The China Perspective recently had the ooportunity to interview Yongye Biotechnology International's Larry Gilmore, VP of Corporate Strategy, about Yongye's business, challenges and opportunities in China's rapidly expanding agricultural markets. 

1)    TCP: What’s the distinctive about your product? How does it benefit plants and animals? What’s the raw material? What’s the technology?

LG: We have two lines of product which are unique formulations for both plants and animals and each product has the same base component which is Fulvic Acid. This is our own proprietary fulvic acid compound which is extracted from humic acid as you can see in the chart.

Fulvic acid is a complex, acidic, biochemical polymer which is produced naturally by the decomposition of plant material over a long period of time. 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.

Yongye’s patented plant product mixture process and patent pending animal product mixture process are for the invention of specific formulas used in these base products. We are the first company to patent such formulas in our industry. We also make sure our products are certified by all appropriate authorities starting with the Ministry of Agriculture which allows domestic manufacturing and sales of the product.

Plant

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. 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 farmers may be expected to experience increases on par with the following results under the proper fertilizer and water conditions:

Animal

Currently, our animal product line is specifically targeted at the 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 healing 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.

2)    TCP: Who is Yongye's average customer, and how much land do they grow on? And what do they grow?

LG: Our customer is our distributor as is shown in this chart. We sold to 5 major distributors in 4 major provinces last year and this accounted for 92% of our revenue. They sell on to other distributors and ultimately the product ends up in our Branded Store or on a large farm.

3)    TCP: Are there any similar products in the market? What’s the difference between Yongye’s product and the peers?

There are many other competitors in our market area as shown in the chart here. We see about 164 similar products, but only 5 very similar to ours. We feel ours has the most complete set of added nutrients and when combined our sales and support staff make Shengmingsu the best overall.

4) TCP: Yongye had 775 stores as of Q3 of 2008 (a 228% increase over 2007) and 350 stores in a trial process. Does Yongye own these stores or is there some kind of partnership? How long does the trial period take and do you have an expected success rate? Do you see your advertising costs significantly increasing in 2009 relative to the number of stores you add to your network?

LG: The branded stores are independently owned agriculture stores. Much like an Ace Hardware here in the USA in the sense that it is know in the community and people trust the store for quality products. This branded stores give us a footprint in the community and we use this as an anchor point to sell our product. These stores sell other agriculture products and can even sell competitors products. We clean up the store, put in visual identity markers such as banners and so on, plus we add a computer running our infomercial which shows farmers how to us the product. This is a one time marketing expense and no other fees or cash changes hands between us and the store owner.

There is not specified time period for the trials process, but it will at least take two quarters to see if they can handle the product and sell it well. We don’t see our advertising budget growing specifically because of the branded stores, but it will scale with our increase in revenue from $48M in 2008 to $66M in 2009.

5)   TCP: Also, could you provide some color on Selling, General and Administrative costs for 2009 as a percentage of Sales, are you expecting around 21% like in Q3?

LG: We don’t expect any major changes in the future. We have given some guidance on our FY2009 revenue which is $66M and net income which is $15.8MM and comes from the Make Good we have in place from our 2008 September financing.

6)    TCP: The 11th year plan has called for an increase in agriculture productivity, particularly in the western regions. Does the Government's stimulus plan affect your business?

LG: Agriculture has always played a vital role in the Chinese economy, especially given the fact that the Country's already below average per capita land resources continue to decline due to large scale urbanization. In an effort to ensure adequate food supplies, the Chinese government has introduced policies designed to increase yields from the remaining land under cultivation. This has caused rapid growth for agricultural nutrient products such as those that Yongye produces.  Our proprietary fulvic acid extraction process and patented manufacturing processes allow us to offer plant and nutrient products that increase yields and profits for farmers.  In 2008, we used our extensive distribution network of branded stores to deliver our products’ value proposition, and we successfully increased market share in six of the ten provinces we operate in.

In 2009, the agriculture industry is now faced with additional challenges, including the global recession, a historic drought and falling grain prices.  Given the importance of agriculture to the Chinese economy, the central government has made stabilizing agricultural production and increasing farmers’ incomes a state goal of 2009. Total spending on agriculture, farmers and rural areas will total RMB 716.1 billion ($104.6 billion) in 2009 five fold increase over 2008 spending of  RMB 120.6 billion ($17.6 billion), in 2008.

Now, more than ever before, we see a great opportunity to help increase productivity in agriculture.  Given our widely-accepted product offering, product availability and expanded sales distribution network we believe we are well prepared to meet the growing needs of Chinese farmers. 

7)    TCP: How does inflation and commodity prices affect your business?

LG: Of course our end users, the Chinese farmers, will be the most sensitive to any price fluctuations. So we try to keep the price as competitive as we can. We are not the cheapest product such as ours nor are we the most expensive. Our finished goods are sold to us via fixed rate contract and it has not changed in the last year. The raw materials purchased by our finished good supplier are also set up on a fixed rate contract and this should be fairly stable in 2009.

8)    TCP: Yongye has recently launched its animal supplement products, currently what percentage of revenue does this account for and over the next few years what percentage of revs do you expect animal supplements to account for?  Also do the margins for animal supplements differ from plant supplements.

LG: The animal product will be about 5% of revenue. Last year it was about 7%. The margin is roughly the same as for our plant product.

9)    TCP: You currently have production capacity of 10,000 metric tons per anum after Yongye's acquisition of a processing plant in Oct of 2008.  Do you expect to run at full capacity this year and do you have plans for further expansion in 09-10?

LG: We are engaged in the sales of the product and not the manufacturing of it. We have about $20MM of finished goods inventory as of the end of 2008 in preparation for the peak selling season in Q2 and Q3. We actually constructed a new facility of 8,000 tonnes per annum capacity, but leased it back to our contract manufacturer because they have the license for production at this time. We will fold back in all the assets and land and become a manufacturer late this year as stipulated in our September financing agreement. Once the manufacturing is back in the company, we can speak more towards capacity issues.

10) TCP: Accounts Receivable of roughly $20 million and accounts receivable days sales outstanding of 103 days. How does this compare to the industry norm? Can you provide some color on where you expect Accounts Receivable to be for 2009?

LG: Because our 10-K wasn’t out yet, you were not privy to the fact that our latest information which shows that Q3 Accounts receivable Days Sales Outstanding 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 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 also offer contract terms of 3 months which allows distributors to pay over a longer period of time than is traditionally done in other industries.

11)   TCP: It is reported that millions of laid-off Chinese migrants returned to the rural areas. Last year, the government enacted the new land reform. Could you forecast the trends in China’s agriculture sector this year? Could you see any opportunities or challenges for Yongye?

LG: Agriculture continues to be a heavily invested sector in China. The news is chalked full stories following big name investors who have confidence in China’s Agricultural strength. The market volume for agriculture products is huge, 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. Additional policy changes will include protecting farmland working to increase rural incomes to retain farming interest. The goal is to maintain self-sufficiency in food production because no other country can feed the world’s biggest population, Sun said. “Our strategy must be based on stable farmland, and seeking ways to improve yields,” Sun said in a speech to local officials, outlining the government’s near- and long-term agriculture policy and objectives. China, which harvested more summer crops, aims also to boost grain and oilseed output this year, Sun said. To ensure next year’s crops, officials must “stabilize” area planted in winter wheat and use idle land in the off season to grow rapeseed, Sun said.

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 a key raw material in the agricultural supply chain- productive 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 farmlands by shifting the country away from the single household farm plot model to the amalgamation of larger-scale operations which should be more productive due to technology and economies of scale. Farmers will be able to transfer their land-use rights to others through a new market system for rural land-use rights. Chinese authorities commented that, "Without modernizing agriculture, China cannot modernize; without stability and prosperity in rural areas, China cannot have stability and prosperity." The changes are enacted to "ensure national food security and the supply of major agricultural products, and promote increases in agricultural production, farm incomes and rural prosperity."

12) TCP: China encountered severe drought problem this spring, which threatened crop’s outputs. Do you think it will be a long-term issue affecting the rural economy? Does the environmental issue affect your business?

LG: In the last half year of 2008, there have been many news reports of the drought in certain areas of China and the obvious impact it would have on agriculture and thus on our company. Through our contact with government agencies, sales and support staff, distributors, and branded store network, we have a very good connection with the farming community in the markets we serve and thus have good information about the real impacts of the drought on the Chinese farmer. Thus far the impact has not been felt on our revenue for the year end 2008 and we do not believe the impact will curtail our sales activities in the near term for several reasons.

Since the news hit about the drought in late 2008, there have been several events which have occurred to mitigate the water shortages faced by farmers in drought conditions such as additional governmental spending on increased efforts to irrigate land from other water sources and additional rainfall on arable land has come in northern China. The State Flood Control and Drought Relief Headquarters recently said that there has been a reduction of farmland affected. The government has also begun their stimulus injections into the agriculture community to help ward off the affects of any drought induced financial hardships.

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. We are currently focused mostly on economic crops except for the Xinjiang province. Additionally, we emphasize that the drought resistance nature of our plant product will actually assist farmers because the water that is used will be held more effectively. Thus, while the drought will impact China, we feel there are many factors working for the company to help us ward off financial impact due to the drought.