SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Amendment No. 1)
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2008
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to __________
COMMISSION FILE NO. 333-143314
YONGYE INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
6th Floor, Suite 608, Xue Yuan International Tower,
No. 1 Zhichun Road, Haidian District, Beijing, PRC
(Address of principal executive offices)
+86 10 8232 8866
(Issuer’s telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act: Common Stock, par value $.001 per share
Securities Registered Pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ¨ No x
Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.
Yes ¨ No x
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ¨ Accelerated Filer ¨ Non-Accelerated Filer ¨ Smaller Reporting Company x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
The aggregate market value of the 20,000,374 voting and non-voting common equity stock held by non-affiliates of the Registrant was approximately $70,001,309 the last business day of the Registrant’s most recently completed second fiscal quarter, based on the last sale price of the registrant’s common stock on the most recent date on which a trade in such stock took place prior thereto.
There were a total of 32,790,327 shares of the registrant’s Common Stock, par value $0.001 per share, outstanding as of September 9, 2009.
DOCUMENTS INCORPORATED BY REFERENCE
We are filing this Annual Report on Form 10-K/A (the “Amendment”) to amend Part I, Item 1, Financial Statements and Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in the original Annual Report on Form 10-K, filed with the Securities and Exchange Commission (“SEC”). This Amendment has been filed to correct an error in the manner in which we calculated the number of shares outstanding in determining earnings per share, and another error in which we should have reclassified warrants issued as a derivative liability, and the financial statements contained herein are being restated accordingly. In addition, certain revisions are being made to the disclosures included in our Annual Report on Form 10-K for the year ended December 31, 2008 initially filed with the Securities and Exchange Commission (the “Commission”) on March 24, 2009 in response to the Commission’s comment letter dated September 1, 2009.
TABLE OF CONTENTS
ITEM 1 Business
We are engaged in the research, development and sales of fulvic acid based liquid and powder nutrient compounds for plant and animal feed used in the agriculture industry. Fulvic acid is produced by the decomposition of plant material over a period of time and acts as a transport agent, which helps cells absorb essential minerals and elements for growth. Based on our internal data and research, we believe our proprietary technology for fulvic acid extraction creates some of the purest and most effective fulvic acid base on the market in China today. We have found that our fulvic acid has a very light weight molecular composition, which we believe improves the overall permeability of cell walls and allows more complete transport of nutrients across plant membranes, effectively strengthening the overall health of plants. Additionally, the Inner Mongolia Autonomous Region Scientific and Technology Bureau (SEAL), on December 6, 2008, thoroughly reviewed the scientific and economic data provided by the company and reached the opinion that information provided by the project is complete; the data is detailed and reliable, consistent with the identification requirements supports China’s agricultural production development, the product has a wide range of efficacy, thereof promoting plant growth, enhancing plant resistance, increasing production, improving quality, increasing the utilization of fertilizer and etc. Large scale experimentation has proven that the product can increase overall crop yield by 10-20%, and for vegetables, 15-30%, with the significant improvement of the agricultural products quality, and outstanding economic and social benefits, the project has obvious innovations in humic acid extraction process and of the product preparation in selection and application in oxidants, composite precipitators, complexing agent, distributed agent and additives.
Industry and Market Overview
We believe that in order to understand our business, it is important to understand China’s economy. China has grown from a largely semi-subsistence economy to an urban economy in recent years. The population shift to the first and second tier cities (large populations with well developed infrastructure) such as Beijing, Shanghai, Xian & Chengdu is already well documented and now smaller cities such as Hohhot, Kunming and Linyi, with over 1 million people each, are developing larger populations as well. The middle class is growing and consumers are demanding better quality agricultural products and research suggests that as income increases, as with other countries globally, consumers begin to increase consumption of meat, fruit, vegetables, poultry and dairy products (Economic Research Service/USDA, 2000). The agricultural industry in China is expected to grow to keep up with this domestic demand, but added to this is also a global demand for China’s agriculture products. This increased demand is creating much volatility in the supply chain due to currency fluctuations, logistics issues, pricing changes and market risk and we believe farmers are at the crux of both a source of and solution to crop and animal production issues China faces today. This is where we believe our products can help to fulfill market need.
Currently, crop production in China is limited to only 1.827 billion mu (121.8 million hectares or approximately 301 million acres) of arable farm land, which is only about 14% of all of China’s land (China, National Bureau of Statistics, 2008). One principle to ensure food security is the “bottom line”: 1.8 billion mu (120 million hectares) of farmland which is (0.09 hectares) per capita, about a third of the global average. In 1996, China had 1.951 billion mu (130.07 million hectares), or 1.59 mu (0.11 hectares) per person — a loss of 6.4 percent of the arable land in 11 years mainly to urbanization. China approves about 4 million mu (266,667 hectares or 658,667 acres) for construction each year which impacts about 2.82 million mu (188,000 hectares) of farmland. Currently about 70% of new construction in second and third tier cities encroaches on farmland. China’s urban population was about 43.9 percent in 2006 and continues to grow with projections of 70 percent by 2050. China reported 7,438 square km of urban area in 1981 and 32,521 square km in 2005, a 340-percent increase in 25 years.
China has the world’s largest population, which it sustains on a very low amount of arable land on a per capita basis, approximately 0.09 hectare (according to a story appearing in China Daily on October 3, 2008). This is approximately 50% of that present in the United States (Source: US Census Bureau, www.census.gov). This high population density in China requires that each hectare of land feed an average of 10 people compared to the world average of 4.4 people, which means farm land is being used at close to capacity levels just for domestic production levels. Another problem is desertification, the transformation of arable or habitable land to desert due to changes in climate. Desertification claimed 1,200 square miles of land in 2007, or 120,000 hectares. This is a major improvement from losses in the 1990’s which reached 10,000 square miles per annum. According to an estimate by Interfax China, if unabated, the shortage could reach 6.67 million hectares by 2020.
This combination of limited arable land and a large and growing population has created a significant need to increase the output of crops per hectare in China using agricultural inputs as the main technology. In China, the average grain yield per acre grew 98 percent between 1980 and 2005, while total fertilizer use increased 416 percent from 9.1M tons to 47M tons. Much of the excess, however, is lost to the environment, degrading both air and water quality, with 70% of the nutrients being lost due to poor crop management (China Agriculture Statistical Year Book, 1980-2005). The last five years, beginning with 2005, have seen year on year increases in crop production which hasn’t been seen since economic reforms began in the late 1970s (USDA Foreign Agriculture Service). We believe exports and domestic consumption will continue to pressure crop production upwards, so, given the limited amount of arable land, further growth in farming capacity is likely to come from continued reliance on agricultural input technologies.
This is a common occurrence in most developing nations and has prompted the Food and Agriculture Organization of the United Nations to implement an on-going, high priority initiative to increase farmer education proper plant nutrient management. The key point is that the UN is encouraging farmers to increase nutrients to the plant without increasing the amount of fertilizer used. In case of farmer education, the FAO says that the majority of the world’s farmers are females and they tend to continue cultivating in traditional ways. They need to be educated about the modern methods and the governments should take initiatives for this. Overall, we believe that this supports not only our plant nutrient approach, but also our educational approach to selling our product, which is helping farmers to increase yields via overall education and proper use of input products.
Also, with the growth of the economy has come growth in consumers’ demand for a wider choice of food options. One key area of growth is the demand for dairy products. The Chinese Government has now attached great importance to the development of this industry and it is now growing after being dormant for many years. However, average yield per cow is only about 2,000kg, indicating relatively low productivity. One major reason for this low production is mastitis, which is an inflammation of the teats which slows down milk production. This is an industry wide problem where 35-40 cows out of 100 have some form of mastitis, which is typically treated with antibiotics.
With this backdrop, we began selling our plant and animal nutrient products to help farmers increase their farming output. In crop production, we believe that our product assists farmers in generating higher yields from their crops and our first line of animal product for dairy cows assists with the reduction of mastitis to increase milk production.
Our Domestic Market
The amount of land used for agriculture in China is declining because of urban encroachment and increasing non-agricultural use of land, and a large number of farmers have moved to cities for higher paying jobs. China is going through rapid urbanization, creating pressure to use arable land for development and industrial purposes. Arable land is also being lost because of pollution (especially by heavy metals), uncontrolled erosion, overuse of chemical fertilizers and desertification. At the end of 2007, China had a total of 122 million hectares of arable farmland, which is expected to decrease to about 97 million hectares by 2015 (China National Grain and Oil Information Center).
As the overall economy grows, consumer demand for better quality food products is also growing. Over 60% of the nation’s population is comprised of low income, rural farmers (Asian Development Bank). The government has made raising the level of rural income, especially in Western China, a top economic and social goal. The government expects annual rural income to grow between 5% and 10% through 2010. With increased income among a large portion of the population, demand for better food products, including organic “Green Food,” is expected to grow. The need to use land efficiently has led to a genuine need to improve productivity. China’s increasingly affluent urban centers and rising concerns about food quality and safety have led to greater demand for organic plant and animal nutrients (Demand for Food Quantity and Quality in China, USDA/ERS, January 2007).
Barely meeting domestic demand for agricultural products, food security has become a national priority in China (as noted in China’s Food and Agriculture: Issues for the 21st Century, ERS/USDA). China is self-sufficient in its ability to raise most of its staple crops, which is a part of food security, but increasingly dependent on imports of some agricultural products, such as soybeans, to meet rising domestic demand. This was after China’s agricultural output increased 19% in the period 1988 to 2004 from 394,080,000 tons to 469,469,000 tons (China’s Hunger: The Consequences of a Rising Demand for Food and Energy).
We estimate, by the end of 2008, the overall fertilizer market generated over $50 billion in sales in China and has grown about 30% a year from 2005 to 2009. Demand for organic plant fertilizers and nutrients is expected to grow with increasing concern over food quality and environmental issues. Over reliance on chemical fertilizers has led to soil degradation and water pollution, raising the importance of alternative means of increasing productivity. The government plans to spend approximately $169 billion, 1.6% of GDP, between 2006 and 2010 on environmental objectives (OECD, 2006). In 2007, China spent about $5.9 billion on direct subsidies for grain production and the purchase of agricultural materials, up 63% from 2006. The government is planning on additional farm subsidies, land reform initiatives, and elimination of certain agricultural taxes and is promoting the production of organically grown products by setting new standards.
Domestic competition for plant nutrients typically comes from companies in the traditional fertilizer industry, though the plant nutrient market does not directly compete with traditional fertilizer products. China’s fertilizer industry is highly fragmented, with over 2,800 fertilizer products registered with the government in 2007 (according to the PRC Ministry of Agriculture). Yongye competes against 164 other fulvic acid fertilizer products (Chinese Fertilizer Net), however, we believe that only four other similarly enhanced fulvic acid based products are truly competitors. We have found that most of the products provided by local fertilizer companies are low quality, liquid compound fertilizers, many of which are not licensed for sale. We believe these products do not provide plants with a full range of nutrients and international producers have higher quality offerings, but are comparatively expensive. Yongye’s animal nutrient product, which we believe helps to reduce the onset of mastitis, competes against medicines with antibiotic properties, which are usually used to treat livestock after the onset of infection. The Company’s nutrient product for dairy cows underwent internal research and market testing, which substantiated its beliefs that it improved milk production and helped dairy cows avoid a number of diseases including mastitis. Thus, we believe that the use of our animal nutrient product may promote health and decrease the need for expensive medicines in dairy cows.
The Market for Plant Nutrients
Yongye’s Market: Ten Provinces
We believe that we have the following four competitive advantages:
We believe that our strategic growth plan for 2009 capitalizes on the following market conditions to build long term profitability:
Our Corporate History and Background
We were incorporated in the State of Nevada on December 12, 2006 under the corporate name “Golden Tan, Inc.” At that time we were engaged in the business of offering sunless tanning services and selling tanning lotions. In 2008, we began to pursue an acquisition strategy, whereby we sought to acquire an undervalued business with a history of operating revenues in markets that provide room for growth.
The following chart reflects our current organizational structure as of the date hereof:
Yongye International Organizational Structure
On April 17, 2008, we entered into a Share Exchange Agreement (the “Exchange Agreement”) with Fullmax Pacific Limited, a company organized under the laws of the British Virgin Islands (“Fullmax”), the shareholders of Fullmax (the “Shareholders”), who together owned shares constituting 100% of the issued and outstanding ordinary shares of Fullmax (the “Fullmax Shares”), and our principal shareholder (the “Principal Shareholder”). Pursuant to the terms of the Exchange Agreement, the Shareholders transferred to us all of the Fullmax Shares in exchange for the issuance of 11,444,755 (the “Shares”) shares of our Common Stock (the “Share Exchange”). As a result of the Share Exchange, Fullmax became our wholly owned subsidiary and at that time, the Shareholders acquired approximately 84.7% of our issued and outstanding Common Stock. As a result of the Share Exchange, we are now engaged in the sales of fulvic acid based plant and animal nutrients in China.
In November 2007, Asia Standard Oil Limited, a Hong Kong company that is the wholly owned subsidiary of Fullmax (“Asia Standard”), entered into a Sino-foreign cooperative joint venture agreement with Inner Mongolia Yongye (“CJV Agreement”), a PRC company that has been in the business of researching, producing and selling its own proprietary plant and animal nutrient products since 2003 (“Inner Mongolia Yongye”). Asia Standard and Inner Mongolia Yongye formed Yongye Nongfeng Biotechnology Co., Ltd., a new cooperative joint venture under PRC law (the “CJV” or “Yongye Nongfeng Biotechnology”) in January 2008. Yongye Nongfeng Biotechnology was incorporated and approved by the Inner Mongolia Department of Commerce and the Inner Mongolia Administration for Industry and Commerce on January 4, 2008. Under the CJV Agreement, being its capital contribution obligation, Inner Mongolia Yongye shall assign (i) its intellectual property rights, registered trademark and patents; (ii) assist the CJV to recruit the whole management team; (iii) assist the CJV to handle various governmental approval and filing matters; (iv) arrange the office and manufacturing sites for the CJV; and (v) assist the CJV to take care of foreign employees. As a separate matter, Inner Mongolia Yongye shall assign its customers and sales contracts to the CJV. In addition, the CJV has an option to purchase the manufacturing plant of Inner Mongolia Yongye in two years. The CJV has a ten-year term commencing from January 2008, subject to extension and early termination. The CJV agreement is essentially a joint venture agreement that governs the division of profits between the parties and generally provides for how the CJV should be managed and governed, subject to applicable PRC law. The CJV agreement may be amended or supplemented by mutual agreement of the parties. The CJV agreement may be terminated upon unanimous consent of the board of directors of the CJV, subject to governmental approval. PRC law mandates the dissolution of a contractual joint venture, subject to governmental approval, in certain cases: (i) the term of cooperation expires; (ii) the cooperative enterprise is unable to continue operation due to the occurrence of heavy losses or grievous injury caused by force majeure; (iii) the cooperative enterprise is unable to continue operation because one or several partners fail to implement the obligations stipulated in the cooperative enterprise contract and the articles of association; (iv) an occurrence of other causes for dissolution as set forth in the cooperative enterprise contract and the articles of association; and (v) the cooperative enterprise violates laws and administrative regulations, and is ordered to be closed by law. Any rights of Inner Mongolia Yongye to terminate the CJV agreement would be limited to (iii) in the preceding sentence, subject to governmental approval; in the event of (ii) or (iv) in the preceding sentence, the board of directors of the CJV must make such determination, subject to governmental approval.
We operate our businesses in China solely through Yongye Nongfeng Biotechnology, which is 99.5% owned by Asia Standard and 0.5% owned by Inner Mongolia Yongye as stipulated in the CJV contract. Such percentages reflect the equity ownership assuming the total amount of registered capital has been fully paid, which is $21,000,000, of which $20,900,000 shall be contributed by Asia Standard Oil Limited, and $100,000 shall be contributed by Inner Mongolia Yongye. Because ASO only paid $16,778,741 in the year ended 2008 and Inner Mongolia Yongye fully paid the $100,000, based upon the amount of registered capital that has been paid to date the percentages are 99.4% and 0.6%, respectively as of December 31, 2008. As agreed by Inner Mongolia Yongye separately, the former primary contract manufacturer of Shengmingsu products for Yongye Nongfeng Biotechnology, it shall assign its management and administrative team, manufacturing employees, customers, and sales contracts to Yongye Nongfeng Biotechnology.
As part of the September Financing, we began a restructuring process which required us to purchase the land, buildings and equipment which comprised the 10,000 TPA capacity completed in October 2008. We began this process by purchasing the predecessor’s 2000TPA equipment in October 2008, but in order to complete the process we needed to own the fertilizer license issued by the PRC Ministry of Agriculture. The fertilizer license, previously issued to Inner Mongolia Yongye, was issued in the name of Yongye Nongfeng Biotechnology (the “License”) on June 1, 2009, which now permits Yongye Nongfeng Biotechnology to manufacture its own finished products. Now that the License has been received, we intend to acquire the remaining land and assets related to the manufacture of finished products from Inner Mongolia Yongye (the “CJV Restructuring”). The total liability incurred for payments to the Predecessor company is limited to USD$6M and thus far USD$.95M has been paid to the predecessor company.
Our Principal Products and Services
The base of our product is our own proprietary fulvic acid compound, which is extracted from humic acid. Fulvic acid is a complex, acidic, biochemical polymer which can either be produced naturally by the decomposition of plant material over a long period of time or via a manufacturing process. Fulvic acid binds itself to cellulose fibers and strengthens the cell walls of plants and animals and acts as a transport agent helping cells absorb the essential minerals and elements for growth. Fulvic acid usually carries 70 or more minerals and trace elements as part of its molecular complexes. These are in ideal natural form to be absorbed by plants and interact with living cells. Plants readily absorb high amounts of fulvic acid, and more readily maintain the minerals and trace elements brought in by fulvic acid. Fulvic Acid creates bioactivity in plant cells and makes them healthier. Our proprietary process extracts fulvic acid from humic acid and creates the base fulvic acid compound used in both our plant (liquid form) and animal nutrient (powder form) products. We have determined that this process will remain a trade secret due to its importance in the creation of our final product. If we were to patent this process, we would necessarily have to publicly disclose certain information as part of the patent application, and thus lose our competitive advantage we believe we currently have.
We believe, and our research has shown, Fulvic Acid (FA) has the following key attributes when used in the agricultural industry for both plants and animals:
The principal raw material used in creating fulvic acid is Humic Acid (HA). Humic Acid is naturally occurring organic soil matter or “humic substance” which is mined from Leonardite Coal. Humic Acid exhibits a high cation exchange capacity (CEC) or in other words makes it easier for soil nutrient particles to move within the soil, and thus to be taken in by plants. Humic Acid also increases the nutrient intake ability of plants through “chelation”. Normally, trace elements are positively charged while the pores or openings on the roots and leaves of plants are negatively charged which restricts the transfer of minerals because of the mismatched charges. However, with the addition of a chelate, Humic Acid, the minerals are encapsulated in the chelate and the positive charge changes into a net negative or neutral charge, which allows the element to pass through the pore and into the plant. Also, we have believe that the regular use of HA organic liquid compound fertilizer can enable fertilizer, insecticide, herbicide and water use to be reduced. We believe this can be supportive to the environment since it may prevent contamination of water sources caused by runoff.
Product Functions and Results: Plant Line
Our plant products are sold by the 100 ml bottle and in cases of 100 bottles each. The average farmer in China has a cultivated land area of 2-4 Mu and this requires about 6-12 bottles of product which is sprayed on every 15 days over a 45 day growing period. We believe that if the farmer uses our product correctly, he can decrease the use of fertilizers to normal levels and decrease overall usage of pesticides and herbicides which may reduce their overall input costs. Internal studies show that, depending upon the crop, the farmer will see increases in yields and value in the market place which should increase overall income. Each crop varies in response to the product, but we believe farmers may be expected to experience increases on par with the following results under the proper fertilizer and water conditions:
Product Functions and Results: Animal Line
Currently, our animal product line is specifically targeted at dairy cows, although we plan to develop products customized for other animals in the future. We believe that our animal products will help increase the capacity of the dairy supply chain by increasing the health of the dairy cows and reducing their problems with mastitis. We use our base of fulvic acid and add the Chinese herbs Matrine & Oxymatrine. Matrine and Oxymatrine are non-steroidal analgesics which are anti-inflammatory in nature and are administered in treatment of mild to severe pain or treatment of inflammatory states. They also have a variety of biological activities.
In general, our internal studies show that the financial impact for farmers from using our product has been an annual net profit increase per cow due to an increase in production, and if used for treatment of mastitis, a decrease in the costs associated with the purchase of additional products to reduce bacterial inflammation, which could also be expected to increase annual net profit. We sell our product in 300g packets that are bundled into ten (10) 20g bags. A typical regime of use would be one cow taking 1.5g daily over a 100 day period of time.
New Products for 2009
In 2008, we did not roll out any customized products within our two product lines because the market demand for our universal product for plants and for animals was sufficient to gain market share and drive revenue. However, for 2009, we will continue to look at opportunities to develop market driven additions to our product lines as demand exists.
Currently, we use a universal product which can be applied to all types of crops, but will increase our product offerings to the following:
Corn, La Jiao Pepper, Wheat, Rice, Cucumber, Tomato, Cotton, Potato, Sunflower, Grapes, Tropical Fruits and Flowers.
When we introduce these products into the market place, we plan to charge a small percentage more than we do for the universal product, which should increase our revenue by a small amount. This will not replace our universally applied product as we will leave it in the market as well. We also expect to increase the price as market forces demand.
After successful sales in our test market, we will continue to offer our Dairy Cow products, but expect to increase sales of the product due to targeted marketing in selected provinces. We are also working on the introduction of products for pigs, chickens and sheep.
Our Contract Manufacturing Outsourced Process
We believe that our competitive advantage begins with our core intellectual property (“IP”) and cost effective production capability, which is attributed to our IP and manufacturing process we are acquiring from our contract manufacturer, Inner Mongolia Yongye. The former chief scientist of Inner Mongolia Yongye worked specifically on the Shengmingsu line of products for the first five years of development and has over 40 years of experience in the industry. This has led to two invention patents applied for by Inner Mongolia Yongye (the “Predecessor Company”), which are used in the manufacturing process. Currently, one of the two patent applications has been granted (plant patent) and is in the name of the CJV while the other one is still pending (animal patent). The pending patent’s transfer to the CJV has been approved and when issued, it will be issued in the name of Yongye Nongfeng Biotechnology Co., Ltd. These invention patents cover the formulation and stabilization of our unique plant and animal nutrient products. Our products are approved and certified by the PRC Ministry of Agriculture.
The production process and IP we are acquiring from Inner Mongolia Yongye is scientifically designed to ensure that the end product takes advantage of the Intellectual Property and our vertical integration of our main raw materials provider to ensure constantly high quality product. Inner Mongolia Yongye is ISO 9001:2000 (quality control certified (July 2007)), a Hohhot Industry and Commerce Bureau AAA trusted company (awarded July 2007) and a Greenfood certified (August 2008) production facility. The production facility is housed in a 2,000 sq. meter building which is adjacent to a 4,000 sq meter building used for heating and water filtration. The actual production process for Fulvic Acid is the key intellectual property component. This process, generally described, is as follows:
Our products are packaged in bottles, bags and boxes. Each type of packaging material, along with packaging labels, is purchased from three to four manufacturers. These materials are readily available in the market. The products are then assembled and packaged in Inner Mongolia and shipped to distributors and retailers.
Manufacturing Outsourcing Contract (10,000 Tonnes Per Annum Capacity)
From January 2008 until March 2009, Yongye Nongfeng Biotechnology had an outsourcing contract with Inner Mongolia Yongye for the production of our finished nutrient product. From January 2008 until September 2008, the manufacturer was running at 2,000TPA capacity, but after constructing a new 8,000TPA facility, capacity was increased to 10,000TPA. All employees have been transferred to Yongye Nongfeng. The contract between the two companies had the following stipulations:
Our Marketing and Sales Support
Our sales staff is trained to work with the distributor network, retail stores and farmers to ensure that our customers receive the right product and after-sales support. They share their knowledge by walking through farming communities, organizing training courses, inviting local agricultural experts and university professors to speak on proper agricultural techniques as well as the use of our product. The Predecessor Company ended 2007 with marketing and sales staff of 91, which included temporary staff, and at December 31, 2008 had 65 full-time staff. We expect that we will grow in 2009 to meet demand and support the sales of the product to our distributors. Our management in Beijing works with this staff to coordinate all marketing and sales activities.
In the past we have grown via market trials and word of mouth, but in 2008 we introduced many larger market media programs. We work with our independent distributors to coordinate television advertisements on local channels and arrange other mass media events. We will continue to use conferences and seminars, newspaper ads and pamphlets to get customer recognition and product branding. Our staff emphasizes the technological components of our products to help end users understand the differences in products available and how to use them. Word-of-mouth advertising and sample trials of new products in new areas are essential.
One new strategy will include an infomercial campaign to promote and educate farmers on benefits of Yongye’s nutrient products and provide in-store training for farmers on the use of the products. In 2009, we began running this on CCTV, which is the agricultural channel in China. In this way, we hope to increase the predictability of operational and sales performance for both the franchisee and the farmer.
Our Distribution & Sales Network
Our Distributor Network channel is comprised by provincial or regional agents who purchase our products and sell them through a chain of local agents whose terminal sales point is a retail store or large farm. As of March 31, 2009 there were approximately 3,500 retail stores selling Shengmingsu products. This group of stores is comprised of pre-existing, independently owned agricultural product stores, which sell our product to local farmers. As of March 31, 2009, there were 2,000 such stores in the Yongye Branded Store network and 1,500 stores which are in a trials basis to become a branded store.
This network of retail stores create a “community-direct” model through which our distributors sell our product. In these stores, Yongye products are featured and prominently displayed. We believe these stores have a local feel and have long time recognition in the community as the “trusted” local agricultural product expert. Before a distributor decides to bring a store into his segment of the Branded Store network, he may require it to go through a trials process whereby the owner works with him to reach specific performance goals. After branding, each store has the opportunity to sell a nationally distributed product which attracts attention to the store.
While we generally encourage distributors to model each branded store after our own national model, he ultimately has the control over the final implementation of the branding along with the store owner. Store owners receive a proven product, training and promotional assistance. Some stores are supplied with a computer that has educational and promotional programs used to help farmers understand the benefits of using Yongye products. The goal being to encourage farmers to make Yongye products a greater part of their annual planning process while building brand awareness.
Raw Materials and Our Principal Suppliers
The humic acid we use comes from lignite coal which is mined in Inner Mongolia and it can be purchased at normal market rates on a per ton basis. Humic Acid is mined from lignite or Leonardite coal. Leonardite is defined as highly oxidized low grade lignite that contains a relatively high concentration of the smaller molecular units (fulvic acids (FA)). China has approximately 12% of the world’s lignite reserves according to the survey of energy resources published by the World Energy Council.
We believe we are able to produce a high quality fulvic acid base product by controlling the input of humic acid from direct, contracted suppliers. Currently, they have four principal suppliers which are all in Hohhot City: Heng Ya Trading Company, Bo Yi Ze Trading Company, Feng Li Trading Company and Sinochem. Their main supplier has dedicated one production line to us and has based their production design on our specific technical requirements. This line produces much of the humic acid we need, but only constitutes about 40% of their capacity. The other suppliers take up slack in supply when needed.
In addition to humic acid, we also utilize up to 18 different components in our production process, all of which can be readily obtained from numerous sources in local markets and require no special purchase requirements.
The Chinese fertilizer industry is highly fragmented. By 2007, there were over 2,000 fertilizer products in the government’s registry. We compete more specifically with producers of fulvic acid products and there are 164 of these in the registry (Source: Chinese Fertilizer Net). Of these 164, we believe that only four other products are similar to ours in the type of raw materials added. The top three producers of these products based on revenue generated in 2007 were:
We believe that we have the following four competitive advantages:
The past few years have seen tremendous growth in the company and our employee base has also scaled with the business model. In focusing on our distribution base rather than on direct sales to farmers, we have decreased the number of temporary employees which are reflected in the 2007 numbers, and have hired full time sales professionals who work directly with distributors and branded stores. Here are our 2006, 2007 and 2008 numbers broken out between Yongye Nongfeng Biotechnology Co., Ltd. (YNFB), and its contracted manufacturing company Inner Mongolia Yongye (YBL):
As of December 31, 2008, all employees, including manufacturing staff, have signed contracts with Yongye Nongfeng Biotechnology Company, Ltd. and work exclusively for us. The manufacturing and R&D staff will be transferred over in 2009 as part of the restructuring process. None of our employees are under collective bargaining agreements. We believe that we maintain a satisfactory working relationship with our employees and we have not experienced any significant labor disputes or any difficulty in recruiting staff for our operations.
Research and Development
The product development life cycle is an important part of the way we do business. We bring new products to market in the following way: market research, funding approval, R&D on product, trials, approvals, model for marketing and market entry. The typical process may take up to three years depending upon the governmental approval process.
Inner Mongolia Yongye, the predecessor company, has carried on independent research for many years in the area of biochemistry including humic acid and fulvic acid research, development and industrialization. This research was transferred to Yongye Nongfeng as part of the CJV agreement and is the intellectual property we currently use. Inner Mongolia Yongye filed two invention patent applications with the State of Intellectual Property Office of the PRC with the application numbers 200610131953.7 and 200510118240.2. Currently, one of the two patent applications has been granted (plant patent) and is in the name of the CJV while the other one is still pending (animal patent). The pending patent’s transfer to the CJV has been approved and when issued, it will be issued in the name of Yongye Nongfeng Biotechnology Co., Ltd. We also filed two trademark registration applications with the Trademark Bureau of the State Administration of Industry and Commerce of the PRC.
Our invention patents cover the mixture of both the base formulas for the plant and animal nutrient products and we will work to ensure that this mixture process is consistently carried out while also protecting our Intellectual Property. The Inner Mongolia Science & Technology Department has tested and compared our fulvic acid product with other fulvic acid products and found that it has a lighter weight and higher bio-activity than the other products it tested. Our extraction process for fulvic acid remains a trade secret and is protected by a non-compete contract with Professor Gao Jing.
In addition to trademark and patent protection law in China, we also rely on contractual confidentiality and non-compete provisions to protect our intellectual property rights and brand. We also take the further steps of limiting the number of people involved in the production process and, when taking in raw materials and preparing them for mixture, we refer to each ingredient by a number rather than its name.
Our products and services are subject to regulation by central and provincial governmental agencies in the PRC. Business and company registrations, along with the products, are certified on a regular basis and must be in compliance with the laws and regulations of the PRC and provincial and local governments and industry agencies, which are controlled and monitored through the issuance of licenses. Our licenses include:
Our operating license enables us to undertake research and development, sales and services of humic acid liquid fertilizer, sales of pesticides, and export and import of products, technology and equipment. The registration No. is 150000400000679, and it is valid until February 2010. Once the term has expired, the license is renewable for a five-year term. The license is in the name of the CJV.
Green Food Certified
All of our fertilizer products are certified by the PRC government as green products for growing Grade AA “Green” foods which means they contain little or no chemical materials and can be used to grow organic foods. This is given by the China Green Food Research Center which has been researching organic food issues since 1992 and is part of the PRC Ministry of Agriculture. Our certificate is valid from August 2007 to August 2010 and requires an annual inspection, which we passed in 2008.
Fertilizer registration is required for the production of liquid fertilizer and issued by the Ministry of Agriculture of the PRC. Our registration number is Agriculture Fertilizer No. 2630 (2008).
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. We make capital expenditures from time to time to stay in compliance with applicable laws and regulations, though the cost in not directly passed on to our customers as we do not use cost-based pricing.
Our principal executive offices are located on the 6th Floor, Suite 608, at Xue Yuan International Tower, No. 1 Zhichun Road, Haidian District, Beijing, PRC. Our telephone number at that address is 86 -10-8232-8866 x8880. Our corporate website is www.yongyebiotech.com. Information contained on or accessed through our website is not intended to constitute and shall not be deemed to constitute part of this registration statement on Form S - 1.
We are not a party to any material legal proceedings nor are we aware of any circumstance that may reasonably lead a third party to initiate legal proceedings against us.
Our principal executive offices are located at 6th floor, Xue Yuan International Tower, No. 1 Zhichun Road, Haidian District, Beijing PRC and the telephone number is 86-10-8232-8866 x8880. The office space is approximately 1,000 square meters in area. Inner Mongolia Yongye’s main production facility is in the High Tech Economic Development Zone in Hohhot City in Inner Mongolia.
There is no private ownership of land in China. All land ownership is held by the government of the PRC, its agencies and collectives. Land use rights can be transferred upon approval by the land administrative authorities of the PRC (State Land Administration Bureau) upon payment of the required land transfer fee. Inner Mongolia Yongye owns the land use rights for the land on which its manufacturing facility is situated, which have a term of 50 years from 2003.
ITEM 1A Risk Factors
An investment in our Common Stock is speculative and involves a high degree of risk and uncertainty. You should carefully consider the risks described below, together with the other information contained in this prospectus, including the consolidated financial statements and notes thereto, before deciding to invest in our Common Stock. Additional risks not presently known to us or that we presently consider immaterial may also adversely affect our Company. If any of the following risks occur, our business, financial condition and results of operations and the value of our Common Stock could be materially and adversely affected.
Risks Related to Our Business
The CJV is still in the process of transitioning its business operations from our predecessor company.
We established the Cooperative Joint Venture, Yongye Nongfeng Biotechnology, on January 4, 2008, with the intention and ultimate goal of carrying out the business of marketing and distributing our fulvic acid plant and animal nutrient products. We have transitioned all personnel, services, and control issues for the distribution and sales operations from our predecessor company Inner Mongolia Yongye (which currently, under contract, has a 0.5% ownership interest in the Cooperative Joint Venture and is under the control of Mr. Zishen Wu), to the Cooperative Joint Venture (Mr. Wu is also the CEO of the Cooperative Joint Venture). All personnel, services, and control issues relating to the manufacturing operations - from procurement of raw materials to final production, have also been transferred to Yongye Nongfeng from the predecessor company, which was our primary contract manufacturing company for acquiring finished goods for all of 2008 and the first three quarters of 2009. This was implemented as part of the restructuring plan agreed upon in the September 2008 financing. We began transitioning the manufacturing entity to the CJV starting with the valuation of the Predecessor’s 2,000TPA equipment in October 2008, continued with the issuance of the fertilizer license into the name of the CJV on June 1, 2009 by the Ministry of Agriculture, and will be completed with the transfer of the title for the land and remaining buildings, which we anticipate will occur by October 11, 2009. The total liability incurred for payments to the predecessor company is limited to USD$6M and thus far USD$.95M has been paid to the predecessor company.
We have complied with all of the stipulations in the supplemental agreement related to the transition of the business. The IP related transfer for the plant product has been officially completed with the patent being granted to the predecessor company and then transferred into the name of the CJV. However, the patent for the animal product has not been granted though the transfer agent has approved the transfer of the patent into the name of the CJV once it has been granted.
To the extent that the current corporate structure is ineffective in facilitating our business operations as contemplated, we may decide to unwind or modify the current Cooperative Joint Venture in favor of a more efficient corporate structure, which may include formation of a wholly owned foreign entity. This may be accomplished without seeking approval from investors in the financing.
Currently, all of the distributorship agreements are in the name of Yongye Nongfeng, however, there are no formal agreements between Yongye Nongfeng and the branded stores. The limited operating history and the early stage of development of the Cooperative Joint Venture make it difficult to evaluate its business and future prospects. Although the “Predecessor” company, Inner Mongolia Yongye’s revenues have risen quickly and has transferred the same agreements to the CJV, we cannot assure you that the Cooperative Joint Venture will continue to maintain such profitability or that it will not incur net losses in the future. We expect that our operating expenses will increase as we expand. Any significant failure to realize anticipated revenue growth could result in operating losses.
Our reliance upon our contract manufacturer for finished goods may hinder our ability to be profitable.
We are dependent upon our relationship with our contract manufacturer, Inner Mongolia Yongye, which provides us with 100% of their production of goods up until the time that all the manufacturing assets are transferred to the CJV. The CJV has the opportunity to purchase from other suppliers, but Inner Mongolia Yongye is required to sell us 100% of their production and they supplied us with approximately 100% of our finished goods in 2008. Should they be unable to procure sufficient amounts of their raw materials, they may be unable to meet all of our demand. Or, if they have production restrictions and cannot perform their obligations as agreed, we may be unable to specifically enforce our agreements and will need to find other suppliers. If they are unable to obtain adequate quantities of humid acid at economically viable prices, our business could be unprofitable and investors may lose their entire investment in us.
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 plan to continue to expand rapidly. To meet the demand of our customers, we must continue to expand our distribution network in terms of numbers and locations. The continued growth of our business has resulted in, and will continue to result in, substantial demand on our management, operational and other resources. In particular, the management of our growth will require, among other things:
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 would be materially and adversely affected.
We rely on contractual arrangement with Inner Mongolia Yongye for our China operations, which may not be as stable and effective in providing operational control as direct ownership.
We rely on the CJV Agreement with Inner Mongolia Yongye to operate our business. Under the current CJV agreement, as a legal matter, if Inner Mongolia Yongye exercises its contractual rights to terminate the CJV agreement, we would have no rights to prevent such an event from occurring. In addition, if Inner Mongolia Yongye fails to perform its obligations under the CJV agreement, 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 claiming damages, which we cannot assure you 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 its contracts with us.
The CJV agreement is governed by PRC laws and provides for the resolution of disputes through either arbitration or litigation in the PRC. 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 these contractual arrangements. In the event we are unable to enforce these contractual arrangements, we may not be able to exert effective control over our operating entities, and our ability to conduct our business may be negatively affected.
Inner Mongolia Yongye’s reliance upon third-party suppliers for raw materials may hinder our ability to be profitable.
Inner Mongolia Yongye, or the CJV once the restructuring process is complete, is dependent upon its relationships with third parties for its supply of humic acid. Inner Mongolia Yongye has three major suppliers of humic acid, which provided approximately 100% of its raw material feedstock in 2007, and 100% in 2008. Should any of these suppliers terminate their supply relationships, Inner Mongolia Yongye, or the CJV once the restructuring is complete, may be unable to procure sufficient amounts of humic acid to meet the demand and our profitability may be limited. In addition, these suppliers may not perform their obligations as agreed, and it may not be possible to specifically enforce the related agreements. If Inner Mongolia Yongye, or the CJV once the restructuring is complete, is unable to obtain adequate quantities of humid acid at economically viable prices, our business could become unprofitable and investors may lose their entire investment in us.
Adverse weather conditions could reduce demand for fertilizer products.
The demand for our nutrient products fluctuates significantly with weather conditions, which may delay the application of the fertilizer or render it unnecessary at all. If any natural disasters, such as flood, drought, hail, tornado or earthquake, occur, demands for our products will be reduced.
Our business will suffer if Inner Mongolia Yongye loses its land use rights.
There is no private ownership of land in China and all land ownership is held by the government of the PRC, its agencies and collectives. Land use rights can be obtained from the government for a period up to 70 years, and are typically renewable. Land use rights can be transferred upon approval by the land administrative authorities of the PRC (State Land Administration Bureau) upon payment of the required land transfer fee. Inner Mongolia Yongye has received the necessary land use right certificate for its primary operating facilities, but we can give no assurance that these land use rights will be renewed on favorable terms or renewed at all. If Inner Mongolia Yongye, or the CJV once the restructuring is complete, loses its land right certificates we may lose access to production facilities that may be difficult or impossible to replace. Should we, or the CJV once the restructuring is complete, have to relocate, the workforce may be unable or unwilling to work in the new location and operations will be disrupted during the relocation. The relocation or loss of facilities could cause us, or the CJV, to lose sales and/or increase costs of production, which will negatively impact our financial results.
Our business will be harmed if our major distributors reduce their orders or discontinue doing business with us.
For the year ended December 31, 2008, we sold our products primarily through 5 major distributors in our top 4 provinces. These five major customers accounted for 92% (and one major customer accounted for 43%) of our net revenue for the year ended December 31, 2008. These five major customers accounted for 82% (and the same one major customer accounted for 29%) of the predecessor’s net revenue for the year ended December 31, 2007. Although we believe that our relationship with these distributors is good, we have no long-term supply agreements with them and any or all of them could termination their relationship with us in favor of competitors with increased productions capabilities or offering lower prices or other favorable terms. If some or all of these distributors reduce their orders or discontinue doing business with us, we could have difficulties finding new distributors to distribute our products and our revenues and net income could in turn decline considerably. Our reliance on these major distributors could also affect our bargaining power in getting favorable prices for our products. In addition, untimely payment and/or failure to pay by these major distributors would negatively affect our cash flow.
If we cannot renew our fertilizer registration certificate, which expires in one year, we will be unable to sell some of our products which will cause our sales revenues to significantly decrease.
All fertilizers produced in China must be registered with the PRC Ministry of Agriculture. No fertilizer can be manufactured without such registration. Inner Mongolia Yongye has obtained a Fertilizer Registration Certificate from the PRC Ministry of Agriculture. Such certificate was issued in February 2008 and was reissued in June 2009 in the name of the CJV. The certificate has a 5-year life span that includes annual renewals through 2010. Then, if all conditions remain satisfied, it will be issued as a permanent license from 2010 with no further annual renewals needed.
Our belief is that the PRC Ministry of Agriculture generally will grant an application for renewal in the absence of illegal activity by the applicant. However, there is no guarantee that the PRC Ministry of Agriculture will grant renewal of 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.
Key employees are essential to growing our business.
Mr. Zishen Wu is essential to our ability to continue to grow our business. Mr. Zishen Wu has established relationships within the industries in which we operate. If Mr. Wu or other members of our senior management were to leave us, our growth strategy might be hindered, which could limit our ability to increase revenue. In addition, we face competition for attracting skilled personnel. If we fail to attract and retain qualified personnel to meet current and future needs, this could slow our ability to grow our business, which could result in a decrease in market share.
We will continue to encounter risks and difficulties in implementing our business model, including potential failure to:
If we are not successful in addressing any or all of these risks, our business may be materially and adversely affected.
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 expect competition to persist and intensify in the future. Our competitors are mainly domestic leaders in the fertilizer markets in China. We face the risk that new competitors with greater resources than us will enter our markets.
If we need additional financing, we may not be available to find such financing on satisfactory terms or at all.
Our capital requirements may be accelerated as a result of many factors, including timing of development activities, underestimates of budget items, unanticipated expenses or capital expenditures, future product opportunities with collaborators, 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, if 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. 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. 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.
Financial damages may be imposed on us if we are unable to retain certain “financial professionals” as required by the securities purchase agreements.
The April Purchase Agreement and September Purchase Agreement obligate us to hire a chief financial officer who has experience as a senior financial officer of a United States public reporting company and who is (i) fluent in English, (ii) residing or will reside, upon employment by us, in Asia, and (iii) familiar with GAAP and auditing procedures and compliance for the United States public companies and to enter into an employment agreement with such professional for a term of no less than two years. Although we have hired Mr. Sam (Yue) Yu as the chief financial officer in accordance with the preceding obligations, if we fail to continue comply with the above obligations regarding such financial professional, we may incur financial damages in the amount of 1% of the proceeds of the financing, monthly, up to an aggregate amount of 6% of the amount of the financing.
The imposition of such financial damages would require the use of capital that we had planned to use, and may require, in connection with our business.
If we fail to adequately protect or enforce our intellectual property rights, or to secure rights to patents and trademarks of others, 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 one patent for our plant product and have one patent pending for our animal product with the State Intellectual Property Office of the PRC. We also have two trademark registration applications to the Trademark Bureau of State Administration of Industry and Commerce of the PRC. However, we cannot predict the degree and range of protection patents and trademarks will afford us against competitors. Third parties may find ways to invalidate or otherwise circumvent our 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, such actions may be costly whether we win or lose.
Our success also depends on the skills, knowledge and experience of our scientific and technical personnel, consultants, advisors, licensors and contractors. To help protect our proprietary know-how and inventions for which patents may be unobtainable or difficult to obtain, we rely on trade secret protection and confidentiality agreements. If any of our intellectual property is disclosed, our value would be significantly impaired, and our business and competitive position would suffer.
If we infringe the rights of third parties, we could be prevented from selling products, forced to pay damages and compelled to defend against litigation.
If our products, formula, methods, processes and other technologies infringe proprietary rights of other parties, we 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 it wins or loses. All of the above could result in a substantial diversion of valuable management resources.
We believe we have taken reasonable steps, including comprehensive internal and external prior patent 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 no third-party patent has been filed or will be filed that may contain subject matter of relevance to our development, causing a third-party patent holder to claim infringement. 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.
We have never paid cash dividends and are not likely to do so in the foreseeable future.
We have never declared or paid any cash dividends on our Common Stock. We currently intend to retain any future earnings for use in the operation and expansion of our business. We do not expect to pay any cash dividends in the foreseeable future but will review this policy as circumstances dictate.
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 and, beginning with our next annual report, a report by our independent registered public accounting firm addressing these assessments. The process of designing and implementing effective internal controls is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to expend significant resources to maintain a system of internal controls that is adequate to satisfy our reporting obligations as a public company. We cannot assure you that we will not, in the future, identify areas requiring improvement in our internal control over financial reporting. We cannot assure you that the measures we will take to remediate any areas in need of improvement will be successful or that we will implement and maintain adequate controls over our financial processes and reporting in the future as we continue our growth. If we are unable to establish appropriate internal financial reporting controls and procedures, it could cause us to fail to meet our reporting obligations, result in the restatement of our financial statements, harm our operating results, subject us to regulatory scrutiny and sanction, cause investors to lose confidence in our reported financial information and have a negative effect on the market price for shares of our Common Stock.
Lack of experience as officers of publicly traded companies of our management team may hinder our ability to comply with Sarbanes-Oxley Act.
It may be time consuming, difficult and costly for us to develop and implement the 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, we may not be able to obtain the independent auditor certifications that Sarbanes-Oxley Act requires publicly traded companies to obtain.
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 new rules subsequently implemented by the SEC, has required changes in corporate governance practices of public companies. We expect these new rules and regulations to increase our legal, accounting and financial compliance costs and to make certain corporate activities more time-consuming and costly. In addition, we will incur additional costs associated with our public company reporting requirements. We are currently evaluating and monitoring developments with respect to these new rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.
Risks Associated With Doing Business In China
There are substantial risks associated with doing business in China, as set forth in the following risk factors.
Our operations and assets in China are subject to significant political and economic uncertainties.
Changes in PRC laws and regulations, or their interpretation, or the imposition of confiscatory taxation, restrictions on currency conversion, imports and sources of supply, devaluations of currency or the nationalization or other expropriation of private enterprises could have a material adverse effect on our business, results of operations and financial condition. Under our current leadership, the Chinese government has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the Chinese government will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice.
We derive a substantial portion of our sales from China.
Substantially all of our sales are generated from China. We anticipate that sales of our products in China will continue to represent a substantial proportion of our total sales in the near future. Any significant decline in the condition of the PRC economy could adversely affect consumer demand of our products, among other things, which in turn would have a material adverse effect on our business and financial condition.
Currency fluctuations and restrictions on currency exchange may adversely affect our business, including limiting our ability to convert Chinese renminbi into foreign currencies and, if Chinese renminbi were to decline in value, reducing our revenue in U.S. dollar terms.
Our reporting currency is the U.S. dollar and our operations in China use their local currency as their functional currencies. Substantially all of our revenue and expenses are in Chinese 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. Since 1994, 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 Chinese government changed its policy of pegging the value of Chinese renminbi to the U.S. dollar. Under the new policy, Chinese 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 21.3% appreciation of the Renminbi against the U.S. dollar between July 21, 2005 and December 31, 2008.
It is possible that the Chinese government could adopt a more flexible currency policy, which could result in more significant fluctuation of Chinese renminbi against the U.S. dollar. We can offer no assurance that Chinese renminbi will be stable against the U.S. dollar or any other foreign currency.
The income statements appearing elsewhere herein are translated into U.S. dollars at the average exchange rates in each applicable period. To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currencies denominated transactions will result in reduced revenue, operating expenses and net income for our international operations. Similarly, to the extent the U.S. dollar weakens against foreign currencies, the translation of these foreign currency denominated transactions will result in increased revenue, operating expenses and net income for our international operations. We are also exposed to foreign exchange rate fluctuations as we convert the financial statements of Fullmax Ltd and Asia Standard Oil, Ltd into U.S. dollars in consolidation. If there is a change in foreign currency exchange rates, the conversion of the 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 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 create fluctuations that will lead to a transaction 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.
Although Chinese governmental policies were introduced in 1996 to allow the convertibility of Chinese renminbi into foreign currency for current account items, conversion of Chinese renminbi into foreign exchange for capital items, such as foreign direct investment, loans or securities, requires the approval of the State Administration of Foreign Exchange, or SAFE, which is under the authority of the People’s Bank of China. These approvals, however, do not guarantee the availability of foreign currency conversion. We cannot be sure that we will be able to obtain all required conversion approvals for our operations or that Chinese regulatory authorities will not impose greater restrictions on the convertibility of Chinese renminbi in the future. Because a significant amount of our future revenue may be in the form of Chinese renminbi, our inability to obtain the requisite approvals or any future restrictions on currency exchanges could limit our ability to utilize revenue generated in Chinese renminbi to fund our business activities outside of China, or to repay foreign currency obligations, including our debt obligations, which would have a material adverse effect on our financial condition and results of operations.
We may have limited legal recourse under PRC law if disputes arise under our contracts with third parties.
The Chinese government has enacted some laws and regulations dealing with matters such as corporate organization and governance, foreign investment, commerce, taxation and trade. However, their experience in implementing, interpreting and enforcing these laws and regulations is limited, and our ability to enforce commercial claims or to resolve commercial disputes is unpredictable. If our new business ventures are unsuccessful, or other adverse circumstances arise from these transactions, we face the risk that the parties to these ventures may seek ways to terminate the transactions, or, may hinder or prevent us from accessing important information regarding the financial and business operations of these acquired companies. The resolution of these matters may be subject to the exercise of considerable discretion by agencies of the Chinese government, and forces unrelated to the legal merits of a particular matter or dispute may influence their determination. Any rights we may have to specific performance, or to seek an injunction under PRC law, in either of these cases, are severely limited, and without a means of recourse by virtue of the Chinese legal system, we may be unable to prevent these situations from occurring. The occurrence of any such events could have a material adverse effect on our business, financial condition and results of operations.
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 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.
We may not be guaranteed of a continuance to receive the preferential tax treatment we currently enjoy under PRC law, 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 that was effective as of January 1, 2008. Pursuant to the new law, the enterprise income tax of 25% shall be applied to any enterprise. While the Company was approved by the local tax authority in April 2008 to pay revenue tax at a rate of 1.25% of gross revenue rather than on 25% of net income as defined by PRC accounting principles, and to receive a tax rebate of 31.2% on all income taxes paid prior to this approval. We would have had to pay $3,571,000 in income tax under the regular tax rate, which would have been an additional $2,707,000 over the actual amount we paid for 2008. We do not know how long this will continue or if any new law may change the preferential treatment granted to us. We also do not know if we will continue to receive the rebate after the approval date. This preferential tax treatment is reviewed and granted each year by local tax authorities. Any loss or substantial reduction of the tax benefits enjoyed by us would reduce our net profit.
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 RMB to fund our business activities outside the PRC or to make dividends or other payments in United States dollars. The PRC government strictly regulates conversion of RMB 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 RMB 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:
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 issued updated internal implementing rules (“Implementing Rules”) in relation to Notice 75. The Implementing Rules were promulgated and became effective on May 29, 2007. Such Implementing Rules provide more detailed provisions and requirements regarding the overseas investment foreign exchange registration procedures. However, even after the promulgation of Implementing Rules there still exist uncertainties regarding the SAFE registration for PRC residents’ interests in overseas companies. It remains uncertain whether PRC residents shall go through the overseas investment foreign exchange registration procedures under Notice 75 or Implementing Rules, who may indirectly hold our shares through the participation and exercise of incentive stock options granted to our members of our management by Full Alliance.
As a result, we cannot predict how they will affect our business operations following a business combination. For example, our ability to conduct foreign exchange activities following a business combination, such as remittance of dividends and foreign-currency-denominated borrowings, may be subject to compliance with the SAFE registration requirements by such PRC residents, over whom we have no control. In addition, we cannot assure you that such PRC residents will be able to complete the necessary approval and registration procedures required by the SAFE regulations. We will require all our shareholders, following a business combination, who are PRC residents to comply with any SAFE registration requirements, if required by Notice 75, Implementing Rules or other applicable PRC laws and regulations, although we have no control over either our shareholders or the outcome of such registration procedures. Such uncertainties may restrict our ability to implement our business combination strategy and adversely affect our business and prospects following a business combination.
Recent 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 September 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 the State Administration of Foreign Exchange, or 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. 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 “Administrative Permits”), including a list of application materials with respect to the listing on overseas stock exchanges by SPVs.
Based on our understanding of current PRC Laws, we are not sure whether the New M&A Rule would require us or our entities in China to obtain the CSRC approval in connection with the transaction contemplated by the Exchange Agreement in connection with the share exchange.
Further, if the PRC government finds that we or our management members did not obtain the CSRC approval, which CSRC may think we should have obtained before our executing the Exchange Agreement, we could be subject to severe penalties. The New M&A Rule does not stipulate the specific penalty terms, so we are not able to predict what penalties we may face, and how such penalties will affect our business operations or future strategy.
The Chinese government exerts substantial influence over the manner in which we must conduct our business activities.
China only recently has permitted provincial and local economic autonomy and private economic activities, and, as a result, we are dependent on our relationship with the local government in the province in which we operate our business. Chinese government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, environmental regulations, land use rights, property and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of these jurisdictions may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations. Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof, and could require us to divest ourselves of any interest we then hold in Chinese properties.
Future inflation in China may inhibit our activity to conduct business in China.
In recent years, the Chinese economy has experienced periods of rapid expansion and high rates of inflation. During the past ten years, the rate of inflation in China has been as high as 20.7% and as low as (2.2)%. These factors have led to the adoption by Chinese government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation. While inflation has been more moderate since 1995, high inflation may in the future cause Chinese government to impose controls on credit and/or prices, or to take other action, which could inhibit economic activity in China, and thereby harm the market for our products.
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 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 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.
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 agriculture sector.
In general, the agriculture sector in China is affected by a series of factors both natural, economic and social such as climate, market, technology regulation, and globalization, which makes risk management difficult. Agriculture in China faces similar risks as do other countries, however, these can either be mitigated or exacerbated due to governmental intervention through policy promulgation and implementation either in the agriculture sector itself or sectors which provide critical inputs to agriculture such as energy or outputs such as transportation. While not an exhaustive list, the following factors could significantly affect our ability to do business:
Currently, the Company does not hold and does not intend to purchase insurance policies to protect revenue in the case that the above conditions cause loss of revenue.
We may have difficulty establishing adequate management, legal and financial controls in the PRC.
The PRC historically has been deficient in Western style management and financial reporting concepts and practices, 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 meet Western standards. We may have difficulty 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 avian flu, severe acute respiratory syndrome, or SARS, or another epidemic or outbreak. From 2005 to 2007, there have been reports on the occurrences of avian flu in various parts of China and elsewhere in Asia, including a few confirmed human cases and deaths. Any prolonged recurrence of 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, and a general slowdown in the Chinese economy. 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 avian flu, SARS or any other epidemic.
Risks Related to the Common Stock
The market price of our Common Stock may be volatile.
The market price of our Common Stock has been and will likely continue to be highly volatile, as is the stock market in general. 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 of our Common Stock. These factors may materially adversely affect the market price of our Common Stock, regardless of our performance. In addition, the public stock markets have experienced extreme price and trading volume volatility. This volatility has significantly affected the market prices of securities of many companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our Common Stock.
ITEM 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations
Except for the historical information contained herein, the matters discussed in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this report are forward-looking statements that involve risks and uncertainties. The factors listed in the section captioned “Risk Factors,” as well as any cautionary language in this report, provided examples of risks, uncertainties and events that may cause our actual results to differ materially from those projected. Except as may be required by law, we undertake no obligation to update any forward-looking statement to reflect events after the date of this prospectus.
Restatement of Financial Statements
Due to the complexities of placing the April 2008 Escrow Shares and September 2008 Escrow Shares into escrow and subsequently accounting for the performance measures and potential transfer of such shares, the company believed and accounted for such shares as contingently issuable shares for purposes of calculating earnings per share and excluded such outstanding escrowed shares from the calculation of the weighted average number of common shares outstanding. However, after further examination subsequent to the original filing of our Form 10-K for the year ended December 31, 2008, it was determined that since the April 2008 Escrow Shares and September 2008 Escrow Shares are neither contingently cancellable nor contingently returnable to the Company, the shares should have been included in the denominator in computing the Company’s basic and diluted net income per share.
In connection with the April Offering and September Offering in 2008, the Company issued the “April Warrants” and “September Warrants” to certain investors and Roth Capital Partners, LLC (“Roth”) (See Financial Statements Note 12). 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 accordance with Emerging Issues Task Force Issue (EITF) No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, such potential cash payments that are not within the Company’s control would preclude equity classification and therefore the warrants should have been classified as a liability and adjusted to fair value through earnings at each reporting dates starting from the issuance date.
As of December 31, 2008, a liability of $2,107,931 representing the fair value of the April Warrants and the September Warrants should have been recorded and the retained earnings should have been increased by $2,118,797 representing the net decrease in fair value of these warrants through December 31, 2008 from their respective dates of issuance. These fair value adjustments should have been recorded through earnings for the respective periods. Refer to Note 1(C) to the accompanying consolidated financial statements for details.
We are engaged in the development and distribution of fulvic acid based liquid and powder nutrient compounds used in the agriculture industry. Our headquarters is in Beijing, China and additional administrative offices and our manufacturing unit are located in Hohhot, Inner Mongolia, China. Currently, we sell two lines of products, both based on our fulvic acid compound base: a plant nutrition liquid compound and animal nutrition powder which is a food additive. Our products start with our proprietary fulvic acid base which is extracted from humic acid, and to which we add other natural substances to customize the base for use in our plant and animal product lines. Based on our internal data and research, we believe our proprietary technology for fulvic acid extraction creates some of the purest and most effective fulvic acid base on the market in China today. We have found that our fulvic acid has a very light weight molecular composition, which we believe improves the overall permeability of cell walls and allows more complete transport of nutrients across plant membranes, effectively strengthening the overall health of plants. We believe our proprietary process for extracting fulvic acid from humic acid and our patented process for mixing our plant nutrient and patent pending process for mixing our animal nutrient are key differentiators in the market and may help us provide a high quality product that we can control from procurement of raw materials to final production, which we also believe may help our products to provide reliable and predictable results from season to season.
We are headquartered in Beijing, China and Inner Mongolia Yongye’s manufacturing plant is located in the Inner Mongolia province of China. Currently, we sell two lines of product based on our fulvic acid base: plant nutrition liquid compound and animal nutrition food additive. Our products start with our fulvic Acid base then, in addition, we add other natural substances to customize the base for use in our plant or animal lines of products. Our plant products are intended to add naturally occurring macro and micro nutrients such as nitrogen, phosphorus, potassium, boron and zinc. Our animal product adds natural herbs which we believe may help to reduce bacterial inflammation (mastitis) in cows. It also assists many animals to digest food more completely and thus we believe that our animal products may help animals who use them to be healthier.
Our predecessor company, Inner Mongolia Yongye, began recording sales of its first plant product in 2005 and by 2007 marketed and sold both plant product in 10 provinces and animal product in 2 provinces. In 2008, we sold approximately 5,100 tons of plant product (427,200 units), which represented 93% of revenue at USD $44.8M. We also sold approximately 6 tons of our animal product (approximately 98,000 units). This represented 7% of revenue at USD $3.25M. In its highly concentrated form, based on internal sales data and readily available government data, our plant product was sprayed on approximately 2% of all available arable land in our 10 provinces and in our largest province, Xinjiang, it was applied to 5% of the land available for cultivation. Yongye’s top 3 provinces by revenue for 2008 represented 70% of sales and were Hebei at $20,541,267 (43%), Xinjiang at $6,886,634 (14%) and Gansu at $6,291,070 (13%). By the end of 2008, our manufacturing partner’s capacity enabled us to produce approximately 10,000 ton per annum of Shengmingsu product. These facilities run at almost full capacity to meet peak season demands and store inventory for next year. On average, our Shengmingsu products sell for approximately $10,000 per ton.
The financial statements we are reporting for 2007 are for our predecessor company, Inner Mongolia Yongye, which has now transferred all 2008 and 2009 sales contracts and income, intellectual property and patents, and personnel, exclusive of manufacturing and R&D personnel, into the name of Yongye Nongfeng Biotechnology (“Yongye Nongfeng”), the new Cooperative Joint Venture. After this transfer, Inner Mongolia Yongye became the primary contract manufacturing company for the new Cooperative Joint Venture and provided product at a cost plus price for the entire year of 2008. Inner Mongolia Yongye also kept the existing assets and long-term liabilities on its balance sheet.
Factors affecting our operating results
Demand for our products
One major tenet of the PRC government’s 11th Five-Year National Economic and Social Plan (the “NESDP”) (2006-2010) is the focus towards developing China’s western region. This is one of the top-five economic priorities of the nation. The goal is to increase rural income growth which will in turn increase demand for more food and agriculture products. Currently, a large majority of our products are sold in this western region and this government focus will increase our opportunity to sell more plant and animal nutrients to farmers who have to keep up with the demand for higher quantity and higher quality of products.
According to the Asian Development Bank statistics, well over 60% of the nation’s 1.3 billion total population is comprised of low-income, rural farmers. According to the 11th Five-Year NESDP (2006-2010), raising the level of rural income is a top economic and social goal for the country. Many government initiatives, including removal of certain agricultural and local product taxes, have been implemented to spur rural income development. The government expects annual rural income to grow between 5% and 10% through 2010 (Xinhua, October 12, 2008). Additionally, according to the National Population and Family Planning Commission, China's population will reach 1.5 billion by 2030. Therefore, the country has the challenge of producing approximately 100 million more tons of crops needed to feed the additional 200 million people. This put pressure on the agricultural system to increase production capacity.
Supply of Finished Goods
Currently, we purchase our finished goods from our main supplier, Inner Mongolia Yongye and then sell it through our distribution system. In order to generate greater profit margins, we set out to control our cost of goods sold and have put into place a fixed rate contract with our main supplier and this will extend over the next five years. Each quarter we will go through a review process with our supplier to adjust the fixed rate for the next quarter. We did not receive any rate increases in 2008.
Earthquake in Sichuan
The earthquake in Sichuan was a devastating event in the recent history of China. While the impact was felt all the way to Beijing, the disruption of business and the ensuing relief efforts were largely contained to the province itself and mainly to the areas nearest the epicenter. Because of this, the impact to our business was minimal. China’s Agriculture Minister Sun Zhengcai said in an interview with Xinhua that agriculture production would not be widely changed due to the earthquake in Sichuan primarily because the local output of the impacted area was quite small. He also mentioned that harvesting had been stepped up to ensure food security nationwide.
We typically face the seasonal demand patterns similar to other companies in our sector. In general, the first and fourth quarters are typically our slowest quarters and in 2008 we brought in approximately 20% and 6% of sales in these quarters. The second and third quarters drive the bulk of our overall sales with 36% and 38% respectively of the year’s net sales. Our Shengmingsu plant line faces the most seasonality of our two product lines with our Shengmingsu for animals experiencing less fluctuation during the year as a result of seasonal buying patterns. This year, while we did experience fluctuations by quarter of our animal line, we believe that this was due more in part to fluctuations in our sales and marketing efforts than due to seasonal buying patterns. We do not expect to face this type of revenue fluctuation for our animal product, which doesn’t typically experience the same seasonal tapering that our plant product faces.
Agriculture continues to be a heavily invested sector in China. Brand name investors continue to invest into China’s agriculture space because they have confidence in China’s long term outlook. The market volume for agriculture products is large, both for domestic sales and export and there is no set threshold for foreign investment into the sector as opposed to other industries, such as energy, finance, mining, and telecommunications. This is driven by the growing demand for higher quality food products domestically and international reliance on food products from China. Currently, China is the world’s biggest grower and consumer of grains and yet must boost crop yields by at least 1 percent a year to ensure the country has enough food to feed its 1.3 billion people, according to the Minister of Agriculture, Sun Zhengcai (China Economic Net, July 21, 2008).
Additional policy changes are expected to include protecting farmland and working to increase rural incomes to retain farming interest with the goal being to maintain self-sufficiency in food production by improving yields based on stable farmland. This extended to ensuring crop production for 2009 by targeting idle farmland to grow new crops.
New Land Reform Policy
Farmland in China is owned by the local government, but given to local farmers under 30 year use contracts. With the allure of higher incomes and better living conditions in the city, farmers have abandoned the land and no others farmers have stepped in to bring it back into production. This has created a shortage of productive agricultural land. The government has acknowledged this issue and recently enacted a new land use reform policy which liberalizes the exchange of land among the nation’s farmers. This creates a new model for China’s 730 million farmers with the idea being to create more stable farmland by shifting the country away from the single household farm plot model to the amalgamation of larger-scale operations which should be more productive due to technology and economies of scale. Farmers will be able to transfer their land-use rights to others through a new market system for rural land-use rights. This will ensure national food security through increasing the supply of agricultural products.
In the last six months of 2008, it was widely reported that China faced substantial drought conditions in important agricultural areas (as noted by The Economist in its “China’s Dry Patch” article dated February 6, 2009). This led many to the conclusion that this weather condition would have an overall negative impact on China’s annual agricultural output for 2008 and potentially for 2009 which would then have an impact on our company’s revenue. At the time, we did not believe this to be the case and set out to corroborate this with related government agencies, our sales and support staff, distributors, and branded store network owners in our provincial locations. We then gathered localized information about ways the drought might impact our distributors, their customers and our end users and found that they believed it would not create an impact on their sales and thus on our revenue for 2008. We also do not believe it will impact our sales activities in 2009 at this point in time.
In the ensuing months after the initial reports, there were several key events which occurred to mitigate some of the impact of the drought conditions faced by the farmers such as additional governmental spending on increased efforts to irrigate land using other water sources and additional rainfall which fell on once drought impacted areas in northern China as reported in Xinhua on February 9, 2008. The State Flood Control and Drought Relief Headquarters reported that there was a reduction of farmland affected because of these key events (Xinhua February 9, 2009). The government has also begun their stimulus injections into the agriculture community to help ward off the affects of any drought induced financial hardships (as reported in USA Today, February 8, 2009).
Additionally, we believe that several market conditions also bode well for us in the sales of our plant product during this time. Overall, the drought has impacted northern China and primarily large field crop growers such as wheat, corn and soy bean. Currently, our distributors concentrate on selling to farmers who grow economic crops such as tomatoes, celery, turnips, and carrots though in Xinjiang province our product is used on larger farms where field crops are grown such as Lajiao peppers. Additionally, in all drought situations, we believe that the drought resistant nature of our plant product will actually benefit crops because of the increased water retention characteristics of our product. Internal research has shown that fulvic acid has the ability to strengthen plant cells and root systems which then allows plants to retain water more effectively and use it more efficiently, which we believe may, along with other mitigating factors discussed above, help us ward off the impact of the 2008 fall and winter droughts on our sales in our current market area.
Yongye International, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
RESULTS OF OPERATIONS
Fiscal year ended December 31, 2008 compared with Fiscal year ended December 31, 2007
Our business for the year ended December 31, 2008 exceeded previous estimates and grew at a rate of 266% in net sales or a $34.9M increase over the same period in 2007. This demonstrated our ability to scale our distribution and sales mechanisms and drive robust revenue based on our new business model throughout the full year of 2008. This was primarily driven by higher volumes shipped through the first three quarters with the fourth quarter being the slowest due to seasonality. Numerous factors contributed to our strong growth: strong market demand, continued cost containment and steady pricing model, government policy support, industry growth, and sales and marketing leadership in our markets.
We believe that presenting a comparison of the results of our operations to our predecessor helps to provide a meaningful understanding of the underlying business since it enables a comparison of operations periodically. However, due to the transition from the predecessor to the Company that resulted in differences between our current operating model and our predecessor’s, the comparison of our information with the historical information of our predecessor might not be sufficient to be indicative of our future financial position, results of operations or cash flows. In particular, certain assets and liabilities of our predecessor differ significantly from our assets and liabilities.
The approximate 1,125 retail stores selling Shengmingsu products have been assembled into a network of stores through the work of our distributors. These stores have typically been in existence for many years and sell many other agriculture products including competitive products and we do not receive payment from the owner and they do not pay Yongye Nongfeng any fees or distribute any profits to us. Each distributor works to source successful, independently owned agricultural product stores to bring them into their segment of the branded store network. Our distributors work with the store owner to feature Yongye products in a prominent fashion and will also display brochures and advertisements for our products. Some stores will feature a computer which runs our current infomercials. Before the store is brought into the Branded Store network, it may be selling Yongye products as a “non-branded” store as arranged with our distributors. To become a “branded store” the distributor may require the store to go through a trials process to ensure the store reaches certain performance standards set by the distributor and the distributor will alone determine whether or not the store is considered a branded store. While we work with all of our distributors to standardize this model so that a minimum level of similarity is replicated across all the branded stores, it is implemented by the distributor.
The following table shows, for the periods indicated, information derived from our consolidated statements of income.
Our financial position at December 31, 2008 and December 31, 2007:
We increased our cash position to $4,477,477 at December 31, 2008 from $376,002 at December 31, 2007, which is an overall increase of $4,101,475, or
1091%. This was primarily due to increased collections of accounts receivable and the April and September financings. Accounts receivable increased by 69% to $2,748,042 as of December 31, 2008 from $1,630,609 as of December 31, 2007 due to increased growth in sales for the year. Property, plant and equipment increased to $5,368,074 at December 31, 2008 from $2,486,487 at December 31, 2007, which was a 116% increase and was largely due to the addition of the 8,000TPA facility in the third quarter. Additionally, shareholders’ equity increased by $14,389,131 to $27,300,603 as of December 31, 2008, which is an overall 111% increase compared to $12,911,472 on December 31, 2007, and was due primarily to the influx of our two financing transactions on April 17, 2008 and September 5, 2008 and net income for the year.
Sales revenue for the year ended December 31, 2008 was $48,092,271, an increase of $34,954,865 or 266%, compared with the corresponding period in 2007. This increase was the result of an increase in sales volume due to rapid expansion of our sales network and an increased footprint in each community via our branded stores.
Gross profit for the year ended December 31, 2008 was $24,926,587, and represented 52% of sales. This was an increase of $19,063,891, or 325%, when compared with $5,862,696 in the corresponding period in 2007. However, when compared as a percentage of revenues, Gross Profit Margin increased 7% from 45% to 52% from 2007 to 2008. The overall increase in margin was largely due to the economies of scale experienced by our contract manufacturer which were then passed along to Yongye Nongfeng in the form of lower unit costs.
The number of independently owned stores brought into our branded store network grew to 1,125 in the period ended December 31, 2008 from 200 in the same period ended December 31, 2007 which was an increase of 463%. This was due in large part to continued growth of the network throughout 2008 and the conversion of many non-branded stores into branded stores.
Additionally, Yongye Nongfeng was not required to pay VAT for the plant products sold, which increased its gross sales in 2008, whereas Inner Mongolia Yongye paid VAT for all products sold in 2007, which led to an approximate 4% decrease in gross sales. Once the product is recognized by the tax bureau as belonging in the agricultural fertilizer category, it is exempted from VAT taxation for all its future sales. Under the PRC taxation law, our product is categorized as an agricultural fertilizer and as such is exempted from VAT taxation. Our plant product was recognized by the tax bureau as agricultural fertilizer in 2008, so Yongye Nongfeng did not pay VAT for it. We expect this trend will continue as long as Yongye sells plant products.
Our number of branded stores grew to 1,125 in the period ended December 31, 2008 from 200 in the same period ended December 31, 2007 which was an increase of 463%
Sales by Product Line
Sales of plant product increased 298% to 427,196 units for the year ended December 31, 2008 from 107,269 units in the same period ended December 31, 2007.
Sales of animal product increased 77% to 98,058 units for the year ended December 31, 2008 from 55,305 units in the same period ended December 31, 2007.
Five major customers accounted for 92% and one major customer accounted for 43% of the Company’s net revenue for the twelve months period ended December 31, 2008. Five major customers accounted for 83% and one major customer accounted for 29% of the Predecessor’s net revenue for the twelve months period ended December 31, 2007. The Company and the Predecessor’s total sales to five major customers were $44,109,813 and $10,924,986, for the twelve months period ended December 31, 2008 and 2007, respectively.
Cost of Goods Sold
Cost of goods sold for the year ended December 31, 2008 was $23,165,684 which is 48% of revenues. This is an increase of $15,890,974 over the previous period which represents a 218% increase overall. However, as a percent of revenue, this represented an overall decrease of 7% when compared with the corresponding period in 2007 which was 55%. The overall decrease in cost of goods sold as a percentage was primarily due to the significant increase of sales and the fixed costs allocated to each unit of product throughout the twelve months ended December 31, 2008.
The major reason for the drop in cost by percentage is the change in business models between the two periods of 2008 and 2007. In year 2007, Inner Mongolia Yongye simply bought raw materials and produced them into finished goods at relatively small levels of production. This led to lower margins due to lower economies of scale and lower volume discounts on raw materials.
However, in 2008, Inner Mongolia Yongye became a contract manufacturer to Yongye Nongfeng which purchased 100% of the finished goods produced and did so at approximately 223% increase over 2007 with 525,254 units being sold in 2008 as opposed to 162,574 units in 2007. Based on this projected high volume of purchases, Inner Mongolia Yongye offered Yongye Nongfeng a fixed rate contract for finished goods for 2008. This helped Inner Mongolia Yongye reduce its fixed costs allocated to each unit of product which increased its overall margins and this was passed on to Yongye Nongfeng via the fixed rate contract. This helped increase the margin to 52%.
Selling, General & Administrative Expenses
Selling, general and administrative (“SG&A”) expenses for the year ended December 31, 2008 was $11,238,772, an overall increase of $10,312,776 or 1114% when compared with the corresponding period in 2007. However, while we increased revenues by 266%, we only increased spending on SG&A by 16% as a percentage of revenue. The increase in SG&A expenses was primarily due to increased sales activities in a larger number of provinces as we sold product in an 5 additional provinces as of the year ended December 31, 2008 as compared to the year ended December 31, 2007; we had increased staffing at the administrative level as we employed an additional 57 administrative staff than during the year ended December 31, 2007; we experienced increased executive salaries in the amount of $369,370 over the year ended December 31, 2007; advertising activities increased in the amount of $5,093,703 over the year ended December 31, 2007; increase of branded stores set-up cost of $1,113,146 as we added a new advertising and distribution model in the current year; increase of freight expense of $765,392 due to increased sales; increase of legal, audit and other professional fees of $793,102 due to the cost of being a public company; and we provided an allowance for doubtful accounts of $305,338 during the year ended December 31, 2008, while no such allowance was provided for the year ended December 31, 2007. Other increased expenses included office expense, rental and travel expenses, etc due to our business expansion.
Gain on change in fair value of derivative liabilities
The Company has accounted for warrants issued to investors and Roth in April Offering and September Offering in year 2008 as liability measured at fair value. The change in their fair value during the year ended December 31, 2008 added to Consolidated Statement of Income of a gain of $2,118,797. No such gain was recognized for the year ended December 31, 2007, as the Predecessor Company did not issue any such security during the year 2007. In addition, the gain recognized for the year ended December 31, 2008 was due to the significant decrease of our stock price at December 31, 2008 ($1.60) compared to that at issuance date April 17, 2008 ($2.22) and September 5, 2008 ($3.75).
Enterprise Income Taxes
The Company did not carry on any business and did not maintain any branch office in the United States during the years ended December 31, 2008 and 2007 and does not intend to repatriate any earnings from the Chinese operations. Therefore, no provision for withholding or U.S. federal income taxes or tax benefits on the undistributed earnings and/or losses of the Company has been made.
The predecessor is located in the economic development area in Inner Mongolia Autonomous Region; the predecessor is exempt from income tax according to the tax law in China.
For the year ended December 31, 2008, the Company’s income tax expense was $864,292 and income taxes payable was $219,366 as of December 31, 2008 as compared to $0 and $0 for the same period in 2007.
The Company’s Cooperative Joint Venture subsidiary, Yongye Nongfeng is subject to PRC Enterprise Income Tax at a rate of 25% of net income from its foundation on January 4, 2008 to March 31, 2008, and 1.25% of gross revenue since April 1, 2008. The difference in tax rates occurred because, while the CJV was entitled to the “Check and Ratify” taxation method rate, and did apply for it, the CJV did not receive approval for such rate until the second quarter of 2008. Under the PRC taxation system, the enterprise income taxation is conducted on a quarter by quarter basis and, therefore, we were subject to the rate of 25% of net income for the full first quarter of 2008 and computed the tax at 1.25% of gross revenue for the remaining three quarters of 2008.
Net income for the period ended December 31, 2008 increased by $8,952,204 to $13,310,758 from $4,358,554 in the same period ended December 31, 2007, which is a 205% increase. However, this also represented a decrease in the overall percentage of net income to sales by 5% going from 33% in the period ended December 31, 2007 to 28% in December 31, 2008. This was primarily due to increased SG&A over the period as described above.
Basic and diluted earnings per share (EPS) for the year ended December 31, 2008, were $0.68 and $0.56, respectively. The weighted average shares outstanding used to calculate basic and diluted EPS for the period were 19.6 million and 20.1 million, respectively.
Foreign Currency Translation Gains
The reporting currency of the Company is the US dollar. We use our local currency, Renminbi (RMB), as our functional currency. Results of operations and cash flows are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of shareholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.
The value of the USD versus the RMB continued to decline during the fourth quarter of 2008. As a result of the appreciation of the RMB, we recognized a foreign currency translation gain of $331,100 for the year ended December 31, 2008 compared to a gain of $723,298 for the same period in 2007. Given the uncertainty of exchange rate fluctuations, we cannot estimate the effect of these fluctuations on our future business, product pricing, and results of operations or financial condition. All of our revenues and expenses were denominated in RMB Yuan. The income statement accounts were translated at 1 RMB Yuan to 0.1459 USD and balance sheet amounts were translated at 1 RMB Yuan to 0.1436 USD.
Liquidity and Capital Resources
Inner Mongolia Yongye, the predecessor company, has historically financed its operations and capital expenditures principally through shareholder loans, and bank loans. As a newly formed Cooperative Joint Venture, Yongye Nongfeng, has used the net proceeds of both the April and September Offerings of approximately $20 million to finance the purchase of raw materials and finished inventory from Inner Mongolia Yongye, capital equipment and an expansion of our facilities and production, build out of our distribution network through advertising and marketing programs and their associated expenses, and increasing the number of our branded stores that distributors will do once they have more product available and more advertising coverage. We believe customers will increase, product will be pulled through the channels and distributors will penetrate the market with more branded stores to accommodate and spur sales growth.
As is customary in the industry, we provide payment terms to most of our distributors which typically exceed the terms that we ourselves receive from our finished goods suppliers. We typically provide 90 day terms to our provincial level customers and ask for all others to make cash payments up front or upon delivery. Therefore, the Company’s liquidity needs have generally consisted of working capital necessary to finance receivables and raw material inventory. We believe that over the next 12 months our existing cash, cash equivalents and cash flows from operations will be sufficient to meet our anticipated future cash needs. We may, however, require additional cash resources due to changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue. We will determine how to meet these specific cash flow needs as they arise. Therefore, there can be no assurance that such additional investment will be available to us, or if available, that it will be available on terms acceptable to us. Cash and Cash Equivalents balance amounted to $4,477,477 and $376,002 as of December 31, 2008 and December 31, 2007, respectively
Financial Cash Flow Highlights for Fiscal Years Ended
The Company’s working capital at December 31, 2008, increased $20,783,102 to $23,438,892 from $2,655,790 on December 31, 2007. The increase in working capital by 783% over the same period in 2007 resulted primarily from the April and September financings, increased receipts of accounts receivables during the fourth quarter, increased build up of inventory in preparation for shipments beginning in Q1 of 2009, and the substantially different business model of the CJV which carries very little current liabilities.
The changes described above were generally due to the fact that our provincial level distributors typically pay us 90 days after we ship products to them, which is according to the terms set in the agreements with them. Because we are constrained by the seasonal forces and the elongated payment terms of the agriculture industry, we slowly build up accounts receivable starting in the first quarter and more rapidly add to this throughout the peak season of the second and third quarter. As the end of the year approaches, we typically have had the ability to collect a great deal of our receivables so as to start the new year with a much lower balance.
Because of the seasonal nature of agriculture industry, the peak season for the sale of our product is in the second and third quarters of the year. We normally build up inventory in the first and fourth quarters to prepare for shipments to customers as they order product for the peak selling season in the second and third quarters. The significant increase in the balance of inventory we recently experienced was in line with this business practice. Additionally, our contract manufacturer brought on increased capacity from 2,000TPA to 10,000TPA in preparation for increased sales of the product which we expect to occur. We expect that we will maintain a similar balance in the future year ends.
Accounts receivable Days Sales Outstanding (“DSO”) is defined as average accounts receivable for the period divided by net sales per day and for the fiscal year ended December 31, 2008 decreased 12 days to 18 days at December 31, 2008 from 30 days at December 31, 2007 and Days Sales in Inventory (“DIO”) is defined as average inventory in the period divided by the cost of sales per day and decreased by 55 days to 242 days at December 31, 2008 from 297 days at December 31, 2007. As is customary in China’s agriculture industry, we give credit terms which allow our distributors to pay over a longer period of time than is traditionally done in other industries.
For the fiscal year ended December 31, 2008, net cash used in operating activities increased $4,048,555 to $8,666,893 from $4,618,338 for the year ended December 31, 2007. Reductions in cash were primarily attributable to growth in the business which required larger finished goods purchases and resulted in a large inventory balance of $20,708,193 at the end of 2008 which is needed for peak season sales in 2009. Also, while we significantly reduced our accounts receivable balance from Q3 to Q4, this was still $3,053,380 by year end December 31, 2008.
For the fiscal year ended December 31, 2008, net cash used in investing activities increased $5,166,351 to $5,475,572 from $309,221 in the same period in 2007 and was primarily attributable to acquisitions of plant, property and equipment of $5,475,572.
For the fiscal year ended December 31, 2008, gross cash from financing activities increased $14,639,056 to $19,848,424 from $5,209,368 year ended 2007. This resulted from our offerings received on April 17, 2008 and September 8, 2008 and bank loans for property and equipment. This was offset by expenses incurred in issuance of stock to shareholders of $1,461,659 resulting in net cash of $18,286,765. Net cash from financing activities increased $ 13,089,528 to $ 18,286,765 year ended 2008 from $ 5,197,237 year ended 2007.
Impact of inflation
We are subject to commodity price risks arising from price fluctuations in the market prices of the raw materials. We have generally been able to pass on cost increases through price adjustments. However, the ability to pass on these increases depends on market conditions influenced by the overall economic conditions in China. We manage our price risks through productivity improvements and cost-containment measures. We do not believe that inflation risk is material to our business or our financial position, results of operations or cash flows.
Off Balance Sheet Arrangements
We do not have any off-balance sheet arrangements as defined by standards issued by the Financial Accounting Standards Board, and accordingly, no such arrangements are likely to have a current or future effect on our financial position, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Critical Accounting Policies
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions, and estimates that affect the amounts reported in the consolidated financial statements and accompanying notes. The second footnote to the Company’s financial statements (Summary of Significant Accounting Policies) describes the major accounting policies and methods used in the preparation of the financial statements.
The following are considered to be the Company’s crucial accounting policies:
The Company’s revenue recognition policies are in compliance with Staff Accounting Bulletin (“SAB”) 104. Sales revenue is recognized at the date of customer’s receipt of shipment when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are recorded as customer deposits. Sales revenue represents the invoiced value of goods, net of value-added tax (VAT). The Company’s plant products sold in PRC are exempted from any VAT. Under the PRC taxation law, product which is categorized as agricultural fertilizer is exempted from VAT taxation. Once the product is recognized by the tax bureau as agricultural fertilizer category, it is exempted from VAT taxation for all future sales. Our plant product was recognized by tax bureau as agricultural fertilizer in 2008, so Yongye Nongfeng did not pay VAT for it. The Company’s animal products sold in PRC are subject to a Chinese value-added tax at a rate of 4% of the gross sales price in 2008 because Yongye Nongfeng was recognized by the PRC tax bureau as a small-scale tax payer in PRC in 2008 since it is a newly founded enterprise. This VAT cannot be offset by VAT paid by the Company on raw materials and other materials included in the cost of the finished product.
Use of estimates
The preparation of financial statements in conformity with generally accepted accounting principles of the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant accounting estimates reflected in the Company’s financial statements include the useful lives of and impairment for property, plant and equipment, and potential losses on uncollectible receivables. Actual results could differ from these estimates.
We estimate the useful lives of our property, plant and equipment (“PP&E”) under the assumption that they are capable for use in the period commonly observed for the similar type of PP&E, and there is no indication that revolutionary technology will appear in the foreseeable future that would cause them to be obsolete.
As we discussed in the notes to financial statements, we routinely assesses the financial strength of its customers and, based upon factors surrounding the credit risk of our customers, establishes an allowance for uncollectible accounts receivable. As a consequence, we believe that our accounts receivable credit risk exposure beyond such allowances is limited. The Company recognizes an allowance for doubtful accounts to ensure accounts receivable are not overstated due to uncollectability and are maintained for all customers based on a variety of factors, including the length of time the receivables are past due, significant one-time events and historical experience. Based on the age of the receivables, the Company reserves 10% of accounts receivable balances that have been outstanding for more than 6 months but less than one year, 20% of accounts receivable balances that have been outstanding between one year and two years, 50% of receivable balances that have been outstanding between two year and three years, and 100% of receivable balances that have been outstanding for more than three years. An additional reserve for individual accounts is recorded when the Company becomes aware of a customer's inability to meet its financial obligation, such as in the case of bankruptcy filings or deterioration in the customer's operating results or financial position. If circumstances related to customers change, estimates of the recoverability of receivables would be further adjusted. We base the Accounts Receivable and Bad Debt Reserve policy on the historical experience of the Predecessor company’s sale and collection rates for the same products.
We believe that the accounting estimates related to useful lives of PP&E and potential losses on uncollectible receivables are “critical accounting estimate” because: (1) It is susceptible to change from period to period because it requires company management to make assumptions about future sales and cost of sales over the lives of the PP&E; and (2) the impact that recognizing an allowance for uncollectible accounts receivables would have on the assets reported on our balance sheet as well as our net profit/loss would be material. Management's assumptions about future sales prices and future sales volumes require significant judgment because actual sales prices and volumes have fluctuated in the past and are expected to continue to do so. Management has discussed the development and selection of this critical accounting estimate with the audit committee of our board of directors and the audit committee has reviewed the company's disclosure relating to it in this MD&A.
Inventory is stated at the lower of cost, which takes into account historical prices on a continuing basis, or market. Cost is determined by the weighted average method. Provision for diminution in value on inventories is made using specific identification method.
ITEM 8 Financial Statements and Supplementary Data
Consolidated Financial Statements
The information required by Item 8 appears after the signature page to this report.
ITEM 10 Directors, Executive Officers and Corporate Governance
Directors and Executive Officers
Set forth below is information regarding our current directors and executive officers as of the date of this prospectus:
Zishen Wu, Chief Executive Officer, President and Chairman
Mr. Wu has been the CEO, President and Chairman of the Board of Directors of Yongye Nongfeng since inception in January 2008 and Yongye International, Inc. since April 2008. Mr. Wu was General Manager of Inner Mongolia Yongye Biotechnology, Co., Ltd. from January 2003 to December 2007. Mr. Wu began his career as an official at the State Planning Department in Inner Mongolia from 1984 to 1988. From 1989 to 2000, Mr. Wu was appointed to various managerial positions from Director to Chairman of several State Owned Conglomerates in textile, diary and agriculture industries. In 2003 Mr. Wu founded Inner Mongolia Yongye Biotechnology Company to produce plant and animal nutrients. Mr. Wu currently is the deputy director for the Inner Mongolia Charmer of Commerce and a member of Executive Committee for Industry and Commerce Association in Inner Mongolia.
Taoran Sun, Vice Chairman
Mr. Sun joined Yongye International, Inc. as the Vice Chairman in 2008. Mr. Sun has over 16 years experience with leading media and marketing companies in China. In 1996, Mr. Sun co-founded Blue Focus PR Consulting and has remained on the Board of Directors and serves there currently. In 2005, Mr. Sun founded and served as CEO and Chairman of Lakala (Beijing) Billing Service Co. Ltd., which is an electronic payment system company. Mr. Sun received his B.A. in Economics from Beijing University in 1991.
Sam Yu, Chief Financial Officer
Mr. Sam (Yue) Yu joined the Company as Chief Financial Officer on March 25, 2009. Before joining the Company, Mr. Yu provided capital market consulting services for Chinese companies listed on NASDAQ. Prior to that, Mr. Yu had served as Chief Operating Officer of Lionax International Investment Holding Ltd., a Chinese company listed on NYSE Euronext, from 2007 to 2008. Mr. Yu also previously held positions of General Manager, Fire and Security Sector, Asia Pacific; General Manager, Suzhou Branch; Business Development Manager; and Manager of Financial Analysis; with Underwriters Laboratories Inc. in Asia and its Chicago headquarters from 2002 to 2007. Mr. Yu was awarded a B.S. in Accounting at the University of International Business and Economics in China. He then earned an M.B.A. in General Management from the Stanford Graduate School of Business.
Qiang Zhao, VP Sales and Marketing and Director
Prior to joining the Company as the Chief Marketing Officer and director in April 2008, Mr. Zhao had over 16 years of marketing experiences where he worked for several well-known, globally competitive consumer product companies as Head of Marketing. Mr. Zhao was Senior Vice President of Marketing for Guangdong Galanz Group, a household appliance company that manufactures a line of microwave ovens for Hamilton Beach Brands. Prior to Galanz Group, Mr. Zhao was President of Gracewell, one of the well-known lingerie companies in China, and Senior Vice President of Marketing at Meijin, a well-known, domestic PDA manufacturer. Mr. Zhao received his B.A. in Journalism from China Media University, and his MBA from Cheung Kong Graduate School of Business. Mr. Zhao has written and published three sales & marketing books in China and he is Senior Adviser of the “Sales and Marketing Journal” & the “China Business News.”
Larry Gilmore, VP Corporate Strategy
Prior to joining the Company in April 2008, Mr. Gilmore was SVP of operations for Asia Standard Energy from 2005 to 2007 and had the responsibility for raising private equity for PRC small to medium enterprises and renewable energy projects and corporate oversight on finance and accounting. Mr. Gilmore served as a Director for Asia Standard Energy from November 2007 to April 2008. Mr. Gilmore served as Managing Director of GC Global from 2001 to 2004 and assisted large organizations in major scale change initiatives. Prior to this he was the Manager of Human Resources at Alcatel and Senior Consultant at Deloitte and Touche. As a result of the resignation of Ms. Vini Dharmawan on July 23, 2008, Mr. Gilmore was appointed by the Board of Directors to serve as Interim Principal Financial Officer until a permanent replacement for this position was identified. Upon the hiring of Sam Yu, Mr. Gilmore no longer serves as the Interim Principal Financial Officer. Mr. Gilmore obtained a B.S. in Business Administration from California State University, Sacramento in 1985 and his M.S. in International Education from University of Southern California in 2001.
Ling Zhu, Secretary and Treasurer
Zhu Ling joined the Company as Secretary in August 2008 and as Treasurer in April 2009. Ms. Zhu joined Yongye Nongfeng’s Board of Directors as Director in January 2008. Ms. Zhu currently serves as Managing Director, and as a member of the Board of Directors, of China Consolidated Investments Limited, which she joined in Dec. 2002. Prior of that, she worked as Marketing Director in Beijing Lianshi Technology Co. Ltd., one Hong Kong based software development company, from October 2001 to December 2002. From June 1999 to September 2001, Ms. Zhu worked as Assistant General Manager at Golden Medicine Commodities Network Co., Ltd. She received her Master’s degree in Public Health from University of New South Wales in 1999 and her Bachelor’s degree in Medicine from Beijing University of Traditional Chinese Medicine in 1993.
Xiaochuan Guo, Independent Director
Professor Guo Xiaochuan joined the Company as an Independent Director in April 2008. Professor Guo received his B.S., M.S. and PhD in management science in Fudan University. He is currently the Dean of College of Economic & Management and Director of MBA Center of Inner Mongolia University where he has worked since 1998. Professor Guo worked as lecturer for Inner Mongolia University from 1988 to 1992. Professor Guo was the founder of the MBA program at Inner Mongolia University. Professor Guo serves as an Independent Director of Inner Mongolia PingZhuang Energy Resource Co., Ltd. Professor Guo also served as an Independent Director of Inner Mongolia Yili Industrial Group Co., Ltd from April 2002 to December 2007. He has served as director and Independent Directors in several enterprises, such as Inner Mongolia Shunxin Ningcheng Laojiao Co., Ltd., Inner Mongolia Rixin Group, Rising Securities and Baotou Aluminum (Group) Co., Ltd.
Rijun Zhang, Independent Director
Dr. Zhang Rijun joined the Company as an Independent Director in April 2009. Dr. Rijun is a professor in animal nutrition and feed biotechnology. He has served as the Director of the Laboratory of Feed Biotechnology, State Key Lab of Animal Nutrition, College of Animal Science and Technology at China Agricultural University since December 2004, and the Director of the United Laboratory of Marine Biotechnology of the China National Fisheries Group & Chinese Academy of Science since January 2001. Dr. Zhang was a research trainee from July 1987 to September 1991 and an assistant researcher from September 1991 to September 1995 at Beijing Agricultural University. Dr. Zhang was an assistant researcher from September 1995 to August 1996, a lecturer from September 1996 to December 1999 and an associate professor from December 1999 to November 2004, at China Agricultural University. Dr. Zhang serves as a director on the board of directors of each of Beijing Green Hongke Ecology Sci & Tech Co., Ltd. and Biotechnology Research Center of Beijing AOLONGGANG. Through his work experience Dr. Zhang engaged in the research and development of patent products and technologies and participated in numerous academic research projects. Dr. Zhang has been granted honors and awards including Beijing Association of Animal and Vet Science Award and Wuhan Municipal Government First Award of Scientific and Technological Progress. Dr. Zhang received his Ph.D degree in 1996 and master’s degree in 1993 in Animal Nutrition Science from Beijing Agricultural University and his bachelor’s degree in Veterinary Medicine from Beijing Agricultural University in 1987.
Xindan Li, Independent Director
Professor Li Xindan joined the Company as an Independent Director in April 2009. Professor Xindan has served as the Deputy Dean of the Graduate School of Management Science and Engineering and the Director of the Institute of Financial Engineering at Nanjing University since January 2001. Prof. Li also serves as an independent director of Hitecker Company Limited, Union Securities Co. and Nanjing Agriculture Commercial Bank. From January 1997 to January 2001, Prof. Li served as the Head of the Institute of Finance and Investment, the Deputy Department Chair and Department Chair of the Department of Finance, at Southeast University. Prof. Li was a lecturer from July 1988 to July 1990, an assistant professor from July 1990 to December 1993 and an associate professor from December 1993 to May 1999 at Southeast University. Prof. Li was a Fulbright Visiting Professor at Yale University from September 2004 to August 2005. Through his work experience Prof. Li led research projects and published books and papers in the economic and finance fields. Prof. Li has been granted honors and awards including Outstanding Expert with Special Subsidies by the State Council and New Century Outstanding Talents by the Ministry of Education of PRC. Prof. Li received his Ph.D. degree in Finance in 1999 and his bachelor’s degree in Management Science and his bachelor’s degree in Economic in 1988 from Fudan University, China.
Sean Shao, Independent Director
Mr. Sean Shao joined the Company as an Independent Director in April 2009. Mr. Sean Shao currently serves as the Chairman of Compensation Committee and Director of Agria Corporation (NYSE:GRO), Chairman of Audit Committee and Director of China Nuokang Bio-Pharmaceutical, Inc., Chairman of Audit Committee and Director of China Biologic Products, Inc. (OTCBB:CBPO.OB), Chairman of Audit Committee and Director of China Public Security Technology, Inc. (NASDAQ:CPBY). Prior to that, Mr. Shao worked as the Chief Financial Officer of Trina Solar Limited (NYSE: TSL) from September 2006 to June 2008, the Chief Financial Officer of ChinaEdu Corporation (NASDAQ:CEDU) from September 2005 to August 2006 and the Chief Financial Officer of Watchdata Technologies Ltd. from August 2004 to September 2005. Mr. Shao had previously worked as Audit Senior Manager of Deloitte & Touche, Beijing and Toronto Offices for ten years since 1994. From January 1991 to February 1994, Mr. Shao worked as the Director of Finance and Administration of Caledonia Marble Co., Ltd.. From April 1989 to November 1990, Mr. Shao was the Financial Controller of T.C. Construction Co., Ltd. Mr. Shao received his master’s degree in Health Care Administration from the University of California at Los Angeles in 1988 and his bachelor’s degree in art from East China Normal University in 1982. Mr. Shao is a member of the American Institute of Certified Public Accountants.
There are no family relationships among our directors or officers.
Section 16(A) Beneficial Ownership Reporting Compliance
Under U.S. securities laws, directors, certain executive officers and persons holding more than 10% of our common stock must report their initial ownership of the common stock, and any changes in that ownership, to the SEC. The SEC has designated specific due dates for these reports. Based solely on our review of copies of such reports filed with the SEC and written representations of our directors and executive offers, we believe that all persons subject to reporting filed the required reports on time in 2008.
Code of Ethics
Our Board of Directors has adopted a Code of Conduct and Ethics (the “Code”) that applies to all of our employees, officers and directors. The Code covers compliance with law; fair and honest dealings with the company, with competitors and with others; fair and honest disclosure to the public; and procedures for compliance with the Code. You can obtain a copy of the Code by sending a written request to the attention of Mr. Sam Yu, 6th Floor, Suite 608, Xue Yuan International Tower, No. 1 Zhichun Road, Haidian District, Beijing, PRC.
Board Composition and Meetings of the Board of Directors
The Board of Directors is currently composed of seven members. All actions of the Board of Directors require the approval of a majority of the directors in attendance at a meeting at which a quorum is present. Through December 31, 2008, our Board of Directors acted by written consent once and had not taken action at a meeting of the Board.
It is our policy that all members of the Board of Directors attend the Annual Meeting of Stockholders in person, although we recognize that directors occasionally may be unable to attend for personal or professional reasons. We generally hold a meeting of the Board on the same date as the annual stockholder meeting.
Audit Committee and Audit Committee Financial Expert
Our Audit Committee is currently composed of Messrs. Sean Shao, Li Xindan and Guo Xiaochuan, each of whom is an “independent director” as defined by Rule 4200(a)(15) of the Marketplace Rules of The Nasdaq Stock Market, Inc. Mr. Sean Shao acts as chairman of the Audit Committee. In addition, the Board of Directors has determined that Mr. Sean Shao is an “audit committee financial expert” and “independent” as defined under the relevant rules of the SEC and Nasdaq. The Audit Committee assists the Board of Directors in fulfilling its oversight of the quality and integrity of the Company’s financial statements and the Company’s compliance with legal and regulatory requirements. The Audit Committee is responsible for retaining (subject to stockholder ratification) and, as necessary, terminating, the independent auditors, annually reviews the qualifications, performance and independence of the independent auditors and the audit plan, fees and audit results, and pre-approves audit and non-audit services to be performed by the auditors and related fees. The Audit Committee also oversees the performance of the Company’s internal audit and compliance functions. The Chairman of the Audit Committee is Sean Shao.
The Compensation Committee is governed by a written charter. The Compensation Committee consists of Guo Xiaochuan, Sean Shao and Li Xindan. Compensation decisions during the fiscal year ended December 31, 2008 were made by the full Board of Directors. The Committee is charged with the responsibility of reviewing and approving executive officers’ compensation. The Chairman of the Compensation Committee is Li Xindan. Each member of the Compensation Committee meets the independent requirements applicable to such committee under the Marketplace Rules of The Nasdaq Stock Market, Inc. (the “Nasdaq Marketplace Rules”).
Nominating and Corporate Governance Committee
The Nominating and Corporate Governance Committee consists of Li Xindan, Guo Xiaochuan and Sean Shao. The Chairman of the Nominating and Corporate Governance Committee is Guo Xiaochuan. To date, the Nominating and Corporate Governance Committee have not engaged any third parties to assist them in identifying candidates for the Board.
As a result of the review of Nasdaq Marketplace Rules, the Board has determined that the following directors, comprising a majority of the entire Board, are independent: Guo Xiaochuan, Sean Shao, Li Xindan and Zhang Rijun.
Policy Regarding Board Attendance
Our directors are expected to attend Board meetings as frequently as necessary to properly discharge their responsibilities and to spend the time needed to prepare for each such meeting. Our directors are expected to attend annual meetings of stockholders, but we do not have a formal policy requiring them to do so.
The Company has a process for shareholders who wish to communicate with the Board of Directors. Shareholders who wish to communicate with the Board may write to it at the Company’s address given above. These communications will be reviewed by one or more employees of the Company designated by the Board, who will determine whether they should be presented to the Board. The purpose of this screening is to allow the Board to avoid having to consider irrelevant or inappropriate communications.
ITEM 11 Executive Compensation
Background and Compensation Philosophy
Our Compensation Committee has not adopted or established a formal policy or procedure for determining the amount of compensation paid to our executive officers. No pre-established, objective performance goals or metrics have been used by the Compensation Committee in determining the compensation of our executive officers.
Elements of Compensation
Some of our executive officers receive a base salary to compensate them for services rendered during the year. Our policy of compensating our certain executives with a cash salary has served the Company well. Because of our history of attracting and retaining executive talent, we do not believe it is necessary at this time to provide our executives equity incentives, or other benefits for the Company to continue to be successful.
Base Salary and Bonus. The value of base salary and bonus for each our executive reflects his skill set and the market value of that skill set in the sole discretion of the Compensation Committee.
Equity Incentives. The Company and its subsidiaries have not established an equity based incentive program and have not granted stock based awards as a component of compensation. In the future, we may make awards under an equity incentive plan pursuant to which awards may be granted if our Compensation Committee determines that it is in the best interest of the Company and its stockholders to do so.
Retirement Benefits. Our executive officers are not presently entitled to company-sponsored retirement benefits.
Perquisites. We have not provided our executive officers with any material perquisites and other personal benefits and, therefore, we do not view perquisites as a significant or necessary element of our executive’s compensation.
Deferred Compensation. We do not provide our executives the opportunity to defer receipt of annual compensation.
Summary Compensation Table
The following table sets forth all cash compensation paid by the Company, as well as certain other compensation paid or accrued, for each of the last two fiscal years of our company to each named executive officers.
Summary Compensation of Named Executive Officers
* Prior to Mr. Yu’s employment as chief financial officer, Mr.Gilmore served as our interim chief financial officer.
During each of the last two fiscal years, none of our other officers had salary and bonus greater than $100,000. The bonuses given to the above executive officers were discretionary and were generally linked to our business position, the executive officer’s performance for the year and reflects the executive officer’s skill set and the market value of that skill set. In addition, our executive officers and/or their respective affiliates will be reimbursed by us for any out-of-pocket expenses incurred in connection with activities conducted on our behalf. There is no limit on the amount of these out-of-pocket expenses and there will be no review of the reasonableness of such expenses by anyone other than our Board of Directors, which includes persons who may seek reimbursement, or a court of competent jurisdiction if such reimbursement is challenged.
Our non-independent directors are paid an annual stipend of $50,000 in monthly installments and are also reimbursed for expenses incurred by them in connection with attending Board of Directors’ meetings. Our Independent Directors receive an annual stipend of $40,000 in monthly installments and are also reimbursed for travel related fees.
The following table sets forth all cash compensation paid by the Company, as well as certain other compensation paid or accrued, to its directors for the fiscal year ended December 31, 2008:
Summary Compensation of Directors
Bonuses and Deferred Compensation
We do not have any bonus, deferred compensation or retirement plan. All decisions regarding compensation are determined by our Compensation Committee.
Options and Stock Appreciation Rights
We do not currently have a stock option or other equity incentive plan. We may adopt one or more such programs in the future.
We have entered into an employment agreement with each of Wu Zishen, Qiang Zhao, Larry Gilmore and Sam (Yue) Yu. The CJV entered into an employment contract on April 17, 2008 with Mr. Wu Zishen to employ him as its Chairman and CEO. Mr. Wu is entitled to an annual gross salary in an amount of $205,479 including all allowances, social insurance and housing fund. Mr. Wu is also entitled to a stipend of $50,000 per year for board activities. He may also pay premiums for social security insurance schemes such as pension, unemployment, medical insurance and other social insurance coverage in accordance with relevant PRC laws and regulations. The CJV has a right to adjust the salary and welfare benefits of Mr. Wu appropriately based on his capability, experience, attitude, performance, achievement, working-age and position as well as its salary and position adjustment policies and business conditions experienced. Either party to the agreement has a right to terminate the agreement, subject to the terms and conditions therein.
We have entered into a service agreement with each of our non-independent directors for an annual stipend of $50,000 to be paid in monthly installments. We have entered into a service agreement with each of our independent directors for an annual stipend of $40,000 to be paid in monthly installments.
The CJV entered into an employment contract effective as of March 25, 2009 with Mr. Sam (Yue) Yu to employ him as its Chief Financial Officer. Mr. Yu is entitled to an annual gross salary in an amount of $145,000 and a discretionary bonus.
The CJV entered into an employment contract on April 17, 2008 with Mr. Qiang Zhao to employ him as its VP Sales & Marketing. Mr. Zhao is entitled to an annual gross salary in an amount of $136,986 including all allowances, social insurance and housing fund. Mr. Zhao is also entitled to a stipend of $50,000 per year for board activities. He also pays premiums for social security insurance schemes such as pension, unemployment, medical insurance and other social insurance coverage in accordance with relevant PRC laws and regulations. The CJV has a right to adjust the salary and welfare benefits of Mr. Zhao appropriately based on his capability, experience, attitude, performance, achievement, working-age and position as well as its salary and position adjustment policies and business conditions experienced. Either party to the agreement has a right to terminate the agreement, subject to the terms and conditions therein.
The CJV entered into an employment contract on April 17, 2008 with Mr. Larry Gilmore to employ him as its VP Corporate Strategy and was later amended to include the role of interim Principal Financial Officer. Mr. Gilmore’ annual gross salary for 2008 amounted to $62,500 including all allowances in accordance with relevant PRC laws and regulations. The CJV has a right to adjust the salary and welfare benefits of Mr. Gilmore appropriately based on his capability, experience, attitude, performance, achievement, working-age and position as well as its salary and position adjustment policies and business conditions experienced. Either party to the agreement has a right to terminate the agreement, subject to the terms and conditions therein.
Payment of Post-Termination Compensation
The Company does not have change-in-control agreements with any of its directors or executive officers, and the Company is not obligated to pay severance or other enhanced benefits to executive officers upon termination of their employment.
ITEM 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth certain information regarding beneficial ownership of our Common Stock as of September 9, 2009 by (i) each person (or group of affiliated persons) who is known by us to own more than five percent (5%) of the outstanding shares of our Common Stock, (ii) each director and named executive officer, and (iii) all of our directors and executive officers as a group. As of September 9, 2009, we had 32,790,327 shares of Common Stock outstanding.
Beneficial ownership is determined in accordance with SEC rules and generally includes voting or investment power with respect to securities. Unless otherwise noted, the principal address of each of the stockholders, directors and officers listed below is 6th Floor Xue Yuan International Tower, No. 1 Zhichun Road, Haidian District, Beijing, PRC.
Unless otherwise indicated, all share ownership figures include shares of our Common Stock assumable upon securities convertible or exchangeable into shares of our Common Stock within sixty (60) days of September 9, 2009, which are deemed outstanding and beneficially owned by such person for purposes of computing his or her percentage ownership, but not for purposes of computing the percentage ownership of any other person.
Changes in Control
There are no arrangements known to us, including any pledge by any person of our securities, the operation of which may at a subsequent date result in a change in control of the Company.
ITEM 13 Certain Relationships and Related Transactions, Director Independence
Based on CJV contractual terms, Inner Mongolia Yongye is a 0.5% owner of Yongye Nongfeng and Asia Standard Oil, Ltd. is a 99.5% owner in the CJV. However, based upon actual capital injection into the CJV, Inner Mongolia Yongye is a 0.6% owner of Yongye Nongfeng Biotechnology and Asia Standard Oil, Ltd. is a 99.4% owner. Mr. Zishen Wu controls Inner Mongolia Yongye and is the CEO of Yongye Nongfeng Biotechnology. He also sits on the boards of both companies as Chairman. During the years ended December 31, 2008 and 2007, Inner Mongolia Yongye entered into several intercompany loan transactions with affiliated entities, none of which have been assumed by Yongye Nongfeng Biotechnology. In addition, in January 2008, Yongye Nongfeng Biotechnology entered into a Cooperation Agreement with Inner Mongolia Yongye providing for the terms of contract manufacturing of nutrient product on terms disclosed elsewhere herein. In January 2008 Inner Mongolia Yongye and Yongye Nongfeng Biotechnology also entered into a Sales Agreement providing for the sale of existing nutrient inventory on terms disclosed elsewhere herein.
As of December 31, 2008, the predecessor is Yongye Nongfeng’s only vendor that provided $43,509,906 (100%) of the Company’s purchased finished goods for the year ended December 31, 2008. As of December 31, 2008, due from related party is $192,741 and represents the payment the Company made for the predecessor for its professional fees and research & development fee. According to the contract, the predecessor sells to Yongye Nongfeng at fixed prices of RMB 350 per case for plant products and RMB 120 per case for animal products.
During the year ended December 31, 2008, the Company borrowed $1,617,293 from Ms. Yin’s (Mr. Wu’s wife) company Inner Mongolia Chilechuan Culture Development Co., Ltd. The amounts are unsecured and non-interest bearing, and has been repaid before December 31, 2008.
Yongye Nongfeng and the predecessor entered lease-exchange arrangements to lease land, buildings and equipments to each other. On June 1, 2008, a land lease agreement was entered into in which Yongye Nongfeng would lease a land of 74,153 square meters from the predecessor from June 1, 2008 to May 31, 2009. On September 28, 2008, a building lease agreement and an equipment lease agreement were entered into in which the predecessor would lease a building of 3,967 square meters and a set of equipments from Yongye Nongfeng from September 28, 2008 to September 27, 2009. The estimated value of rentals of land lease and the combination of building and equipment lease are not materially different. Therefore, pursuant to the agreements, both Yongye Nongfeng and the predecessor would not charge any rental to each other for the lease.
As of December 31, 2007, the predecessor has borrowed $2,507,371 from Mr. Zishen Wu. These loans are short term in nature with no stated repayment term, unsecured and non-guaranteed, and non-interest bearing. Also, at December 31, 2007 the predecessor has $12,153 of long-term, unsecured and non-interest bearing loans from shareholders.
Other than the foregoing, there have been no transactions since January 1, 2007 or any currently proposed transaction, or series of transactions, to which the Company was or is to be a party in which the amount involved exceeds $120,000 and in which any current or former director or officer of the Company, any 5% or greater shareholder of the Company or any member of the immediate family of any such persons had or will have a direct or indirect material interest other than as disclosed below.
Policies and Procedures for Review, Approval or Ratification of Transactions with Related Persons
It is the Company’s policy that the Company will not enter into transactions required to be disclosed under item 404 of the SEC’s Regulation S-K unless the audit committee or another independent body of the board first reviews and approves the transactions.
Promoters and Certain Control Persons
We did not have any promoters at any time