong, China

March 15, 2012

 

63
 

 

Changes in Internal Controls over Financial Reporting

 

There were no significant changes in our internal controls over financial reporting identified in connection with this evaluation that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our Company’s internal controls over financial reporting.

 

ITEM 9B. Other Information.

 

There is no information required to be disclosed in a report on Form 8-K during the fourth quarter of the year covered by this Form 10-K but not reported.

 

Part III

 

ITEM 10. Directors, Executive Officers and Corporate Governance

 

The information required by this item relating to our directors and nominees, regarding compliance with Section 16(a) of the Securities Act of 1934, and regarding our Audit Committee is included under the captions “Directors and Executive Officers of Our Company” and “Section 16(a) Beneficial Ownership Reporting Compliance,” and “—Role of the Audit Committee” in our Proxy Statement related to the 2011 Annual Meeting of Shareholders and is incorporated herein by reference.

 

Pursuant to General Instruction G(3) of Form 10-K, the information required by this item relating to our executive officers is included under the caption “Executive Officers of Our Company” in Part I of this report.

 

We have adopted a code of ethics that applies to our principal executive officer and all members of our finance department, including the principal financial officer and principal accounting officer. This code of ethics is posted on our website. The Internet address for our website is www.yongyeintl.com, and the code of ethics may be found from our main web page by clicking first on “Investor Relations” and then on “Corporate Governance” under “Investor Relations,” next on “The Code of Business Ethics and Conduct” under “Corporate Governance.”

 

We intend to satisfy any disclosure requirement under Item 5.05 of Form 8-K regarding an amendment to, or waiver from, a provision of this code of ethics by posting such information on our website, on the web page found by clicking through to “Code of Business Ethics and  Conduct” as specified above.

 

ITEM 11. Executive Compensation

 

The information appearing under the headings “Director Compensation” and “Executive Compensation” in our Proxy Statement related to the 2011 Annual Meeting of Shareholders is incorporated herein by reference.

 

Changes in Control

 

There are no arrangements known to us, including any pledge by any person of our securities, the operation of which may at a subsequent date result in a change in control of our Company. 

 

ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

The information required by this item relating to security ownership of certain beneficial owners and management is included under the caption “Security Ownership of Management and Certain Beneficial Owners,” and the information required by this item relating to securities authorized for issuance under equity compensation plans is included under the caption “Executive Compensation – Options and Stock Appreciation Rights,” in each case in our Proxy Statement related to the 2011 Annual Meeting of Shareholders, and is incorporated herein by reference.

 

ITEM 13. Certain Relationships and Related Transactions, Director Independence

 

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 US$160,470 for the year ended December 31, 2011. The operating lease was renewed on January 4, 2012 for the period from January 4, 2012 to December 31, 2012. Total minimum lease payment is US$251,632 for the year ending December 31, 2012.

 

64
 

 

In April 2011, Yongye Nongfeng obtained two short-term bank loans of RMB 52,500,000 (equivalent to US$8,209,282) and RMB47,500,000 (equivalent to US$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. Yongye Nongfeng repaid the two short-term loans in December 2011.

 

Policies and Procedures for Review, Approval or Ratification of Transactions with Related Persons

 

It is our Company’s policy that we will not enter into transactions required to be disclosed under item 404 of the SEC’s Regulation S-K unless the audit committee or another independent body of the board first reviews and approves the transactions.

 

Promoters and Certain Control Persons

 

We did not have any promoters at any time during the past five fiscal years. Except as set forth in our discussion above, none of our directors, director nominees or executive officers has been involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules and regulations of the SEC.

 

Director Independence

 

The Board of Directors has determined that each of Xiaochuan Guo, Sean Shao, Xindan Li, Rijun Zhang and Homer Sun are independent under Rule 5605(a)(2) of the listing rules of The NASDAQ Stock Market LLC.

 

ITEM 14. Principal Accountant Fees and Services

 

The information required by this item is included under the captions “Proposal No. 2: Ratification of Appointment of the Independent Public Accountants — Audit Fees” and “—Pre-Approval Policies and Procedures” in our Proxy Statement related to the 2011 Annual Meeting of Shareholders and is incorporated herein by reference. 

 

65
 

 

Part IV

Exhibits and Financial Statement Schedules

 

Exhibit

No.

  Description
2.1   Share Exchange Agreement, dated as of April 17, 2008.(1)
2.2   Articles of Merger with Agreement and Plan of Merger.(6)
3.1   Amended Articles of Incorporation.(1)
3.2   Articles of Merger with Agreement and Plan of Merger.(6)
3.3   Bylaws.(5)
3.4   Certificate of Designation. (10)
4.1   Form of Investor Warrant (i).(1)
4.2   Form of Investor Warrant (ii).(1)
4.3   Form of Placement Agent Warrant.(5)
4.4   Registration Rights Agreement, dated as of April 17, 2008.(1)
4.5   Registration Rights Agreement, dated as of September 5, 2008.(2)
4.6   Registration Rights Agreement, dated as of May 9, 2009.(3)
4.7   Registration Rights Agreement, dated as of May 29, 2011. (10)
10.1   Securities Purchase Agreement, dated as of April 17, 2008.(1)
10.2   Cooperation Agreement dated January 15, 2008 by and between Inner Mongolia Yongye Biotechnology Co., Ltd. and Yongye Nongfeng Biotechnology Co., Ltd.(1)
10.3   Sino-foreign Cooperative Joint Venture Contract, dated November 16, 2007 by and between Inner Mongolia Yongye Biotechnology Co., Ltd. and Asia Standard Oil Limited.(1)
10.4   Supplemental Agreement to the Sino-foreign Cooperative Joint Venture Contract by and between Inner Mongolia Yongye Biotechnology Co., Ltd. and Asia Standard Oil Limited.(1)
10.5   Securities Purchase Agreement, dated as of September 5, 2008.(2)
10.6   Make Good Escrow Agreement, dated as of September 5, 2008.(2)
10.7   Securities Purchase Agreement, dated as of May 8, 2009.(3)
10.8   Employment Contract of Zishen Wu, dated as of March 12, 2012 (effective January 1, 2010), and amendments thereto. *
10.9   Employment Contract of Sam (Yue) Yu, dated as of March 12, 2012 (effective March 25, 2009), and amendments thereto. *
10.10   Employment Contract of Nan Xu, dated as of March 12, 2012 (effective September 1, 2011). *
10.11   Form of Non-Independent Director Contract.(5)
10.12   Form of Independent Director Contract.(5)
10.13   Form of Vehicle Usage Agreement. (8)
10.14   Working Capital Loan Contract dated April 2, 2011, by and between Inner Mongolia Yongye Nongfeng Biotech Co., Ltd. and China Everbright Bank, Hohhot Branch. (9)
10.15   Working Capital Loan Contract dated April 18, 2011, by and between Inner Mongolia Yongye Nongfeng Biotech Co., Ltd. and China Everbright Bank, Hohhot Branch. (9)
10.16   Maximum Amount Guarantee Contract dated April 2, 2011, by and between Inner Mongolia Yongye Nongfeng Biotech Co., Ltd. and China Everbright Bank, Hohhot Branch. (9)
10.17   Comprehensive Credit Facility Agreement dated April 2, 2011, by and between Inner Mongolia Yongye Nongfeng Biotech Co., Ltd. and China Everbright Bank, Hohhot Branch. (9)
10.18   Securities Purchase Agreement, dated as of May 29, 2011. (10)
10.19   Stockholders’ Agreement, dated as of May 29, 2011. (10)
10.20   Pledge Agreement, dated as of May 29, 2011. (10)
10.21   Loan Agreement dated December 23, 2011 by and between Inner Mongolia Yongye Biotechnology Co., Ltd. and China Citic Bank, Hohhot Branch.*
10.22   Maximum Amount Pledge Contract; dated December 23, 2011, by and between Inner Mongolia Yongye Biotechnology Co., Ltd. and China Citic Bank, Hohhot Branch.*

 

66
 

 

10.23   Loan Agreement dated December 26, 2011 by and between Inner Mongolia Yongye Biotechnology Co., Ltd.] and China Citic Bank, Hohhot Branch.*
10.24   Personal Property Pledge Contract, dated December 23, 2011, by and between Inner Mongolia Yongye Biotechnology Co., Ltd. and China Citic Bank, Hohhot Branch.*
14   Code of Ethics.(7)
21   Subsidiaries of the Registrant.*
23.1   Consent of KPMG, an independent registered public accounting firm.*
99.1   Certificate of Scientific and Technological Advancements granted by the Inner Mongolia Autonomous Region Science and Technology Bureau, dated December 8, 2008.(5)
99.2   Consent of Scientific and Technological Advancements granted by the Inner Mongolia Autonomous Region Science and Technology Bureau, dated December 8, 2008.(5)
    Wuchuan County Government's approval of Wuchuan Shuntong's Lignite Coal Resource Project, dated May 10, 2009. (10)
    Wuchuan County Government's approval of the transfer of the Lignite Coal Resource Project from Wuchuan Shuntong to Inner Mongolia Yongye Fumin Biotechnology Limited, dated July 28, 2010. (10)
    Inner Mongolia Government's approval of the change of the title for the Lignite Coal Resource Project from Wuchuan Shuntong to Inner Mongolia Yongye Fumin Biotechnology Limited, dated December 3, 2010. (10)
31.1   Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31.2   Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
32   Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).*
101.INS   XBRL Instance Document
101.SCH   XBRL Taxonomy Extension Schema Document
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document 
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document

 

* Filed Herewith.

 

(1)           Incorporated by reference herein to the Report on Form 8-K filed on April 22, 2008.

 

(2)           Incorporated by reference herein to the Company’s Registration Statement on Form S-1/A (Reg. No. 333-150949) filed with the Securities and Exchange Commission on September 9, 2008.

 

(3)           Incorporated by reference herein to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 8, 2009.

 

(4)           Incorporated by reference herein to the Company’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 7, 2009.

 

(5)           Incorporated by reference herein to the Company’s Registration Statement on Form S-1 (Reg. No. 333-159892) filed with the Securities and Exchange Commission on June 11, 2009.

 

(6)           Incorporated by reference herein to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on June 24, 2009.

 

(7)           Incorporated by reference herein to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 5, 2009.

 

(8)           Incorporated by reference herein to the Company’s Registration Statement on Form S-1/A (Reg. No. 333-159892) filed with the Securities and Exchange Commission on August 13, 2009.

 

(9)           Incorporated by reference herein to the Company’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 9, 2011.

 

(10)        Incorporated by reference herein to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 31, 2011.

 

67
 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    YONGYE INTERNATIONAL, INC.
     
Date:      March 15, 2012 By: /s/ Zishen Wu
    Name: Zishen Wu
    Title: Chief Executive Officer
     
Date:      March 15, 2012 By: /s/ Sam Yu
    Name: Sam Yu
    Title: Chief Financial Officer

 

Pursuant to the requirements of the Securities and Exchange Act of 1934, this Report has been signed below by the following person on behalf of the Registrant and in the capacities and on the dates indicated.

 

Date:      March 15, 2012 By: /s/ Zishen Wu
    Name: Zishen Wu
    Title:

Chief Executive Officer and Chairman

(principal executive officer)

     
Date:      March 15, 2012 By: /s/ Sam Yu
    Name: Sam Yu
    Title:

Chief Financial Officer

(principal financial and accounting officer)

     
Date:      March 15, 2012 By: /s/ Nan Xu
    Name: Nan Xu
    Title: Director
     
Date:      March 15, 2012 By: /s/ Homer Sun
    Name: Homer Sun
    Title: Director
     
Date:      March 15, 2012 By: /s/ Xiaochuan Guo
    Name: Xiaochuan Guo
    Title: Director
     
Date:      March 15, 2012 By: /s/ Rijun Zhang
    Name: Rijun Zhang
    Title: Director
     
Date:      March 15, 2012 By: /s/ Xindan Li
    Name: Xindan Li
    Title: Director
     
Date:      March 15, 2012 By: /s/ Sean Shao
    Name: Sean Shao
    Title: Director

 

 

68
 

 

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Stockholders

Yongye International, Inc.:

 

We have audited the accompanying consolidated balance sheets of Yongye International, Inc. and subsidiaries (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of comprehensive income, changes in equity and cash flows for each of the years in the three-year period ended December 31, 2011. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Yongye International, Inc. and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Yongye International, Inc.’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 15, 2012 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

 

/s/ KPMG

Hong Kong, China

March 15, 2012

 

F-1
 

 

YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

   Note   December 31, 2011   December 31, 2010 
Current assets               
Cash       US$81,154,880   US$41,913,469 
Restricted cash        40,000    40,000 
Accounts receivable, net of allowance for doubtful accounts   4    153,629,522    26,110,813 
Inventories   5    86,117,000    65,878,047 
Deposits to suppliers   6    2,664,360    10,906,295 
Prepaid expenses        4,954,359    733,429 
Other receivables        385,263    760,377 
Deferred tax assets   17    2,283,388    158,675 
Total Current Assets        331,228,772    146,501,105 
                
Property, plant and equipment, net   7    21,929,444    21,547,152 
Intangible asset, net   8    21,649,890    23,598,739 
Land use right, net   9    6,129,151    4,218,006 
Prepayment for mining project   10    35,511,520    34,151,063 
Other assets   11    31,621,465    7,325,049 
Goodwill        10,694,636    10,284,922 
Total Assets       US$458,764,878   US$247,626,036 
                
Current liabilities               
Short-term bank loan   12   US$28,308,563   US$- 
Long-term loans and payables - current portion   13    4,279,234    457,880 
Accounts payable        13,098,183    6,127,606 
Income tax payable        3,161,538    6,137,119 
Advance from customers        4,095,580    60,841 
Accrued expenses        4,437,220    3,024,235 
Other payables   14    3,159,070    5,310,517 
Derivative liabilities - fair value of warrants   15    317,183    1,036,268 
Total Current Liabilities        60,856,571    22,154,466 
                
Long-term loans and payables   13    7,464,683    383,285 
Other non-current liability   17    4,297,842    - 
Deferred tax liabilities   17    4,857,800    - 
Total Liabilities       US$77,476,896   US$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 December 31, 2011       US$49,399,990   US$- 
                
Equity               
Common stock: par value $.001; 75,000,000 shares authorized; 49,370,711 shares issued and outstanding at December 31, 2011 and 48,187,044 shares issued and outstanding at December 31, 2010   15   US$49,371   US$48,187 
Additional paid-in capital   15    150,654,849    144,599,839 
Retained earnings        148,804,997    63,943,371 
Accumulated other comprehensive income        17,078,758    6,623,806 
Total equity attributable to Yongye International, Inc.        316,587,975    215,215,203 
Noncontrolling interest        15,300,017    9,873,082 
Total Equity       US$331,887,992   US$225,088,285 
                
Commitments and Contingencies   19           
                
Total Liabilities, Redeemable Series A Convertible Preferred Shares and Equity       US$458,764,878   US$247,626,036 

 

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

 

F-2
 

 

YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

       For the Years Ended 
   Note   December 31, 2011   December 31, 2010   December 31, 2009 
Sales                    
External customers       US$390,379,489   US$214,091,716   US$95,870,906 
Related party   20    -    -    2,221,936 
                     
Total sales        390,379,489    214,091,716    98,092,842 
                     
Cost of sales                    
External customers        162,078,410    94,833,834    44,966,126 
Related party        -    -    1,023,260 
                     
Cost of sales        162,078,410    94,833,834    45,989,386 
                     
Gross profit        228,301,079    119,257,882    52,103,456 
                     
Selling expenses        73,886,542    40,612,300    14,720,657 
                     
Research and development expenses        13,130,627    4,852,004    1,690,248 
                     
General and administrative expenses        35,694,045    13,994,936    4,289,488 
                     
Income from operations        105,589,865    59,798,642    31,403,063 
                     
Other income/(expenses)                    
Interest expense        (1,429,111)   (86,440)   (81,966)
Interest income        123,054    60,904    11,865 
Subsidy income        2,973,362    3,081,049    237,364 
Other income /(expenses), net        223,496    (613,105)   (63,212)
Change in fair value of derivative liabilities   15    719,085    (41,212)   (24,009,802)
                     
Total other income /(expenses), net        2,609,886    2,401,196    (23,905,751)
                     
Earnings before income tax expense        108,199,751    62,199,838    7,497,312 
                     
Income tax expense   17    18,407,554    10,867,857    4,997,105 
                     
Net income        89,792,197    51,331,981    2,500,207 
                     
Less: Net income attributable to the noncontrolling interest        4,930,571    2,895,055    304,556 
                     
Net income attributable to Yongye International, Inc.        84,861,626    48,436,926    2,195,651 
                     
Net income per share of common stock:                    
Basic   21   US$1.57   US$1.05   US$0.07 
Diluted   21   US$1.55   US$1.05   US$0.07 
                     
Weighted average shares used in computation:                    
Basic   21    49,055,252    46,119,772    31,324,830 
Diluted   21    49,161,073    46,308,924    31,324,830 
                     
Net income        89,792,197    51,331,981    2,500,207 
Other comprehensive income                    
Foreign currency translation adjustment, net of nil income taxes        10,951,316    6,595,296    (309)
                     
Comprehensive income        100,743,513    57,927,277    2,499,898 
Less: Comprehensive income attributable to the noncontrolling interest        5,426,935    3,195,684    304,553 
Comprehensive income attributable to Yongye International, Inc.       US$95,316,578   US$54,731,593   US$2,195,345 

 

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

 

F-3
 

  

YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

 

       Redeemable series A Convertible
Preferred Shares
   Common Stock                   Equity         
                                   Accumulated   attributable to         
                       Additional           Other   Yongye         
                       Paid-in   Subscription   Retained   Comprehensive   International,   Noncontrolling   Total 
   Note   Shares   Amount   Shares   Amount   Capital   receivable   Earnings   Income   Inc.   Interest   Equity 
Balance as of January 1, 2009        -    -    26,760,258   US$26,760   US$13,633,604   US$-   US$13,310,794   US$329,445   US$27,300,603   US$1,204,043   US$28,504,646 
Net income        -    -    -    -    -    -    2,195,651    -    2,195,651    304,556    2,500,207 
Other comprehensive income        -    -    -    -    -    -    -    (306)   (306)   (3)   (309)
Common stock issued for cash May 8, 2009   15    -    -    5,834,083    5,834    7,907,201    -    -    -    7,913,035    -    7,913,035 
Common stock issued for cash December 22, 2009   15    -    -    8,000,000    8,000    56,300,000    -    -    -    56,308,000    -    56,308,000 
Common stock issued for cash December 31, 2009   15    -    -    1,200,000    1,200    8,548,800    (8,550,000)   -    -    -    -    - 
Warrants exercised   15    -    -    2,737,900    2,738    25,532,505    -    -    -    25,535,243    -    25,535,243 
Transfer of equity interest of a non-wholly owned subsidiary to non-controlling interest   3    -    -    -    -    9,461,196    -    -    -    9,461,196    2,368,804    11,830,000 
Capital contribution to a non-wholly owned subsidiary   1    -    -    -    -    (2,799,998)   -    -    -    (2,799,998)   2,799,998    - 
                                                             
Balance as of December 31, 2009        -    -    44,532,241    44,532    118,583,308    (8,550,000)   15,506,445    329,139    125,913,424    6,677,398    132,590,822 
Net income        -    -    -    -    -    -    48,436,926    -    48,436,926    2,895,055    51,331,981 
Other comprehensive income        -    -    -    -    -    -    -    6,294,667    6,294,667    300,629    6,595,296 
Subscription received        -    -    -    -    -    8,550,000    -    -    8,550,000    -    8,550,000 
Stock issued for acquiring Customer List   8    -    -    3,600,000    3,600    21,236,400    -    -    -    21,240,000    -    21,240,000 
Stock compensation to management and independent directors   15    -    -    -    -    4,310,640    -    -    -    4,310,640    -    4,310,640 
Warrants exercised   15    -    -    54,803    55    469,491    -    -    -    469,546    -    469,546 
Balance as of December 31, 2010        -   US$-    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        -    -    -    -    -    -    84,861,626    -    84,861,626    4,930,571    89,792,197 
Other comprehensive income        -    -    -    -    -    -    -    10,454,952    10,454,952    496,364    10,951,316 
Stock compensation to management and independent directors   15    -    -    1,183,667    1,184    6,055,010    -    -    -    6,056,194    -    6,056,194 
Issuance of redeemable series A convertible preferred shares   15    5,681,818    49,399,990    -    -    -    -    -    -    -    -    - 
Balance as of December 31, 2011        5,681,818   US$49,399,990    49,370,711   US$49,371   US$150,654,849   US$-   US$148,804,997   US$17,078,758   US$316,587,975   US$15,300,017   US$331,887,992 

 

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

 

F-4
 

 

YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

   For the Years Ended 
   December 31, 2011   December 31, 2010   December 31, 2009 
CASH FLOWS FROM OPERATING ACTIVITIES               
Net income  US$89,792,197   US$51,331,981   US$2,500,207 
Adjustments to reconcile net income to net cash (used in)/ provided by operating activities:               
Depreciation and amortization   8,574,526    3,723,839    578,511 
Loss on sale of property, plant and equipment   -    -    5,995 
Provision/(Reversal) of allowance for doubtful accounts   14,973,439    -    (305,338)
Change in fair value of derivative liabilities   (719,085)   41,212    24,009,802 
Stock compensation expense   6,056,194    4,310,640    - 
Deferred tax benefit   (2,639,450)   (154,767)   - 
Changes in operating assets and liabilities (net of effect of an acquisition in 2009):               
Accounts receivable   (139,381,935)   (19,252,818)   (3,099,156)
Inventories   (17,326,312)   (21,859,880)   (21,262,135)
Deposit to suppliers   8,299,720    (4,436,327)   (6,107,924)
Prepaid expenses   (4,128,949)   (603,146)   77,013 
Other receivables   390,750    (354,500)   298,444 
Other assets   (9,866,857)   (6,076,207)   (1,751,395)
Accounts payable- related party   -    (887,614)   832,723 
Accounts payable- third parties   6,616,383    5,628,946    344,589 
Income tax payable   1,060,140    1,868,346    3,860,435 
Advance from customers   3,966,320    29,934    (1,843,898)
Accrued expenses   1,307,892    2,444,434    (105,659)
Other payables   1,821,586    137,178    (222,593)
Net Cash (Used in)/Provided by Operating Activities   (31,203,441)   15,891,251    (2,190,379)
                
CASH FLOWS FROM INVESTING ACTIVITIES               
Change in restricted cash   -    (40,000)   - 
Payment for intangible asset   (3,000,000)   -    - 
Prepayment for mining project   -    (33,309,976)   - 
Payment for land use right   (1,807,699)   -    - 
Proceeds from sale of property, plant and equipment   -    93,412    12,425 
Purchase of property, plant and equipment   (2,264,361)   (11,028,190)   (1,560,587)
Purchase of property, plant and equipment from a related party   -    (1,677,532)   (2,834,676)
Net Cash Used in Investing Activities   (7,072,060)   (45,962,286)   (4,382,838)

 

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

 

F-5
 

 

 

YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

 

   For the Years Ended 
   December 31, 2011   December 31, 2010   December 31, 2009 
CASH FLOWS FROM FINANCING ACTIVITIES               
                
Proceeds from short-term bank loans   43,314,821    -    2,923,600 
Repayment of short term loans   (15,469,579)   (2,950,396)   - 
Repayment of long-term loans and payables   (1,738,717)   (712,391)   (248,150)
Proceeds from common stock and warrants issued and warrants exercised   -    8,634,397    69,547,206 
Proceeds from preferred shares, net of issuance cost of $600,010   49,399,990    -    - 
Payment for common stock and warrants issuance costs   -    -    (4,528,456)
Net Cash Provided by Financing Activities   75,506,515    4,971,610    67,694,200 
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH   2,010,397    1,494,713    (80,279)
NET INCREASE /(DECREASE) IN CASH   39,241,411    (23,604,712)   61,040,704 
Cash at beginning of year   41,913,469    65,518,181    4,477,477 
Cash at end of year  US$81,154,880   US$41,913,469   US$65,518,181 
                
Supplemental cash flow information:               
Cash paid for income taxes  US$19,986,864   US$9,154,278   US$1,136,670 
Cash paid for interest expense   1,386,763    93,402    77,342 
                
Noncash investing and financing activities:               
Acquisition of property, plant and equipment included in long-term loans and payables   189,229    315,426    532,425 
Acquisition of other assets included in long-term loans and payables   11,554,688    525,739    272,977 
Acquisition of property, plant and equipment included in other payables   980,169    1,852,473    - 

 

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

 

F-6
 

 

YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

DECEMBER 31, 2011, 2010 AND 2009

 

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 US$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.

 

During the year ended December 31, 2009, ASO made a capital contribution of US$55,999,965 into Yongye Nongfeng. During the year ended December 31, 2011, ASO made a capital contribution of US$42,541,199 into Yongye Nongfeng. These contributions resulted in an increase in ASO’s registered capital interest in Yongye Nongfeng to 98.8%.

 

F-7
 

 

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 US$14,731,880 (equivalent to RMB100 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 10). The construction of the production plant of Yongye Fumin, which is located in Wuchuan County, was completed in the fourth quarter of 2010.

 

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 US$50 million. The redeemable Series A convertible preferred shares are convertible into common stock of the Company at an initial conversion price of US$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 consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and include the financial statements of the Company and its subsidiaries.

 

All significant intercompany transactions and balances are eliminated on consolidation.

 

USE OF ESTIMATES

 

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Significant items subject to such estimates and assumptions include the useful lives of fixed assets; the allowance for doubtful accounts; the fair value determination of financial and equity instruments and stock compensation awards, the realizability of deferred tax assets and inventories; the recoverability of goodwill, intangible asset, land use right and property, plant and equipment; and accruals for income tax uncertainties and other contingencies. The current economic environment has increased the degree of uncertainty inherent in those estimates and assumptions.

 

ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS

 

Accounts receivable are recorded at the invoiced amount and do not bear interest. The Company maintains an allowance for doubtful accounts for estimated losses inherent in its accounts receivable portfolio. In establishing the required allowance, management considers historical losses adjusted to take into account current market conditions and the customers’ financial condition, the amount of receivables in dispute, the accounts receivables aging and customers’ repayment patterns. The Company reviews its allowance for doubtful accounts monthly. Past due balances are reviewed individually for collectability. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company does not have any off-balance-sheet credit exposure related to its customers.

 

INVENTORIES

 

Inventories are stated at the lower of cost or market. Cost is determined using the weighted average method. Cost of work in progress and finished goods comprise direct materials, direct production costs and an allocation of production overheads based on normal operating capacity.

 

PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment are stated at cost. Depreciation on property, plant and equipment other than leasehold improvements is calculated on the straight-line method over the estimated useful lives of the assets. Amortization on leasehold improvements is calculated on the straight-line method over the estimated useful life or lease period, whichever is shorter. Estimated useful lives are as follows:

 

F-8
 

 

Buildings   30 years
Machinery and equipment   10 years
Office equipment and furniture   5 years
Vehicles   10 years
Software   10 years
Leasehold improvements   3 years

 

When items are retired or otherwise disposed of, income is charged or credited for the differences between the net book value of the item disposed and proceeds received thereon.

 

LAND USE RIGHT

 

Land use right represents the exclusive right to occupy and use a piece of land in the PRC for a specified contractual term. Land use right is carried at cost, less accumulated amortization. Amortization is calculated using the straight-line method over the life of the right of 48 years.

 

REVENUE RECOGNITION

 

The Company manufactures and sells two principal products which are plant product and animal product. Sales of plant product were US$386,166,674, US$207,514,478 and US$91,172,988 for the years ended December 31, 2011, 2010 and 2009, respectively. Sales of animal product were US$4,212,815, US$6,577,238 and US$6,919,854 for the years ended December 31, 2011, 2010 and 2009, respectively. The Company sells its products primarily through approved distributors. As of December 31, 2011 and 2010, the Company sold its products to 25 approved distributors, and as of December 31, 2009, the Company sold its products to 8 approved distributors.

 

Revenue on product sales is recognized when:

 

·Persuasive evidence of an agreement with the customer exists which is evidenced by signed distributor sales contract;

 

·Delivery of the products has occurred and accepted by the customers, which is evidenced by goods receipt notes signed by the customers. According to the distributor sales contracts between the Company and its customers, the risks and rewards of ownership of the products is transferred to the customers upon the issuance of the goods receipt notes and there are no rights of return that may be exercised at will by the customers (other than for defective products). After the goods receipt notes are signed, the Company has no remaining obligations that affect the customers’ acceptance of the products. For the years ended December 31, 2011, 2010 and 2009, there was no sales return from the customers;

 

·The selling price, which is specified in the distributor sales contract, is fixed. Under the distributor sales contract, upon the sale of the products to the customers and the issuance of the good receipts notes, the Company has the legal enforceable right to receive full payment of the sales amount. The customers’ obligation to pay the Company is not dependent on the customer selling the products or collecting cash from their customers (or end users); and

 

·Collectability at time of delivery for sales is reasonably assured. To the extent, the Company determines that collectability is not reasonably assured at time of delivery of the products to the distributors, revenue is not recognized until the Company determines that collectability is reasonably assured, which generally is evidenced by receipt of cash. As a matter of business practice, the Company provides credit term up to six months to customers with well-established trading records, which the Company believes is also the credit term offered by other PRC’s manufacturing companies in the agricultural industry.

 

OPERATING LEASE

 

The Company leases office premises under non-cancelable operating leases. Payments made under operating leases are charged to the consolidated statements of comprehensive income on a straight-line basis over the lease term.

 

F-9
 

 

ADVERTISING COSTS

 

Advertising costs are expensed as incurred and included in selling expenses. Advertising costs for the years ended December 31, 2011, 2010 and 2009 were US$31,283,339, US $27,253,854, and US $10,384,724, respectively.

 

RESEARCH AND DEVELOPMENT COSTS

 

Research and development costs are expensed as incurred. Research and development costs for the years ended December 31, 2011, 2010 and 2009 were US$13,130,627, US$4,852,004 and US$1,690,248, respectively.

 

IMPAIRMENT OF LONG-LIVED ASSETS

 

In accordance with Impairment or Disposal of Long-Lived Assets Subsections of FASB ASC Subtopic 360-10, Property, Plant, and Equipment - Overall , long-lived assets, such as property, plant and equipment, and purchased intangible asset subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset or asset group be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by that asset or asset group to its carrying value. If the carrying value of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary. No impairment of long-lived assets was recognized for the years ended December 31, 2011, 2010 and 2009.

 

GOODWILL

 

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired.  Goodwill is not amortized, but is instead tested for impairment. Goodwill is reviewed for impairment annually in accordance with the provisions of FASB ASC Topic 350, Intangibles - Goodwill and Other. The goodwill impairment test is a two-step test. Under the first step, the fair value of the reporting unit is compared with its carrying value (including goodwill). If the fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit and the enterprise must perform step two of the impairment test (measurement). Under step two, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation and the residual fair value after this allocation is the implied fair value of the reporting unit goodwill. Fair value of the reporting unit is determined using a discounted cash flow analysis. If the fair value of the reporting unit exceeds its carrying value, step two does not need to be performed.

 

The Company performs its annual impairment review of goodwill at each September 30, and when a triggering event occurs between annual impairment tests. No impairment of goodwill was recorded for the years ended December 31, 2011, 2010 and 2009.

 

INCOME TAXES

 

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the consolidated statements of comprehensive income in the period that includes the enactment date. A valuation allowance is provided to reduce the amount of deferred tax assets if it is considered more likely than not that some portion or all of the deferred tax assets will not be realized.

 

F-10
 

 

The Company recognizes in the consolidated financial statements the impact of a tax position, if that position is more likely than not of being sustained upon examination, based on the technical merits of the position. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. The Company has elected to classify interest and penalties related to unrecognized tax benefits, if and when required, as a component of income tax expense in the consolidated statements of comprehensive income.

 

EMPLOYEE BENEFIT PLANS

 

Pursuant to relevant PRC regulations, Yongye Nongfeng and Yongye Fumin are required to make contributions to various defined contribution plans organized by municipal and provincial PRC governments. The contributions are made for each PRC employee at rates ranging from 40.8% to 42.8% on a standard salary base as determined by the local social security bureau. Contributions to the defined contribution plans are charged to the consolidated statements of comprehensive income when the related service is provided. For the years ended December 31, 2011, 2010 and 2009, contributions to the defined contribution plans were US$367,824, US$322,266, and US$133,367, respectively.

 

The Company has no other obligation for the payment of employee benefits associated with these plans beyond the contributions described above.

 

STOCK-BASED COMPENSATION

 

The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and recognizes the cost over the period during which an employee is required to provide service in exchange for the award, which generally is the vesting period.

 

FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS

 

The Company’s reporting currency is the US dollar. The financial position and results of operations of the Company’s subsidiaries in the PRC are measured using the Renminbi as the functional currency. Assets and liabilities of the subsidiaries are translated at the prevailing exchange rate in effect at each period end. Income statement accounts are translated at the average rate of exchange during the period. Translation adjustments are included as a component of comprehensive income in the consolidated statements of comprehensive income.

 

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 Company has early adopted ASU 2011-05.

 

FAIR VALUE MEASUREMENTS

 

The Company applies the provisions of ASC Subtopic 820-10, Fair Value Measurements, for fair value measurements of financial assets and financial liabilities and for fair value measurements of nonfinancial items that are recognized or disclosed at fair value in the financial statements.  ASC Subtopic 820-10 also establishes a framework for measuring fair value and expands disclosures about fair value measurements.

 

ASC Subtopic 820-10 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and it considers assumptions that market participants would use when pricing the asset or liability.

 

F-11
 

 

ASC Subtopic 820-10 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC Subtopic 820-10 establishes three levels of inputs that may be used to measure fair value.  The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to measurements involving significant unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:

 

·Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

 

·Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

 

·Level 3 inputs are unobservable inputs for the asset or liability.

 

The level in the fair value hierarchy within which a fair value measurement in its entirety falls is based on the lowest level input that is significant to the fair value measurement in its entirety.

 

The Company did not have any nonfinancial assets or liabilities that are measured at fair value on a recurring basis as of December 31, 2011, 2010 and 2009.

 

EARNINGS PER SHARE

 

Basic earnings per share (“EPS”) is computed by dividing net income attributable to common stockholders by the weighted average number of common stock outstanding during the year using the two-class method. Under the two-class method, net income attributable to common stockholders is allocated between common stock and other participating securities based on participating rights in undistributed earnings. Nonvested shares and redeemable Series A convertible preferred shares are participating securities since the holders of these securities participate in dividends on the same basis as common stockholders. Diluted EPS is calculated by dividing net income attributable to common stockholders as adjusted for the effect of dilutive common stock equivalent, if any, by the weighted average number of common stock and dilutive common stock equivalent outstanding during the year. Potential dilutive securities are not included in the calculation of diluted earnings per share if the impact is anti-dilutive.

 

SEGMENT REPORTING

 

The Company has one operating segment, which is the manufacture and sales of fulvic acid based liquid and powder nutrient compounds. Substantially all of the Company’s operations and customers are located in the PRC. Consequently, no geographic information is presented.

 

CONTINGENCIES

 

In the normal course of business, the Company is subject to loss contingencies, such as legal proceedings and claims arising out of its business, that cover a wide range of matters, including, among others, government investigations and tax matters.  An accrual for a loss contingency is recognized when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated.

 

F-12
 

 

REDEEMABLE PREFERRED SHARES

 

The holders of the redeemable Series A convertible preferred shares issued by the Company 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 certain conditions. When it is probable that the redeemable Series A convertible preferred shares will become redeemable, the Company recognizes changes in the redemption value immediately as they occur and adjust the carrying value of the Series A convertible preferred shares to equal the redemption value at the end of each reporting period. The Company assesses the probability of whether the redeemable Series A convertible preferred shares are redeemable at each reporting period end.

 

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

In September 2011, the FASB issued ASU 2011-08, Intangibles-Goodwill and Other (Topic 350). ASU 2011-08 permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. If an entity concludes it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it need not perform the two-step impairment test. The ASU is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted.

 

NOTE 3 – ACQUISITION OF SHENGMINGSU MANUFACTURING BUSINESS

 

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 (“Acquisition”). In October 2009, the Company completed the Acquisition. Management has determined that the acquisition date of the Acquisition was the closing date or October, 2009, when all conditions precedent to the closing were met, including obtaining all the required licenses and permits from the PRC government to operate the productive assets acquired, obtaining approvals from the PRC government, and on which the Company legally transferred the 4.5% equity interest in Yongye Nongfeng to Inner Mongolia Yongye. The reason for the Acquisition was to expand the Company’s manufacturing business. The operating results of Shengmingsu manufacturing business have been included in the consolidated financial statements since that date. The transaction costs of the Acquisition were not material, and have been recorded in general and administrative expenses.

 

The Acquisition has been accounted for under ASC 805 using the acquisition method whereby the Company recognized the identifiable assets acquired and liabilities assumed. The excess of the cost of the acquisition over the fair value of net assets acquired has been recognized as goodwill. The acquired goodwill is not deductible for tax purpose.

 

The following summarize the fair value of the total consideration transferred.

 

Consideration  Fair value 
Cash  US$4,692,265 
4.5% equity interest in Yongye Nongfeng   11,830,000 
Total consideration  US$16,522,265 

 

The estimated fair value of the 4.5% equity interest in Yongye Nongfeng was determined by an independent valuer by using discount cash flow model.

 

The difference between the fair value of 4.5% equity interest transferred and the amount by which noncontrolling interest is adjusted due to the transfer is recognized in additional paid-in capital and amounted to US$9,461,196.

 

F-13
 

 

The fair value of the total consideration transferred was allocated as follows: 

 

   Fair value   Useful life 
Property, plant and equipment          
- Buildings  US$1,443,489    30 years 
- Machinery and equipment   577,191    10 years 
- Vehicles   351,161    10 years 
- Office equipment and furniture   13,280    5 years 
Total property, plant and equipment   2,385,121      
Land use right   4,188,750    48 years 
Goodwill   9,948,394      
           
Total consideration  US$16,522,265      

 

The goodwill of US$9,948,394 arising from the Acquisition consists largely of the synergies and cost reductions through economies of scale.

 

Unaudited supplemental pro forma financial information

 

The following unaudited supplemental pro forma financial information represents the consolidated results of operations of the Company as if the Acquisition had occurred as of the beginning of January 1, 2009. The unaudited supplemental pro forma financial information is not necessarily indicative of what the Company’s consolidated results of operations actually would have been had it completed the acquisition at the beginning of the period. In addition, the unaudited supplemental pro forma financial information does not attempt to project the future results of operations after the Acquisition.

 

   For the Year Ended 
   December 31, 2009 
      
Revenues  US$98,092,842 
Net income   2,654,684 
Net income per share attributable to Yongye International, Inc.     
Basic  US$0.07 
Diluted   0.07 

 

Since the acquisition date, the revenues from Shengmingsu manufacturing business, which were all inter-company sales, were eliminated in the consolidated financial statements.

 

NOTE 4 – ACCOUNTS RECEIVABLE

 

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

 

   December 31, 2011   December 31, 2010 
         
Accounts receivable  US$168,852,106   US$26,110,813 
Less: allowance for doubtful accounts   (15,222,584)   - 
Total  US$153,629,522   US$26,110,813 

 

There was no write-off of accounts receivable for the years ended December 31, 2011, 2010 and 2009. As of March 15, 2012, accounts receivable amounting to approximately US$73 million were subsequently collected.

 

The activities in the allowance for doubtful accounts for the years ended December 31, 2011, 2010 and 2009 are as follows:

 

F-14
 

 

   For the Years Ended 
   December 31, 2011   December 31, 2010   December 31, 2009 
             
Allowance for doubtful accounts at beginning of year  US$-   US$-   US$- 
Charged to bad debt expense   14,973,439    -    - 
Foreign currency translation adjustment   249,145    -    - 
Allowance for doubtful accounts at end of year  US$15,222,584   US$-   US$- 

 

The Company considers historical losses adjusted to take into account current market conditions and the customers’ financial condition, the amount of receivables in dispute and past due, the accounts receivables aging and customers’ repayment patterns. Past due balances are reviewed individually for collectability. The provision for doubtful receivables is recorded in general and administrative expenses.

 

NOTE 5 – INVENTORIES

 

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

 

   December 31, 2011   December 31, 2010 
         
Finished goods  US$75,073,119   US$50,435,480 
Work in progress   10,028,719    14,683,295 
Raw materials   805,534    641,051 
Consumables and packing supplies   209,628    118,221 
Total  US$86,117,000   US$65,878,047 

 

As of December 31, 2011, certain finished goods of US$18,872,375, were pledged as security for a short-term bank loan (See Note 12). In addition, as of December 31, 2011, finished goods included US$6,340,411 of products that were sold to customers for which the related revenue was not recognized in accordance with the Company’s accounting policy on revenue recognition.

 

NOTE 6 – DEPOSITS FOR 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. The lignite coal and most chemical component materials will be consumed in the production process at Yongye Nongfeng and Yongye Fumin. As of December 31, 2011 and 2010, the deposits to suppliers amounted to US$2,616,231 and US$10,845,221, respectively.

 

NOTE 7 – PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment at December 31, 2011 and 2010 consisted of the following:

 

   December 31, 2011   December 31, 2010 
         
Buildings  US$14,329,776   US$13,168,830 
Machinery and equipment   7,025,521    6,567,721 
Office equipment and furniture   511,713    484,468 
Vehicles   2,406,278    2,110,077 
Software   19,909    19,146 
Leasehold improvements   902,962    754,085 
    25,196,159    23,104,327 
           
Less: Accumulated depreciation and amortization   3,266,715    1,557,175 
           
Total  US$21,929,444   US$21,547,152 

 

F-15
 

 

Depreciation and amortization expense related to property, plant and equipment for the years ended December 31, 2011, 2010 and 2009 was US$1,709,540, US$872,324, and US$545,887, respectively. 

 

As of December 31, 2011 and 2010, sixteen and twenty-five vehicles with initial carrying amount of US$794,984 and US$1,247,575 were pledged as security for the long-term bank loans of US$189,229 and US$315,426, respectively. The bank loans were provided for the purchases of the vehicles (See Note 13).

 

As of December 31, 2011, the Company pledged its building with an original carrying amount of approximately US$6,053,000 as security for a short-term bank loan (See Note 12).

 

NOTE 8 – INTANGIBLE ASSET

 

Intangible asset at December 31, 2011 and 2010 consisted of the following:

 

   December 31, 2011 
   Weighted             
   average   Gross       Net 
   amortization   carrying   Accumulated   carrying 
   period   amount   amortization   amount 
Amortizing intangible assets:                    
Customer List   9 years   US$25,897,553   US$(4,316,259)  US$21,581,294 
Patent   10 years    114,327    (45,731)   68,596 
Total       US$26,011,880    (4,361,990)   21,649,890 

 

   December 31, 2010 
   Weighted             
   average   Gross       Net 
   amortization   carrying   Accumulated   carrying 
   period   amount   amortization   amount 
Amortizing intangible assets:                    
Customer List   9 years   US$24,905,410   US$(1,383,634)  US$23,521,776 
Patent   10 years    109,947    (32,984)   76,963 
Total       US$25,015,357    (1,416,618)   23,598,739 

 

Amortization expense for the years ended December 31, 2011, 2010 and 2009 was US$2,945,372, US$1,360,281, and US$10,627, respectively. The estimated annual amortization expense for intangible asset in each of the next five years is US$2,888,939.

 

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 US$3 million cash. The US$3 million cash consideration was paid in March 2011.

 

The Company 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.

F-16
 

 

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.

 

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 9 – LAND USE RIGHT

 

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

 

   December 31, 2011   December 31, 2010 
         
Land use right  US$6,342,142   US$4,331,801 
Less: Accumulated amortization   212,991    113,795 
Total  US$6,129,151   US$4,218,006 

 

As of December 31, 2011, the Company pledged its land use right with an original carrying amount of approximately US$4,504,000 as security for a short-term bank loan (See Note 12).

 

NOTE 10 - PREPAYMENT FOR MINING PROJECT

 

On March 1, 2010, the Company entered into an agreement with its then 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 of Wuchuan County (the “Project Site”) for cash consideration of 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 December 31, 2011, the Company has not obtained certain other 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 production 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 11 – 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”. In addition, as of December 31, 2011, other assets included an amount of US$4,857,800 representing the tax effect of the difference between the amount paid for the vehicles and the tax basis of the assets (See Note 17).

 

F-17
 

 

NOTE 12 – SHORT-TERM BANK LOAN

 

In April 2011, Yongye Nongfeng obtained two short-term bank loans of RMB 52,500,000 (equivalent to US$8,209,282) and RMB 47,500,000 (equivalent to US$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. Yongye Nongfeng repaid the short-term loans in December 2011.

 

In December 2011, Yongye Nongfeng obtained two short-term bank loans of RMB 60,000,000 (equivalent to US$9,436,188) and RMB 120,000,000 (equivalent to US$18,872,375) from China Citic Bank. These two short-term bank loans carry a fixed annual interest rate of 7.93% and are pledged by the inventory, land use right and buildings of Yongye Nongfeng. The two short-term loans are due on June 22, 2012.

 

NOTE 13 – LONG-TERM LOANS AND PAYABLES

 

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

 

   December 31, 2011   December 31, 2010 
         
Vehicle loans-employees  US$189,229   US$315,426 
Vehicle loans-distributors   11,554,688    525,739 
Total  US$11,743,917   US$841,165 

 

As of December 31, 2011 and 2010, vehicle-employees loans of US$189,229 and US$315,426, respectively, were secured by sixteen and twenty-five vehicles with initial carrying amount of US$794,984 and US$1,247,575, respectively. 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 11). 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 December 31, 2011 are: US$4,279,234, US$4,414,836, US$3,049,045, US$802, and US$0, respectively.

 

NOTE 14 – OTHER PAYABLES

 

Other payable as of December 31, 2011 mainly represented payable of US$980,169 for the construction of the production plant in Yongye Fumin and non income tax payable of US$1,834,577. Other payable as of December 31, 2010 mainly represented consideration payable of US$3 million for the acquisition of Customer List (See Note 8), and payable of $1,852,473 for the construction of the production plant in Yongye Fumin.

 

F-18
 

 

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 US$0.001 per share (the “April Investor Shares”) and 1,623,905 warrants (See below) for aggregate gross proceeds equal to US$10,000,651 (the “April Offering”). 

 

On September 5, 2008, the Company entered into a securities purchase agreement with certain investors (the “September Investors”), for the sale in a private placement of an aggregate of 6,073,006 shares of the Company’s common stock, par value US$0.001 per share (the “September Investor Shares”) and 1,518,253 warrants (See below) for aggregate gross proceeds equal to approximately US$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 US$0.001 per share (the “May Shares”) for aggregate gross proceeds equal to US$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 US$0.001 per share, to the Underwriters at a price per share of US$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 US$60,000,000. Underwriting discounts and commissions and offering expenses were US$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 US$9,000,000, which, after net of commissions and discounts of US$450,000, was received on January 4, 2010.

 

In connection with the acquisition of Customer List (See Note 8) 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 unvested 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.

 

On October 10, 2011, the Company granted 1,166,333 unvested 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. As of December 31, 2011, the shares are not yet 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 US$50 million. The redeemable Series A convertible preferred shares are convertible into common stock of the Company at an initial conversion price of US$8.80, subject to further adjustments as discussed below.

 

F-19
 

 

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 US$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.

 

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 non-assessable shares of common stock. The initial conversion price is US$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 US$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 U.S. GAAP.

 

F-20
 

 

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

 

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 December 31, 2011. The Company assesses the probability of whether the redeemable Series A convertible preferred shares are 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 US$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 US$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.

F-21
 

 

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 US$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.

 

During the year ended December 31, 2011, no “April Warrants” and “September Warrants” were exercised by April Investors and September Investors.

 

During the year ended December 31, 2010, 54,803 “April Warrants” and “September Warrants” were exercised by certain April Investors and September Investors. In connection with the exercise, the Company issued 54,803 shares of common stock and received US$84,397 from warrant holders that cash exercised.

 

During the year ended December 31, 2009, 2,939,183 “April Warrants” and “September Warrants” were exercised by certain April Investors and September Investors, some of whom elected cashless exercise. In connection with the exercise, the Company issued 2,539,653 shares of common stock and received US$526,611 from warrant holders that cash exercised.

 

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 US$1.54 per share and accordingly, the exercise price of the April Warrants and the September Warrants was reduced to US$1.54 per share.  The exercise price of the May Warrants (US$1.848) was not affected but is also subject to potential down-round adjustments in future periods. As of December 31, 2011 and 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 earn