Attached files

file filename
EX-31.2 - Deyu Agriculture Corp.v223840_ex31-2.htm
EX-32.1 - Deyu Agriculture Corp.v223840_ex32-1.htm
EX-32.2 - Deyu Agriculture Corp.v223840_ex32-2.htm
EX-31.1 - Deyu Agriculture Corp.v223840_ex31-1.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
  
  
FORM 10-Q
     

  
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended: March 31, 2011
 
or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______to______.
 
 
DEYU AGRICULTURE CORP.
 
 
 (Exact name of registrant as specified in its
charter)
 
 
Nevada
 
333-160476
 
80-0329825
(State or other jurisdiction of
incorporation or organization)
 
(Commission File No.)
 
(I.R.S. Employer Identification
No.)
 
 
Tower A, Century Centre, Room 808, 8 North Star
Road, Beijing, PRC
 
 
 (Address of principal executive offices)
 
(626) 242-5292 
 
 86-13828824414
 
 
(Registrant’s telephone number, including area code)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

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 o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company filer.  See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):
 
Large Accelerated Filer   o         Accelerated Filer   o         Non-Accelerated Filer   o         Smaller Reporting Company   x

Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act. Yes o No x

As of May 20, 2011, there were 10,524,774 shares outstanding of the registrant’s common stock.
 


 
 

 

DEYU AGRICULTURE CORP.

FORM 10-Q

MARCH 31, 2011

INDEX
 
PART I
     
ITEM 1.
FINANCIAL STATEMENTS
 
     
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS  OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS
3
     
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
13
     
ITEM 4.
CONTROLS AND PROCEDURES
13
     
PART II
     
ITEM 1.
LEGAL PROCEEDINGS
14
     
ITEM 1A.
RISK FACTORS
14
     
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
14
     
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
14
     
ITEM 4.
(REMOVED AND RESERVED)
14
     
ITEM 5.
OTHER INFORMATION
14
     
ITEM 6.
EXHIBITS
14
     
SIGNATURES
18
 
 
- 2 -

 
 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
March 31, 2011





Consolidated Financial Statements:
 
   
Consolidated Balance Sheets (Unaudited)
F-1
   
Consolidated Statements of Operations (Unaudited)
F-2
   
Consolidated Statements of Cash Flows (Unaudited)
F-3
   
Notes to Consolidated Financial Statements (Unaudited)
F-4

 
 

 

 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
         
 
Assets
 
March 31,
2011
   
December 31,
2010
 
   
(Unaudited)
   
(Audited)
 
Current Assets
           
  Cash and cash equivalents
  $ 6,315,157     $ 6,281,304  
  Restricted cash
    2,290,671       -  
  Accounts receivable, net
    19,696,303       11,166,452  
  Inventory
    14,765,623       18,359,505  
  Advance to supplier
    6,141,278       3,596,991  
  Prepaid expenses
    1,562,242       2,219,332  
  Other current assets
    814,769       849,593  
     Total Current Assets
    51,586,043       42,473,177  
                 
Property, plant, and equipment, net
    5,465,400       4,626,004  
Construction-in-progress
    8,351,678       7,224,504  
Goodwill
    1,060,446       1,052,139  
Other assets
    10,233,631       10,553,328  
Intangible assets, net
    976,080       -  
                 
     Total Assets
  $ 77,673,278     $ 65,929,152  
                 
Liabilities and Equity
               
                 
Current Liabilities
               
  Short-term loan
  $ 2,652,139     $ 2,631,364  
  Accounts payable
    1,356,969       540,956  
  Advance from customers
    7,596,117       6,484,589  
  Accrued expenses
    1,838,831       1,619,186  
  Preferred stock dividends payable
    106,697       238,620  
  Due to related parties
    9,926,240       8,030,303  
  Other current liabilities
    3,243,140       2,943,681  
     Total Current Liabilities
    26,720,133       22,488,699  
                 
Equity
               
  Series A convertible preferred stock, $.001 par value, 10,000,000 shares
               
       authorized,  1,956,088 and 2,106,088 shares outstanding, respectively
    1,956       2,106  
  Common stock, $.001 par value; 75,000,000 shares authorized,
               
       10,499,774 and 10,394,774 shares issued and outstanding, respectively
    10,500       10,350  
  Additional paid-in capital
    19,785,710       18,770,230  
  Other comprehensive income
    2,574,149       2,272,633  
  Retained earnings
    25,728,379       22,385,134  
     Total Stockholders' Equity
    48,100,694       43,440,453  
     Noncontrolling Interest
    2,852,451       -  
     Total Equity
    50,953,145       43,440,453  
                 
     Total Liabilities and Equity
  $ 77,673,278     $ 65,929,152  
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
F-1

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
 
   
For The Three Months Ended
 
   
March 31,
 
 
 
2011
   
2010
 
             
Net revenue
  $ 41,432,261     $ 14,447,282  
Cost of goods sold
    (33,078,926 )     (10,936,119 )
Gross Profit
    8,353,335       3,511,163  
                 
Selling expenses
    (3,373,255 )     (621,714 )
General and administrative expenses
    (2,286,595 )     (261,911 )
Total Operating Expense
    (5,659,850 )     (883,625 )
Operating income
    2,693,485       2,627,538  
                 
Interest income
    6,415       912  
Interest expense
    (74,378 )     (61,537 )
Non-operating income
    44,977       -  
Total Other Expense
    (22,986 )     (60,625 )
                 
Income before income taxes
    2,670,499       2,566,913  
Income tax benefit
    626,250       -  
Net income
    3,296,749       2,566,913  
Add: Net loss attributable to noncontrolling interest
    144,183       -  
Net income attributable to Deyu Agriculture Corp.
    3,440,932       2,566,913  
Preferred stock dividends
    (97,687 )     -  
Net income available to common stockholders
  $ 3,343,245     $ 2,566,913  
                 
Net income per common share - basic
  $ 0.32     $ 0.52  
Net income per common share - diluted
  $ 0.24     $ 0.52  
Weighted average number of common shares outstanding - basic
    10,469,774       4,930,000  
Weighted average number of common shares outstanding - diluted
    14,581,134       4,930,000  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
F-2

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

   
For The Three Months Ended
 
   
March 31,
 
   
2011
   
2010
 
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net income available to common stockholders
  $ 3,343,245     $ 2,566,913  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation & amortization
    259,426       79,993  
Share-based compensation
    137,588       -  
Preferred stock dividends accrued
    106,210       -  
Deferred income tax benefit
    (624,143 )     -  
Noncontrolling interest
    (144,183 )     -  
Reserves for sales discount
    -       374,976  
Decrease (increase) in current assets:
               
Accounts receivable
    (8,403,192 )     (682,310 )
Inventories
    3,732,240       (5,851,426 )
Advance to suppliers
    (1,920,033 )     -  
Prepaid expense and other current assets
    135,385       (346,914 )
Other assets
    30,336       -  
Increase (decrease) in liabilities:
               
Accounts payable
    808,040       -  
Advance from customers
    695,488       -  
Accrued expense and other liabilities
    1,027,090       170,392  
Net cash used in operating activities
    (816,503 )     (3,688,376 )
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Construction and remodeling of factory and warehouses
    (1,251,461 )     -  
Purchase of machinery and equipment
    (1,042,170 )     (935,339 )
Net cash used in investing activities
    (2,293,631 )     (935,339 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Proceeds from capital contributions
    3,800,374       -  
Net proceeds from short-term loans from related parties
    1,824,179       233,749  
Cash restricted for credit line of bank acceptance notes
    (2,280,224 )     -  
Payment of preferred dividends
    (239,407 )     -  
Net proceeds from short-term loans from bank
    -       2,182,479  
Net repayments of short-term loans from related parties
    -       (79,097 )
Net cash provided by financing activities
    3,104,922       2,337,131  
                 
EFFECT OF EXCHANGE RATE CHANGE ON CASH AND CASH EQUIVALENTS
    39,065       (397 )
                 
NET INCREASE (DECREASE) IN CASH & CASH EQUIVALENTS
    33,853       (2,286,981 )
CASH & CASH EQUIVALENTS, BEGINNING BALANCE
    6,281,304       2,562,501  
CASH & CASH EQUIVALENTS, ENDING BALANCE
  $ 6,315,157     $ 275,520  
                 
SUPPLEMENTAL DISCLOSURES:
               
Income tax paid
  $ -     $ -  
Interest paid
  $ 78,878     $ 49,985  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
 
F-3

 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
NOTE 1.
NATURE OF BUSINESS AND BASIS OF FINANCIAL STATEMENT PREPARATION

Deyu Agriculture Corp. (the “Company”), formerly known as Eco Building International, Inc., was incorporated under the laws of the State of Nevada on December 23, 2008.  We completed the acquisition of City Zone Holdings Limited (“City Zone”), an agricultural products distributor in the Shanxi Province of the Peoples Republic of China (the “PRC”) engaged in procuring, processing, marketing, and distributing various grain and corn products, by means of a share exchange, effective April 27, 2010.  As a result of the share exchange, City Zone became our wholly-owned subsidiary.  We currently conduct our business primarily through the operating PRC subsidiaries, including Jinzhong Deyu Agriculture Trading Co., Ltd. (“Jinzhong Deyu”), Jinzhong Yuliang Agriculture Trading Co., Ltd. (“Jinzhong Yuliang”), Jinzhong Yongcheng Agriculture Trading Co., Ltd. (“Jinzhong Yongcheng”), and Betian Yu Biotechnology (Beijing) Co., Ltd. (“Detian Yu”) and its subsidiaries and variable interest entities.

On May 11, 2010, our Board of Directors adopted a resolution to change our name to "Deyu Agriculture Corp."  FINRA declared the name change effective on June 2, 2010.

Reverse Acquisition

On April 27, 2010, we entered into a Share Exchange Agreement (“Share Exchange”) under which we issued 8,736,932 shares of common stock, par value $0.001 per share, to Expert Venture Limited (“Expert Venture”), a company organized under the laws of the British Virgin Islands, and the other shareholders of City Zone (“the “City Zone Shareholders”).  As a result of the Share Exchange, City Zone became our wholly-owned subsidiary and City Zone Shareholders acquired a majority of our issued and outstanding common stocks.  Concurrent with the Share Exchange, Mr. Jianming Hao (“Mr. Hao”), the managing director of City Zone and all of its operating subsidiaries, was appointed our Chief Executive Officer.

As a result, the Share Exchange has been accounted for as a reverse acquisition using the purchase method of accounting, whereby City Zone is deemed to be the accounting acquirer (legal acquiree) and we are to be the accounting acquiree (legal acquirer).  The financial statements before the date of the Share Exchange are those of City Zone with our results being consolidated from the date of the Share exchange.  The equity section and earnings per share have been retroactively restated to reflect the reverse acquisition and no goodwill has been recorded.

City Zone was incorporated in the British Virgin Islands on July 27, 2009 under the BVI Business Companies Act, 2004.  In November 2009, pursuant to a restructuring plan set out below, City Zone has become the holding company of a group of companies comprising Most Smart, Shenzhen Redsun, Shenzhen JiRuHai, Beijing Detian Yu, Jinzhong Deyu, Jinzhong Yongcheng, and Jinzhong Yuliang.

Restructuring

In November 2009, pursuant to a restructuring plan (“Restructuring”) intended to ensure compliance with the PRC rules and regulations, City Zone, through a series of acquisitions and wholly-owned subsidiaries, acquired 100% equity interests in Jinzhong Deyu, Jinzheng Yuliang, and Jinzhong Yongcheng.  The former shareholders and key management of Jinzhong Deyu, Jinzhong Yongcheng, and Jinzhong Yuliang became the ultimate controlling parties and key management of City Zone.  This restructuring exercise has been accounted for as a recapitalization of Jinzhong Deyu, Jinzhong Yongcheng, and Jinzhong Yuliang with no adjustment to the historical basis of the assets and liabilities of these companies, while the historical financial positions and results of operations are consolidated as if the restructuring occurred as of the beginning of the earliest period presented in the accompanying consolidated financial statements.  For the purpose of consistent and comparable presentation, the consolidated financial statements have been prepared as if City Zone had been in existence since the beginning of the earliest and throughout the whole periods covered by these consolidated financial statements.
 
 
F-4

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Variable Interest Entities

On November 16, 2010, Detian Yu entered into a series of contractual arrangements (the “Contractual Arrangements”) with each of Beijing Jundaqianyuan Investment Management Co., Ltd. (“Junda”), Jinzhong Longyue Investment Consultancy Services Co., Ltd. (“Longyue”), and their shareholders, pursuant to which Detian Yu effectively took over management of the business activities of Junda and Longyue.

Junda is a limited liability company incorporated in the PRC on June 13, 2010 with registered capital of $14,637 (or RMB 100,000) by Jianming Hao, Chairman and Chief Executive Officer of the Company, and Wenjun Tian, President and Executive Director of the Company.  As of December 31, 2010, Junda’s equity interest was 100% held by several executives and managers of the Company, including (a) Jianming Hao, owning 33% of Junda, (b) Wenjun Tian, owning 34% of Junda, (c) Jianbin Zhou, the Chief Operating Officer of the Company, owning 10% of Junda, (d) Li Ren, Vice President of Branding and Marketing of the Company, owning 5% of Junda, (e) Yongqing Ren, Vice President of the Corn Division of the Company, owning 3% of Junda and (f) Junde Zhang, Vice President of the Grains Division of the Company, owning 3% of Junda.  As a result, the execution of the Contractual Arrangements with Junda is considered a related party transaction.

The Contractual Arrangements are comprised of a series of agreements with a term of ten (10) years, including:

 
·
Exclusive Management and Consulting Service Agreements, through which Detian Yu shall provide to each of Junda and Longyue management consulting services in relation to the business of Junda and Longyue in exchange for 35% of the net income after taxes of Junda and Longyue every fiscal year.

 
·
Business Cooperation Agreements, through which Detian Yu shall provide business cooperation opportunities and services including clients, cooperation partners and market information in the fields of grain processing, sales and financing to each of Junda and Longyue in exchange for cooperation fees and commissions from each of Junda and Longyue equal to 65% of the net income after tax of each of Junda and Longyue in every fiscal year.

 
·
Business Operations Agreements, through which Detian Yu has exclusive authority of all decision-making of ongoing operations, including establishing compensation levels and hiring and firing of key personnel.  In order to ensure normal operation of Junda and Longyue, Detian Yu agrees to act as the guarantor and provide guarantee on the performance of the obligations of Junda and Longyue under all contracts executed by Junda and Longyue.

 
·
Share Pledge Agreements, through which the shareholders of Junda and Longyue have agreed to pledge all of their respective equity interests in Junda or Longyue (as the case may be) as security for the performance of all of the obligations or debts under the Exclusive Management and Consulting Service Agreements and Business Cooperation Agreements assumed by Junda and Longyue, and under a counter-guarantee to all the payments made by Detian Yu for the performance of the guarantees assumed by Detian Yu under the Business Operation Agreements.

 
·
Power of Attorney, signed by each of the shareholders of Junda and Longyue, authorizes a designee appointed by Detian Yu to exercise all of their respective voting rights as a shareholder.
 
 
F-5

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
·
Equity Acquisition Option Agreements, through which the shareholders of Junda and Longyue granted Detian Yu an irrevocable and unconditional right to purchase, or cause a designated party of Detian Yu to purchase, part or all of the equity interests in Junda and Longyue from such shareholders, when and to the extent that, applicable PRC laws permit.  The consideration for the equity acquisition option for Junda is RMB 80,000,000 and the consideration for the equity option for Longyue is RMB 120,000,000.

Details of our subsidiaries and variable interest entities subject to consolidation are as follows:

Name of Subsidiary
Domicile and Date of Incorporation
Registered Capital
Percentage of Ownership
Principal Activities
City Zone Holdings Limited (“City Zone”)
British Virgin Islands, July 27, 2009
$20,283,581
100%
Holding company of Most Smart
         
Most Smart International Limited (“Most Smart”)
Hong Kong, March 11, 2009
$1
100%
Holding company of Shenzhen Redsun
         
Redsun Technology (Shenzhen) Co., Ltd. (“Shenzhen Redsun”)
The PRC, August 20, 2009
$30,000
100%
Holding company of Shenzhen JiRuHai
         
Shenzhen JiRuHai Technology Co., Ltd. (“Shenzhen JiRuHai”)
The PRC, August 20, 2009
$14,638
100%
Holding company of Beijing Detian Yu
         
Detian Yu Biotechnology (Beijing) Co., Ltd. (“Detian Yu”)
The PRC, November 30, 2006
$7,637,723
100%
Wholesale distribution of simple-processed and deep-processed packaged food products and staple food.  Holding company of the following first four entities.
         
Jinzhong Deyu Agriculture Trading Co., Ltd. (“Jinzhong Deyu”)
The PRC, April 22, 2004
$1,492,622
100%
Organic grains preliminary processing and wholesale distribution.
         
Jinzhong Yongcheng Agriculture Trading Co., Ltd. (“Jinzhong Yongcheng”)
The PRC, May 30, 2006
$288,334
100%
Organic corns preliminary processing and wholesale distribution.
         
Jinzhong Yuliang Agriculture Trading Co., Ltd. (“Jinzhong Yuliang”)
The PRC, March 17, 2008
$281,650
100%
Organic corns preliminary processing and wholesale distribution.
         


Name of Subsidiary
Domicile and Date of Incorporation
Registered Capital
Percentage of Ownership
Principal Activities
Beijing Jundaqianyuan Investment Management Co., Ltd. (“Junda”)
The PRC, June 13, 2010
$14,637
Variable interest
Shareholding of Deyufarm
         
Jinzhong Longyue Investment Consultancy Services Co., Ltd. (“Longyue”)
The PRC, June 2, 2010
$4,393
Variable interest
Shareholding of Deyufarm
         
Deyufarm Innovation Food (Beijing) Co., Ltd. (“Deyufarm”)
The PRC, June 13, 2010
$10,493,516
100%
Wholesale distribution of packaged food products and instant millet beverage.  Holding company of the following two companies.
         
Sichuan HaoLiangXin Instant Food Co., Ltd. (“HaoLiangXin”)
The PRC, April 25, 2008
$1,202,460
100%
Manufacturing and wholesale distribution of instant grain vermicelli and buckwheat tea products.
         
Beijing Xinggu Deyufarm Food Co., Ltd. (“Xinggu Deyufarm”)
The PRC, November 25, 2010
$1,515,152
100%
Manufacturing of instant grain vermicelli products.

 
 
F-6

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The unaudited consolidated financial statements of Deyu Agriculture Corp. and subsidiaries have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and pursuant to the requirements for reporting on Form 10-Q.  Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for annual financial statements.  However, the information included in these interim financial statements reflects all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary for the fair presentation of the consolidated financial position and the consolidated results of operations.  Results shown for interim periods are not necessarily indicative of the results to be obtained for a full year. The consolidated balance sheet information as of December 31, 2010 was derived from the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K.  These interim financial statements should be read in conjunction with that report.  Certain comparative amounts have been reclassified to conform to the current period's presentation.

The consolidated financial statements include the accounts of Deyu Agriculture Corp. and its wholly-owned subsidiaries and joint ventures. All material intercompany balances and transactions have been eliminated.
 
 
F-7

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Basis of presentation

The accompanying consolidated financial statements include the financial statements of Deyu Agriculture Corp., its wholly-owned subsidiaries, and those variable interest entities where the Company is the primary beneficiary.  All significant intercompany account balances and transactions have been eliminated in consolidation.  Results of operations of companies purchased are included from the dates of acquisition.

These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.  The Company’s function currency is the Chinese Yuan, or Renminbi (“RMB”); however, the accompanying consolidated financial statements have been translated and presented in United States Dollars (“USD”).

On April 27, 2010, as a result of the consummation of the Share Exchange, we changed our fiscal year end from May 31 to December 31 to conform to the fiscal year end of City Zone.

Use of estimates

The preparation of the consolidated financial statements in conformity with generally accepted  accounting  principles requires management to make estimates and  assumptions  that  affect  the  reported  amounts  of  assets and liabilities and disclosure of contingent assets and liabilities at the date  of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Management makes its estimates based on historical experience and various other assumptions and information that are available and believed to be reasonable at the time the estimates are made.  Therefore, actual results could differ from those estimates under different assumptions and conditions.

Cash and cash equivalents

Cash and cash equivalents consist of cash on hand, cash in bank and all highly liquid investments with original maturities of three months or less.
 
As of March 31, 2011, $2,290,671 of cash was restricted as a pledge for $7,635,570 (RMB 50,000,000) of short-term loan obtained from Bank of Communications in April 2011 (see Note 18 – Subsequent Events).

Accounts receivable
 
Accounts receivable are recorded at net realizable value consisting of the carrying amount less allowance for doubtful accounts, as needed.  We assess the collectability of accounts receivable based primarily upon the creditworthiness of the customer as determined by credit checks and analysis, as well as the customer’s payment history.  Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends, and changes in customer payment patterns to evaluate the adequacy of these reserves.  As of March 31, 2011 and December 31, 2010, there were no customers with accounts receivable greater than six months past due.

Inventories
 
The Company's inventories are stated at lower of cost or market.  Cost is determined on moving-average basis.  Costs of inventories include purchase and related costs incurred in delivering the products to their present location and condition.  Market value is determined by reference to selling prices after the balance sheet date or to management’s estimates based on prevailing market conditions.  Management periodically evaluates the composition of its inventories at least quarterly to identify slow-moving and obsolete inventories to determine if valuation allowance is required.  As of March 31, 2011 and December 31, 2010, management had identified no material slow moving or obsolete inventory.
 
 
F-8

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Property, plant, and equipment

Property, plant, and equipment are stated at cost less accumulated depreciation.  Expenditures for maintenance and repairs are charged to earnings as incurred; additions, renewals and betterments are capitalized.  When property, plant, and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations.

Depreciation is computed using the straight-line method over the estimated useful lives of the assets as follows:

 
Useful Life
(in years)
Automobiles
5
Buildings
30
Office equipment
5-6
Machinery and equipment
10
Furniture & fixtures
5-6
Leasehold Improvement
3

Construction-in-progress

Construction-in-progress consists of amounts expended for warehouse construction.  Construction-in-progress is not depreciated until such time as the assets are completed and put into service.  Once warehouse construction is completed, the cost accumulated in construction-in-progress is transferred to property, plant, and equipment.

Long-lived assets

The Company applies the provisions of FASB ASC Topic 360 (ASC 360), "Property, Plant, and Equipment" which addresses financial accounting and reporting for the impairment or disposal of long-lived assets.  The Company periodically evaluates the carrying value of long-lived assets to be held and used in accordance with ASC 360, at least on an annual basis.  ASC 360 requires the impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amounts.  In that event, a loss is recognized based on the amount by which the carrying amount exceeds the fair market value of the long-lived assets.  Loss on long-lived assets to be disposed of is determined in a similar manner, except that fair market values are reduced for the cost of disposal.

Goodwill and intangible assets

Good is calculated as the purchase premium after adjusting for the fair value of net assets acquired.  Goodwill is not amortized but is reviewed for potential impairment on an annual basis, or when events or circumstances indicate a potential impairment, at the reporting unit level.  A reporting unit, as defined under applicable accounting guidance, is a business segment or one level below a business segment.  Under applicable accounting guidance, the goodwill impairment analysis is a two-step test.  The first step of the goodwill impairment test involves comparing the fair value of each reporting unit with its carrying amount including goodwill.  If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired; however, if the carrying amount of the reporting unit exceeds its fair value, the second step must be performed to measure potential impairment.
 
 
F-9

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The second step involves calculating an implied fair value of goodwill for each reporting unit for which the first step indicated possible impairment.  The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination, which is the excess of the fair value of the reporting unit, as determined in the first step, over the aggregate fair values of the assets, liabilities and identifiable intangibles as if the reporting unit was being acquired in a business combination.  Measurement of the fair values of the assets and liabilities of a reporting unit is consistent with the requirements of the fair value measurements accounting guidance, which 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.  The adjustments to measure the assets, liabilities, and intangibles at fair value are for the purpose of measuring the implied fair value of goodwill and such adjustments are not reflected in the consolidation balance sheet.  If the implied fair value of goodwill exceeds the goodwill assigned to the reporting unit, there is no impairment.  If the goodwill assigned to a reporting unit exceeds the implied fair value of goodwill, an impairment charge is recorded for the excess.  An impairment loss recognized cannot exceed the amount of goodwill assigned to a reporting unit.  An impairment loss establishes a new basis in the goodwill and subsequent reversals of goodwill impairment losses are not permitted under applicable accounting guidance.  In 2010, goodwill was tested for impairment and it was determined that goodwill was not impaired as of December 31, 2010.  No indication of impairment was noted by management as of March 31, 2011.

For intangible assets subject to amortization, an impairment loss is recognized if the carrying amount of the intangible asset is not recoverable and exceeds fair value.  The carrying amount of the intangible asset is considered not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use of the asset.

Fair value measurements

FASB ASC 820, “Fair Value Measurements” (formerly SFAS No. 157) defines fair value for certain financial and nonfinancial assets and liabilities that are recorded at fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  It requires that an entity measure its financial instruments to base fair value on exit price and maximize the use of observable units and minimize the use of unobservable inputs to determine the exit price.  It establishes a hierarchy which prioritizes the inputs to valuation techniques used to measure fair value.  This hierarchy increases the consistency and comparability of fair value measurements and related disclosures by maximizing the use of observable inputs and minimizing the use of unobservable inputs by requiring that observable inputs be used when available.  Observable inputs are inputs that reflect the assumptions market participants would use in pricing the assets or liabilities based on market data obtained from sources independent of the Company.  Unobservable inputs are inputs that reflect the Company’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.  The hierarchy prioritizes the inputs into three broad levels based on the reliability of the inputs as follows:

 
·
Level 1 – Inputs are quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.  Valuation of these instruments does not require a high degree of judgment as the valuations are based on quoted prices in active markets that are readily and regularly available.

 
·
Level 2 – Inputs other than quoted prices in active markets that are either directly or indirectly observable as of the measurement date, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
 
 
F-10

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
·
Level 3 – Valuations based on inputs that are unobservable and not corroborated by market data.  The fair value for such assets and liabilities is generally determined using pricing models, discounted cash flow methodologies, or similar techniques that incorporate the assumptions a market participant would use in pricing the asset or liability.

This guidance applies to other accounting pronouncements that require or permit fair value measurements.  On February 12, 2008, the FASB finalized FASB Staff Position (FSP) No. 157-2, Effective Date of FASB Statement No. 157 (ASC 820).  This Staff Position delays the effective date of SFAS No. 157 (ASC 820) for nonfinancial assets and liabilities to fiscal years beginning after November 15, 2008 and interim periods within those fiscal years, except for those items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).  The adoption of SFAS No. 157 (ASC 820) had no effect on the Company's financial position or results of operations.

We also analyze all financial instruments with features of both liabilities and equity under ASC 480-10 (formerly SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity”) and ASC 815-40 (formerly EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”).  We have determined ASC 480-10 (formerly SFAS 150) and ASC 815-40 (formerly EITF 00-19) has no material effect on our financial position or results of operations.

Revenue recognition

The Company’s revenue recognition policies are in compliance with the SEC Staff Accounting Bulletin No. 104 (“SAB 104”).  The Company recognizes product revenue when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) our price to the customer is fixed or determinable and (iv) collection of the resulting accounts receivable is reasonably assured.  The Company recognizes revenue for product sales upon transfer of title to the customer.  Customer purchase orders and/or contracts are generally used to determine the existence of an arrangement.  Shipping documents and the completion of any customer acceptance requirements, when applicable, are used to verify product delivery or that services have been rendered.  The Company assesses whether a price is fixed or determinable based upon the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment.

The Company’s revenue is recognized net of value-added tax (VAT), reductions to revenue for estimated product returns, and sales discounts based on volume achieved in the same period that the related revenue is recorded.  The estimates are based on historical sales returns, analysis of credit memo data, and other factors known at the time.  Commencing from year 2010, the Company’s general policy is to terminate the offering of sales discounts to customers.  However, the Company may offer sales discounts as incentive for early payments from customers, although those should be infrequent.  For the three months ended March 31, 2011 and 2010, sales discounts were $42,513 and $374,976, respectively.

We offer a right of exchange on our grain products sold through our relationship with grocery store networks.  The consumer who purchases the product may exchange it for the same kind and quantity of product originally purchased.  In accordance with FASB ASC 605-15-25-1 and 605-15-15-2, these are not considered returns for revenue recognition purposes.  For the year ended December 31, 2010, the returns of our product were not material.
 
 
F-11

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Advertising costs

The Company expenses the cost of advertising as incurred or, as appropriate, the first time the advertising takes place.  Advertising costs for the three months ended March 31, 2011 was $946,691.  Advertising costs for the three months ended March 31, 2010 was not material.

Research and development

The Company expenses its research and development costs as incurred.  No material research and development costs was recorded for the three months ended March 31, 2011 and 2010.

Stock-based compensation

In December 2004, the Financial Accounting Standard Board, or the FASB, issued the Statement of Financial Accounting Standards, or SFAS, No. 123(R), “Share-Based Payment”, which replaces SFAS No. 123 and supersedes APB Opinion No. 25.  SFAS No. 123(R) is now included in the FASB’s ASC Topic 718, “Compensation – Stock Compensation.”  Under SFAS No. 123(R), companies are required to measure the compensation costs of share-based compensation arrangements based on the grant-date fair value and recognize the costs in the financial statements over the period during which employees or independent contractors are required to provide services.  Share-based compensation arrangements include stock options and warrants, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans.  In March 2005, the SEC issued Staff Accounting Bulletin No. 107, or SAB 107, which expresses views of the staff regarding the interaction between SFAS No. 123(R) and certain SEC rules and regulations and provides the staff’s views regarding the valuation of share-based payment arrangements for public companies.  SFAS No. 123(R) permits public companies to adopt its requirements using one of two methods.  On April 14, 2005, the SEC adopted a new rule amending the compliance dates for SFAS No. 123(R).  Companies may elect to apply this statement either prospectively, or on a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods under SFAS No. 123.

The Company has fully adopted the provisions of FASB ASC 718 and related interpretations as provided by SAB 107.  As such, compensation cost is measured on the date of grant as the fair value of the share-based payments.  Such compensation amounts, if any, are amortized over the respective vesting periods of the option grant.

Income taxes

The Company accounts for income taxes in accordance with FASB ASC Topic 740, “Income Taxes.”  ASC 740 requires a company to use the asset and liability method of accounting for income taxes, whereby deferred tax assets are recognized for deductible temporary differences, and deferred tax liabilities are recognized for taxable temporary differences.  Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases.  Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion, or all of, the deferred tax assets will not be realized.  Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
 
 
Under ASC 740, a tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur.  The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination.  For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.  The adoption had no effect on the Company’s consolidated financial statements.
 
 
F-12

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Foreign currency translation and comprehensive income

U.S. GAAP requires that recognized revenue, expenses, gains and losses be included in net income.  Certain statements, however, require entities to report specific changes in assets and liabilities, such as gain or loss on foreign currency translation, as a separate component of the equity section of the balance sheet.  Such items, along with net income, are components of comprehensive income.  The functional currency of the Company is Renminbi (“RMB”).  The unit of RMB is in Yuan.  Translation gains are classified as an item of other comprehensive income in the stockholders’ equity section of the consolidated balance sheet.

Statement of cash flows

In accordance with FASB ASC Topic 230, “Statement of Cash Flows,” cash flows from the Company’s operations are calculated based upon the local currencies.  As a result, amounts related to assets and liabilities reported on the consolidated statement of cash flows will not necessarily agree with changes in the corresponding balances on the consolidated balance sheets.

Reclassifications

Certain classifications have been made to the prior year financial statements to conform to the current year presentation.  The reclassifications have no impact on the Company’s 2010 consolidated statement of operations and retained earnings.

Recent pronouncements

In December 2009, FASB issued new guidance regarding improvements to financial reporting by enterprises involved with variable interest entities.  The new guidance provides an amendment to its consolidation guidance for variable interest entities and the definition of a variable interest entity and requires enhanced disclosures to provide more information about an enterprise’s involvement in a variable interest entity.  This amendment also requires ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity and is effective January 1, 2010.  The adoption of this guidance had no impact on our consolidated financial position or results of operations.

In January 2010, FASB issued an amendment regarding improving disclosures about fair value measurements.  This new guidance requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement.  The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements.  Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years.  There was no impact from the adoption of this guidance to our consolidated financial position or results of operations as the amendment only addresses disclosures.

In April 2010, FASB issued an amendment to Stock Compensation.  The amendment clarifies that an employee stock-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity shares trades should not be considered to contain a condition that is not a market, performance, or service condition.  Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity.  The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010.  The adoption of this guidance had no impact on our consolidated financial position or results of operations since our stock-based payment awards have an exercise price denominated in the same currency of the market in which our Company shares are traded.
 
 
F-13

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


NOTE 3.
CONSOLIDATION OF VARIABLE INTEREST ENTITIES

Effective November 16, 2010, the Company included in its consolidated financial statements, the net assets of Junda and Longyue, and their wholly-owned subsidiaries, including Deyufarm, HaoLiangXin, and Xinggu Deyufarm, pursuant to the rights and obligations conveyed by the variable interests resulting in the Company absorbing a majority of Junda’s and Longyue’s expected losses and receiving their expected residual returns.  In accordance with ASC 810, “Consolidation”, the net assets of Junda and Longyue were initially measured at their carrying amounts at the date the requirements of the VIE substance first apply.  Carrying amounts refers to the amounts at which the assets and liabilities would have been carried in the consolidated financial statements if the VIE accounting guidance had been effective when the reporting entity first met the conditions to be the primary beneficiary.  The operating results of Junda and Longyue were included in the consolidated income statements of the Company from the effective date of consummating variable interests.

Selected information of the combined balance sheets of Junda and Longyue, including their wholly-owned subsidiaries, as of March 31, 2011 and December 31, 2010, and the combined results of the operations for the three months ended March 31, 2011 and for the period from November 16, 2010 to December 31, 2010 are summarized as follows:

Junda & Longyue Consolidated & Combined
 
March 31,
2011
   
December 31, 2010
 
Combined Assets (1)
           
Cash and cash equivalents
  $ 503,662     $ 489,886  
Accounts receivable
    1,338,222       5,493  
Inventories
    1,139,248       1,817,506  
Advance to suppliers
    1,339,400       2,418,459  
Prepaid expense
    465,200       895,081  
Fixed assets and construction-in-progress
    2,563,224       830,948  
Deferred tax assets
    651,433       251,632  
All other assets
    45,941       87,907  
Total
  $ 8,046,330     $ 6,796,912  
                 
Combined Liabilities (1)
               
Accounts payable
  $ 532,469     $ 343,944  
Accrued expenses
    491,309       327,959  
Due to related parties
    9,926,240       8,030,303  
Loan from unrelated parties
    2,704,048       2,734,309  
All other liabilities
     155,054       218,400  
Total
  $ 13,809,120     $ 11,654,915  
                 
 
   
Three Months Ended
March 31, 2011
   
Period from Novemer 16, 2010 to December 31, 2010
 
Net sales
  $ 4,838,809     $ 4,000,749  
Net loss
    (1,211,378 )     (756,480 )
                 
 
(1) Total assets and liabilities of combined VIEs are reported net of intercompany balances that have been eliminated in the Company’s consolidation.

 
 
F-14

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Prior to consummating the variable interests with the Company through Junda and Longyue, on July 24, 2010, Deyufarm, wholly-owned by Junda and Longyue, acquired 100% of the equity interest of HaoLiangXin for cash consideration of $1,212,336 (or RMB 8,220,000).  The acquisition was accounted for as a business combination under the purchase method of accounting.  HaoLiangXin’s results of operations were included in Deyufarm’s results beginning July 24, 2010.  The purchase price has been allocated to the assets acquired and the liabilities assumed based on their fair value at the acquisition date (approximated to their carrying value) as summarized in the following:

Purchase price
  $ 1,212,336  
         
Allocation of the purchase price:
       
Cash acquired
    21,110  
Accounts receivable
    508  
Inventories
    264,641  
Advance to suppliers
    304,018  
Other current assets
    42,710  
Property, plant and equipment
    177,871  
Other assets
    3,669  
Accounts payable
    (24,911 )
Advance from customers
    (359,617 )
Other current liabilities
    (241,635 )
Fair value of net assets acquired
    188,364  
         
Goodwill (2)
  $ 1,023,972  
         
(2) The variance of $36,474 as compared to the $1,060,446 recorded in the Company’s consolidated balance sheet as of March 31, 2011 was mainly the effect of foreign currency translation.
 


NOTE 4.
ACCOUNTS RECEIVABLE

Accounts receivable consisted of the following:

   
March 31,
   
December 31,
 
   
2011
   
2010
 
Accounts receivable
  $ 19,696,303     $ 11,166,452  
Less:  Allowance for doubtful accounts
    -       -  
Accounts receivable, net
  $ 19,696,303     $ 11,166,452  

 
 
F-15

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 5.
INVENTORY

Inventory consisted of the following:

   
March 31,
   
December 31,
 
   
2011
   
2010
 
Raw materials
  $ 1,208,463     $ 934,681  
Work in process
    104,088       421,858  
Finished goods
    13,254,287       16,812,946  
Supplies
    198,785       190,020  
Total
  $ 14,765,623     $ 18,359,505  


NOTE 6.
PREPAID EXPENSES

Prepaid expenses consisted of the following:

   
March 31,
   
December 31,
 
   
2011
   
2010
 
Deductible value-added taxes (VAT)
  $ 1,080,781     $ 1,308,220  
Prepaid advertisement
    297,574       643,011  
Prepaid rent
    152,817       180,314  
Prepayment for equipment
    -       7,576  
Prepaid other expenses
    31,070       80,211  
Total
  $ 1,562,242     $ 2,219,332  
 
 
F-16

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)



NOTE 7.
PROPERTY, PLANT, AND EQUIPMENT

Property, plant, and equipment consisted of the following:

   
March 31,
 
December 31,
 
   
2011
 
2010
 
Automobiles
  $ 945,931     $ 933,878  
Buildings
    1,687,028       1,659,116  
Office equipment
    489,199       447,602  
Machinery and equipment
    3,763,601       2,786,421  
Furniture and fixtures
    59,301       58,837  
Leasehold Improvement
    34,207       -  
Total cost
    6,979,268       5,885,854  
Less:  Accumulated depreciation
    (1,513,868 )     (1,259,850 )
Property, plant, and equipment, net
  $ 5,645,400     $ 4,626,004  

The buildings owned by the Company located in Jinzhong, Shanxi Province, China are used for production, warehouse, and offices for the grains business.  The building structure is mainly constructed of light steels and bricks.  During the year ended December, 31 2009, the Company observed a significant decrease in the construction cost of such property structure during its annual impairment testing of long-lived assets.  While future estimated operating results and cash flows are considered, the Company eventually employed the quoted replacement cost of the buildings as comparable market data.  As a result of this analysis, the Company concluded that the carrying amount of the buildings exceeded their appraised fair value, and recorded an impairment of $556,312 for the year ended December 31, 2009.  These charges are classified in the caption “other expenses” within operating expenses.

Depreciation expense for the three month periods ended March 31, 2011 and 2010 was $238,417 and $79,993, respectively.


NOTE 8.
CONSTRUCTION-IN-PROGRESS

Construction-in-progress consisted of the following:

   
March 31,
   
December 31,
 
   
2011
   
2010
 
Construction of Jinzhong processing and storage center
  $ 6,970,122     $ 6,732,189  
Remodeling of Beijing Pinggu factory and warehouse
    1,285,947       492,315  
Construction of Jinzhong factory heating system
    95,609       -  
Total cost
  $ 8,351,678     $ 7,224,504  

The Jinzhong processing and storage center under construction is located in Jinzhong City, Shanxi Province, PRC.  The total construction cost was estimated at $7,068,383, including the cost of obtaining the land use rights which was $2,272,727, machinery, and equipment.  As of March 31, 2011 and December 31, 2010, construction-in-progress amounted to $6,970,122 and $6,732,189 related to this construction project, respectively.
 
 
F-17

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


The Beijing Pinggu deep processing factory and warehouse is located in Pinggu District, Beijing, PRC leased by Xingu Deyufarm under an operating lease agreement.  As of March 31, 2011 and December 31, 2010, construction-in-progress amounted to $1,285,947 and $492,315 related to this construction project.
 
The construction Jinzhong Deyu factory heating system is located in Jinzhong City, Shanxi Province, PRC.  The total construction cost was estimated at $105,536.  As of March 31, 2011 and December 31, 2010, construction-in-progress amounted to $95,609 and $0 related to this construction project, respectively.
 
NOTE 9.
INTANGIBLE ASSETS

Intangible assets consisted of the following:

   
March 31,
   
December 31,
 
   
2011
   
2010
 
Software-ERP System
  $ 992,624     $ -  
Right to use land
    -       74,715  
Less:  Accumulated depreciation
    (16,544 )     (74,715 )
Intangible assets, net
  $ 976,080     $ -  

According to government regulations of the People’s Republic of China (“PRC”), the PRC Government owns all land.  The Company leases and obtains the certificate of right to use the industrial land of 11,667 square meters with the PRC Government in Jingzhong, Shanxi Province where Jinzhong Deyu’s buildings and production facility are located at.  The term of the right is four to five years and renewed upon expiration.  The right was fully amortized as of December 31, 2010 and 2009 using the straight-line method.  The term of the right was for the period from March 14, 2007 to March 14, 2011.  The Company has been in the process of renewing the land use right certificate since the expiration date.  According to a Certification issued by the Jinzhong Municipal Bureau of Land and Resources on March 30, 2010, Jinzhong Deyu holds the legal title of the land use rights during the period of the renewal process.  Amortization expense recorded for the years ended December 31, 2009 and 2008 was $0, respectively.


NOTE 10.
OTHER ASSETS

Other assets consisted of the following:

   
March 31,
   
December 31,
 
   
2011
   
2010
 
Prepaid for acquisition of farmland use rights
  $ 7,121,848     $ 7,066,061  
Timber, timberland, and farmland use rights
    1,570,783       1,558,479  
Installment payment for ERP system
    -       984,848  
Net deferred tax assets – noncurrent
    1,537,716       908,332  
Others
    3,284       35,608  
Total cost
  $ 10,233,631     $ 10,553,328  

On September 30, 2010 and December 20, 2010, we entered into Farmland Transfer Agreements with Shanxi Jinbei Plant Technology Co., Ltd. for the transfer of land use rights (the “Rights”) consisting of 53,000 mu (equivalent to 8,731 acres) and 52,337 mu (equivalent to 8,615 acres), respectively.  We paid RMB 19,415,000 (approximately $2,900,000) and RMB 27,221,000 (approximately $4,066,000) in September 30, 2010 and December 20, 2010, respectively.  The variance in the balance denominated in US Dollar as of March 31, 2011 was the effect of foreign currency translation.  Pursuant to the agreement and the terms of the original land use right certificates, the Rights will continue for 43 years (on average).  The land will be used for agricultural planting of corn and grains.  As of March 31, 2011, the title transfer of the Rights was still in the process.
 
 
F-18

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The cost of timber, timberland, and farmland amounted to RMB 10,285,960, or $1,570,783 and $1,558,479 as of March 31, 2011 and December 31, 2010, respectively.  The variance in the balances denominated in US Dollar was the effect of foreign currency translation.  According to government regulations of the People’s Republic of China (“PRC”), the PRC Government owns timberland and farmland.  The Company leases and obtains the certificate of right to use farmland of approximately 1,605 acres (or 10,032 mu) for the period from August 2005 to December 2031.  For the same farmland, the Company obtains the certificate of the right to timber and 896 acres (or 5,600 mu) of timberland for the period from August 2006 to August 2028.  Timber mainly includes pine trees and poplar trees.  These timber, timberland, and farmland were not for operating use or intended for sale.  Based on management’s assessment, there was no impairment for the years ended March 31, 2011 and December 31, 2010.


NOTE 11.
SHORT-TERM LOAN

Short-term loan consisted of the following:

   
March 31,
   
December 31,
 
   
2011
   
2010
 
Bank loan payable to Jinzhong Economic Development District Rural Credit Union, bearing interest at a floating rate of prime rate plus 129.83%, of which prime rate was based on six-month to one-year loan interest rate released by The People's Bank of China.  The loan was due March 8, 2011.  The use of proceeds from the loan is for purchase of raw materials.  The loan was obtained by Jinzhong Yuliang and guaranteed by Jinzhong Deyu for a period of two years starting from January 13, 2010.  In January 2011, the Company entered into an agreement with the bank for an extension of the loan.  The new term is from February 1, 2011 to October 1, 2011.  The adjustable interest rate is a rate per annum equal to the Prime Rate plus 117.23 percentage points.  The prime rate is based on one- to three-year loan interest rate released by The People's Bank of China.  Jinzhong Deyu continues to provide guarantees on the loan for a period of two years starting from October 1, 2011.
  $ 1,298,047     $ 1,287,879  
                 
 
 
F-19

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)



   
March 31,
   
December 31,
 
   
2011
   
2010
 
Bank loan payable to Shanxi Province Rural Credit Union, bearing interest at bearing interest at a floating rate of prime rate plus 107.00%, of which prime rate was based on six-month-to-one-year loan interest rate released by The People's Bank of China and due January 13, 2011.  The use of proceeds from the loan is restricted for purchase of corns.  The loan was obtained by Jinzhong Yongcheng and guaranteed by Jinzhong Deyu and Jinzhong Yuliang for a period of two years starting from January 13, 2011.  In January 2011, the Company entered into an agreement with bank with an extension for the bank loan.  The new term of bank loan is from January 14, 2011 to June 11, 2011.  The adjustable interest rate is a rate per annum equal to the Prime Rate plus 107 percentage points. The prime rate is based one-to-three-year loan interest rate released by The People's Bank of China.  Jinzhong Deyu and Jinzhong Yuliang remain providing guarantees on the loan for a period of two years starting from June 11, 2011.
    1,298,047       1,287,879  
                 
Loan payable to Hangzhou TianCi Investment Management Co., Ltd., an unrelated party.  The loan was unsecured, bearing no interest and no due date was specified.
    56,046       55,606  
                 
Total
  $ 2,652,139     $ 2,631,364  
 
NOTE 12.
ACCRUED EXPENSES

Accrued expenses consisted of the following:

   
March 31,
   
December 31,
 
   
2011
   
2010
 
Accrued VAT and other taxes
  $ 1,185,835     $ 888,542  
Accrued payroll
    360,694       332,059  
Others
    292,302       398,585  
Total
  $ 1,838,831     $ 1,619,186  


NOTE 13.
INCOME TAXES


United States

The Company is incorporated in the United States of America and is subject to the U.S. federal and state taxation.  No provision for income taxes have been made as the Company has no taxable income in the U.S..  The applicable income tax rate for the Company for the three months ended March 31, 2011 and 2010 was 34%.  No tax benefit has been realized since a 100% valuation allowance has offset deferred tax asset resulting from the net operating losses.
 
 
F-20

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

British Virgin Islands

City Zone, a wholly-owned subsidiary of the Company, is incorporated in the British Virgin Islands (“BVI”) and, under the current laws of the BVI, is not subject to income taxes.

Hong Kong

Most Smart, a wholly-owned subsidiary of the Company, is incorporated in Hong Kong.  Most Smart is subject to Hong Kong taxation on its activities conducted in Hong Kong and income arising in or derived from Hong Kong.  No provision for income taxes have been made as Most Smart has no taxable income in Hong Kong.

People’s Republic of China (PRC)

Under the Enterprise Income Tax (“EIT”) Law of the PRC, the standard EIT rate is 25%.  The PRC subsidiaries of the Company are subject to PRC income taxes on an entity basis on income arising in or derived from the tax jurisdiction in which they operate.  According to the Tax Pronouncement [2008] No. 149 issued by the State Administration of Tax of the PRC, the preliminary processing industry of agricultural products is entitled to EIT exemption starting January 1, 2008.  Three of the Company’s wholly-owned subsidiaries located in the Shanxi Province, China, including Jinzhong Deyu, Jinzhong Yongcheng, and Jinzhong Yuliang are subject to the EIT exemption.  All other subsidiaries and consolidated VIEs are subject to the 25% EIT rate.

The pro
 
 
F-21

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
 
vision for income taxes from continuing operations on income consists of the following for the three months ended March 31, 2011 and 2010:

   
For the Three Months Ended
March 31,
 
   
2011
   
2010
 
Current income tax expense (benefit)
           
U.S.
  $ -     $ -  
PRC
    -       -  
Total current expense (benefit)
  $ -     $ -  
                 
Deferred income tax expense (benefit)
               
U.S.
  $ -     $ -  
PRC
    (626,250 )     -  
Total deferred expense (benefit)
  $ (626,250 )   $ -  

The following is a reconciliation of the statutory tax rate to the effective tax rate for the three months ended March 31, 2011 and 2010:

   
2011
   
2010
 
   
Amount
   
Percent
   
Amount
   
Percent
 
Expected U.S. income tax expense
  $ 907,970       34.0 %   $ 872,750       34.0 %
Increase (decrease) in taxes resulting from:
                               
Tax-exempt income
    (1,743,685 )     (65.3 %)     (872,750 )     (34 %)
Foreign tax differential
    225,332       8.4 %     -       -  
Change in U.S. federal valuation allowance
    54,467       2.0 %     -       -  
Intercompany elimination
    (66,132 )     (2.5 %)     -       -  
Other
    (4,202 )     (0.2 %)     -       -  
Total income tax benefit
  $ (626,250 )     (23.5 %)   $ -       -  

Significant components of the Company’s net deferred tax assets as of March 31, 2011 and December 31, 2010 are presented in the following table:

   
March 31,
2011
   
December 31,
2010
 
Deferred tax assets
           
Net operating loss carryforwards (NOL)
  $ 2,116,096     $ 1,458,421  
Share-based compensation
    257,697       197,126  
Gross deferred tax assets
    2,373,793       1,655,547  
Less: Valuation allowance
    (546,374 )     (466,649 )
Total deferred tax assets, net
  $ 1,827,419     $ 1,188,898  
                 
 
 
F-22

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


NOTE 14.
SHAREHOLDERS’ EQUITY

Reverse Acquisition and Private Placement

On April 27, 2010, we completed the acquisition of City Zone by means of a share exchange.  Simultaneously with the acquisition, we completed a private placement for gross proceeds of $8,211,166 from the sale of our securities to accredited investors at $4.40 per unit, with each “Unit” consisting of one share of Series A Convertible Preferred Stock, and a warrant to purchase 0.4 shares of common stock with an exercise price of $5.06 per share.

On April 27, 2010, the (the “Closing Date”), we entered into a Share Exchange Agreement (“Exchange Agreement”) by and among (i) City Zone, (ii) City Zone’s shareholders, (iii) us, and (iv) our principal stockholders.  Pursuant to the terms of the Exchange Agreement, Expert Venture Limited, a company organized under the laws of the British Virgin Islands (“Expert Venture”) and the other City Zone shareholders will transfer to us all of the shares of City Zone in exchange for the issuance of 8,736,932 shares of our common stock as set forth in the Exchange Agreement, so that Expert Venture and other minority shareholders of City Zone shall own at least a majority of our outstanding shares (the “Share Exchange”).

Our directors approved the Exchange Agreement and the transactions contemplated thereby.  The directors of City Zone also approved the Exchange Agreement and the transactions contemplated thereby.

As a result of the Exchange Agreement effective April 27, 2010, we acquired 100% of the equity interest of City Zone, the business and operations of which now constitutes our primary business and operations through its wholly-owned PRC subsidiaries.  Specifically, as a result of the Exchange Agreement:

 
·
We issued 8,736,932 shares of our common stock to the City Zone Shareholders;
 
·
The ownership position of our shareholders who were holders of common stock immediately prior to the Exchange Agreement changed from 100% to 9.5% (fully diluted) of our outstanding shares; and
 
·
City Zone Shareholders were issued our common stock constituting approximately 65.71% of our fully diluted outstanding shares.

Immediately after the Share Exchange, we entered into a securities purchase agreement (the “Purchase Agreement”) with certain accredited investors (the “Investors”) for the issuance and sale in a private placement of 1,866,174 Units, consisting of 1,866,174 shares of our Series A Convertible Preferred Stock, par value $0.001 per share (the “Investor Shares”) and Series A Warrants to purchase up to 746,479 shares of our Common Stock (the “Warrants”), for aggregate gross proceeds of $8,211,166 (the “Private Placement”).  In connection with the Private Placement, we also entered into a registration rights agreement (the “Registration Rights Agreement”) with the Investors, in which we agreed to file a registration statement (the “Registration Statement”) with the Securities and Exchange Commission (the “SEC”) to register for resale the Investor Shares, within 60 calendar days of the Closing Date of the Private Placement, and use our best efforts to have the Registration Statement declared effective within 180 calendar days of the Closing Date of the Private Placement.  We will pay monthly liquidated damages in cash to each Investor of 0.5% of the dollar amount of the purchase price of the Investor Shares, on a pro rata basis, for each 30 day period the Registration Statement is not declared effective, up to a maximum of 8% of the purchase price.  However, no liquidated damages shall be paid with respect to any shares that we are not permitted to include in the Registration Statement due to the SEC’s application of Rule 415.  On October 21, 2010, the SEC declared our Form S-1 effective.
 
 
F-23

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

In connection with the Private Placement, Maxim Group, LLC acted as our financial advisor and placement agent (the “Placement Agent”).  Maxim received a cash fee equal to 7% of the gross proceeds of the Private Placement.  Maxim also received warrants to purchase 171,911 shares of our Common Stock at a price per share of $5.06 (the “Placement Agent Warrants”).  Pursuant to the Original Placement Agreement entered into by Detian Yu on January 27, 2010 with the Placement Agent (the Original Placement Agreement”), we engaged the Placement Agent to act as the exclusive agent to sell the Units in this Offering on a “commercially reasonable efforts basis.”  The Placement Agent received cash fees equal to 7% of our gross proceeds received in connection with an equity financing and a cash corporate finance fee equally to 1% of our gross proceeds raised in the Offering, payable at the time of each Closing; five (5) year warrants to purchase that number of Series A Preferred Shares and Shares equal to 5% of the aggregate number of Series A Preferred Shares and Shares underlying the Units issued pursuant to this Offering; and a non-refundable cash retainer (or restricted shares) of $25,000 payable upon the execution of the retainer agreement.  We also agreed to pay for all of the reasonable expenses the Placement Agent incurred in connection with the Offering.

On May 10, 2010, we closed on the second and final round (the “Final Closing”) of the private placement offering for the issuance and sale of 589,689 Units, consisting of 589,689 shares of Series A Convertible Preferred Stock and 235,883 five-year Series A Warrants with an exercise price of $5.06 per share, to certain accredited investors (the “Investors”) for total gross proceeds of $2,594,607.

We raised an aggregate amount of $10,805,750 in the Offering.  As of the Final Closing, we had 9,999,999 shares of common stock issued and outstanding.  In connection with the offering, we issued a total of 2,455,863 shares of Series A Convertible Preferred Shares and 982,362 Series A Warrants to the investors.  Additionally, the Placement Agent received 171,911 warrants.

Make Good Escrow Agreement

We also entered into a make good escrow agreement with the Investors (the “Securities Escrow Agreement”), pursuant to which the City Zone Shareholders placed a number of shares of Common Stock equal to 100% of the number of shares of Common Stock underlying the Investor Shares, which are initially convertible into 1,866,174 shares of Common Stock (the “Escrow Shares”) in an escrow account.  The Escrow Shares are being held as security in the event we do not achieve $11 million in audited net income for the fiscal year 2010 (the “2010 Performance Threshold”) and $15 million in audited net income for the fiscal year 2011 (the “2011 Performance Threshold”).  If we achieve the 2010 Performance Threshold and the 2011 Performance Threshold, the Escrow Shares will be released back to the City Zone Shareholders.  If either the 2010 Performance Threshold or 2011 Performance Threshold is not achieved, an aggregate number of Escrow Shares (such number to be determined by the formula set forth in the Securities Escrow Agreement) will be distributed to the Investors, based upon the number of Investor Shares (on an as-converted basis) purchased in the Private Placement and still beneficially owned by such Investor, or such successor, assign or transferee, at such time.  If any Investor transfers Investor Shares purchased pursuant to the Purchase Agreement, the rights to the Escrow Shares shall similarly transfer to such transferee, with no further action required by the Investor, the transferee or us.

Lock-Up Agreement

We also entered into a lock-up agreement with the Investors (the “Lock-Up Agreement”), pursuant to which the Common Stock owned by the management of City Zone will be locked-up until six (6) months after the Registration Statement is declared effective.
 
 
F-24

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Series A Convertible Preferred Stock

The holders of Series A Convertible Preferred Shares (“Series A Preferred”) will be entitled to receive, cumulative dividends in preference to the holders of Common Stock at an annual rate of 5% of the applicable per Series A Preferred original purchase price (the “Dividend Preference” and the “Dividends”).  If, after the Dividend Preference has been fully paid or declared and set apart, the Company shall make any additional distributions, then the holders of Series A Preferred shall participate with the holders of common stock on an as-converted basis with respect to such distributions.  Dividends will be payable in cash or stock, at the Company’s option.
 
 
Upon any liquidation, dissolution or winding up of the Company, the holders of Series A Preferred will be entitled to receive, out of the assets of the Company available for distribution to its stockholders, an amount equal to $4.40 per share (the amount, the “Liquidation Preference Amount”), before any payment shall be made or any assets distributed to the holders of the common stock (the “Liquidation Preference”).
 
 
Each holder of Series A Preferred will have the right, at the option of the holder at any time on or after the issuance of the Series A Preferred, without the payment of additional consideration, to convert Series A Preferred into a number of fully paid and nonassessable shares of common stock equal to: (i) the Liquidation Preference Amount of such share divided by (ii) the Conversion Price in effect as of the date of the conversion.
 
 
For a period of two (2) years following the issuance of the Series A Preferred, the conversion price of Series A Preferred will be subject to adjustment for issuances of common stock (or securities convertible or exchangeable into shares of Common Stock) at a purchase price less than the conversion price of the Series A Preferred. The Series A Preferred Stock does not contain any repurchase or redemption rights.

Current accounting standards require that we evaluate the terms and conditions of convertible preferred stock to determine (i) if the nature of the hybrid financial instrument, based upon its economic risks, is more akin to an equity contract or a debt contract for purposes of establishing classification of the embedded conversion feature and (ii) the classification of the host or hybrid financial instrument.  Based upon a review of the terms and conditions of the Series A Preferred, the Company has concluded that the financial instrument is more akin to an equity financial instrument.  The major consideration underlying this conclusion is that the Series A Preferred is a perpetual financial instrument with no stated maturity or redemption date, or other redemption that is not within the Company’s control.  Other considerations in support of the equity conclusion included the voting rights and conversion feature into common shares.  While the cumulative dividend feature may, in some instances, be likened to a debt-type coupon, the absence of a stated maturity date was determined to establish the cumulative dividend as a residual return, which does not obviate the equity nature of the financial instrument.  Further, there are no cash redemption features that are not within the control of our management.  As a result, classification in stockholders’ equity is appropriate for the Series A Preferred.
 
 
F-25

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Series A Warrants

The warrants issued to the investors and placement agent have strike prices of $5.06 and $4.84, respectively, and expire in five years.  The strike prices are subject to adjustment only for changes in our capital structure, but allow for cashless exercise under a formula that limits the aggregate issuable common shares.  There are no redemption features embodied in the warrants and they have met the conditions provided in current accounting standards for equity classification.

There were 982,362 Series A Warrants sold together with the Series A Preferred to the investors, which:

 
(a)
entitle the holder to purchase 1 shares of Common Stock;
 
(b)
are exercisable at any time after consummation of the transactions contemplated by the Securities Purchase Agreement and shall expire on the date that is five years following the original issuance date of the Series A Warrants;
 
(c)
are exercisable, in whole or in part, at an exercise price of $5.06 per share of Common Stock; and
 
(d)
are exercisable only for cash (except that there will be a cashless exercise option if, after twelve months from the Issue Date, (i) the Per Share Market Value of one share of Common Stock is greater than the Warrant Price (at the date of calculation) and (ii) a registration statement under the Securities Act providing for the resale of the Common Stock issuable upon exercise of Warrant Shares is not in effect, in lieu of exercising this Warrant by payment of cash).

Aggregate gross proceeds from the two closing events amounted to $10,805,750.  Direct financing costs totaled $1,742,993 of which $1,555,627 was paid in cash and the balance of $187,366 represents the fair value of warrants linked to 171,911 shares of our common stock that were issued to a placement agent.  The proceeds and the related direct financing costs were allocated to the Series A Preferred and the warrants (classified in paid-in capital) based upon their relative fair values.  The following table summarizes the components of the allocation:

   
Series A
Preferred
   
Paid-in Capital Warrants
   
Total
 
Fair values of financial instruments
 
$
10,248,092
   
$
1,039,978
   
$
11,288,070
 
                         
Gross proceeds
 
$
9,810,227
   
$
995,523
   
$
10,805,750
 
Direct financing costs
   
(1,581,550
)
   
(161,443
)
   
(1,742,993
)
Fair value of placement agent warrants
   
--
     
187,366
     
187,366
 
   
$
8,228,677
   
$
1,021,446
   
$
9,250,123
 

Fair value considerations:

Our accounting for the sale of Series A Preferred and warrants, and the issuance of warrants to the Placement Agent required the estimation of fair values of the financial instruments on the financing inception date.  The development of fair values of financial instruments requires the selection of appropriate methodologies and the estimation of often subjective assumptions.  We selected the valuation techniques based upon consideration of the types of assumptions that market participants would likely consider in exchanging the financial instruments in market transactions.  The Series A Preferred was valued based upon a common stock equivalent method, enhanced by the cumulative dividend feature.  The dividend feature was valued as the estimated cash flows of the dividends discounted to present value using an estimated weighted average cost of capital.  The warrants were valued using a Black-Scholes-Merton Valuation Technique because it embodies all of the requisite assumptions (including trading volatility, estimated terms and risk free rates) necessary to fair value these instruments.
 
 
F-26

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

These fair values were necessary to develop relative fair value calculation for allocations of certain elements of the financing arrangement, principally proceeds and the related direct financing costs.  The following tables reflect assumptions used to determine the fair value of the Series A Preferred stock:

   
Fair Value
   
Series A Preferred
   
Series A Preferred
 
   
Hierarchy Level
   
April 27, 2010
   
May 10, 2010
 
Indexed common shares
         
1,866,174
     
589,689
 
                       
Components of fair value:
                     
   Common stock equivalent value
       
$
6,631,403
   
$
2,083,094
 
   Dividend feature
         
659,821
     
209,439
 
         
$
7,791,224
   
$
2,292,533
 
                       
Significant assumptions:
                     
   Common stock price
   
3
     
3.55
     
3.53
 
   Horizon for dividend cash flow projection
   
3
     
2.0
     
2.0
 
   Weighted average cost of capital (“WACC”)
   
3
     
15.91
%
   
15.55
%

Fair value hierarchy of the above assumptions can be categorized as follows:

(1)  
Level 1 inputs are quoted prices in active markets for identical assets and liabilities, or derived there from.  There were no level 1 inputs.

(2)  
Level 2 inputs are significant other observable inputs. There were no level 2 inputs.

(3)  
Level 3 inputs are unobservable inputs. Inputs for which any parts are level 3 inputs are classified as level 3 in their entirety.

 
Stock price- Given that management did not believe our trading market price was indicative of the fair value of our common stock at the measurement date, the common stock price value was derived implicitly from an iterative process based upon the assumption that the consideration of the Private Placement was the result of an arm’s length transaction. The Private Placement was composed of Series A Preferred Stock and Series A Warrants which were both indexed to our common stock; accordingly, we used an iterative process to determine the value of our common stock in order for the fair value of the Series A Preferred and Series A Warrants to equal the amount of consideration received in the Private Placement.

 
Dividend horizon- We estimated the horizon for dividend payment at 2 years.

 
WACC- The rates utilized to discount the cumulative dividend cash flows to their present values were based on a weighted average cost of capital of 18.94% and 18.60%, as of April 27, 2010 and May 10, 2010, respectively. This discount rate was determined after consideration of the rate of return on debt capital and equity that typical investors would require in an investment in companies similar in size and operating in similar markets as Deyu Agriculture Corporation. The cost of equity was determined using a build-up method which begins with a risk free rate and adds expected risk premiums designed to reflect the additional risk of the investment. Additional premiums or discounts related specifically to us and the industry are also added or subtracted to arrive at the final cost of equity rate. The cost of debt was determined based upon available financing terms.
 
 
F-27

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
Significant inputs and assumptions underlying the model calculations related to the warrant valuations are as follows:

The following tables reflect assumptions used to determine the fair value of the Warrants:

     
April 27, 2010
   
May 10, 2010
 
Fair Value Hierarchy
Level
 
Investor warrants
   
Agent warrants
   
Investor warrants
 
Agent Warrants
                       
Indexed shares
     
746,479
     
130,632
     
235,883
 
41,279
Exercise price
     
5.06
     
4.84
     
5.06
 
4.84
                             
Significant assumptions:
                           
   Stock price
3
   
3.55
     
3.55
     
3.53
 
3.53
   Remaining term
3
 
5 years
   
5 years
   
5 years
 
5 years
   Risk free rate
2
   
2.39%
     
2.39%
     
2.24%
 
2.24%
   Expected volatility
2
   
45.25%
     
45.25%
     
45.47%
 
45.47%

Fair value hierarchy of the above assumptions can be categorized as follows:

(1)  
There were no Level 1 inputs.
   
(2)  
Level 2 inputs include:

 
Risk-free rate- This rate is based on publicly-available yields on zero-coupon Treasury securities with remaining terms to maturity consistent with the remaining contractual term of the warrants

 
Expected volatility- We did not have a historical trading history sufficient to develop an internal volatility rate for use in the model. As a result, we have used a peer approach wherein the historical trading volatilities of certain companies with similar characteristics as ours and who had a sufficient trading history were used as an estimate of our volatility. In developing this model, no one company was weighted more heavily.

(3)  
Level 3 inputs include:

 
Stock price- Given that management did not believe our trading market price was indicative of the fair value of our common stock at the measurement date, the stock price was determined implicitly from an iterative process based upon the assumption that the consideration of the Private Placement was the result of an arm’s length transaction.

 
Remaining term- We do not have a history to develop the expected term for our warrants.  Accordingly, we have used the contractual remaining term in our calculations.
 
 
F-28

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The following is a summary of the status and activity of warrants outstanding as of March 31, 2010:

Outstanding Warrants
Exercise Price
   
Number of Warrants
 
Average Remaining Contractual Life
$ 5.06       982,362  
4.09 years
$ 4.84       171,911  
4.09 years
Total
      1,154,273    
               

   
Number of Warrants
 
Outstanding as of January 1, 2011
    1,154,273  
Granted
    -  
Forfeited
    -  
Exercised
    -  
Outstanding as of March 31, 2011
    1,154,273  
         


NOTE 15.
SHARE-BASED COMPENSATION

As of March 31, 2011, the Company had one share-based compensation plan as described below.  The compensation cost that had been charged against income for the plan was $137,588 for the three months ended March 31, 2011 and $549,106 for the year ended December 31, 2010.  The related income tax benefit recognized was $257,697 as of March 31, 2011.  A 100% valuation allowance was assessed against the deferred tax assets derived from such tax benefit as of March 31, 2011.

On November 4, 2010, the Company’s Board of Directors approved the Company’s 2010 Share Incentive Plan (the “Plan”).  Under the Plan, 1,000,000 shares of the Company’s common stock shall be allocated to and authorized for use pursuant to the terms of the Plan.  On November 8, 2010, a total of 931,000 non-qualified incentive stock options were approved by our Board of Directors and granted under the Plan, including 851,000 options granted to the Company’s executives and key employees (collectively, “Employees”) and 80,000 options granted to consultants and independent directors of the Board (collectively, “Non-employees”), at an exercise price of $4.40 per share.  On December 15, 2010, 40,000 non-qualified incentive stock options were approved by our Board of Directors and granted under the Plan to a consultant at an exercise price of $4.40 per share.  The option award granted in 2010 shall vest as follows:

 
(i)
33 1/3% of the option grants be vested one (1) month after the date of grant;
 
(ii)
33 1/3% of the option grants be vested twelve (12) months after the date of grant; and
 
(iii)
33 1/3% of the option grants be vested twenty-four (24) months after the date of grant

The fair value of each option award was estimated on the date of grant using a Black-Scholes option pricing model that uses the assumptions noted in the following table.  The model is based on the assumption that it is possible to set up a perfectly hedged position consisting of owning the shares of stock and selling a call option on the stock.  Any movement in the price of the underlying stock will be offset by an opposite movement in the options value, resulting in no risk to the investor.  This perfect hedge is riskless and, therefore, should yield the riskless rate of return.  As the Black-Scholes option pricing model applies to stocks that do not pay dividends, we made an adjustment developed by Robert Merton to approximate the option value of a dividend-paying stock.  Under this adjustment method, it is assumed that the Company’s stock will generate a constant dividend yield during the remaining life of the options.
 
 
F-29

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The following tables reflect assumptions used to determine the fair value of the option award:

Options granted on November 8, 2010:

Exercisable Period
 
12/8/2010 – 11/8/2020
   
11/8/2011 – 11/8/2020
   
11/8/2012 – 11/8/2020
 
Risk-free Rate (%)
    1.12       1.27       1.46  
Expected Lives (years)
    5.04       5.50       6.00  
Expected Volatility (%)
    46.10       44.49       43.04  
Expected forfeitures per year (%)
    0.00-5.00       0.00-5.00       0.00-5.00  
Dividend Yield (%)
    0.00       0.00       0.00  

Options granted on December 15, 2010:

Exercisable Period
 
1/15/2011 –
12/15/2020
   
12/15/2011 –
12/15/2020
   
12/15/2012 –
12/15/2020
 
Risk-free Rate (%)
    2.15       2.32       2.50  
Expected Lives (years)
    5.04       5.50       6.00  
Expected Volatility (%)
    46.15       44.52       43.09  
Expected forfeitures per year (%)
    0.00       0.00       0.00  
Dividend Yield (%)
    0.00       0.00       0.00  

Fair value hierarchy of the above assumptions can be categorized as follows:

(1)  
There were no Level 1 inputs.
   
(2)  
Level 2 inputs include:

 
Risk-free rate- This rate is based on continuous compounding of publicly-available yields on U.S. Treasury securities with remaining terms to maturity consistent with the expected term of the options at the dates of grant.

 
Expected volatility- We did not have a historical trading history sufficient to develop an internal volatility rate for use in the model.  As a result, we have used a peer approach wherein the historical trading volatilities of certain companies with similar characteristics as ours and who had a sufficient trading history were used as an estimate of our volatility.  In developing this model, no one company was weighted more heavily.

 
 
F-30

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(3)  
Level 3 inputs include:

 
Expected lives- The expected lives of options granted were derived from the output of the option valuation model and represented the period of time that options granted are expected to be outstanding.

 
Expected forfeitures per year- The expected forfeitures are estimated at the dates of grant and will be revised in subsequent periods pursuant to actual forfeitures, if significantly different from the previous estimates.

The estimates of fair value from the model are theoretical values of stock options and changes in the assumptions used in the model could result in materially different fair value estimates.  The actual value of the stock options will depend on the market value of the Company’s common stock when the stock options are exercised.

A summary of option activity under the Plan as of March 31, 2011, and changes during the three months then ended is presented below:

Options
 
Shares
   
Weighted-
Average
Exercise
Price
   
Weighted-
Average
Remaining
Contractual
Term
 
Outstanding as of January 1, 2011
    971,000     $ 4.40       -  
Granted
    -       -       -  
Exercised
    -       -       -  
Forfeited
    -       -       -  
Outstanding as of March 31, 2011
    971,000       4.40    
5.18 years
 
Exercisable as of March 31, 2011
    323,666       4.40    
4.80 years
 
Vested and expected to vest (3)
    929,159       4.40    
5.16 years
 
   
(3) Includes vested shares and unnvested shares after a forfeiture rate is applied.
 

A summary of the status of the Company’s unvested shares as of March 31, 2011, and changes during the year ended March 31, 2011, is presented below:

Unvested Shares
 
Shares
   
Weighted-
Average
Grant-
Date Fair Value
 
Unvested as of January 1, 2011
    647,334     $ 1,162,373  
Granted
    -       -  
Vested
    -       -  
Forfeited
    -       -  
Unvested as of March 31, 2011
    647,334     $ 1,162,373  
                 
 
 
F-31

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


NOTE 16.
RELATED PARTY TRANSACTIONS

Due to related parties

   
As of March 31,
   
As of December 31,
 
   
2011
   
2010
 
Advances from -
           
Dongsheng International Investment Co., Ltd.
  $ 5,344,898     $ 3,484,848  
Jinzhong Xinhuasheng Business Trading Co., Ltd.
    3,054,228       3,030,303  
Mr. Wenjun Tian
    1,527,114       1,515,152  
Total
  $ 9,926,240     $ 8,030,303  
                 

Mr. Wenjun Tian, the President and Executive Director of the Company is also the President and Executive Director of Dongsheng International Investment Co., Ltd.  Mr. Hong Wang, a shareholder with over 5% beneficial ownership and a manager of the Company is the President and Executive Director of Jinzhong Xinhuasheng Business Trading Co., Ltd.  Those advances as of March 31, 2011 and December 31, 2010 were unsecured, bearing no interest, and no due date was specified.

Guarantees

As of March 31, 2011 and December 31, 2010, Jinzhong Deyu provided guarantees on short-term loans obtained by Jinzhong Yuliang and Jinzhong Yongcheng.  Jinzhong Yuliang also provided guarantees on a short-term loan obtained by Jinzhong Yongcheng.


NOTE 17.
SEGMENT REPORTING

As defined in ASC Topic 280, “Segment Reporting”, the Company has three reportable segments, including the corn division, the simple-processed grain division, and the deep-processed grain division.  The three segments were identified primarily based on the difference in products.  The corn division is comprised of Jinzhong Yongcheng and Jinzhong Yuliang in the business of bulk purchasing corns from farmers and distributing to agricultural product trading companies through wholesale.  The business of the simple-processed grain division is conducted through Jinzhong Deyu and Detian Yu, by bulk purchasing of grains from farmers and distributing to wholesalers and supermarkets with our own brand names, including “De Yu” and “Shi-Tie” for certified organic grain products.  The deep-processed grain division was newly created in 2010.  Its business is conducted through Detian Yu, Deyufarm and its subsidiaries, by producing and distributing instant grain vermicelli, instant millet beverage, and buckwheat tea to wholesalers and supermarkets with our own brand name, “Deyufang”.  Other entities consolidated under the Company are mainly for holding purposes and do not plan to earn revenues, and may only incur incidental activities.
 
 
F-32

 
 
DEYU AGRICULTURE CORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Information about the three reportable segments is presented in the following tables:

Three Months Ended
March 31, 2011
 
Corn
Division
   
Simple-
Processed
Grain
 Division
   
Deep-
Processed
Grain
Division
   
Others
   
Total
 
Revenues from external customers
  $ 20,491,926     $ 18,892,718     $ 2,047,619     $ -     $ 41,432,263  
Intersegment revenues
    283,851       22,796       -       -       306,647  
Interest revenue
    4,901       1,229       23       200       6,353  
Interest expense
    (78,878 )     -       -       -       (78,878 )
Net interest (expense) income
    (73,977 )     1,229       23       200       (72,525 )
Depreciation and amortization
    (49,640 )     (156,622 )     (26,308 )     (5,849 )     (238,418 )
Noncontrolling interest
    -       -       -       144,183       144,183  
Segment net profit (loss)
    3,592,220       638,140       (434,225 )     (597,073 )     3,343,245  

Three Months Ended
March 31, 2010
 
Corn
Division
   
Simple-
Processed
Grain
 Division
   
Deep-
Processed
Grain
Division
   
Others
   
Total
 
Revenues from external customers
  $ 10,944,641     $ 3,502,641     $ -     $ -     $ 14,447,282  
Intersegment revenues
    -       -       -       -       -  
Interest revenue
    503       409       -       -       912  
Interest expense
    (56,240 )     (5,297 )     -       -       (61,537 )
Net interest expense
    (55,737 )     (4,888 )     -       -       (60,625 )
Depreciation and amortization
    (46,143 )     (33,850 )     -       -       (79,993 )
Segment net profit (loss)
    1,527,393       1,042,956       -       (3,436 )     2,566,913  

All of our revenues were generated from customers in China.  All long-lived assets are located in China.  The following tables set forth our three major customers in each segment:

   
% of Gross Sales for the Three Months Ended
March 31, 2011
Corn Division:
       
Chengdu Zhengda Co., Ltd.
   
7.3
%
Shanghai Yihai Trading Co., Ltd.
   
6.2
%
Shuangliu Zhengda Co., Ltd.
   
5.0
%
Top Three Customers as % of Total Gross Sales:
   
18.5
%
         
Simple-Processed Grain Division:
       
Hebei Xingda Flour Co., Ltd.
   
16.9
%
Tianjin Yimingda Grain Division
   
12.5
%
Hebei Zhuoran Agriculture Technology Co., Ltd.
   
11.6
%
Top Three Customers as % of Total Gross Sales
   
41.0
%
         
Deep-Processed Grain Division:
       
Tianjin Yimingda Grain Division
   
28.9
%
Beijing Qiheyuan Food Technology Co., Ltd.
   
16.5
%
Wuhan Zhengtianyuan Food Co., Ltd.
   
10.7
%
Top Three Customers as % of Total Gross Sales:
   
56.1
%
 
 
NOTE 18.
SUBSEQUENT EVENTS
 
In April, 2011, Detian Yu obtained a bank loan of $7,635,570 (RMB 50,000,000) from Bank of Communication, bearing interest at a floating rate of prime rate plus 30%.  The term of the loan should start from May 10, 2011 to May 9, 2012.

In April 2011, Jinzhong Deyu obtained a line of bank acceptance notes of $5,864,117 (RMB 38,400,000) from Jinzhong City Commercial Bank with maturity date due in six (6) months.

In April 2011, Jinzhong Yuliang also obtained a line of bank acceptance notes of $15,271,139 (RMB 100,000,000) from Jinzhong City Commercial Bank with maturity date due in six (6) months.

In May 2011, Jinzhong Deyu obtained another line of bank acceptance notes of $5,088,344 (RMB 33,320,000) from Jinzhong City Commercial Bank with maturity date due in six (6) months.



 
F-33

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Statements

In this Quarterly Report on Form 10-Q, unless otherwise indicated, the words “we”, “us” and “our” refer to Deyu Agriculture Corp. and all entities owned or controlled by Deyu Agriculture Corp.  All references to “Deyu” or the “Company” in this report mean Deyu Agriculture Corp., a Nevada corporation, and all entities owned or controlled by Deyu Agriculture Corp., except where it is made clear that the term only means the parent or a subsidiary company. References in this report to the “PRC” or “China” are to the People’s Republic of China.

This report contains forward-looking statements.  The words “anticipated”, “believe”, “expect”, “plan”, “intend”, “seek”, “estimate”, “project,”, “could”, “may” and similar expressions are intended to identify forward-looking statements.  These statements include, among others, information regarding future operations, future capital expenditures, and future net cash flow.  Such statements reflect our management’s current views with respect to future events and financial performance and involve risks and uncertainties, including, without limitation, the current economic downturn adversely affecting demand for the our products; our reliance on our major customers for a large portion of our net sales; our ability to develop and market new products; our ability to raise additional capital to fund our operations; our ability to accurately forecast amounts of supplies needed to meet customer demand; market acceptance of our products; exposure to product liability and defect claims; fluctuations in the availability of raw materials and components needed for our products; protection of our intellectual property rights; changes in the laws of the PRC that affect our operations; inflation and fluctuations in foreign currency rates and various other matters, many of which are beyond our control.  Should one or more of these risks or uncertainties occur, or should underlying assumptions prove to be incorrect, actual results may vary materially and adversely from those anticipated, believed, estimated or otherwise indicated.  Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements and there can be no assurance of the actual results or developments.
 
Summary of our Business

We are a Beijing, China-based producer and seller of organic and non-organic, ready-to-eat and ready-to-drink “simple processed” and “deep processed” grain consumer products which are sold in approximately 10,000 supermarkets and convenient stores throughout China.  We are also one of the dominant organic and non-organic agricultural product distributors in Shanxi Province engaged in procuring, processing, marketing and distributing various grain and corn products and byproducts.

 We have experienced high growth in both revenue and net income.  Operating revenue for the year ended December 31, 2010 was $89,175,633, representing a 119% increase from $40,732,447 for the year ended December 31, 2009. Our net income for the year ended December 31, 2010 was $11,502,252, representing a 60% increase from $7,181,132 for the year ended December 31, 2009.  Operating revenue for the three months ended March 31, 2011 was $41,432,261, representing a 187% increase from $14,447,282 for the three months ended March 31, 2010. Our net income for the three months ended March 31, 2011 was $3,440,932, representing a 33% increase from $2,566,913 for the three months ended March 31, 2010.

Our continuous growth relies on our ability to meet the increasing demand for our current products and our expanded product lines.  Management has developed strategies and taken actions to keep up with demands and foreseeable ones.  Such actions include working with farmers to increase current yields, focusing on our ability to enter into new cooperative agreements, signing contracts with new farmer agents, and expanding geographically in Shanxi Province, land acquisitions, building production sites and warehouses, or even consider mergers and acquisitions of suppliers of some of our products (although we are currently not a party to any such negotiations or agreements), vendors, or competitors if considered necessary or bargain purchase.

 
- 3 -

 

As a result of our recent control agreements whereby we now control Deyufarm, our deep processed grain products are higher margin products than our rough processed corn.  As such, we have increased our efforts to enter into supermarkets in tier 1 and tier 2 cities in China.   Additionally, based upon our perceived and historical growing demand for our deep processed grain products, the changing dietary demands, and the increase in health and nutrition consciousness of the Chinese people, we believe we have a unique opportunity to substantially increase our revenues, net income and gross margins.  Management has also begun an initial evaluation of the viability of exporting our deep processed grain products to other countries, such as Japan and the United States.  We believe significant factors that could affect our operating results are the (a) cost of raw materials, (b) prices and margins of our products to our retailers and their markup to the end users, (c) consumer acceptance of our deep processed grain products, (d) general economic conditions in China, and (e) the changing dietary habits of the people of China towards our quality organic food.

Our goal for 2011 is to develop the business model comprised of three major pieces: corn division, simple and deep processed grain divisions, and non-processed and unpacked grains sold in retail stores.  Together that would result in significant growth.  We will shift some capital from corn division to unpacked grain business.  At the same time, we rely on our strengths, competitive edges and support to our corn customers to keep up the revenues.  On the other hand, all of increased distribution channels and brand name recognition out of sales and marketing initiatives and momentum we gain from simple and deep processed grain products would help tremendously on this unpacked grain business.  In addition, the ERP system we implemented to strength and better our procurement capability and accuracy, particularly for retail side of business, would boost up our flexibility and accuracy to eventually increase our business and quality of accounting and internal control.  Meanwhile, the B2B and B2C E-Commerce we built will further enhance our selling capability which should attract especially our current or new wholesale customers who can register as members by paying membership fees to attain lower pricing.  This initiative would help encourage them to order high volume and help our cash flows at the same time.

Plan of Operation

With the corn business being matured and stable and yet increasing demand yearly, we have acquired two pieces of farmland of approximately 17,300 acres of ownership rights between 40 to 47 years at the end of 2010 for a total of approximately $7 million to secure the supply and quality of crops for both grains and corn. The growing season for these parcels commenced in April 2011.  As a result, we believe we have achieved economies of scale through exclusive rights of use to over 109,000 acres of some of China’s most fertile agricultural land, including ownership rights to approximately 19,000 acres.  Since demand of both simple processed and deep processed grain products is increasing through our expanding sales network and brand name recognition, we are increasing the land coverage of our growing base and also our production base for deep processed products.  To achieve that, we are constructing warehouses in Shanxi Province and a new plant in the outskirts of Beijing.

In the year 2011, for sales and marketing strategy, instead of rapidly increasing the number of stores selling our products across Beijing and China as a whole, we have shifted our focus on promoting our name brand and products regionally, and increasing customer purchases on a per store basis.

Since we have been successful of promoting and selling our products through all of our distribution channels and networks, including B2B and B2C E-Commerce, and our brand names are becoming widely known, to support this growth, the Company has carefully planned to build more warehouses and plants and to acquire companies in the future that either fit in or expand Deyu product lines.  It also helps ease requests by many of our wholesalers and retail stores for providing other non-existing Deyu product lines.  Thus, we plan to make a few strategic acquisitions per year vertically or horizontally to sell either under our own brands name or theirs through our distribution networks.

Critical Accounting Policies and Estimates

This discussion and analysis of financial condition and results of operations has been prepared by management based on our consolidated financial statements, which have been prepared in accordance with US GAAP.  The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates our critical accounting policies and estimates, including those related to revenue recognition, valuation of accounts receivable, property and equipment, long-lived assets, intangible assets, derivative liabilities and contingencies.  Estimates are based on historical experience and on various assumptions believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. These judgments and estimates affect the reported amounts of assets and liabilities and the reported amounts of revenue and expenses during the reporting periods.  We consider the following accounting policies important in understanding our operating results and financial condition:

 
- 4 -

 

Use of Estimates

The preparation of the consolidated financial statements in conformity with generally accepted  accounting  principles requires management to make estimates and  assumptions  that  affect  the  reported  amounts  of  assets and liabilities and disclosure of contingent assets and liabilities at the date  of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Management makes its estimates based on historical experience and various other assumptions and information that are available and believed to be reasonable at the time the estimates are made.  Therefore, actual results could differ from those estimates under different assumptions and conditions.

Long-Lived Assets

We apply the provisions of FASB ASC Topic 360 (ASC 360), "Property, Plant, and Equipment" which addresses financial accounting and reporting for the impairment or disposal of long-lived assets.  We periodically evaluate the carrying value of long-lived assets to be held and used in accordance with ASC 360, at least on an annual basis.  ASC 360 requires the impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amounts.  In that event, a loss is recognized based on the amount by which the carrying amount exceeds the fair market value of the long-lived assets.  Loss on long-lived assets to be disposed of is determined in a similar manner, except that fair market values are reduced for the cost of disposal.

Goodwill and Intangible Assets

Good will calculated as the purchase premium after adjust for the fair value of net assets acquired.  Goodwill is not amortized but is reviewed for potential impairment on an annual basis, or when events or circumstances indicate a potential impairment, at the reporting unit level.  A reporting unit, as defined under applicable accounting guidance, is a business segment or one level below a business segment.  Under applicable accounting guidance, the goodwill impairment analysis is a two-step test.  The first step of the goodwill impairment test involves comparing the fair value of each reporting unit with its carrying amount including goodwill.  If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired; however, if the carrying amount of the reporting unit exceeds its fair value, the second step must be performed to measure potential impairment.

The second step involves calculating an implied fair value of goodwill for each reporting unit for which the first step indicated possible impairment.  The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination, which is the excess of the fair value of the reporting unit, as determined in the first step, over the aggregate fair values of the assets, liabilities and identifiable intangibles as if the reporting unit was being acquired in a business combination.  Measurement of the fair values of the assets and liabilities of a reporting unit is consistent with the requirements of the fair value measurements accounting guidance, which 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.  The adjustments to measure the assets, liabilities, and intangibles at fair value are for the purpose of measuring the implied fair value of goodwill and such adjustments are not reflected in the consolidation balance sheet.  If the implied fair value of goodwill exceeds the goodwill assigned to the reporting unit, there is no impairment.  If the goodwill assigned to a reporting unit exceeds the implied fair value of goodwill, an impairment charge is recorded for the excess.  An impairment loss recognized cannot exceed the amount of goodwill assigned to a reporting unit.  An impairment loss establishes a new basis in the goodwill and subsequent reversals of goodwill impairment losses are not permitted under applicable accounting guidance.  In 2010, goodwill was tested for impairment and it was determined that goodwill was not impaired as of December 31, 2010.
 
For intangible assets subject to amortization, an impairment loss is recognized if the carrying amount of the intangible asset is not recoverable and exceeds fair value.  The carrying amount of the intangible asset is considered not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use of the asset.

 
- 5 -

 

Fair Value Measurements

FASB ASC 820, “Fair Value Measurements” (formerly SFAS No. 157) defines fair value for certain financial and nonfinancial assets and liabilities that are recorded at fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  It requires that an entity measure its financial instruments to base fair value on exit price and maximize the use of observable units and minimize the use of unobservable inputs to determine the exit price.  It establishes a hierarchy which prioritizes the inputs to valuation techniques used to measure fair value.  This hierarchy increases the consistency and comparability of fair value measurements and related disclosures by maximizing the use of observable inputs and minimizing the use of unobservable inputs by requiring that observable inputs be used when available.  Observable inputs are inputs that reflect the assumptions market participants would use in pricing the assets or liabilities based on market data obtained from sources independent of the Company.  Unobservable inputs are inputs that reflect the Company’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.  The hierarchy prioritizes the inputs into three broad levels based on the reliability of the inputs as follows:
 
 
·
Level 1 – Inputs are quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.  Valuation of these instruments does not require a high degree of judgment as the valuations are based on quoted prices in active markets that are readily and regularly available.

 
·
Level 2 – Inputs other than quoted prices in active markets that are either directly or indirectly observable as of the measurement date, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 
·
Level 3 – Valuations based on inputs that are unobservable and not corroborated by market data.  The fair value for such assets and liabilities is generally determined using pricing models, discounted cash flow methodologies, or similar techniques that incorporate the assumptions a market participant would use in pricing the asset or liability.
 
This guidance applies to other accounting pronouncements that require or permit fair value measurements.  On February 12, 2008, the FASB finalized FASB Staff Position (FSP) No. 157-2, Effective Date of FASB Statement No. 157 (ASC 820).  This Staff Position delays the effective date of SFAS No. 157 (ASC 820) for nonfinancial assets and liabilities to fiscal years beginning after November 15, 2008 and interim periods within those fiscal years, except for those items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).  The adoption of SFAS No. 157 (ASC 820) had no effect on the Company's financial position or results of operations.

We also analyze all financial instruments with features of both liabilities and equity under ASC 480-10 (formerly SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity”) and ASC 815-40 (formerly EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”).  We have determined ASC 480-10 (formerly SFAS 150) and ASC 815-40 (formerly EITF 00-19) has no material effect on our financial position or results of operations.

Revenue Recognition

Our revenue recognition policies are in compliance with the SEC Staff Accounting Bulletin No. 104 (“SAB 104”).  We recognize product revenue when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) our price to the customer is fixed or determinable and (iv) collection of the resulting accounts receivable is reasonably assured.  We recognize revenue for product sales upon transfer of title to the customer.  Customer purchase orders and/or contracts are generally used to determine the existence of an arrangement.  Shipping documents and the completion of any customer acceptance requirements, when applicable, are used to verify product delivery or that services have been rendered.  The Company assesses whether a price is fixed or determinable based upon the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment.

 
- 6 -

 
  
Our revenue is recognized net of value-added tax (VAT), reductions to revenue for estimated product returns, and sales discounts based on volume achieved in the same period that the related revenue is recorded.  The estimates are based on historical sales returns, analysis of credit memo data, and other factors known at the time.  For the years ended December 31, 2010 and 2009, sales discounts were $0 and $847,849, respectively.  Commencing from year 2010, the Company had terminated the offering of sales discounts to customers.

We offer a right of exchange on our grain products sold through our relationships with our network of grocery stores.  The consumer who purchases the product may exchange it for the same kind and quantity of product originally purchased.  In accordance with FASB ASC 605-15-25-1 and 605-15-15-2, these are not considered returns for revenue recognition purposes.  For the three months ended March 31, 2011, the returns of our products were not material.

Stock-Based Compensation

In December 2004, the Financial Accounting Standard Board, or the FASB, issued the Statement of Financial Accounting Standards, or SFAS, No. 123(R), “Share-Based Payment”, which replaces SFAS No. 123 and supersedes APB Opinion No. 25.  SFAS No. 123(R) is now included in the FASB’s ASC Topic 718, “Compensation – Stock Compensation.”  Under SFAS No. 123(R), companies are required to measure the compensation costs of share-based compensation arrangements based on the grant-date fair value and recognize the costs in the financial statements over the period during which employees or independent contractors are required to provide services.  Share-based compensation arrangements include stock options and warrants, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans.  In March 2005, the SEC issued Staff Accounting Bulletin No. 107, or SAB 107, which expresses views of the staff regarding the interaction between SFAS No. 123(R) and certain SEC rules and regulations and provides the staff’s views regarding the valuation of share-based payment arrangements for public companies.  SFAS No. 123(R) permits public companies to adopt its requirements using one of two methods.  On April 14, 2005, the SEC adopted a new rule amending the compliance dates for SFAS No. 123(R).  Companies may elect to apply this statement either prospectively, or on a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods under SFAS No. 123.

We have fully adopted the provisions of FASB ASC 718 and related interpretations as provided by SAB 107.  As such, compensation cost is measured on the date of grant as the fair value of the share-based payments.  Such compensation amounts, if any, are amortized over the respective vesting periods of the option grant.

Income Taxes

We account for income taxes in accordance with FASB ASC Topic 740, “Income Taxes.”  ASC 740 requires a company to use the asset and liability method of accounting for income taxes, whereby deferred tax assets are recognized for deductible temporary differences, and deferred tax liabilities are recognized for taxable temporary differences.  Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases.  Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion, or all of, the deferred tax assets will not be realized.  Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
 
Under ASC 740, a tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur.  The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination.  For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.  The adoption had no effect on the Company’s consolidated financial statements.

 
- 7 -

 

Foreign Currency Translation and Comprehensive Income

U.S. GAAP requires that recognized revenue, expenses, gains and losses be included in net income.  Certain statements, however, require entities to report specific changes in assets and liabilities, such as gain or loss on foreign currency translation, as a separate component of the equity section of the balance sheet.  Such items, along with net income, are components of comprehensive income.  The functional currency of the Company is Renminbi (RMB).  The unit of RMB is in Yuan.  Translation gains are classified as an item of other comprehensive income in the stockholders’ equity section of the consolidated balance sheet.

Recent Pronouncements

In December 2009, FASB issued new guidance regarding improvements to financial reporting by enterprises involved with variable interest entities.  The new guidance provides an amendment to its consolidation guidance for variable interest entities and the definition of a variable interest entity and requires enhanced disclosures to provide more information about an enterprise’s involvement in a variable interest entity.  This amendment also requires ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity and is effective January 1, 2010.  The adoption of this guidance had no impact on our consolidated financial position or results of operations.

In January 2010, FASB issued an amendment regarding improving disclosures about fair value measurements.  This new guidance requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement.  The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements.  Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years.  There was no impact from the adoption of this guidance to our consolidated financial position or results of operations as the amendment only addresses disclosures.

In April 2010, FASB issued an amendment to Stock Compensation.  The amendment clarifies that an employee stock-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity shares trades should not be considered to contain a condition that is not a market, performance, or service condition.  Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity.  The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010.  The adoption of this guidance had no impact on our consolidated financial position or results of operations since our stock-based payment awards have an exercise price denominated in the same currency of the market in which our Company shares are traded.

 
- 8 -

 

Results of Operations for the Three Months Ended March 31, 2011 as compared to the Three Months Ended March 31, 2010
 
   
For The Three Months
Ended 
March 31,
             
  
 
2011
   
2010
   
Change
   
%
 
                         
Net revenue
  $ 41,432,261     $ 14,447,282       26,984,979       187 %
                                 
Cost of goods sold
    (33,078,926 )     (10,936,119 )     (22,142,807 )     202 %
                                 
Gross Profit
    8,353,335       3,511,163       4,842,172       138 %
                                 
Selling expenses
    (3,373,255 )     (621,714 )     (2,751,541 )     443 %
General and administrative expenses
    (2,286,595 )     (261,911 )     (2,024,684 )     773 %
Other expenses
                             
Research and development expenses
                             
Total Operating Expense
    (5,659,850 )     (883,625 )     (4,776,225 )     541
                                 
Operating income
    2,693,485       2,627,538       65,947       3 %
                                 
Interest income
    6,415       912       5,503       603 %
Interest expense
    (74,378 )     (61,537 )     (12,841 )     21 %
Non-operating income
    44,977               44,977          
Total Other Expense
    (22,986 )     (60,625 )     37,639       (62 ) %
                                 
Income before income taxes
    2,670,499       2,566,913       103,586       4 %
Income tax benefit
    626,250               626,250          
Net income
    3,296,749       2,566,913       729,836       28 %
                                 
Preferred stock dividends
    (97,687 )             (97,687 )        
                                 
Net income available to common stockholders
  $ 3,343,245     $ 2,566,913       776,332       30 %
                                 
Net income per common share – basic
  $ 0.32     $ 0.52       (0.20 )     (39 ) %
                                 
Net income per common share – diluted
  $ 0.24     $ 0.52       (0.28 )     (55 ) %
                                 
Weighted average number of common shares outstanding- basic
    10,469,774       4,930,000       5,539,774       112 %
                                 
Weighted average number of common shares outstanding-dilute
    14,581,134       4,930,000       9,651,134       196 %
 
Net Revenue

Our revenue for the three months ended March 31, 2011 was $41.4 million compared with $14.4 million for the three months ended March 31, 2010, an increase of $27 million, or 187%, of which $11.6 million was attributable to corn sales, $6.5 million to simple processed grain sales and the remaining $8.9 million from deep processed grain sales.  The growth mainly came from our corn business which presently is still the main segment of the Company’s overall business.  Our grains business continued to grow steadily.  Our newly added businesses of unpacked grains and bulk purchase/wholesale trading of rice and flour are reflected in the aggregated revenue of our simple processed grain division.  Bulk purchase/wholesale trading of rice and flour generated revenues of $4.1 million, and unpacked grains contributed revenues of $1.5 million for three months ended March 31, 2011.

The following table breaks down the distribution of our sales volume and amount by division and as a percentage of gross sales:
 
  
 
For the Three Months Ended March 31, 2011
   
For the Three Months Ended March 31, 2010
 
   
Sales
Volume
(ton)
   
Gross Sales
   
Less
Sales
Discount
   
Net Sales
   
% of
total
sales
   
Sales
Volume
(ton)
   
Gross Sales
   
Less
Sales
Discount
   
Net Sales
   
% of
total
sales
 
Corn Division
    66,900       22,211,290               22,211,290       53.61 %     42,559       10,650,704               10,650,704       73.72 %
Simple Processed Grain
    4,810       10,266,896               10,266,896       24.78 %     3,858       3,796,578               3,796,578       26.28 %
Deep Processed Grain
            8,954,075               8,954,075       21.61 %                                        
                                                                                 
Total
    71,710       41,432,261               41,432,261       100 %     46,417       14,447,282               14,447,282       100 %
 
 
- 9 -

 

Revenue from our simple processed grain division for the three months ended March 31, 2011 was $10.27 million, an increase of $6.47 million, or 170%, as compared to the same period in 2010.  Margin was 36% for the three months ended March 31, 2011, compared to 49% for the three months ended March 31, 2010.  This revenue increase is mainly attributable to the effectiveness of our advertisement and sales channel increases.

Revenue from our corn division for the three months ended March 31, 2011 was approximately $22.2 million, an increase of $11.56 million, or approximately 109%, as compared to the same period in 2010.  Margin was 23% for the three months ended March 31, 2011, compared to 21% for the three months ended March 31, 2010.  We believe this growth is attributable to the Company fully taking advantage of its regional advantages as in Shanxi province, and deepening and receiving its cooperation of farmers to expand and to assure the steady supply of materials and by taking advantage of its warehouse and transportation capabilities to benefit from fluctuations of material prices.

Revenue from our deep processed grain division for the three months ended March 31, 2011 was $8.9 million and such margin was approximately 7%.  The Company established its deep processed grain division during the second half of 2010 through acquisitions and research and development.  This division was still in the mode of market development. Until now, The Company was still selling with promoted discounting prices in order to enter the market and we lacked full scale of production.  For the three months ended March31, 2011, our new production lines and manufacturing plants were still in the test phase, and most of such products were produced through outsourcing.  All these factors contributed to a weakness of cost controls.  We believe margins will improve only after all of our lines and manufacturing plants are up and running and are more fully developed.

Our Unpacked Grain business, which we deem to be a part of our Simple Processed Grain division and was newly added during the first quarter 2011, generated revenues of $1.5 million for the three months ended March 31, 2011 with margins of approximately 53%.  The reasons for higher margin in this section as compared to our other traditional simple processed grain segment are selective provisions of unique types of grains to customize product choices demanded by different types of customers for a variety of needs; exclusive rights in most of supermarkets; company taking advantage of procurement, resources of supply, sales channel and name brand effects.

An additional newly-added business in first quarter of 2011, the bulk purchase and wholesale of rice and flour, generated revenue of approximately $4.1 million for the three months ended March 31, 2011, having a margin of approximately 7%.  Since the Company had fully utilized its strengths and resources to develop this business section with low maintenance costs, this section has gradually became a stable part of the Company’s net income.
 
Cost of Goods Sold
 
Cost of goods sold mainly consists of cost of raw materials, labor, utilities, manufacturing costs, manufacturing related depreciation and packaging costs.  Cost of goods sold was $33.1 million for the three months ended March 31, 2011, compared to cost of goods sold of $10.9 million for the three months ended March 31, 2010, an increase of $22.2 million, or 202%.  This increase in cost of goods sold is primarily due to the 187% increase in net revenues for this period.  However, as a percentage of net revenue, cost of goods sold increased 4%, or 80% for the three months ended March 31, 2011 compared to 76% for three months ended March 31, 2010.  The increase in the cost of goods as percentage of new revenue was attributable to the sales mix in the first quarter of 2011 which included our deep processed grain business and bulk trade and purchase business with lower margins.

 Gross Profit
 
As a result of the increases in net revenues and cost of goods sold, gross profits for the three months ended March 31, 2011 was $8.3 million, compared to gross profits of $3.5 million for the three months ended March 31, 2010, an increase of $4.8 million, or 138%.  Gross profit margin for grain sales decreased 4% to 20% for the three months ended March 31, 2011 as compared to 24% for the three months ended March 31, 2010.  

The decrease in gross margin was due to our sales mix in the first quarter of 2011 which included our deep processed grain business and bulk trade and purchase business, both of which had lower than 10% margins that diluted our overall margin as a whole.

 
- 10 -

 
 
Gross margin for our simple-processed grains division was 36% for the three months ended March 31, 2011, a decrease of 13% from 49% for the three months ended March 31, 2010.  The decrease was mainly attributable to newly added business of bulk purchase/wholesale of rice and flour business and unpacked grain business sold in supermarkets were included in this division, the fact of consumer agriculture products cannot reflect price increases of purchase costs in time, and that the Company discounted some models of products which is consistent with our strategy of increasing our market share in the relevant market.

Selling Expenses
 
Selling expenses increased $2.8 million, or 443%, for the three months ended March 31, 2011 as compared to the three months ended March 31, 2010.  Expenses increased to $3.4 million for the three months ended March 31, 2011 from $0.6 million for the three months ended March 31, 2010.  Such increase is attributable to variable cost increases of freight, warehousing and packaging associated with sales increases, sales personnel cost increases associated with increase of sales offices and sales channels, marketing initiatives and advertisement costs which were non-existent during the first quarter of 2010.  As a percent of net revenue, selling expenses were 8% of net revenue for the three months ended March 31, 2011, an increase of 4% from 4% of net revenue for the three months ended March 31, 2010.

General and Administrative Expenses

The following table breaks down our General and Administrative Expenses:
 
  
  
For The Three Months
Ended
March 31,
  
  
 
  
  
 
  
  
  
2011
  
  
2010
  
  
Change
  
  
%
  
                         
Payroll, welfare, and bonuses
 
$
1,141,757
   
$
163,108
   
$
978,649
     
600
%
Professional service expense
   
609,091
             
609,091
       
%
Rent and utilities
   
130,792
     
17,045
     
113,747
     
667
%
Travel and lodging expense
   
128,962
     
21,209
     
107,753
     
508
%
Depreciation & amortization Expense
   
87,613
     
60,549
     
27,064
     
47
%
Others
   
188,380
             
188,380
       
%
Total
 
$
2,286,595
   
$
261,911
   
$
2,024,684
     
773
%

General and administrative expenses increased by $2 million to $2.3 million in the three months ended March 31, 2011, or 773%, compared to $0.3 million for the three months ended March 31, 2010.  The increase was attributable to sales activity increase and business expansion.  As a percentage of net revenues, general and administrative expenses were 6% and 2% for the three months ended March 31, 2011 and March 31, 2010, respectively, which represents an increase of 4%.  Such increase is attributable to an increase of professional managers (or higher level) from 250 during the three months ended March 31, 2010 as compared to 800 for the three months ended March 31, 2011.  Our increase in professional service fees from $0 for the three months ended March 31, 2010 to $609,091 for the three months ended March 31, 2011 increased as a result of our Company becoming a public company in the US, including accounting, legal and consulting fees.  The increase of rent and utilities from $17,045 for the three months ended March 31, 2010 to $130,792 for the three months ended March 31, 2011 is mainly due to newly rented offices in Shanxi Province and Beijing.  Increases in travel and lodging expenses from $21,209 for the three months ended March 31, 2010 to $128,962 for the three months ended March 31, 2011 were attributable to increases of sales and business development activities.

Interest Expense
 
Interest expense for the three months ended March 31, 2011 was $74,378, compared to interest expense of $61,537 for the comparable period in 2010, an increase of $12,841, or 21%.  This increase was partly due to a loan balance of $2.63 million for three months ended March 31, 2011, compared to $3.98 million for three months ended March 31, 2010, of which $2.5 million started in February of 2010.

 
- 11 -

 

Provision for Income Taxes
 
Under the Enterprise Income Tax (“EIT”) Law of the PRC, the standard EIT rate is 25%.  Our PRC subsidiaries are subject to PRC income taxes on an entity basis on income arising in or derived from the tax jurisdiction in which they operate.  According to the Tax Pronouncement [2008] No. 149 issued by the State Administration of Tax of the PRC, the preliminary processing industry of agricultural products is entitled to EIT exemption starting January 1, 2008.  Three of the Company’s wholly-owned subsidiaries located in Shanxi Province, including Jinzhong Deyu, Jinzhong Yongcheng, and Jinzhong Yuliang, are subject to the EIT exemption.  All of our other subsidiaries and consolidated VIEs are subject to the 25% EIT rate.  The operations of Detian Yu, Deyufarm, HaoLiangXin and Xinggu Deyufarm commenced late in the second half of 2010 and as a result, those entities had not been in a profitable position during the remainder of 2010 and therefore, were entitled to income tax benefits.
 
Net Income
 
Net Income, prior to the adjustment for the preferred stock dividend, was $3.4 million for the three months ended March 31, 2011 compared to $2.6 million for the three months ended March 31, 2010, an increase of $0.8 million or 33%.
 
Liquidity and Capital Resources
 
The following summarizes the key components of our cash flows for the three months ended March 31, 2011 and 2010:
 
   
2011
   
2010
 
Net cash provided by operating activities
 
$
(816,503)
   
$
(3,688,376)
 
Net cash (used in) provided by investing activities
   
(2,293,631)
     
(935,339)
 
Net cash provided by (used in) financing activities
   
3,104,922
     
2,337,131
 
Effect of exchange rate change on cash and cash equivalents
   
39,065
     
(397)
 
Net increase in cash and cash equivalents
 
$
33,853
   
$
(2,286,981)
 
 
For the three months ended March 31, 2011, net cash provided by operating activities totaled approximately $(0.8) million, a increase of approximately $2.9 million, or 78%, from approximately $(3.7) million in the three months ended March 31, 2010.  This increase is primarily attributable to our strengthened inventory controls which shortened our inventory cycle, and increasing receivables to receive in advance.

For the three months ended March 31, 2011, net cash used in investing activities was approximately $(2.3) million, a decrease of approximately $1.4 million, or 145%, from approximately $(0.9) million in the three months ended March 31, 2010.  This decrease is primarily attributable to equipment purchases and constructions of plants and warehouses to fulfill our business development strategies.

Net cash provided by financing activities for the three months ended March 31, 2011 was approximately $3.1 million, an increase of approximately $0.8 million, or 33%, from approximately $2.3 million in the three months ended March 31, 2010.  This increase is primarily attributable to short-term loans and SBCVC Fund III Company Limited’s capital injection of $3.8 million on Deyufarm approximately.

We believe that our current levels of cash, cash flows from operations, and bank/related party borrowings will be sufficient to meet our anticipated cash needs for at least the next 12 months. However, we may need additional cash resources in the future if we experience changed business conditions or other developments. We may also need additional cash resources in the future if we find and wish to pursue opportunities for investment, acquisition, strategic cooperation or other similar actions. If we ever determine that our cash requirements exceed our amounts of cash and cash equivalents on hand, we may seek to issue debt or equity securities or obtain a credit facility. Any future issuance of equity securities could cause dilution to our shareholders. Any incurrence of indebtedness could increase our debt service obligations and cause us to be subject to restrictive operating and financial covenants. It is possible that, when we need additional cash resources, financing will only be available to us in amounts or on terms that would not be acceptable to us, if at all.

 
- 12 -

 
 
Summary of Certain Liquidity Events

In connection with an exchange agreement, on April 27, 2010, we issued an aggregate of 8,736,932 shares of our common stock to the shareholders of City Zone.  We received in exchange from the City Zone shareholders 100% of the shares of City Zone, which exchange resulted in City Zone becoming our wholly owned subsidiary.  Immediately after the Share Exchange, we entered into a Purchase Agreement with certain accredited investors for the issuance and sale in a private placement of units, consisting of, 2,455,863 shares of our Series A convertible preferred stock, par value $0.001 per share and Series A warrants to purchase up to 982,362 shares of our common stock, for aggregate gross proceeds of approximately $10,805,750.

On November 4, 2010, the Company’s Board of Directors approved the Company’s 2010 Share Incentive Plan.  Under the Plan, 1,000,000 shares of the Company’s common stock shall be allocated to and authorized for use pursuant to the terms of the Plan.  On November 8, 2010, a total of 931,000 non-qualified incentive stock options were approved by our Board of Directors and granted under the Plan to executives, key employees, independent directors, and consultants at an exercise price of $4.40 per share and on December 15, 2010, 40,000 non-qualified incentive stock shares were approved by our Board of Directors and granted under the Plan to a consultant at an exercise price of $4.40 per share, of which shall vest as follows:
 
33 1/3% of the option grants vested one (1) month after the date of grant;
33 1/3% of the option grants will vest twelve (12) months after the date of grant; and
33 1/3% of the option grants will vest twenty-four (24) months after the date of grant.

On November 5, 2011, we filed a Registration Statement with the SEC on Form S-8 covering the shares underlying the options set forth above.  As of March 31, 2011, none of the options issued pursuant to the Plan have been exercised.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements, financings, or other relationships with unconsolidated entities or other persons, also known as “special purpose entities” (SPEs).
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk

Smaller reporting companies are not required to provide this information.

Item 4. Controls and Procedures.

(a)           Evaluation of disclosure controls and procedures. At the conclusion of the period ended March 31, 2011 we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of March 31, 2011, our disclosure controls and procedures were effective and adequately designed to ensure that the information required to be disclosed by us in the reports we submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the applicable rules and forms and that such information was accumulated and communicated to our Chief Executive Officer and Chief Financial Officer, in a manner that allowed for timely decisions regarding required disclosure.

 
- 13 -

 

We do not expect that our disclosure controls and procedures will prevent all errors and all instances of fraud. Disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Further, the design of disclosure controls and procedures must reflect the fact that there are resource constraints, and the benefits must be considered relative to their costs. Because of the inherent limitations in all disclosure controls and procedures, no evaluation of disclosure controls and procedures can provide absolute assurance that we have detected all our control deficiencies and instances of fraud, if any. The design of disclosure controls and procedures also is based partly on 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. 

(b)       Changes in internal controls.  There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION
 
Item 1. Legal Proceedings.

We are currently not involved in any litigation that we believe could have a material adverse effect on our financial condition or results of operations. To our knowledge, there is no action, suit, proceeding, inquiry or investigation before or by any court, public board, government agency, self-regulatory organization or body pending or, to the knowledge of our executive officers or any of our subsidiaries, threatened against or affecting us, our common stock, any of our subsidiaries or any of our companies or our companies’ subsidiaries’ officers or directors in their capacities as such, in which an adverse decision could have a material adverse effect.

Item 1A. Risk Factors.
 
Smaller reporting companies are not required to provide this information.
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.
 
Item 3. Defaults Upon Senior Securities.
 
None.
 
Item 4. (Removed and Reserved).
 
Item 5. Other Information.
 
None.

Item 6. Exhibits.
 
2.1
Share Exchange Agreement Dated April 27, 2010 (1)
   
3.1
Articles of Incorporation of Deyu Agriculture Corp. (2)
   
3.2
Certificate of Amendment of Articles of Incorporation of Deyu Agriculture Corp. (3)
   
3.3
Bylaws of Deyu Agriculture Corp. (2)
   
4.1
Certificate of Designation of Rights and Preferences of Series A Convertible Preferred Stock (1)
   
4.2
Form of Series A Warrant (1)
   
10.1
Securities Purchase Agreement Dated April 27, 2010 (1)
   
10.2
Registration Rights Agreement Dated April 27, 2010 (1)
 
 
- 14 -

 

10.3
Form of Lock-Up Agreement Dated April 27, 2010 (1)
   
10.4
Securities Escrow Agreement Dated April 27, 2010 (1)
   
10.5
Placement Agent Agreement between the Company and Maxim Group, LLC dated January 27, 2010(6)
   
10.6
Share Transfer Agreement between Hong Wang and Yam Sheung Kwok dated April 26, 2010 (6)
   
10.7
Share Transfer Agreement between Jianming Hao and Yam Sheung Kwok dated April 26, 2010 (6)
   
10.8
Share Transfer Agreement between Wenjun Tian and Yam Sheung Kwok dated April 26, 2010 (6)
   
10.9
Share Transfer Agreement between Yongqing Ren and Yam Sheung Kwok dated April 26, 2010 (6)
   
10.10
Share Transfer Agreement between Junde Zhang and Yam Sheung Kwok dated April 26, 2010 (6)
   
10.11
Employment Agreement between David Lethem, as Chief Financial Officer, and the Company dated June 18, 2010 (4)
   
10.12
Certificate from China Organic Food Certification Center dated December 21, 2009 (6)
   
10.13
Corn Purchase Letter of Intent between Shanghai Yihai Trading Co., Ltd., Shanxi Office and Jinzhong Yuliang Agricultural Trading Co., Limited dated December 20, 2009 (6)
   
10.14
Warehouse Lease Agreement between Shanxi 661 Warehouse and Jinzhong Yongcheng Agricultural Trading Co., Limited dated December 21, 2006 (6)
   
10.15
Warehouse Lease Agreement between Shanxi Means of Production Company, Yuci Warehouse (formerly, the 671 Warehouse) and Jinzhong Yongcheng Agricultural Trading Co., Limited dated December 28, 2008 (6)
  
10.16
Railway Lease Agreement between Shanxi Cereal & Oil Group, Mingli Reservation Depot and Jinzhong Yongcheng Agriculture Trading Co., Limited dated December 21, 2006 (6)
   
10.17
Railway Lease Agreement between Shanxi Yuci Cereal Reservation Depot and Jinzhong Yongcheng Agriculture Trading Co., Limited dated November 15, 2007 (6)
   
10.18
Railway Lease Agreement between Yuci Dongzhao Railway Freight Station and Jinzhong Yongcheng Agriculture Trading Co., Limited dated December 21, 2006 (6)
   
10.19
Agricultural Technology Cooperation Agreement between Jinzhong Deyu Agriculture Trading Co., Ltd. and Millet Research Institute, Shanxi Academy of Agricultural Science dated October 2007 (6)
   
10.20
Agricultural Technology Cooperation Agreement between Sorghum Institute, Shanxi Academy of Agricultural Sciences and Jinzhong Deyu Agriculture Trading Co., Ltd. dated August 24, 2008 (6)
   
10.21
Certificate of Forest Rights for the Yuci Forest Right Certificate (2005) No. 01518 dated August 11, 2006 (6)
   
10.22
Farmland Transfer Agreement between Detian Yu Biotechnology (Beijing) Co. Ltd. and Shanxi Jinbei Plant Technology Co, Ltd. dated September 30, 2010 (6)
   
10.23
Land Use Rights Acquisition Contract Dated September 30, 2010 (5)
   
10.24
Deyu Agriculture Corp. 2010 Share Incentive Plan (7)
   
10.25
Exclusive Management and Consulting Service Agreement, dated November 16, 2010, by and between Detian Yu Biotechnology (Beijing) Co. Limited and Beijing Jundaqianyuan Investment Management Co., Ltd. (English translated version) (8)
 
 
- 15 -

 

10.26
Exclusive Management and Consulting Service Agreement, dated November 16, 2010, by and between Detian Yu Biotechnology (Beijing) Co. Limited and Jinzhong Longyue Investment Consulting Co., Ltd. (English translated version) (8)
   
10.27
Business Cooperation Agreement, dated November 16, 2010, by and between Detian Yu Biotechnology (Beijing) Co. Limited and Beijing Jundaqianyuan Investment Management Co., Ltd. (English Translated Version) (8)
   
10.28
Business Operation Agreement, dated November 16, 2010, by and among Detian Yu Biotechnology (Beijing) Co. Limited, Beijing Jundaqianyuan Investment Management Co., Ltd. and each of the shareholders of Beijing Jundaqianyuan Investment Management Co., Ltd. (English translated version) (8)
   
10.29
Business Operation Agreement, dated November 16, 2010, by and among Detian Yu Biotechnology (Beijing) Co. Limited, Jinzhong Longyue Investment Consulting Co., Ltd. and both of the shareholders of Jinzhong Longyue Investment Consulting Co., Ltd. (English translated version) (8)
   
10.30
Share Pledge Agreement, dated November 16, 2010, by and among Detian Yu Biotechnology (Beijing) Co. Limited and the following shareholders of Beijing Jundaqianyuan Investment Management Co., Ltd.: Tian Wenjun, Hao Jianming, Yang Jianhui, Zhou Jianbin, Ren Li, Ren Yongqing, Zhang Junde and Wang Tao (English translated version) (8)
 
10.31
Share Pledge Agreement, dated November 16, 2010, by and among Detian Yu Biotechnology (Beijing) Co. Limited and the following shareholders of Jinzhong Longyue Investment Consulting Co., Ltd.: Zhao Jing and Zhao Peilin (English translated version) (8) 
 
10.32
Form of Power of Attorney (English translated version) (8) 
   
10.33
Equity Acquisition Option Agreement, dated November 16, 2010,  by and among Detian Yu Biotechnology (Beijing) Co. Limited and the following shareholders of Beijing Jundaqianyuan Investment Management Co., Ltd.: Tian Wenjun, Hao Jianming, Yang Jianhui, Zhou Jianbin, Ren Li, Ren Yongqing, Zhang Junde and Wang Tao (English translated version) (8)
   
10.34
Equity Acquisition Option Agreement, dated November 16, 2010,  by and among Detian Yu Biotechnology (Beijing) Co. Limited and the following shareholders of Jinzhong Longyue Investment Consulting Co., Ltd.: Zhao Jing and Zhao Peilin (English translated version) (8)
   
10.35
Business Cooperation Agreement, dated November 16, 2010, by and between Detian Yu Biotechnology (Beijing) Co. Limited and Jinzhong Longyue Investment Consulting Co., Ltd. (English Translated Version) (8)
   
10.36
Village Collective Farmland Transfer Agreement, dated December 20, 2010, by and between Detian Yu Biotechnology (Beijing) Co., Ltd. and Shanxi Jinbei Plant Technology Development Co., Ltd. (English Translated and Mandarin Versions) (9)
   
10.37
Contract of Agreement, effective as of January 10, 2011,  by and between Deyu Agriculture Corp. and Charlie Lin (10)
   
14.1
Code of Conduct (6)
   
16.1
Letter from Auditor (11)
   
21
List of Subsidiaries (12)
   
31.1
Certifications of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
   
31.2
Certifications of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
 
 
- 16 -

 

32.1
Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley Act Of 2002*
   
32.2
Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley Act Of 2002*
   
99.1
Audit Committee Charter adopted August 19, 2010 (6)
 
(1) 
Incorporated by reference to our Form 8-K filed on May 3, 2010.
(2)
Incorporated by reference to our Registration Statement on Form S-1 filed on July 8, 2009.
(3)
Incorporated by reference to our Form 8-K filed on June 4, 2010.
(4)
Incorporated by reference to our Form 8-K filed on June 18, 2010.
(5)
Incorporated by reference to our Form 8-K filed on October 6, 2010.
(6)
Incorporated by reference to our Form S-1/A filed on October 21, 2010.
(7)
Incorporated by reference to our Form S-8 filed on November 5, 2010.
(8)
Incorporated by reference to our Form 8-K filed on November 17, 2010.
(9)
Incorporated by reference to our Form 8-K filed on December 21, 2010.
(10)
Incorporated by reference to our Form 8-K filed on January 10, 2011.
 (11)
Incorporated by reference to our Form 8-K filed on May 3, 2010.
(12)
Incorporated by reference to our Form 10-K filed on March 31, 2011

* Filed herewith.

 
- 17 -

 

SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
DEYU AGRICULTURE CORP.
 
Signature
 
Title
 
Date
         
         
/s/ Jianming Hao
 
Chief Executive Officer, Principal Executive Officer
 
May 23, 2011
Jianming Hao
       
         
/s/ Charlie Lin
 
Chief Financial Officer, Principal Financial and Accounting Officer
 
May 23, 2011
Charlie Lin
       
 
 
- 18 -