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EX-32 - EXHIBIT 32 - Yongye International, Inc.v320179_ex32.htm
EX-31.1 - EXHIBIT 31.1 - Yongye International, Inc.v320179_ex31-1.htm
EX-10.1 - EXHIBIT 10.1 - Yongye International, Inc.v320179_ex10-1.htm
EX-10.3 - EXHIBIT 10.3 - Yongye International, Inc.v320179_ex10-3.htm
EX-10.2 - EXHIBIT 10.2 - Yongye International, Inc.v320179_ex10-2.htm
EX-31.2 - EXHIBIT 31.2 - Yongye International, Inc.v320179_ex31-2.htm
EX-10.4 - EXHIBIT 10.4 - Yongye International, Inc.v320179_ex10-4.htm

 

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

 

(Mark One)

 

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

 

For the quarterly period ended June 30, 2012

or

 

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

 

For the transition period from to

 

Commission File Number 001-34444

 

Yongye International, Inc.

(Exact name of registrant as specified in its charter)

 

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

 

6th Floor, Suite 608, Xue Yuan International Tower,

No. 1 Zhichun Road, Haidian District Beijing, PRC

(Address of principal executive offices)

 

(Former name, former address and former fiscal year, if changed since last report)

 

+86 10 8232 8866

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x     No 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. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o Accelerated filer x
Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company o

 

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 August 6, 2012, there were 50,537,044 shares of common stock, par value $.001 per share, issued and outstanding.

 

 
 

 

TABLE OF CONTENTS

 

    Page
     
PART I. Financial Information 1
ITEM 1. FINANCIAL STATEMENTS 1
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITIONS. 23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 39
ITEM 4. CONTROLS AND PROCEDURES 40
     
PART II. OTHER INFORMATION 40
ITEM 1. LEGAL PROCEEDINGS 40
ITEM 1A. RISK FACTORS 41
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 63
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 63
ITEM 4. MINING SAFETY DISCLOSURE 63
ITEM 5. OTHER INFORMATION 63
ITEM 6. EXHIBITS 63

  

i
 

 

 

PART I.

Financial Information

 

ITEM 1.FINANCIAL STATEMENTS

 

 
 

 

 YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES 

UNAUDITED CONSOLIDATED BALANCE SHEETS 

 

   Note  June 30, 2012   December 31, 2011 
Current assets             
Cash     US$81,952,040   US$81,154,880 
Restricted cash      40,000    40,000 
Accounts receivable, net of allowance for doubtful accounts  3   188,359,652    153,629,522 
Inventories  4   103,720,614    86,117,000 
Deposits to suppliers  5   25,240,430    2,664,360 
Prepaid expenses      774,372    4,954,359 
Other receivables      253,299    385,263 
Deferred tax assets      1,349,974    2,283,388 
Total Current Assets      401,690,381    331,228,772 
              
Property, plant and equipment, net  6   21,787,890    21,929,444 
Intangible asset, net  7   20,346,860    21,649,890 
Land use right, net  8   6,111,971    6,129,151 
Prepayment for mining project  9   35,760,100    35,511,520 
Other assets  10   44,682,486    31,621,465 
Goodwill      10,769,499    10,694,636 
Total Assets     US$541,149,187   US$458,764,878 
              
Current liabilities             
              
Short-term bank loans  11  US$25,339,309   US$28,308,563 
Long-term loans and payables - current portion  12   7,518,593    4,279,234 
Accounts payable      12,175,256    13,098,183 
Income tax payable      8,802,549    3,161,538 
Advance from customers      138,951    4,095,580 
Accrued expenses  13   14,888,397    4,437,220 
Other payables  14   2,956,623    3,159,070 
Derivative liabilities - fair value of warrants  15   247,896    317,183 
Total Current Liabilities      72,067,574    60,856,571 
              
Long-term loans and payables  12   11,036,284    7,464,683 
Other non-current liability      4,327,927    4,297,842 
Deferred tax liabilities  10   6,831,827    4,857,800 
Total Liabilities     US$94,263,612   US$77,476,896 
              
Redeemable Series A convertible preferred shares: par value $.001; 7,969,044 shares authorized; 6,079,545 shares and 5,681,818 shares issued and outstanding as of June 30, 2012 and December 31, 2011, respectively  15  US$51,208,657   US$49,399,990 
              
Equity             
Common stock: par value $.001; 75,000,000 shares authorized; 49,370,711 shares issued and outstanding at June 30, 2012 and December 31, 2011, respectively  15  US$49,371   US$49,371 
Additional paid-in capital      153,079,165    150,654,849 
Retained earnings      204,488,483    148,804,997 
Accumulated other comprehensive income      19,594,212    17,078,758 
Total equity attributable to Yongye International, Inc.      377,211,231    316,587,975 
Noncontrolling interest      18,465,687    15,300,017 
Total Equity     US$395,676,918   US$331,887,992 
Commitments and Contingencies  19   -    - 
              
Total Liabilities, Redeemable Series A Convertible Preferred Shares and Equity     US$541,149,187   US$458,764,878 

 

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

 

2
 

 

YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

       For the Three Months Ended   For the Six Months Ended 
   Note   June 30, 2012   June 30, 2011   June 30, 2012   June 30, 2011 
                          
Sales       $177,625,986   $154,704,865   $241,991,630   $204,926,076 
                          
Cost of sales        69,535,733    62,939,174    98,488,872    85,860,458 
                          
Gross profit        108,090,253    91,765,691    143,502,758    119,065,618 
                          
Selling expenses        38,554,590    29,152,923    52,757,647    36,834,243 
                          
Research and development expenses        7,384,804    5,555,634    8,893,542    6,608,614 
                          
General and administrative expenses (including a reversal of allowance for doubtful accounts of US$6,334,832 and nil for the six months ended June 30, 2012 and 2011, respectively)        8,646,763    5,586,019    6,437,292    12,864,324 
                          
Income from operations        53,504,096    51,471,115    75,414,277    62,758,437 
                          
Other income/(expenses)                         
                          
Interest expense        (1,102,126)   (291,751)   (2,106,295)   (309,862)
Interest income        75,336    16,860    135,410    27,164 
Subsidy income        -    655,071    -    655,071 
Other income, net        2,662    26,560    34,716    101,619 
Change in fair value of derivative liabilities   15    9,889    83,435    69,287    413,587 
                          
Total other (expenses)/income, net        (1,014,239)   490,175    (1,866,882)   887,579 
                          
Earnings before income tax expense        52,489,857    51,961,290    73,547,395    63,646,016 
                          
Income tax expense   17    9,272,206    10,127,255    13,012,428    12,760,047 
                          
Net income        43,217,651    41,834,035    60,534,967    50,885,969 
Less: Net income attributable to the noncontrolling interest        2,107,788    2,297,271    3,042,814    2,982,777 
                          
Net income attributable to Yongye International, Inc.       $41,109,863   $39,536,764   $57,492,153   $47,903,192 
                          
Net income per share of common stock:                         
Basic   21   $0.75   $0.78   $1.02   $0.95 
Diluted   21   $0.74   $0.77   $1.02   $0.94 
                          
Weighted average shares used in computation:                         
Basic   21    49,370,711    49,276,070    49,370,711    48,734,565 
Diluted   21    49,445,176    49,378,396    49,453,572    48,845,281 
                          
Net income        43,217,651    41,834,035    60,534,967    50,885,969 
Other comprehensive income                         
Foreign currency translation adjustment, net of nil income taxes        297,059    3,845,490    2,638,310    5,672,157 
                          
Comprehensive income        43,514,710    45,679,525    63,173,277    56,558,126 
Less: Comprehensive income attributable to the noncontrolling interest        2,121,775    2,469,167    3,165,670    3,234,579 
Comprehensive income attributable to Yongye International, Inc.        41,392,935    43,210,358    60,007,607    53,323,547 

 

 

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

  

3
 

 

YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES

 

UNAUDITED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

 

       Redeemable series A Convertible
Preferred Shares
   Common Stock               Equity         
                               Accumulated   attributable to         
                       Additional       Other   Yongye         
                       Paid-in   Retained   Comprehensive   International,   Noncontrolling   Total 
   Note   Shares   Amount   Shares   Amount   Capital   Earnings   Income   Inc.   Interest   Equity 
Balance as of December 31, 2011        5,681,818   US$49,399,990    49,370,711   US$49,371   US$150,654,849   US$148,804,997   US$17,078,758   US$316,587,975   US$15,300,017   US$331,887,992 
Comprehensive income                                                       
Net income        -    -    -    -    -    57,492,153    -    57,492,153    3,042,814    60,534,967 
Other comprehensive income        -    -    -    -    -    -    2,515,454    2,515,454    122,856    2,638,310 
Stock compensation to management and independent directors   15    -    -    -    -    2,424,316    -    -    2,424,316    -    2,424,316 
Paid-in-kind dividends on redeemable Series A convertible preferred shares   15    397,727    1,808,667    -    -    -    (1,808,667)   -    - (1,808,667)    -    - (1,808,667) 
Balance as of June 30, 2012        6,079,545   US$51,208,657    49,370,711   US$49,371   US$153,079,165   US$204,488,483   US$19,594,212   US$377,211,231   US$18,465,687   US$395,676,918 

 

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

 

4
 

 

  YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES 

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

   For the Six Months Ended 
   June 30, 2012   June 30, 2011 
CASH FLOWS FROM OPERATING ACTIVITIES          
Net income  US$60,534,967   US$50,885,969 
Adjustments to reconcile net income to net cash provided by/(used in) operating activities:          
Depreciation and amortization   7,072,522    3,261,186 
Reversal of allowance for doubtful accounts   (6,334,832)   - 
Change in fair value of derivative liabilities   (69,287)   (413,587)
Stock compensation expense   2,424,316    4,950,600 
Deferred tax expense   300,108    162,234 
Changes in operating assets and liabilities:          
Accounts receivable   (27,170,173)   (115,140,649)
Inventories   (17,028,433)   23,582,770 
Deposits to suppliers   (22,118,726)   (41,373,219)
Prepaid expenses   4,212,958    (693,128)
Other receivables   134,726    (5,805)
Other assets   (5,099,274)   (1,995,399)
Accounts payable   (1,002,120)   12,662,550 
Income tax payable   5,610,204    8,251,950 
Advance from customers   (3,988,722)   606,546 
Accrued expenses   10,413,691    26,366,405 
Other payables   193,633    1,108,043 
           
Net Cash Provided by/(Used in) Operating Activities   8,085,558    (27,783,534)
           
CASH FLOWS FROM INVESTING ACTIVITIES          
Payment for intangible asset   -    (3,000,000)
Purchase of property, plant and equipment   (1,449,852)   (1,608,789)
Net Cash Used in Investing Activities   (1,449,852)   (4,608,789)

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

 

5
 

 

   For the Six Months Ended 
   June 30, 2012   June 30, 2011 
CASH FLOWS FROM FINANCING ACTIVITIES          
Proceeds from short-term bank loans   25,318,859    15,384,852 
Repayment of long-term loans and payables   (3,091,865)   (351,242)
Repayment of short-term bank loans   (28,483,717)   - 
Proceeds from preferred shares, net of issuance cost of $600,010   -    49,399,990 
Net Cash (Used in)/Provided by Financing Activities   (6,256,723)   64,433,600 
           
EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH   418,177    878,510 
NET INCREASE IN CASH   797,160    32,919,787 
Cash at beginning of period   81,154,880    41,913,469 
Cash at end of period  US$81,952,040   US$74,833,256 
           
Supplemental cash flow information:          
           
Cash paid for income taxes  US$7,128,066   US$4,345,862 
Cash paid for interest expense   2,069,219    309,862 
           
Noncash investing and financing activities:          
Acquisition of property, plant and equipment included in other payables   422,754    1,081,041 
Acquisition of other assets by assuming long-term loans and payables   9,820,930    1,977,956 
Paid-in-kind dividends on redeemable Series A convertible preferred shares   1,808,667    - 

 

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

 

6
 

 

YONGYE INTERNATIONAL, INC. AND SUBSIDIARIES

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

JUNE 30, 2012 AND 2011

 

NOTE 1 -ORGANIZATION AND DESCRIPTION OF BUSINESS

 

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

 

In November 2007, ASO entered into a Sino-Foreign cooperative joint venture contract with Inner Mongolia Yongye Biotechnology Co., Ltd. (“Inner Mongolia Yongye”) to form Yongye Nongfeng, pursuant to which, Inner Mongolia Yongye and ASO were to own 10% and 90% of the equity interests in Yongye Nongfeng, respectively. Inner Mongolia Yongye was formed on September 16, 2003 in the People’s Republic of China (the “PRC”). Mr. Zishen Wu, Chief Executive Officer, President and Chairman of the Company, owns a controlling equity interest in Inner Mongolia Yongye.

 

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

 

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

 

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

 

7
 

 

On July 20, 2010, Yongye Nongfeng set up a wholly-owned subsidiary, Inner Mongolia Yongye Fumin Biotechnology Co., Ltd. (“Yongye Fumin”), with registered capital of US$14,731,880 (equivalent to RMB100 million). Yongye Fumin is engaged in the manufacturing and sale of fulvic acid based liquid and powder nutrient compounds. Yongye Fumin was established to expand the production capacity for fulvic acid based liquid and powder nutrient compounds, and to produce humic acid using lignite coal (See Note 9). The construction of the production plant of Yongye Fumin, which is located in Wuchuan County, was completed in the fourth quarter of 2010.

 

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

 

During the six months ended June 30, 2012, the Company began to sell two new products, a crop seed nutrient product and a crop root nutrient product named “Zhongbaosheng” and “Qianggenbao”, respectively. During the three and six months ended June 30, 2012, revenue from the two new products were US$21 million and US$69 million, respectively.

 

NOTE 2 -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted as permitted by rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). The December 31, 2011 consolidated balance sheet was derived from the audited consolidated financial statements of the Company. The accompanying unaudited consolidated financial statements should be read in conjunction with the December 31, 2011 audited consolidated financial statements of the Company included in the Company’s annual report on Form 10-K for the year ended December 31, 2011.

 

In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of the financial position as of June 30, 2012, the results of operations for the three and six months ended June 30, 2012 and 2011 and cash flows for six months ended June 30, 2012 and 2011, have been made.

 

The Company’s business is subject to seasonal variations; thus, the results of operations for the three months ended June 30, 2012 are not necessarily indicative of the results for the full fiscal year ending December 31, 2012. Generally, the second and third quarters are peak sales periods, and first and fourth quarters are low sales periods for the Company.

 

All significant intercompany transactions and balances are eliminated on consolidation.

 

USE OF ESTIMATES

 

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

 

8
 

 

 NOTE 3 - ACCOUNTS RECEIVABLE

 

Accounts receivable at June 30, 2012 and December 31, 2011 consisted of the following:

 

   June 30, 2012   December 31, 2011 
         
Accounts receivable  US$197,359,480   US$168,852,106 
Less: allowance for doubtful accounts   (8,999,828)   (15,222,584)
Total  US$188,359,652   US$153,629,522 

 

The activities in the allowance for doubtful accounts for the six months ended June 30, 2012 and 2011 are as follows:

 

   June 30, 2012   June 30, 2011 
         
Allowance for doubtful accounts at beginning of period  US$15,222,584   US$- 
Charged to bad debt expense   -    - 
Reversal of allowance for doubtful accounts, net   (6,334,832)   - 
Foreign currency translation adjustment   112,076    - 
Allowance for doubtful accounts at end of period  US$8,999,828   US$- 

 

Past due balances are reviewed individually for collectability. During the six months ended June 30, 2012, the entire accounts receivable as of December 31, 2011, including all the past due accounts were collected by the Company. Accordingly, the Company reassessed its allowance for doubtful accounts and recorded a reversal of the allowance for doubtful accounts in the amount of US$6.3 million, which was included in general and administrative expenses. The reversal of the allowance for doubtful accounts primarily related to successful settlement of past due accounts receivable from certain distributors that management had assessed collection to be doubtful due to historical collection pattern, the size of the distributors’ businesses, and length of the relationship with the distributors. Although the Company continues to deliver products to these distributors, revenues from sale of products to these distributors are not recognized until collectability is reasonably assured, and this is generally evidenced by receipt of cash until sufficient period of historical collection experience can be demonstrated. The Company determines the adequacy of the allowance for doubtful accounts by considering the amount of historical losses adjusted to take into account current market conditions and the customers’ financial condition, the amount of receivables in dispute and past due, the accounts receivables aging and customers’ repayment patterns.

 

NOTE 4 - INVENTORIES

 

Inventories at June 30, 2012 and December 31, 2011 consisted of the following:

 

   June 30, 2012   December 31, 2011 
         
Finished goods  US$71,966,332   US$75,073,119 
Work in progress   27,931,646    10,028,719 
Raw materials   3,387,607    805,534 
Consumables and packing supplies   435,029    209,628 
Total  US$103,720,614   US$86,117,000 

 

As of December 31, 2011, certain finished goods of US$18,991,849 were pledged as security for short-term bank loans (See Note 11). In addition, as of June 30, 2012 and December 31, 2011, finished goods included US$23,251,377 and US$6,340,411, respectively, of products that were sold to customers for which the related revenue was not recognized in accordance with the Company’s accounting policy on revenue recognition.

 

9
 

 

 

NOTE 5 - DEPOSITS TO SUPPLIERS

 

The Company is required to pay deposits to the suppliers for the full amount of certain raw materials ordered. These raw materials primarily consist of lignite coal, chemical component materials and packing materials. The lignite coal and chemical component materials will be consumed in the production process at Yongye Nongfeng and Yongye Fumin. As of June 30, 2012 and December 31, 2011, the deposits to suppliers for raw materials amounted to US$24,696,228 and US$2,616,231, respectively. As of August 2, 2012, raw materials amounting to approximately US$12 million were subsequently received.

 

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

 

NOTE 6 - PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment at June 30, 2012 and December 31, 2011 consisted of the following:

 

    June 30, 2012     December 31, 2011  
             
Buildings   US$ 14,891,527     US$ 14,329,776  
Machinery and equipment     7,127,252       7,025,521  
Office equipment and furniture     521,852       511,713  
Vehicles     2,423,122       2,406,278  
Software     26,067       19,909  
Leasehold improvements     972,631       902,962  
Construction in progress     1,658       -  
      25,964,109       25,196,159  
Less: Accumulated depreciation and amortization     (4,176,219 )     (3,266,715 )
                 
Property, plant and equipment, net   US$ 21,787,890     US$ 21,929,444  

 

Depreciation and amortization expense related to property, plant and equipment for the three months ended June 30, 2012 and 2011 was US$440,318 and US$453,803, respectively. Depreciation and amortization expense related to property, plant and equipment for the six months ended June 30, 2012 and 2011 was US$909,504 and US$833,473, respectively. 

 

As of June 30, 2012 and December 31, 2011, seven and sixteen vehicles with initial carrying amount of US$468,426 and US$794,984 were pledged as security for the long-term bank loans of US$129,423 and US$189,229, respectively. The bank loans were provided for the purchases of the vehicles (See Note 12).

 

As of June 30, 2012 and December 31, 2011, the Company pledged its building with an original carrying amount of approximately US$6.1 million as security for the short-term bank loan (See Note 11). 

 

NOTE 7 - INTANGIBLE ASSET

 

Intangible asset at June 30, 2012 and December 31, 2011 consisted of the following:

 

10
 

 

    June 30, 2012  
    Weighted                    
    average     Gross           Net  
    amortization     carrying     Accumulated     carrying  
    period     amount     amortization     amount  
Amortizing intangible assets:                        
Customer List     9 years     US$  26,078,836       (5,795,297 )     20,283,539  
Patent     10 years       115,128       (51,807 )     63,321  
Total           US$  26,193,964       (5,847,104 )     20,346,860  

 

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

 

Amortization expense for the three months ended June 30, 2012 and 2011 was US$730,693 and US$755,628, respectively. Amortization expense for the six months ended June 30, 2012 and 2011 was US$1,485,114 and US$1,453,508, respectively. The estimated annual amortization expense for intangible asset in each of the next five years is US$2,909,161.

 

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

 

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

 

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

 

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

 

NOTE 8 - LAND USE RIGHT

 

As of June 30, 2012 and December 31, 2011, land use right represented:

 

11
 

 

    June 30, 2012     December 31, 2011  
             
Land use right   US$  6,386,536     US$  6,342,142  
Less: Accumulated amortization     (274,565 )     (212,991 )
Total   US$  6,111,971     US$  6,129,151  

 

As of June 30, 2012 and December 31, 2011, the Company had pledged its land use right with an original carrying amount of approximately US$4.5 million as security for certain short-term bank loans (See Note 11).

 

NOTE 9 - PREPAYMENT FOR MINING PROJECT

 

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

 

In August 2011, Inner Mongolia’s Ministry of Land and Resources granted the Company a Mineral Resource Exploration Permit which gives it exclusive exploration rights for the 29.74 square kilometer Project Site for an initial period of three years effective August 2, 2011 (the “Exploration Right”). As of June 30, 2012, the Company had not obtained all other government approvals, including the Geological Report and Geological Exploration Report, for it to acquire the Mineral Right. During the six months ended June 30, 2012, the Company engaged a third party mineral institute to assist the Company in obtaining Geological Exploration Report. The Company believes the cost to be incurred in completing the remaining administrative procedures and obtaining government approvals are not significant. The Project Site in Wuchuan is located near Yongye Fumin’s production plant which manufactures the majority of the Company’s products. The Company believes the acquisition of the Mineral Right will allow it to secure a long term supply of humic acid, which is a major raw material used in the manufacture of fulvic acid based liquid and powder nutrient compounds, and which is sourced from lignite coals.

 

NOTE 10 - OTHER ASSETS

 

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

 

The cost of these vehicles has been recorded as “Other asset” which is expensed over a five-year period in “Cost of Sales”. In addition, as of June 30, 2012 and December 31, 2011, other assets included an amount of US$6,831,827 and US$4,857,800 respectively, representing the tax effect of the difference between the amount paid for the vehicles and the tax basis of the assets.

 

NOTE 11 - SHORT-TERM BANK LOANS

  

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

 

In April 2012, Yongye Nongfeng obtained a short-term bank loan of RMB 100,000,000 (equivalent to US$15,837,068) with fixed annual interest rate of 8.528% from China Everbright Bank. The short-term bank loan is guaranteed by the Company’s Chairman and his wife, and is due on April 28, 2013. In June 2012, Yongye Nongfeng obtained a short-term bank loan of RMB 60,000,000 (equivalent to US$9,502,241) with fixed annual interest rate of 8.203% from China Citic Bank. The short-term bank loan is pledged by the land use right and building of Yongye Nongfeng, and is due on June 20, 2013.

 

12
 

 

NOTE 12 - LONG-TERM LOANS AND PAYABLES

 

As of June 30, 2012 and December 31, 2011, the long-term loans consisted of the following:

 

    June, 2012     December 31, 2011  
             
Vehicle loans-employees   US$  129,423     US$  189,229  
Vehicle loans-distributors     18,425,454       11,554,688  
Total   US$  18,554,877     US$  11,743,917  

 

As of June 30, 2012 and December 31, 2011, vehicle loans-employees of US$129,423 and US$189,229, respectively, were secured by seven and sixteen vehicles with initial carrying amount of US$468,426 and US$794,984, respectively. The vehicle loans-employees are payable in monthly installments over three to five years. Interest rates on the loans range from 5.40% to 14.54% annually and are subject to the change of the base interest rate prescribed by People’s Bank of China. The vehicle loans were obtained by individual employees of the Company after the Company made the initial down payment of the purchase price of the vehicles. The Company and the individual employees entered into trust agreements that stipulate that (i) the vehicles are legally registered under the individuals’ name, (ii) the Company has the rights of official use, (iii) the Company has the rights to the legal title of the vehicles at all times and is entitled to change the registered owner to the Company or designated third party at any time, (iv) the Company assumes the risk of loss, damage, penalty and other obligations related to the operation and ownership of the vehicle to the extent that the loss or damages were not caused by the individuals’ improper use of the vehicle, (v) the individuals have no right to sell, lease, lend or pledge the vehicles to any other person or entity, and (vi) the Company is obligated to repay the loans in full, and to bear the costs of the related repairs, maintenance, insurance and taxes. Consequently, the Company has recognized the cost of the vehicles as other assets and the loans as liabilities in its consolidated balance sheet.

 

Vehicle loans-distributors represented loans that were initially obtained by the distributors from banks and financial institutions. The Company and the distributors entered into agreements, pursuant to which the Company would assume the full repayment of the loans on behalf of these distributors in exchange for the distributors agreeing to comply with certain sales conditions (See Note 10). The loans have two or three year terms and are payable in monthly installments. Interest rates on the loans range from 5.40% to 18.24% annually, subject to the change of the base interest rate prescribed by People’s Bank of China.

 

The aggregate maturities of the long-term loans and payables for each of the five years subsequent to June 30, 2012 are: US$7,518,593, US$7,822,378, US$3,213,906, US$0, and US$0, respectively.

 

NOTE 13- ACCRUED EXPENSES

 

As of June 30, 2012 and December 31, 2011, the accrued expenses primarily consisted of accrued research and development expenses that amounted to US$6,617,430 and US$667,266, respectively, accrued advertising and promotion expenses that amounted to US$5,232,410 and US$2,388,238, respectively, and accrued freight charges amounted to US$1,194,538 and US$7,920, respectively.

 

NOTE 14- OTHER PAYABLES

 

Other payable as of June 30, 2012 mainly represented payables of US$422,754 for the construction of the production plant in Yongye Fumin and non income tax payable of US$1,939,346. Other payable as of December 31, 2011 mainly represented payable of US$980,169 for the construction of the production plant in Yongye Fumin and non income tax payable of US$1,834,577.

 

NOTE 15- EQUITY FINANCING

 

Capital stock

 

Concurrent with the Share Exchange, the Company entered into a securities purchase agreement on April 17, 2008 with certain investors (the “April Investors”) for the sale in a private placement of an aggregate of 6,495,619 shares of the Company’s common stock, par value US$0.001 per share (the “April Investor Shares”) and 1,623,905 warrants (See below) for aggregate gross proceeds equal to US$10,000,651 (the “April Offering”). 

 

13
 

 

On September 5, 2008, the Company entered into a securities purchase agreement with certain investors (the “September Investors”), for the sale in a private placement of an aggregate of 6,073,006 shares of the Company’s common stock, par value US$0.001 per share (the “September Investor Shares”) and 1,518,253 warrants (See below) for aggregate gross proceeds equal to approximately US$9,350,000 (the “September Offering”).

 

On May 8, 2009, the Company entered into a securities purchase agreement with certain investors (the “May Investors”), for the sale in a private placement of an aggregate of 5,834,083 shares of the Company’s common stock, par value US$0.001 per share (the “May Shares”) for aggregate gross proceeds equal to US$8,984,595 (the “May Offering”).

 

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

 

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

 

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

 

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

 

On October 10, 2011, the Company granted 1,166,333 restricted shares to management and independent directors of the Company in accordance with Yongye International, Inc. 2010 Omnibus Securities and Incentive Plan, as an incentive to such individuals to promote the success of the Company’s business. As of June 30, 2012, the shares have not yet vested.

 

Redeemable Series A convertible preferred shares

 

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

 

In June 2012, 397,727 shares redeemable Series A convertible preferred shares were issued to MSPEA as paid-in-kind dividends. Total fair value of the paid-in-kind dividends as of the declaration and issuance date was US$1,808,667. The estimated fair values of the paid-in-kind dividends were determined using Monte Carlo Simulation Model.

 

The significant terms of the redeemable Series A convertible preferred shares are as follows:

 

14
 

 

Liquidation Preference

 

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

 

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

 

Dividends

 

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

 

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

 

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

 

Conversion

 

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

 

The Actual Net Income means, in respect of any fiscal year or quarter, the consolidated net income of the Company for such fiscal year or quarter (as applicable), after all charges and provisions for taxes and minority interests and adjusted to exclude certain items, as audited (for fiscal years) or reviewed (for fiscal quarters) in accordance with U.S. GAAP.

 

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

 

15
 

 

Automatic Conversion

 

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

 

Voting Rights

 

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

 

Redemption

 

The holders of the redeemable Series A convertible preferred shares have the right to require the Company to redeem all or a portion of the outstanding redeemable Series A convertible preferred shares upon the occurrence of any of the following conditions: (i) a material breach by any of the Company and Full Alliance of any of the key obligations under the securities purchase agreement and related transaction documents, (ii) the failure to remain current in the Company’s securities filings, (iii) the failure to obtain the Exploration Right (See Note 9) and recover amounts paid for such rights, on or prior to June 30, 2012, and (iv) the discontinuation of Mr. Zishen Wu as CEO of the Company prior to December 31, 2014, unless his cessation of duties results from his death, disability or incapacity. In such cases, the redemption price for the redeemable Series A convertible preferred shares would be equal to an amount that would yield a total internal rate of return of 30% on the purchase price of the redeemable Series A convertible preferred shares.

 

The holders of the redeemable Series A convertible preferred shares also have the right to redeem all or a portion of their redeemable Series A convertible preferred shares if (i) the quotient of the Company’s aggregate earnings per share in any six rolling consecutive quarters from the first quarter of 2010 onwards divided by the aggregate amount of the earnings per share of the corresponding periods in the prior year is less than 120%, and (ii) net income of any fiscal year between 2011 and 2014 is less than the relevant Income Threshold for such year. In such cases, the redemption price for the redeemable Series A convertible preferred shares would be equal to an amount that would yield a total internal rate of return of 20% on the purchase price of the redeemable Series A convertible preferred shares. The “Income Threshold” is defined as: US$75 million for the fiscal year 2011, US$101 million for the fiscal year 2012, US$121 million for the fiscal year 2013 and US$145 million for the fiscal year 2014, subject to certain adjustments caused by future issuances of the Company’s securities that have a dilutive effect on the holders of the redeemable Series A convertible preferred shares.

 

Based on the historical income level, year to date income and projected net income and earnings per share for the next three years, management believes it is not probable that the Series A convertible preferred shares are redeemable as at December 31, 2011 and June 30, 2012. The Company assesses the probability of whether the redeemable Series A convertible preferred shares are redeemable at each reporting period end.

 

Warrants

 

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

 

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

 

16
 

 

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

 

Concurrent with the offering of the “May Shares”, the Company issued to Roth as the placement agent, 246,224 warrants (“May Warrants”). The warrants have a five-year exercise period and an initial exercise price of US$1.848. On November 9, 2009, Roth executed an irrevocable cashless exercise of all the “May Warrants”. The Company issued 198,247 shares of common stock of the Company in exchange for the surrender of all the May Warrants.

 

During the three and six months ended June 30, 2012 and 2011, no “April Warrants” and “September Warrants” were exercised by April Investors and September Investors.

 

According to the terms of these warrants, the Company could be required to pay cash to the warrant holders under certain events that are not within the control of the Company.  Specifically, upon the occurrence of certain “fundamental transactions” as defined, the warrant holders (but not the shareholders of the Company’s common stock) are entitled to receive cash equal to the value of the warrants to be determined based on an option pricing model and certain specified assumptions set forth in the warrant agreement.  In addition, the terms of the warrants include a “down-round” provision under which the exercise price could be affected by future equity offerings undertaken by the Company.  If the Company issues any common stock or common stock equivalents, as defined, at any time the warrants are outstanding, at an effective price less than the then warrant exercise price, the exercise price of warrants will be reduced to the effective price of newly issued common stock or common stock equivalents.  In the “May Offering”, the Company issued new common stock at a price of US$1.54 per share and accordingly, the exercise price of the April Warrants and the September Warrants was reduced to US$1.54 per share.  The exercise price of the May Warrants (US$1.848) was not affected but is also subject to potential down-round adjustments in future periods. As of June 30, 2012 and December 31, 2011, there were 148,172 warrants outstanding, of which 48,714 and 99,458 warrants will expire if unexercised by April 2013 and September 2013, respectively.

 

The potential cash payments and the down-round provision preclude the classification of these warrants as equity. Accordingly, the warrants are accounted for as a liability and adjusted to fair value through earnings at each reporting date. The gain resulting from the decrease in fair value of warrants was US$9,889 and US$83,435 for the three months ended June 30, 2012 and 2011, respectively. The gain resulting from the decrease in fair value of warrants was US$69,287 and US$413,587 for the six months ended June 30, 2012 and 2011, respectively.

 

The estimated fair values of the warrants issued to April Investor and September Investor were determined at June 30, 2012 and December 31, 2011 using Binominal Option Pricing Model with Level 2 inputs. The following table sets forth, by level within the fair value hierarchy, the Company’s financial liabilities that were measured at fair value on a recurring basis as of June 30, 2012 and December 31, 2011.

 

   Fair Value Measurements Using: 
       Quoted Prices in
Active Markets for
Identical Financial
Assets and Liabilities
   Significant Other
Observable Inputs
   Significant
Unobservable Inputs
 
June 30, 2012  Total   Level 1   Level 2   Level 3 
                 
Liabilities at fair value:                    
Derivative liabilities-warrants  US$247,896    -   US$247,896    - 

 

17
 

 

   Fair Value Measurements Using: 
       Quoted Prices in
Active Markets for
Identical Financial
Assets and Liabilities
   Significant Other
Observable Inputs
   Significant
Unobservable Inputs
 
December 31, 2011  Total   Level 1   Level 2   Level 3 
                 
Liabilities at fair value:                    
Derivative liabilities-warrants  US$317,183    -   US$317,183    - 

 

The fair values of the warrants are summarized as follows:

 

   April Warrants   September Warrants 
Fair value of warrant per share (US$) at:          
Date of issuance  US$1.07   US$2.08 
December 31, 2011   2.11    2.16 
June 30, 2012   1.60    1.71 

 

The fair values of the warrants outstanding as of June 30, 2012 and December 31, 2011 were determined based on the Binominal option pricing model, using the following key assumptions:

 

   June 30, 2012   December 31, 2011 
   April 
Warrants
   September
Warrants
   April 
Warrants
   September
Warrants
 
                 
Expected volatility   57.1%   69.3%   65.5%   64.1%
                     
Expected dividends yield   0%   0%   0%   0%
                     
Time to maturity   0.8 years    1.2 years    1.3 years    1.7 years 
                     
Risk-free interest rate per annum   0.590%   0.590%   1.202%   1.202%
                     
Fair value of underlying common shares (per share)  US$3.09   US$3.09   US$3.52   US$3.52 

 

Stock-based compensation

 

Pursuant to the 2010 Omnibus Securities and Incentive Plan (the “Plan”), which was approved by the stockholders of the Company in the annual meeting held on June 11, 2010, the Company was authorized to issue up to 2,350,000 shares of the Company’s common stock to selected executives, key employees and directors. The number of shares of the Company’s common stock that can be issued is limited to an aggregate of 1,500,000 shares in any calendar year. The purpose of the Plan is to provide incentives to such individuals to promote the success of the Company’s business.

 

In October 2010, the Company granted 1,183,667 restricted shares to management and independent directors of the Company in accordance with the Plan. Management was granted 1,137,000 shares on October 8, 2010, and the independent directors were granted 46,667 shares on October 15, 2011. The shares vested in April 2011.

 

In October 2011, the Company granted 1,166,333 restricted shares to management and independent directors of the Company in accordance with the Plan. Management was granted 1,073,000 shares, and the independent directors were granted 93,333 shares on October 10, 2011. The shares vest in October 2012.

 

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At June 30, 2012, there was US$1,345,362 unrecognized compensation cost related to unvested shares granted under the Plan, which is expected to be recognized over a weighted average period of approximately 3 months. The total stock-based compensation cost recognized in the general and administrative expenses for the three months ended June 30, 2012 and 2011 were US$1,212,158 and US$370,866, respectively. The total stock-based compensation cost recognized in the general and administrative expenses for the three months ended June 30, 2012 and 2011 were US$2,424,316 and US$4,950,600, respectively.

 

A summary of the Company’s unvested shares as of June 30, 2012, and changes during the three and six months ended June 30, 2012, is presented below: 

 

       Weighted average 
       grant-date 
Restricted shares  Shares   fair value 
Balance at January 1, 2012   1,166,333   US$4,875,272 
Granted   -    - 
Vested   -    - 
Forfeited   -    - 
Balance at March 31, 2012   1,166,333    4,875,272 
Granted   -    - 
Vested   -    - 
Forfeited   -    - 
Balance at June 30, 2012   1,166,333   US$4,875,272 

 

NOTE 16 - STATUTORY RESERVE

 

Yongye Nongfeng and Yongye Fumin are required to allocate at least 10% of its after tax profits as determined under generally accepted accounting principal in the PRC to a statutory surplus reserve until the reserve balance reaches 50% of its registered capital. For the six months ended June 30, 2012 and 2011, Yongye Nongfeng and Yongye Fumin made appropriations to this statutory reserve of US$5,833,961, and US$5,889,753, respectively. The accumulated balance of the statutory reserve of Yongye Nongfeng and Yongye Fumin as of June 30, 2012 and December 31, 2011 was US$27,557,130 and US$21,723,169, respectively.

 

In accordance with the PRC laws and regulations, Yongye Nongfeng and Yongye Fumin are restricted in its ability to transfer a portion of its net assets to the Company in the form of dividends, which amounted to US$26,179,274, representing the amount of accumulated balance of statutory reserve of Yongye Nongfeng and Yongye Fumin attributable to the Company as of June 30, 2012.

 

NOTE 17 - INCOME TAXES

 

Effective from January 1, 2008, the PRC’s statutory income tax rate is 25%. The Company’s PRC subsidiaries are subject to income tax rate of 25%, unless otherwise specified. During 2010, Yongye Nongfeng was qualified as a High-Tech Enterprise which entitles it to a preferential tax rate of 15% for three years from January 1, 2010 to December 31, 2012.

 

The Company’s effective income tax rates for the three months ended June 30, 2012 and 2011 were 17.66% and 19.49%, respectively, and were 17.69% and 20.05% for the six months ended June 30, 2012 and 2011. The effective income tax rate for the three and six months ended June 30, 2012 differs from the PRC statutory income tax rate of 25% primarily due to the effect of Yongye Nongfeng’s preferential tax treatment, which is partly offset by the effect of non-deductible expenses.

 

There has been no change in unrecognized tax benefits during the six months ended June 30, 2012. In addition, the Company does not expect that the amount of unrecognized tax benefits will change significantly within the next 12 months. No interest and penalties related to unrecognized tax benefits was recorded for the three and six months ended June 30, 2012.

 

19
 

 

NOTE 18 - FAIR VALUE MEASUREMENTS

 

The fair values of the financial instruments as of June 30, 2012 and December 31, 2011 represent the estimated amounts that would be received to sell those assets or that would be paid to transfer those liabilities in an orderly transaction between market participants at that date. The fair value measurements maximize the use of observable inputs. However, in situations where there is little, if any, market activity for the asset or liability at the measurement date, the fair value measurement reflects the Company’s own judgments about the assumptions that market participants would use in pricing the asset or liability. Those judgments are developed by the Company based on the best information available in the circumstances, including expected cash flows and appropriately risk-adjusted discount rates, available observable and unobservable inputs.

 

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

 

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

 

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

 

Long-term loans and payables: The fair value of the Company’s long-term loans and payables is estimated by discounting future cash flows using current market interest rates offered to the Company and its subsidiaries for debts with substantially the same characteristics and maturities, and which approximated to its carrying amount as of June 30, 2012 and December 31, 2011.

 

NOTE 19 - COMMITMENTS AND CONTINGENCIES

 

In December 2010, the Company entered into an operating lease for an office space in Beijing, PRC for the period from January 1, 2011 to December 31, 2013. The lease expense for the Beijing office was US$66,005 and US$64,172 for the three months ended June 30, 2012 and 2011, respectively, and US$132,121 and US$127,559 for the six months ended June 30, 2012 and 2011, respectively. As of June 30, 2012, the minimum lease payment for each of the twelve month periods ending June 30, 2013 and 2014 under a non-cancellable operating lease agreement was US$264,234 and US$132,117 respectively, or an aggregate amount of US$396,351. There is no minimum lease payment in the next third, fourth and fifth twelve month periods.

 

On May 26, 2011 and June 3, 2011, the Company and three of its officers and directors were named in putative class action lawsuits filed in the US Federal District Court for the Southern District of New York alleging, among other things, that the Company and such officers and directors issued false and misleading information to investors about the Company’s financial and business condition. These securities class action complaints generally alleged that the Company’s business was not growing at the rate it represented and that the Company’s financial results as reported to the Securities and Exchange Commission were inconsistent with its production capabilities. On March 5, 2012, the plaintiffs voluntarily dismissed this action with prejudice as to themselves as named plaintiffs.

 

On July 19, 2011, the Company and certain of its officers and directors were named in a derivative suit filed in the First Judicial District Court of the State of Nevada and Carson City alleging, among other things, that such directors and officers breached their fiduciary duties to the Company, misrepresented the Company’s earnings, wasted corporate assets and unjustly enriched themselves at the expense of the Company. The derivative complaint also alleges that the Company, at the direction of or with the approval of its directors, failed to implement an adequate system of internal and financial controls. This lawsuit is in its early stages. The Company believes the claims contained in the lawsuit to be without merit and intends to defend itself vigorously.

 

20
 

 

NOTE 20 - RELATED PARTY TRANSACTIONS AND BALANCES

 

On January 4, 2011, the Company entered into an operating lease with Inner Mongolia Yongye for a research and development activity facility in Beijing, PRC for the period from January 4, 2011 to December 31, 2011. The operating lease was renewed on January 4, 2012 for the period from January 4, 2012 to December 31, 2012 and covered larger leasing area. The lease expense for the research and development facility paid to Inner Mongolia Yongye was US$63,297 and US$39,898 for the three months ended June 30, 2012 and 2011, respectively, and was US$126,700 and US$79,308 for the six months ended June 30, 2012 and 2011. Total minimum lease payment is US$126,697 for the next twelve month period.

 

In April 2012, Yongye Nongfeng obtained the short-term bank loan of RMB 100,000,000 (equivalent to US$15,837,068) with fixed annual interest rate of 8.528% from China Everbright Bank. The short-term bank loan is guaranteed by the Company’s Chairman and his wife, and is due on April 28, 2013.

  

 NOTE 21 - EARNINGS PER SHARE

 

The following table sets forth the computation of basic earnings per share for the periods indicated:

 

   For the Three Months Ended 
   June 30,
2012
   June 30,
2011
 
Numerator:          
Net income attributable to Yongye International, Inc.  US$41,109,863   US$39,536,764 
           
Paid-in-kind dividends on redeemable Series A convertible preferred shares, net of amounts accumulated in prior reporting periods   913,042   (201,370)
Earnings allocated to participating nonvested shares   (870,331)   (73,453)
Earnings allocated to participating redeemable Series A convertible preferred shares   (4,311,588)   (1,017,644)
Net income for basic earnings per share   36,840,986    38,244,297 
Denominator:          
Weighted average shares of common stock   49,370,711    49,276,070 
Basic earnings per common stock   0.75    0.78 

 

    For the Six Months Ended  
   

June 30,
2012

   

June 30,
2011 

 
Numerator:                
Net income attributable to Yongye International, Inc.   US$ 57,492,153     US$ 47,903,192  
                 
Paid-in-kind dividends on redeemable Series A convertible preferred shares, net of amounts accumulated in prior reporting periods     40,439       (201,370 )
Earnings allocated to participating nonvested shares     (1,192,568 )     (606,543 )
Earnings allocated to participating redeemable Series A convertible preferred shares     (5,858,782 )     (628,540  )
Net income for basic earnings per share     50,481,242       46,466,739  
Denominator:                
Weighted average shares of common stock     49,370,711       48,734,565  
Basic earnings per common stock     1.02       0.95  

 

The holders of the redeemable Series A convertible preferred shares are  entitled to receive cumulative paid-in-kind dividends in additional shares of redeemable Series A convertible preferred shares, on each anniversary of the Issuance Date (See Note 15) (“Cumulative Dividends”), and therefore net income attributable to Yongye International, Inc is reduced by dividends accumulated for each reporting period in the computation of basic earnings per share. At each reporting period prior to the dividends declaration date, the fair value of the dividends accumulated is measured based on what it would be if the end of the reporting period was the dividend determination date.  In June 2012, 397,727 shares of paid-in-kind dividends with a total fair value of the US$1,808,667 were issued to MPSEA. The paid-in kind dividends for the three and six month periods ended June 30, 2012 represent the fair value of the dividends on the declaration date, net of the amount accumulated in prior reporting periods within the anniversary of the Issuance Date.

 

The following table sets forth the computation of diluted earnings per share for the periods indicated:

 

   For the Three Months Ended 
   June 30,
2012
   June 30,
2011
 
Numerator:          
           
Net income allocated to common stockholders as reported in basic EPS  US$36,840,986   US$38,244,297 
Change in fair value of derivative liabilities   (9,889)   (83,435)
Net income for diluted earnings per share   36,831,097    38,160,862 
Denominator:          
Weighted average shares of common stock as reported in basic EPS   49,370,711    49,276,070 
Dilutive effect of warrants   74,465    102,326 
    49,445,176    49,378,396 
           
Diluted earnings per common stock   0.74    0.77 

 

21
 

 

   For the Six Months Ended 
   June 30,
2012
   June 30,
2011
 
Numerator:          
           
Net income allocated to common stockholders as reported in basic EPS  US$50,481,242   US$46,466,739 
Change in fair value of derivative liabilities   (69,287)   (413,587)
Net income for diluted earnings per share   50,411,955    46,053,152 
Denominator:          
Weighted average shares of common stock as reported in basic EPS   49,370,711    48,734,565 
Dilutive effect of warrants   82,861    110,716 
    49,453,572    48,845,281 
           
Diluted earnings per common stock   1.02    0.94 

 

NOTE 22 - CONCENTRATIONS AND CREDIT RISKS

 

At June 30, 2012, the Company held cash in banks of approximately US$81,863,373 that is uninsured by the government authority. To limit exposure to credit risk relating to deposits, the Company primarily places cash deposits only with large financial institution in the PRC with acceptable credit rating.

 

Five major customers accounted for 46% of the Company’s total revenue for the three months ended June 30, 2012, and 47% of the Company’s total revenue for the six months ended June 30, 2012. Five major customers accounted for 33% of the Company’s total revenue for the three months ended June 30, 2011, and 34% of the Company’s total revenue for the six months ended June 30, 2011. The Company’s total revenue to five major customers were US$81,605,811 and US$114,681,108 for the three and six months ended June 30, 2012, respectively. The Company’s total revenue to five major customers were US$51,775,780 and US$69,258,378 for the three and six months ended June 30, 2011, respectively. All these major customers are distributors in the PRC agriculture industry.

 

For the three months ended June 30, 2012      For the six months ended June 30, 2012  

Largest

Customers

 

Primary 

Provinces

  Amount of Sales    

% Total

Sales

   

Largest

Customers

 

Primary 

Provinces

  Amount of Sales    

% Total

Sales

 
Customer A   Shandong   US$ 19,870,690       11 %   Customer E   Inner Mongolia   US$  30,116,951       12 %
                                             
Customer B   Guangdong     17,608,619       10 %   Customer A   Shandong     23,839,329       10 %
                                             
Customer C   Henan     16,380,450       9 %   Customer C   Henan     20,888,735       9 %
                                             
Customer D   Liaoning; Heilongjiang; Jilin     15,124,464       9 %   Customer B   Guangdong     20,814,750       8 %
                                             
Customer E   Inner Mongolia     12,621,588       7 %   Customer D   Liaoning; Heilongjiang; Jilin     19,021,343       8 %
                                             
Total       US$ 81,605,811       46 %   Total       US$  114,681,108       47 %

 

For the three months ended June 30, 2011      For the six months ended June 30, 2011  

Largest

Customers

 

Primary 

Provinces

  Amount of Sales    

% Total

Sales

   

Largest

Customers

 

Primary 

Provinces

  Amount of Sales    

% Total

Sales

 
Customer D   Liaoning; Heilongjiang; Jilin   US$ 11,714,097       7 %   Customer A   Shandong   US$  15,482,182       8 %
Customer A   Shandong     11,140,841       7 %   Customer D   Liaoning; Heilongjiang; Jilin     15,111,830       7 %
Customer B   Guangdong     10,665,071       7 %   Customer B   Guangdong     13,550,836       7 %
Customer F   Jiangsu     9,193,809       6 %   Customer G   Shaanxi     13,097,356       6 %
Customer C   Henan     9,061,962       6 %   Customer F   Jiangsu     12,016,174       6 %
Total       US$ 51,775,780       33 %   Total       US$  69,258,378       34 %

 

22
 

 

Three major suppliers accounted for 77% (US$44,725,788), of which one major supplier accounted for 32% (US$18,255,847) of the Company’s inventory purchase for the three months ended June 30, 2012. Three major suppliers accounted for 70% (US$75,077,488), of which one major supplier accounted for 27% (US$29,338,145) of the Company’s inventory purchase for the six months ended June 30, 2012. Three major suppliers accounted for 83% (US$22,790,351), of which one major supplier accounted for 31% (US$8,539,793) of the Company’s inventory purchase for the three months ended June 30, 2011. Three major suppliers accounted for 87% (US$50,562,626), of which one major supplier accounted for 36% (US$20,794,408) of the Company’s inventory purchase for the six months ended June 30, 2011. If these suppliers terminate their supply relationship with the Company, the Company may be unable to purchase sufficient raw materials on acceptable terms, which may adversely affect the Company’s results of operations.

 

The Company’s operations are carried out in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC as well as by the general state of the PRC’s economy. In addition, the Company’s business may be influenced by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, rates and methods of taxation, and the extraction of mining resources, among other factors.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITIONS.

 

The following discussion of the financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto. Except as otherwise indicated or as the context may otherwise require, all references to “we”, “the Company”, “us” and “our” refer to Yongye International, Inc. (formerly known as Yongye Biotechnology International, Inc.) and its consolidated subsidiaries. The following discussion contains forward-looking statements. The words or phrases “would be,” “will allow,” “expect to”, “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” or similar expressions are intended to identify forward-looking statements. Such statements include those concerning our expected financial performance, our corporate strategy and operational plans. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of risks and uncertainties, including: (a) those risks and uncertainties related to general economic conditions in China, including regulatory factors that may affect such economic conditions; (b) whether we are able to manage our planned growth efficiently and operate profitable operations, including whether our management will be able to identify, hire, train, retain, motivate and manage required personnel or that management will be able to successfully manage and exploit existing and potential market opportunities; (c) whether we are able to generate sufficient revenues or obtain financing to sustain and grow our operations; and (d) whether we are able to successfully fulfill our primary requirements for cash which are explained below under “Liquidity and Capital Resources”. Unless otherwise required by applicable law, we do not undertake, and we specifically disclaim any obligation, to update any forward-looking statements to reflect occurrences, developments, unanticipated events or circumstances after the date of such statement.

 

Company Overview

 

We are a leading crop nutrient company in China in term of total sales in 2011. We are primarily engaged in the research, development, manufacturing and sales of fulvic acid based crop and animal nutrient products for the agriculture and stock farming industry. We are headquartered in Beijing with production facilities in Hohhot, Inner Mongolia Autonomous Region of China (“Inner Mongolia”). Our products are sold nationwide in 30 provinces, autonomous regions and centrally-administered municipalities across China.

 

23
 

 

Products

 

Currently, our principal product is our liquid crop nutrient products, from which we derived substantially all of our sales for the six months ended June 30, 2012. We also produce powder animal nutrient product which is mainly used for dairy cows. In the first quarter of 2012, we launched two new crop nutrient products, a crop seed nutrient product and a crop root nutrient product. The crop seed nutrient product helps crop seeds sprout and improves the growth of roots, and the crop root nutrient product improves crop roots’ ability to absorb water and fertilizers and enhance crop resistance against drought, freezing, diseases, and stalk leaning. We believe, by using our regular crop nutrient together with our new products at different stages of crop growth, the combined effectiveness of our products will further enhance crop yield. We market our regular crop and animal products under the trade name “Shengmingsu” (“生命素” in Chinese means “Life Essential”). Our new products for crop seeds and roots are named “Zhongbaosheng” and “Qianggenbao” respectively. We produce our liquid crop nutrient products, including the newly launched crop seed product and crop root product, based on our proprietary formulae utilizing fulvic acid as the primary compound base and combining with various micro nutrients such as zinc and boron, macro nutrients like nitrogen, phosphorous and potassium (“NPK”) and other nutrients that are essential for the crop health. Our crop nutrient’s core fulvic acid compound improves crop yield by enhancing the absorption of fertilizers and micro nutrients. In addition, the micro nutrients and NPK included in our crop nutrient formula serve as supplements during key growth stages of crops. We believe that our crop nutrient products are particularly well-suited for use in China, which generally has highly degraded farming soil as a result of over-farming, decades of over-use of chemical fertilizers and less advanced farming practices compared with more developed nations. Our regular crop nutrient product is most commonly applied through directly spraying onto leaves of crops after dilution with water, and typically used at certain critical growth stages of crops in addition to normal fertilizer application. Our crop seed nutrient product is used by soaking the seeds in our product after water dilution. Soaking time and proportions of water to product vary among different crops and users should follow our product specifications. At the time of transplant of seeding crop, our crop root nutrient is used by applying the product onto the crop roots after water dilution and blending with soil. After the transplant, the water-diluted crop root product is used to irrigate the crops at the roots. Soaking time and water-product proportions during and after transplanting varies and users should follow our product specifications.

 

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

 

Our powder animal nutrient product consists of our fulvic acid compound base and additional nutrients and Chinese herbs. Our animal products are currently targeted at and administered to dairy cows through mixture with cow feed.

 

Sales and Distribution

 

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

 

24
 

 

 

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

 

 

The following chart illustrates our multi-tiered distribution model: 

 

 

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

 

As of June 30, 2012, our products were sold in 30 provinces, autonomous regions and centrally-administered municipalities across China. We sell our products to 25 provincial-level distributors, who then sell our products to 810 county-level distributors and 32,015 Branded Retailers. Our multi-tiered distribution model allows us to penetrate the vast and highly fragmented rural area of China by utilizing our internal sales team to manage and leverage thousands of sales personnel at our provincial-level distributors, county-level distributors and Branded Retailers. Our internal sales team actively manages our multi-tier distribution network by participating in major distributor sales activities and providing training presentations and seminars.

 

25
 

 

Raw Materials and Production

 

Our product’s core compound, fulvic acid, is extracted from humic acid. Humic acid is formed by the biodegradation of dead organic matter which is buried and compressed under soil, and humic acid is mostly contained in peat, lignite coal, leonardite coal, etc. Our production process primarily involves the extraction of fulvic acid and then blending it with macro and micro nutrients based on our patented formulae. The molecular structure of fulvic acid is smaller than humic acid, which enables fulvic acid to be more easily absorbed by crop leaves.

 

Currently, our key raw materials for fulvic acid are lignite coal and humic acid purchased from third party suppliers, and the prices of lignite coal and humic acid are affected by factors such as market demand, quality and transportation cost. The humic acid we use comes from top grade lignite coal which is mined in Inner Mongolia and is typically sold on a per ton basis. We currently procure lignite coal from independent third party suppliers in Inner Mongolia for our manufacturing needs. Prior to 2011, the key raw material for our products was humic acid which was procured from third party suppliers. Upon the completion of our Wuchuan Facility at the end of 2010, we have been able to produce the majority of our products by extracting fulvic acid in-house from lignite coal and no longer completely rely on humic acid from intermediaries. Other raw materials used in our products include chemicals used in our extraction and blending processes as well as macro and micro nutrients. Fluctuations in raw material costs will affect our cost of sales and gross profit margin, and we may not be able to pass such increased costs on to our distributors and then to our end customers.

 

We have two production facilities in Hohhot City, Inner Mongolia, with one located in Jinshan Industrial Park (the “Jinshan Facility”) and one in Wuchuan County (the “Wuchuan Facility”).  Prior to the fourth quarter of 2010, the Jinshan Facility was our sole manufacturing facility and the Jinshan Facility uses purchased humic acid as the key raw material to produce our products.  Our Wuchuan Facility was completed in the fourth quarter of 2010 and directly utilizes lignite coal as the key raw material to produce fulvic acid and bypasses intermediaries from whom we used to purchase humic acid. 

 

Currently, we procure lignite coal from independent third party suppliers in Inner Mongolia.  In March 2010, in order to secure a long-term supply of humic acid, we entered into an agreement to acquire a mineral resource project in Wuchuan County, Inner Mongolia.  In August 2011, Yongye Fumin, our wholly-owned subsidiary, obtained a Mineral Resource Exploration Permit for this project site in Wuchuan County, Inner Mongolia, which was issued by the Inner Mongolia Ministry of Land and Resources. Such approval granted us exclusive exploration rights for this project site for an initial period of three years beginning August 2, 2011.  We are in the process of applying for the governmental approval for the Mineral Right and are preparing for the relevant reports, including but not limited to a Geological Report and a Geological Exploration Report. In June 2012, we commenced detailed exploration process to obtain a Geological Exploration Report. Upon the granting of the Mineral Right, we will be able to further vertically integrate our operations.

 

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

 

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

 

For the six months ended June 30, 2012, our actual production output for liquid crop nutrient product was 19,364 tons and the actual output for powder animal nutrient was 684 tons.  We may continue to invest in production capacity expansion as required to respond to increasing demand for our products in the future.

 

26
 

 

Research and Development

 

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

 

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

 

Intellectual Property

 

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

 

Marketing and Branding

 

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

 

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

 

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

 

27
 

 

Recent Developments

 

On May 26, 2011 and June 3, 2011, we and three of our officers and directors were named in putative class action lawsuits filed in the US Federal District Court for the Southern District of New York alleging, among other things, that we and such officers and directors issued false and misleading information to investors about our financial and business condition. These securities class action complaints generally allege that our business was not growing at the rate we represented and that our financial results as reported to the Securities and Exchange Commission were inconsistent with our production capabilities. On March 5, 2012, the plaintiffs voluntarily dismissed this action with prejudice as to themselves as named plaintiffs.

 

On July 19, 2011 we and certain of our officers and directors were named in a derivative suit filed in the First Judicial District Court of the State of Nevada and Carson City alleging, among other things, that such directors and officers breached their fiduciary duties to us, misrepresented our earnings, wasted corporate assets and unjustly enriched themselves at the expense of us. The derivative complaint also alleges that we, at the direction of or with the approval of our directors, failed to implement an adequate system of internal and financial controls. This lawsuit is in its early stages.  We believe that the claims contained in the lawsuit to be without merit and intend to defend ourselves vigorously.

 

In April 2012, Yongye Nongfeng obtained a short-term bank loan of RMB 100,000,000 (equivalent to US$15,837,068) with fixed annual interest rate of 8.528% from China Everbright Bank. The short-term bank loan is guaranteed by our Chairman and his wife, and is due on April 28, 2013. In June 2012, Yongye Nongfeng obtained a short-term bank loan of RMB 60,000,000 (equivalent to US$9,502,241) with fixed annual interest rate of 8.203% from China Citic Bank. The short-term bank loan is pledged by the land use right and building of Yongye Nongfeng, and is due on June 20, 2013.

 

Factors affecting our operating results

 

Market Potential for Crop Nutrient Products in China

 

The long-term market growth of crop nutrient products in China is primarily driven by the need to improve crop yield to ensure sufficient food supply in view of limited and shrinking per capita arable land in China. Currently, with only approximately 9% of the world’s arable land, China needs to feed 1.3 billion people, or approximately 21% of the world’s population. According to the National Population and Family Planning Commission of China, China’s population will reach 1.5 billion by 2030. Therefore, the country faces the challenge of producing additional food to feed the additional 200 million people within the next 20 years. This puts great pressure on China’s agricultural system to increase production output.

 

 

 

Over-farming, decades of overuse of chemical fertilizers and less advanced farming practices have led to degraded soil quality in China. Although, according to FAO (Food and Agriculture Organization), China leads the world in fertilizer consumption, applying more fertilizers than the world average on a per hectare basis, nevertheless, the crop yield lags behind most developed countries. This creates a huge demand for crop nutrient products that can help improve fertilizer utilization and increase crop yield. Fulvic acid based crop nutrients are particularly well suited for the market, as it can allow crops to more effectively absorb fertilizers and minerals from the degraded soils.

 

28
 

 

 

The market for our crop nutrient product is large and has attractive long-term growth prospects. China has 1.8 billion mu (each mu is equivalent to approximately 667 square meters) of arable land in total. Typically, each mu of arable land requires at least 300 ml of our liquid crop nutrient product for one growing season. For the year of 2011, our crop nutrient product is estimated to have been used in only less than 5% of the arable land in China, assuming there is one and half growing season per annum on average for all the arable land across China.

 

Agriculture Sector

 

The agriculture industry in China enjoys favorable government policies. In 2012, the government plans to spend RMB1.2 trillion (US$194 billion) on agriculture, rural areas and farmers, 15.5% higher than the amount in 2011. According to the 12th Five-Year National Economic and Social Plan (2011-2015) of China, the Chinese government will continue to support the agriculture industry. Increasing the agriculture production capacity and developing high-yield, high-quality and high-efficiency agriculture are the focus of the Chinese government. Given our product’s ability to improve fertilizer utilization, increase crop yield, improve product quality, and enhance crop’s drought-resistance, we expect that we will further benefit from the Chinese government’s agricultural policy.

 

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

 

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

 

Distribution Network

 

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

 

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

 

29
 

 

Our end-customers are comprised of large farms which purchase directly from distributors, and individual farmers who purchase either through Branded Retailers or promotional events held by local distributors. Our Branded Retailer network has been a key driver of our sales. The number of Branded Retailers increased from 30,086 as of December 31, 2011 to 32,015 as of June 30, 2012. Hebei, Shanxi, Jiangsu, Henan and Xinjiang provinces accounted for the majority of newly recruited Branded Retailers.

 

Below is a table setting forth the expansion of our Branded Retailer network.

 

Branded Retailer by Region  Year End 2010   Q2 End 2011   Year End 2011   Q2 End 2012 
                 
Hebei/Beijing/Tianjin   3,532    3,795    3,935    4,195 
Inner Mongolia   501    567    765    896 
Shandong   3,198    3,325    3,358    3,370 
Guangdong/Hainan   641    845    941    1,052 
Henan   1,920    2,208    2,456    2,626 
Heilongjiang/Jilin/Liaoning   1,231    2,066    2,180    2,220 
Xinjiang   1,395    1,946    2,097    2,260 
Hubei/Hunan   3,040    2,949    2,978    3,111 
Gansu/Qinghai   887    915    920    920 
Jiangsu   1,186    1,748    1,936    2,108 
Shanxi   1,106    1,288    1,310    1,505 
Anhui   1,222    1,390    1,420    1,420 
Shaanxi   1,443    1,480    1,491    1,589 
Sichuan/Chongqing   691    958    1,044    1,056 
Jiangxi/Fujian   666    937    1,006    1,139 
Yunnan/Guizhou   620    896    1,076    1,192 
Zhejiang   138    191    252    386 
Guangxi   184    428    472    521 
Ningxia   427    433    441    441 
Shanghai   8    8    8    8 
Total   24,036    28,373    30,086    32,015 

 

Seasonality

 

Our regular liquid crop nutrient product is most commonly applied by directly spraying onto leaves of crops in the second and third quarters, which correspond to the growing seasons for most crops in most parts of China. Accordingly, the sales during the second and third quarters usually represent 70-80% of our total annual sales. Therefore, higher volume of finished goods were usually accumulated during the non-peak seasons in preparation for the subsequent peak sales seasons which will result in higher inventory turnover days during non-peak seasons. In 2012, we launched two new products which are positioned specifically for crop seeds and roots, the peak sales seasons of which fall in the first quarter. Although these two new products contributed the majority of our sales in the first quarter and small portion of our sales in the second quarter of 2012, due to the fact that these two new products were newly introduced to the market, we expect that these two new products will only account for a small portion of our total sales in 2012 on a full year basis.

 

Pricing

 

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

 

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

 

The pricing of the two new crop products launched in 2012 is at the same level of our regular crop nutrient products. We may adjust our selling prices from time to time in the future based on then market conditions, and any such adjustments may affect our margins, market demand and financial results.

 

Competition

 

While we compete with both nationwide and local manufacturers of humic or fulvic acid crop nutrients, we believe that we are a clear market leader. The Chinese agriculture industry and the retail market for agricultural goods are highly fragmented. As of the end of July 2012, there were more than 4,000 fertilizer products registered in the PRC Ministry of Agriculture’s registry. We mainly compete directly with producers of humic or fulvic acid based products, of which there were around 1,000 registered as of the end of July 2012.

  

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

 

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

 

RESULTS OF OPERATIONS

 

Summary Statement of Comprehensive Income Data

 

in US$, except for percentages  For the Three Months
Ended June 30,
   For the Six Months
Ended June 30,
   For the Three Months Ended
June 30,
   For the Six Months
Ended June 30,
 
   2012    2011    2012    2011     Variance        Variance      
Sales   177,625,986    154,704,865    241,991,630    204,926,076    22,921,121    14.8%   37,065,554    18.1%
                                         
Cost of sales   69,535,733    62,939,174    98,488,872    85,860,458    6,596,559    10.5%   12,628,414    14.7%
                                         
Gross profit   108,090,253    91,765,691    143,502,758    119,065,618    16,324,562    17.8%   24,437,140    20.5%
                                         
Selling expenses   38,554,590    29,152,923    52,757,647    36,834,243    9,401,667    32.2%   15,923,404    43.2%
                                         
Research and development expenses   7,384,804    5,555,634    8,893,542    6,608,614    1,829,170    32.9%   2,284,928    34.6%
                                         
General and administrative expenses (including a reversal of allowance for doubtful accounts of US$6,334,832 and nil for the six months ended June 30, 2012 and 2011, respectively)   8,646,763    5,586,019    6,437,292    12,864,324    3,060,744    54.8%   (6,427,032)   (50.0)%
                                         
Income from operations   53,504,096    51,471,115    75,414,277    62,758,437    2,032,981    3.9%   12,655,840    20.2%
                                         
Other income/(expenses)                                        
Interest expense   (1,102,126)   (291,751)   (2,106,295)   (309,862)   (810,375)   277.8%   (1,796,433)   579.8%
Interest income   75,336    16,860    135,410    27,164    58,476    346.8%   108,246    398.5%
Subsidy income   -    655,071    -    655,071    (655,071)   (100.0)%   (655,071)   (100.0)%
Other income/(expenses), net   2,662    26,560    34,716    101,619    (23,898)   (90.0)%   (66,903)   (65.8)%
Change in fair value of derivative liabilities   9,889    83,435    69,287    413,587    (73,546)   (88.1)%   (344,300)   (83.2)%
Total other income/(expenses), net   (1,014,239)   490,175    (1,866,882)   887,579    (1,504,414)   (306.9)%   (2,754,461)   (310.3)%
Earnings before income tax expense   52,489,857    51,961,290    73,547,395    63,646,016    528,567    1.0%   9,901,379    15.6%
Income tax expense   9,272,206    10,127,255    13,012,428    12,760,047    (855,049)   (8.4)%   252,381    2.0%
Net income   43,217,651    41,834,035    60,534,967    50,885,969    1,383,616    3.3%   9,648,998    19.0%
Less: Net income attributable to the noncontrolling interest   2,107,788    2,297,271    3,042,814    2,982,777    (189,483)   (8.2)%   60,037    2.0%
                                         
Net income attributable to Yongye International, Inc.   41,109,863    39,536,764    57,492,153    47,903,192    1,573,099    4.0%   9,588,961    20.0%
Earnings per share:                            -    -    - 
Basic earnings per common stock   0.75    0.78    1.02    0.95    -    -    -    - 
Diluted earnings per common stock   0.74    0.77    1.02    0.94    -    -    -    - 
                                         
Weighted average shares used in computation:                                        
Basic earnings per common stock   49,370,711    49,276,070    49,370,711    48,734,565    -    -    -    - 
Diluted earnings per common stock   49,445,176    49,378,396    49,453,572    48,845,281    -    -    -    - 

 

31
 

 

Review of Results of Operation for the Three and Six Months Ended June 30, 2012

 

Our sales increased by 14.8% to US$177.6 million for the three months ended June 30, 2012, from US$154.7 million for the same period of 2011. Our sales increased by 18.1% to US$242.0 million for the six months ended June 30, 2012, from US$204.9 million for the same period of 2011.

 

Our gross profit increased by 17.8% to US$108.1 million for the three months ended June 30, 2012, from US$91.8 million for the same period of 2011. Gross profit margin was 60.9% for the three months ended June 30, 2012, as compared to 59.3% for the same period of 2011. Gross profit increased by 20.5% to US$143.5 million for the six months ended June 30, 2012, from US$119.1 million for the same period of 2011. Gross profit margin was 59.3% for the six months ended June 30, 2012, as compared to 58.1% for the same period of 2011.

 

Our net income attributable to Yongye International, Inc. increased by 4.0% to US$41.1 million, or US$0.74 diluted earnings per share, for the three months ended June 30, 2012, from US$39.5 million, or US$0.77 diluted earnings per share, for the same period of 2011. Our net income attributable to Yongye International, Inc. increased by 20.0% to US$57.5 million, or US$1.02 diluted earnings per share, for the six months ended June 30, 2012, from US$47.9 million, or US$0.94 diluted earnings per share, for the same period of 2011.

 

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Sales

 

Below is an analysis of our sales for the three months ended June 30, 2012 and 2011, as well as the six months ended June 30, 2012 and 2011.

 

Our sales increased by US$22.9 million, or 14.8%, to US$177.6 million for the three months ended June 30, 2012, from US$154.7 million for the same period of 2011. For the three months ended June 30, 2012, we derived US$176.3 million, or 99.3% of our total sales, from liquid crop nutrient, and we derived US$1.3 million, or 0.7% of our total sales, from the powder animal nutrient. For our liquid crop nutrient, the regular crop nutrient contributed US$155.6 million, or 88.2% of total liquid crop nutrient, while the two new products for crop seeds and roots contributed US$20.7 million, or 11.8% of our total liquid crop nutrient sales for the three months ended June 30, 2012.

 

For the three months ended June 30, 2012, the average selling price (“ASP”) of our liquid crop nutrient product was US$11,808 per ton, as compared to US$11,617 per ton for the same period of 2011. The small increase in our ASP is the result of the effect of currency rate fluctuations.

 

Our sales increased by US$37.1 million, or 18.1%, to US$242.0 million for the six months ended June 30, 2012, from US$204.9 million for the same period of 2011. For the six months ended June 30, 2012, we derived US$238.3 million, or 98.5% of our total sales, from liquid crop nutrient, and we derived US$3.7 million, or 1.5% of our total sales, from the powder animal nutrient. For our liquid crop nutrient, the regular crop nutrient contributed US$169.6 million, or 71.2% of total liquid crop nutrient, while the two new products for crop seeds and roots, contributed US$68.6 million, or 28.8% of our total liquid crop nutrient sales for the six months ended June 30, 2012.

 

The following table set forth the sales breakdown by region for the three months ended June 30, 2012 and 2011, and the six months ended June 30, 2012 and 2011:

 

   2012   2011   YoY   YoY   2012   2011   YoY   YoY 
Sales By Region (US$
million)
  Q2   Q2   Change
in US$
   Change
in %
   1H   1H   Change
in US$
   Change
in %
 
Hebei/Beijing/Tianjin   21.1    32.5    (11.4)   (35.1)%   28.1    38.0    (9.9)   (26.1)%
Inner Mongolia   12.6    10.0    2.6    26.0%   35.1    12.2    22.9    187.7%
Shandong   20.1    11.1    9.0    81.1%   24.1    15.7    8.4    53.5%
Guangdong/Hainan   17.6    10.7    6.9    64.5%   20.8    13.7    7.1    51.8%
Henan   16.4    9.1    7.3    80.2%   20.9    11.9    9.0    75.6%
Heilongjiang/Jilin/Liaoning   15.1    11.7    3.4    29.1%   19.0    15.1    3.9    25.8%
Xinjiang   3.4    4.1    (0.7)   (17.1)%   4.1    6.0    (1.9)   (31.7)%
Hubei/Hunan   2.8    6.7    (3.9)   (58.2)%   3.4    9.5    (6.1)   (64.2)%
Gansu/Qinghai   6.4    4.7    1.7    36.2%   8.1    6.3    1.8    28.6%
Jiangsu   11.9    9.2    2.7    29.3%   14.6    12.0    2.6    21.7%
Shanxi   5.6    4.9    0.7    14.3%   7.9    6.3    1.6    25.4%
Anhui   3.2    8.5    (5.3)   (62.4)%   3.9    11.8    (7.9)   (66.9)%
Shaanxi   10.1    6.5    3.6    55.4%   12.6    13.1    (0.5)   (3.8)%
Sichuan/Chongqing   9.8    7.9    1.9    24.1%   12.6    10.7    1.9    17.8%
Jiangxi/Fujian   11.0    8.0    3.0    37.5%   13.7    10.2    3.5    34.3%
Yunnan/Guizhou   10.5    9.0    1.5    16.7%   13.0    11.9    1.1    9.2%
Zhejiang   *    *    -    -         *    -    - 
Guangxi   *    0.1    (0.1)   (100.0)%   0.1    0.3    (0.2)   (66.7)%
Ningxia   *    *    -    -         0.1    (0.1)   (100.0)%
Shanghai   *    *    -    -         *    -    - 
Others   *    *    -    -         0.1    (0.1)   (100.0)%
Total   177.6    154.7    22.9    14.8%   242.0    204.9    37.1    18.1%

 

* Less than US$50,000

 

33
 

 

Our revenue in Hebei, Anhui, Hubei and Xinjiang decreased compared to the same period of 2011, primarily due to delayed revenue recognition. Our shipment to such provinces actually increased or remained stable. In the fourth quarter of 2011, in consideration of the deteriorating payment ability of certain distributors in the above mentioned provinces, we delayed the recognition of revenues generated from sales to those distributors until payment collectability can be reasonably assured, which is generally evidenced by receipt of cash. We will recognize revenues for these distributors upon shipment when sufficient period of historical collection experience can be demonstrated. In addition, in the first half of 2012, we reduced shipment to certain provincial distributors which had prolonged payment periods in 2011 to better manage our accounts receivable. We intend to use this as an incentive for those distributors to pay off the accounts receivable in a timely manner. None of our distributors has an overdue account receivable at the end of the second quarter of 2012.

 

Production Output

 

Our production output for our liquid crop nutrient product was 8,910 tons for the three months ended June 30, 2012, and 19,364 tons for the six months ended June 30, 2012. The inventory turnover was 139 days for the three months ended June 30, 2012 as compared to 85 days for the same period of 2011. The inventory turnover was 173 days for the six months ended June 30, 2012 as compared to 115 days for the same period of 2011.

 

During the three months ended June 30, 2012, we sold 14,933 tons of liquid crop nutrient products and 206 tons of powder animal nutrient products. During the six months ended June 30, 2012, we sold 20,147 tons of liquid crop nutrient products and 586 tons of powder animal nutrient products.

 

Cost of Sales

 

Our cost of sales increased by US$6.6 million, or 10.5%, to US$69.5 million for the three months ended June 30, 2012, from US$62.9 million for the same period of 2011. Cost of sales increased by US$12.6 million, or 14.7%, to US$98.5 million for the six months ended June 30, 2012, from US$85.9 million for the same period of 2011.

 

For the three months ended June 30, 2012, our cost of sales accounted for 39.1% of our total sales, as compared to 40.7% for the same period of 2011. For the six months ended June 30, 2012, our cost of sales accounted for 40.7% of our total sales, as compared to 41.9% for the same period of 2011.

 

Gross Margin

 

Our gross margin was 60.9% for the three months ended June 30, 2012, as compared to 59.3% for the same period of 2011. Gross margin was 59.3% for the six months ended June 30, 2012, as compared to 58.1% for the same period of 2011. The increase in gross margin was mainly due to the decreased purchase price of certain raw materials.

 

Selling Expenses

 

Our selling expenses increased by US$9.4 million, or 32.2%, to US$38.6 million for the three months ended June 30, 2012, from US$29.2 million for the same period of 2011. As a percentage of sales, selling expenses increased from 18.8% for the three months ended June 30, 2011 to 21.7% for the same period of 2012. The increase of selling expenses was primarily due to an increase in advertising and promotion expense, and distributors’ seminar expenditure of US$9.3 million relating to marketing and promotional activities in our markets.

 

Selling expenses increased by US$16.0 million, or 43.2%, to US$52.8 million for the six months ended June 30, 2012, from US$36.8 million for the same period of 2011. As a percentage of sales, selling expenses increased from 18.0% for the six months ended June 30, 2011 to 21.8% for the same period of 2012. The increase of selling expenses was primarily due to an increase in advertising and promotion expense, and distributors’ seminar expenditure of US$15.5 million relating to marketing and promotional activities for our original and newly launched products in our markets.

 

34
 

 

General and Administrative Expenses

 

Our general and administrative expenses increased by US$3.0 million, or 54.8%, to US$8.6 million for the three months ended June 30, 2012, from US$5.6 million for the same period of 2011. As a percentage of sales, general and administrative expenses increased from 3.6% for the three months ended June 30, 2011 to 4.9% for the same period of 2012. The increase of general and administrative expenses was mainly due to an increase in management equity compensation expenses and other administrative related expenditure for the three months ended June 30, 2012.

 

General and administrative expenses decreased by US$6.5 million, or 50.0%, to US$6.4 million for the six months ended June 30, 2012, from US$12.9 million for the same period of 2011. As a percentage of sales, general and administrative expenses decreased from 6.3% for the six months ended June 30, 2011 to 2.7% for the same period of 2012. The decrease of general and administrative expenses was mainly due to the reversal of allowance for doubtful accounts of US$6.3 million which was provided in the first quarter of 2012, and a decrease in management compensation expenses by US$2.5 million to US$2.4 million for the six months ended June 30, 2012 from US$4.9 million for the same period of 2011. Except for the reversal of allowance for doubtful accounts, general and administrative expenses amounted to US$12.8 million, which mainly included management compensation expenses resulted from the granted restricted stock in October 2011, staff salary expenditure and other administrative related expenditure for the six months ended June 30, 2012.

 

Research and Development Expenses

 

We incurred US$7.4 million of research and development expenses for the three months ended June 30, 2012, as compared to US$5.6 million for the same period of 2011. The research and development expenses was US$8.9 million for the six months ended June 30, 2012, as compared to US$6.6 million for the same period of 2011.

 

Our research and development expenses mainly consisted of field test expenses for new products, tests on different crops and tests in newly developed markets.

 

Income Tax Rate

 

During the three and six months ended June 30, 2012 and the year ended December 31, 2011, Yongye Nongfeng enjoyed a preferential tax rate of 15% pursuant to the High-Tech Enterprise qualification it received during 2010 which entitled it the preferential tax rate for three years starting from January 1, 2010.

 

Our effective income tax rates for the three months ended June 30, 2012 and 2011 were 17.66% and 19.49%, respectively. Effective income tax rates for the six months ended June 30, 2012 and 2011 were 17.69% and 20.05%, respectively. The effective income tax rates for the three and six months ended June 30, 2012 and 2011 differ from the PRC statutory income tax rate of 25% primarily due to the effect of Yongye Nongfeng’s preferential tax treatment which is partly offset by the effect of non-deductible expenses. The effective income tax rate for the three and six months ended June 30, 2012 decreased as compared to the same period of 2011 was primarily due to a decrease in non-deductible management compensation expenses.

 

Our company’s PRC subsidiaries have cash balance of US$77.1 million as of June 30, 2012 which is planned to be permanently reinvested in the PRC. The distributions from our PRC subsidiaries are subject to the U.S. federal income tax at 34%, less any applicable foreign tax credits. Due to our plan to indefinitely reinvest our earnings in our PRC business, we have not provided for deferred tax liabilities on undistributed earnings of our PRC subsidiaries.

 

Net Income

 

Our net income attributable to Yongye International, Inc. was US$41.1 million (representing a net profit margin of 23.1%) for the three months ended June 30, 2012 as compared to US$39.5 million (representing a net profit margin of 25.6%) for the same period of 2011. The decrease in our net profit margin is primarily due to the increase in selling expenses and general and administrative expenses.

 

35
 

 

Net income attributable to Yongye International, Inc. was US$57.5 million (representing a net profit margin of 23.8%) for the six months ended June 30, 2012 as compared to US$47.9 million (representing a net profit margin of 23.4%) for the same period of 2011.

 

Liquidity and capital resources

 

Selected consolidated balance sheet data:

 

in US$, except for
 percentages
  As of
June 30, 2012
   As of
December 31, 2011
   Variance   %   Note 
                     
Cash and restricted cash   81,992,040    81,194,880    797,160    1%     
Accounts receivable, net of allowance for doubtful accounts   188,359,652    153,629,522    34,730,130    23%   1)
Inventories   103,720,614    86,117,000    17,603,614    20%   2)
Deposits to suppliers   25,240,430    2,664,360    22,576,070    847%   3)
Property, plant and equipment, net   21,787,890    21,929,444    (141,554)   (1)%     
Prepayment for mining project   35,760,100    35,511,520    248,580    1%   4)
Total assets   541,149,187    458,764,878    82,384,309    18%     
Long-term loans and payables - current portion   7,518,593    4,279,234    3,239,359    76%     
Short term bank loan   25,339,309    28,308,563    (2,969,254)   (10)%     
Accounts payable   12,175,256    13,098,183    (922,927)   (7)%     
Income tax payable   8,802,549    3,161,538    5,641,011    178%     
Accrued expenses   14,888,397    4,437,220    10,451,177    236%     
Other payables   2,956,623    3,159,070    (202,447)   (6)%     
Total current liabilities   72,067,574    60,856,571    11,211,003    18%     
Long-term loans and payables   11,036,284    7,464,683    3,571,601    48%     
Other non-current liability   4,327,927    4,297,842    30,085    1%     
Total equity attributable to Yongye International, Inc.   377,211,231    316,587,975    60,623,256    19%     
Total equity   395,676,918    331,887,992    63,788,926    19%   5)

 

1)The increase in accounts receivable of US$34.7 million was consistent with our strong sales growth in the six months ended June 30, 2012.

 

Past due balances are reviewed individually for collectability. During the six months ended June 30, 2012, the entire accounts receivable as of December 31, 2011, including all the past due accounts were collected, we reassessed the allowance for doubtful accounts and recorded a reversal of the allowance for doubtful accounts in the amount of US$6.3 million, which was included in general and administrative expenses. The reversal of the allowance for doubtful accounts primarily related to successful settlement of past due accounts receivable from certain distributors that we had assessed collection to be doubtful due to historical collection pattern, the size of the distributors’ businesses, and length of the relationship with them. Although we continue to deliver products to these distributors, revenues from sale of products to these distributors are not recognized until collectability is reasonably assured, which is generally evidenced by receipt of cash until sufficient timely collection experience can be demonstrated. We determines the adequacy of the allowance for doubtful accounts by considering the amount of historical losses adjusted to take into account current market conditions and customers’ financial condition, the amount of receivables in dispute and past due, the accounts receivables aging and customers’ repayment patterns.

 

36
 

 

Accounts receivable as of June 30, 2012 and December 31, 2011 consisted of the following:

 

   June 30, 2012   December 31, 2011 
         
Accounts receivable  US$197,359,480   US$168,852,106 
Less: allowance for doubtful accounts   (8,999,828)   (15,222,584)
Total  US$ 188,359,652   US$ 153,629,522 

 

Of the US$197.4 million of our gross accounts receivable as of June 30, 2012, none of our accounts receivable were past our six month credit term and we provided allowance for doubtful accounts in the amount of US$9.0 million, taking into account current market conditions, customers’ financial condition, the accounts receivable ageing and the customers’ repayment patterns. For the gross accounts receivable balance as of June 30, 2012, our top three customers accounted for US$66.2 million or 33.5% and our top five customers accounted for US$102.2 million or 51.8% of the total amount of accounts receivable.

 

The ageing of gross accounts receivable as of June 30, 2012 and December 31, 2011 was:

 

Receivable Ageing  June 30, 2012   %   December 31, 2011   % 
                 
Current:                    
0-3 months  US$158,481,506    80.3%  US$39,960,713    23.7%
3-6 months   38,877,974    19.7%   117,318,791    69.5%
Subtotal   197,359,480    100.0%   157,279,504    93.2%
                     
Past due:                    
Past due 0-30 days   -    -    11,572,602    6.8%
Past due over 30 days   -    -    -    - 
Subtotal   -    -    11,572,602    6.8%
                     
Total   197,359,480    100%   168,852,106    100%

 

  Days sales outstanding (“DSO”) is defined as average accounts receivable for the period divided by net sales for the period times the days of this period. DSO increased by 24 days from 49 days for the three months ended June 30, 2011 to 73 days for the same period of 2012, mainly due to the significant amount of accounts receivable by the year end of 2011. We currently have no accounts receivable outstanding over six months, which is the normal credit term we provided to our customers.
   
2) The increase in inventory of US$17.6 million was mainly due to the incremental inventory stocking in the six months ended June 30, 2012. To prepare for the peak seasons of our regular crop nutrient products which take place in the second and third quarters, we accumulated higher volumes of finished goods of our regular crop nutrient product and thus resulted in increased inventory and higher inventory turnover days during the three and six months ended June 30, 2012.
   
  Inventory turn-over days (“Inventory days”) is defined as average inventory for the period divided by cost of sales for the period times the days of this period. Inventory days increased by 54 days from 85 days for the three months ended June 30, 2011 to 139 days for the same period in 2012.

 

3) We increased deposit to suppliers by US$22.6 million during the six months ended June 30, 2012 in anticipation of strong production demand in the third quarter. The deposits were paid primarily to suppliers of lignite coal and chemical components to lock in price and secure availability.

 

4) The cash consideration for the resource project is RMB 240 million or approximately US$35 million. According to preliminary third party analysis, the mineral resource of the project we acquired is at surface level and the “open pit” mining method is recommended. Also, our Wuchuan Facility was built near the mineral resource project to minimize future shipping expense.

 

37
 

 

5)Total equity increased by US$63.8 million from US$331.9 million as of December 31, 2011 to US$395.7 million as of June 30, 2012. The increase in our total equity was mainly due to an increase in retained earnings of US$55.7 million for the net income attributable to Yongye International, Inc. during the period and an increase in additional paid in capital of US$2.4 million, as a result of the 1,166,333 restricted shares granted to management and independent directors.

 

Summary consolidated cash flow data:

 

in US$, except for percentages  For the Six Months Ended
June 30,
     
   2012   2011   Change 
Net cash provided by/(used in) operating activities   8,085,558    (27,783,534)   35,869,092 
Net cash used in investing activities   (1,449,852)   (4,608,789)   3,158,937 
Net cash (used in)/provided by in financing activities   (6,256,723)   64,433,600    (70,690,323)
Effect of exchange rate change on cash   418,177    878,510    (460,333)
Net increase in cash   797,160    32,919,787    (32,122,627)
Cash at beginning of period   81,154,880    41,913,469    39,241,411 
Cash end of period   81,952,040    74,833,256    7,118,784 

 

The sources and uses of cash for the six months ended June 30, 2012 are summarized below:

 

Cash provided by operating activities was US$8.1 million for the six months ended June 30, 2012, and cash used in operating activities was US$27.8 million for the six months ended June 30, 2011. The increase in cash provided by operating activities in the six months ended June 30, 2012 compared to the same period of 2011 was primarily due to the decrease of US$31.7 million in working capital consumption. That was mainly driven by collection of accounts receivable, yet partially offset by a higher inventory balance. Other factors include an increase of US$9.6 million in earnings.

 

Net cash used in investing activities was US$1.4 million and US$4.6 million for the six months ended June 30, 2012 and 2011, respectively.

 

Net cash used in financing activities was US$6.3 million for the six months ended June 30, 2012, and cash provided by financing activities was US$64.4 million for the six months ended June 30, 2011. The net cash used in financing activities in the six months ended June 30, 2012 was mainly due to repayment of short-term bank loans.

 

Foreign Currency Translation Gains

 

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

 

Impact of Inflation

 

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

 

Off Balance Sheet Arrangements

 

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

 

38
 

 

 

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Foreign Exchange Risk

 

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

 

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

 

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

 

Interest Rate Risk

 

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

 

Credit Risk

 

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

 

Inflation

 

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

 

Our Company’s Operations are Substantially in Foreign Countries

 

Substantially all of our operations are conducted in China and are subject to various political, economic, and other risks and uncertainties inherent in conducting business in China. Among other risks, our Company and our subsidiaries’ operations are subject to the risks of restrictions on transfer of funds; export duties, quotas, and embargoes; domestic and international customs and tariffs; changing taxation policies; foreign exchange restrictions; and political conditions and governmental regulations.

 

39
 

 

ITEM 4.CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

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

 

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

 

Changes in Internal Controls over Financial Reporting

 

During the period covered by this quarterly report on Form 10-Q, there was no change in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II.

OTHER INFORMATION

 

ITEM 1.LEGAL PROCEEDINGS

 

On May 26, 2011 and June 3, 2011, we and certain of our officers and directors were named in putative class action lawsuits filed in the US Federal District Court for the Southern District of New York alleging, among other things, that we and such officers and directors issued false and misleading information to investors about our financial and business condition. These securities class action complaints generally alleged that the Company’s business was not growing at the rate it represented and that the Company’s financial results as reported to the Securities and Exchange Commission were inconsistent with its production capabilities. On March 5, 2012, the plaintiffs voluntarily dismissed this action with prejudice as to themselves as named plaintiffs.

 

On July 19, 2011 we and certain of our officers and directors were named in a derivative suit filed in the First Judicial District Court of the State of Nevada and for Carson City alleging, among other things, that such directors and officers breached their fiduciary duties to us, misrepresented our earnings, wasted corporate assets and unjustly enriched themselves at the expense of us. We believe the claims contained in these lawsuits to be without merit and intend to defend ourselves vigorously.

 

40
 

 

ITEM 1A.     RISK FACTORS

 

Investing in our securities involves risk. Before making an investment decision, you should carefully consider the following riskfactors as well as the risks described in our most recent Annual Report on Form 10-K, or any updates to our riskfactors in our Quarterly Reports on Form 10- Q, together with all of the other information appearing in or incorporated by reference into this Quarterly Report, in light ofyour particular investment objectives andfinancial circumstances. Our business, financial condition or results of operations could be materially adversely affected by any of these risks. The trading price of our securities could decline due to any of these risks, and you may lose all or part ofyour investment.

 

Risks Related to Our Business

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

·sufficient working capital and stringent cost controls;

 

·increased sales and sales support activities;

 

·improved administrative and operational systems;

 

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

 

·strengthening of financial and management controls; and

 

·hiring and training of new personnel.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

We derive our revenues from the sale of products through our distributors or and are subject to counterparty risks such as our distributors’ inability to pay. We offer various payment terms to our distributors. The credit period we grant and our credit policies are generally in line with market practice. Under our payment terms, we typically allow our distributors to pay the total purchase price within six months after the receipt of our products. Our peak selling seasons are normally the second quarter and the third quarter, accounting for 70%-80% of our full year sales. Payments for most of our sales made during peak seasons are generally collected in the fourth quarter and the first quarter of the following year. As of June 30, 2012 and December 31, 2011, our accounts receivable amounted to US$188.4 million and US$153.6 million, respectively.

 

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Past due balances are reviewed individually for collectability. During the six months ended June 30, 2012, the entire accounts receivable as of December 31, 2011, including all the past due accounts were collected. Accordingly, we reassessed the allowance for doubtful accounts and recorded a reversal of the allowance for doubtful accounts in the amount of US$6.3 million, which was included in general and administrative expenses. The reversal of the allowance for doubtful accounts primarily related to successful settlement of past due accounts receivable from certain distributors that we had assessed collection to be doubtful due to historical collection pattern, the size of the distributors’ businesses, and length of the relationship with the distributors. Although we continue to deliver products to these distributors, revenues from sale of products to these distributors are not recognized until collectability is reasonably assured, and this is generally evidenced by receipt of cash until sufficient period of historical collection experience can be demonstrated. We determine the adequacy of the allowance for doubtful accounts by considering the amount of historical losses adjusted to take into account current market conditions and the distributors’ financial condition, the amount of receivables in dispute and past due, the accounts receivables aging and distributors’ repayment patterns.

 

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

 

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

 

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

 

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

 

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

 

In 2010, we entered into an agreement with Wuchuan Shuntong to acquire the permit for the rights to explore, develop and produce mineral resources in a certain area of Wuchuan County. The cash consideration of the permit was approximately RMB240 million or US$35 million. The permit allows us to complete all necessary administrative procedures and obtain government approvals to acquire the permit for the rights to explore, develop and produce humic acid bearing resources (“Mineral Rights”). We believe that the Mineral Rights will allow us to secure a long term supply of humic acid, which is a major raw material used in the manufacture of our products. In August 2011, Yongye Fumin, our wholly-owned subsidiary, obtained a Mineral Resource Exploration Permit for this project site in Wuchuan County, Inner Mongolia, which was issued by the Inner Mongolia Ministry of Land and Resources. Such approval granted us exclusive exploration rights for this project site for an initial period of three years beginning August 2, 2011.  We are in the process of applying  for the governmental approval for the Mineral Rights to develop and produce the mineral resources and are preparing for the relevant reports, including but not limited to a Geological Report and Geological Exploration Report. During the six months ended June 30, 2012, we engaged a third party mineral exploration institute to assist us in obtaining the Geological Exploration Report. However, we cannot assure you that we can obtain the Mineral Rights to develop and produce the mineral resources in a timely manner, if at all. Furthermore, the nature and amount of the mineral resources in the Wuchuan project may not be the same as analyzed in the third-party preliminary reports obtained by us in 2009, and our supply of humic acid will be dependent upon market availability. If we are unable to obtain adequate quantities of raw materials at economically viable prices which meet our specifications, our financial condition and results of operation could be adversely affected.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Risks Associated with Doing Business in China

 

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

 

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

 

·the level of government involvement;

 

·the level of development;

 

·the growth rate;

 

·the level and control of capital investment;

 

·the control of foreign exchange; and

 

·the allocation of resources.

 

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

 

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

 

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

 

Currency fluctuations may adversely affect our business.

 

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

 

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

 

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

 

We must comply with the Foreign Corrupt Practices Act.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

·infrastructure conditions and policies.

 

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

 

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

 

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

 

We face risks related to health epidemics and other outbreaks.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

The rate of income tax on companies in China may vary depending on the availability of preferential tax treatment or subsidies based on their industry or location. The PRC government promulgated on March 16, 2007 the new Enterprise Income Tax Law, (“EIT Law”), and it’s implementing rules, which became effective January 1, 2008. Pursuant to the new law, the enterprise income tax of 25% shall be applied to any enterprise. However, Yongye Nongfeng received a High-Tech Enterprise Certificate which entitles it to a preferential tax rate of 15% for three years starting from January 1, 2010. There is no assurance we can renew our High-Tech Enterprise Certificate after it expires or if any new law may change the preferential treatment granted to us. Any loss or substantial reduction of the tax benefits enjoyed by us would reduce our net profit and have a material adverse effect on our financial condition and results of operations.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Risks Related to our Securities

 

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

 

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

 

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

 

From time to time, certain of our stockholders may be eligible to sell all or some of their shares of common stock by means of ordinary brokerage transactions in the open market pursuant to Rule 144, promulgated under the Securities Act of 1933, as amended (“Rule 144”), subject to certain limitations. In general, pursuant to Rule 144, a stockholder (or stockholders whose shares are aggregated) who has satisfied a six-month holding period may, under certain circumstances, sell within any three-month period a number of securities which does not exceed the greater of 1% of the then outstanding shares of common stock or the average weekly trading-volume of the class during the four calendar weeks prior to such sale. Rule 144 also permits, under certain circumstances, the sale of securities, without any limitations, by a non-affiliate of our Company that has satisfied a one-year holding period. We have granted MSPEA and any other holders of the convertible preferred stock certain registration rights with respect to the common stock underlying the convertible preferred stock and any other shares of common stock they may otherwise own or acquire in the future. Any substantial sale of common stock pursuant to Rule 144 or pursuant to any resale prospectus, including a resale prospectus used to register the common stock underlying the convertible preferred stock, may have an adverse effect on the market price of our securities.

 

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

 

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

 

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

 

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

 

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Stockholders should have no expectation of any dividends.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

ITEM 2.         UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

In June 2012, we issued 397,727 shares of redeemable Series A convertible preferred stock to MSPEA as paid-in-kind dividends. Such issuance was made in reliance on a safe harbor from registration from the Securities Act of 1933, as amended, pursuant to Regulation S promulgated thereunder.

 

ITEM 3.         DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4.         MINING SAFETY DISCLOSURE

 

Not applicable.

 

ITEM 5.         OTHER INFORMATION

 

None.

 

ITEM 6.         EXHIBITS

 

Exhibit No.   Description
31.1   Certification of the Chief Executive Officer (Principal Executive Officer) pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31.2   Certification of the Chief Financial Officer (Principal Financial and Accounting Officer) pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
32.1   Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
10.1   Working Capital Loan Agreement dated April 28, 2012 between Inner Mongolia Yongye Nongfeng Biotech Co., Ltd. and China Everbright Bank, Hohhot Branch.*
10.2   Maximum Amount Guarantee Contract dated April 28, 2012 between Zishen Wu and China Everbright Bank, Hohhot Branch.*
10.3   Maximum Amount Guarantee Contract dated April 28, 2012 between Ping Yi and China Everbright Bank, Hohhot Branch.*
10.4   Working Capital Loan Contract dated June 20, 2012 between Inner Mongolia Yongye Nongfeng Biotech Co., Ltd. and China International Trust and Investment Corporation (CITIC), Hohhot Branch.*

 

101.INS XBRL Instance Document**
101.SCH XBRL Taxonomy Extension Schema Document**
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document**
101.DEF XBRL Taxonomy Extension Definition Linkbase Document**
101.LAB XBRL Taxonomy Extension Label Linkbase Document**
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document**

  

 

* Filed Herewith

**To be filed by amendment

  

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SIGNATURES

 

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

  Yongye International, Inc.
  By: /s/ Zishen Wu
    Name:  Zishen Wu
August 9, 2012   Title:  Chief Executive Officer and President
    (Principal Executive Officer)
   
  By: /s/ Sam Yu
    Name:  Sam Yu
    Title:  Chief Financial Offier
    (Principal Financial and Accounting Officer)

 

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