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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 

 
FORM 10-Q
 

 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2012
 
OR
 
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                 to                 .
 
Commission file number 001-33397
 

     
SYNUTRA INTERNATIONAL, INC.
 

      
DELAWARE
 
13-4306188
(State or Other Jurisdiction of
Incorporation or Organization)
 
I.R.S. Employer
Identification No.
 
 
2275 Research Blvd., Suite 500
Rockville, Maryland 20850
 
(Address of Principal Executive Offices, Zip Code)
 
(301) 840-3888
(Registrant’s Telephone Number, Including Area Code)
 
 
 
 

 
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No  x
 
As of November 9, 2012, there were 57,300,713 shares of the registrant’s common stock outstanding.
 
 
 

 
 
TABLE OF CONTENTS
 
Page
 
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
1
   
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
13
   
Item 3. Quantitative and Qualitative Disclosures About Market Risk
25
   
Item 4. Controls and Procedures
25
   
PART II OTHER INFORMATION
   
Item 1. Legal Proceedings
26
   
Item 1A. Risk Factors
26
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
26
   
Item 3. Defaults Upon Senior Securities
26
   
Item 4. Mine Safety Disclosures
26
   
Item 5. Other Information
26
   
Item 6. Exhibits
26
   
Signatures
27
 
 
 

 
 
PART I FINANCIAL INFORMATION
 
ITEM 1.  FINANCIAL STATEMENTS
 
SYNUTRA INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars and shares in thousands, except per share data)
(UNAUDITED)
 
   
September 30, 2012
   
March 31, 2012
 
ASSETS
           
Current Assets:
           
Cash and cash equivalents
 
$
74,521
   
$
64,793
 
Restricted cash
   
62,978
     
30,425
 
Accounts receivable, net of allowance of $6,902 and $7,845, respectively
   
47,075
     
38,753
 
Inventories
   
77,174
     
75,499
 
Due from related parties
   
7,453
     
12,262
 
Income tax receivable
   
35
     
227
 
Receivable from assets disposal
   
0
     
1,037
 
Prepaid expenses and other current assets
   
17,881
     
16,320
 
Deferred tax assets
   
7,653
     
17,827
 
Total current assets
   
294,770
     
257,143
 
                 
Property, plant and equipment, net
   
129,749
     
134,902
 
Land use rights, net
   
10,007
     
10,198
 
Intangible assets, net
   
4,363
     
4,377
 
Restricted cash
   
11,229
     
21,019
 
Other assets
   
3,059
     
1,367
 
Deferred tax assets
   
3,425
     
18,907
 
TOTAL ASSETS
 
$
456,602
   
$
447,913
 
                 
LIABILITIES AND EQUITY
               
Current Liabilities:
               
Short-term debt
 
$
155,755
   
$
86,614
 
Long-term debt due within one year
   
50,725
     
40,831
 
Accounts payable
   
45,473
     
70,927
 
Due to related parties
   
1,888
     
1,655
 
Advances from customers
   
6,263
     
5,991
 
Other current liabilities
   
40,504
     
40,560
 
Total current liabilities
   
300,608
     
246,578
 
Long-term debt
   
98,746
     
92,745
 
Deferred revenue
   
4,213
     
4,377
 
Capital lease obligations
   
7,680
     
4,726
 
Other long-term liabilities
   
6,166
     
2,395
 
Total liabilities
   
417,413
     
350,821
 
                 
Commitments and contingencies
               
Equity:
               
Common stockholders’ equity:
               
Common stock, $.0001 par value: 250,000 authorized; 57,301 and 57,301 issued and outstanding at September 30, 2012 and March 31, 2012, respectively
   
6
     
6
 
Additional paid-in capital
   
135,440
     
135,440
 
Accumulated deficit
   
(125,505
)
   
(71,620
)
Accumulated other comprehensive income
   
28,726
     
32,201
 
Total common stockholders’ equity
   
38,667
     
96,027
 
Noncontrolling interest
   
522
     
1,065
 
Total equity
   
39,189
     
97,092
 
                 
TOTAL LIABILITIES AND EQUITY
 
$
456,602
   
$
447,913
 

 
The accompanying notes are an integral part of the consolidated financial statements.
 
 
1

 
 
SYNUTRA INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
 (Dollars in thousands, except per share data)
(UNAUDITED)
 
  
 
Three Months Ended
   
Six Months Ended
 
  
 
September 30,
   
September 30,
 
  
 
2012
   
2011
   
2012
   
2011
 
Net sales
 
$
66,100
   
$
99,053
   
$
119,686
   
$
142,810
 
Cost of sales
   
48,626
     
57,054
     
84,911
     
84,732
 
Gross profit
   
17,474
     
41,999
     
34,775
     
58,078
 
Selling and distribution expenses
   
14,298
     
12,328
     
27,415
     
24,789
 
Advertising and promotion expenses
   
10,186
     
8,042
     
16,990
     
15,050
 
General and administrative expenses
   
7,162
     
6,672
     
15,019
     
13,251
 
Other operating income, net
   
80
     
70
     
965
     
180
 
Income (loss) from operations
   
(14,092
   
15,027
     
(23,684
   
5,168
 
Interest expense
   
3,934
     
3,872
     
7,490
     
7,284
 
Interest income
   
590
     
612
     
1,077
     
923
 
Other income, net
   
2,111
     
107
     
2,093
     
572
 
Income (loss) before income tax expense
   
(15,325
   
11,874
     
(28,004
)
   
(621
)
Income tax expense
   
29,018
     
3,257
     
26,115
     
208
 
Net income (loss)
   
(44,343
   
8,617
     
(54,119
)
   
(829
)
Net income (loss) attributable to the noncontrolling interest
   
(157
   
92
     
(234
   
242
 
Net income (loss) attributable to common stockholders
 
$
(44,186
 
$
8,525
   
$
(53,885
 
$
(1,071
                                 
Weighted average common stock outstanding – basic and diluted
   
57,301
     
57,301
     
57,301
     
57,301
 
Earnings (loss) per share – basic and diluted
 
$
(0.77
 
$
0.15
   
$
(0.94
 
$
(0.02


The accompanying notes are an integral part of the consolidated financial statements.
 
 
2

 
 
SYNUTRA INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
 (Dollars in thousands)
(UNAUDITED)

  
 
Three Months Ended
   
Six Months Ended
 
  
 
September 30,
   
September 30,
 
  
 
2012
   
2011
   
2012
   
2011
 
Net income (loss)
 
$
(44,343
 
$
8,617
   
$
(54,119
 
$
(829
Other comprehensive income
                               
Currency translation adjustment
   
(289
   
1,784
     
(1,287
   
2,938
 
Comprehensive income (loss)
   
(44,632
   
10,401
     
(55,406
   
2,109
 
Less: Comprehensive income (loss) attributable to noncontrolling interest
   
(157
   
99
     
(236
   
254
 
Comprehensive income (loss) attributable to common stockholders
 
$
(44,475
 
$
10,302
   
$
(55,170
 
$
1,855
 


 The accompanying notes are an integral part of the consolidated financial statements.
 
 
3

 
 
SYNUTRA INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF EQUITY
 (Dollars and shares in thousands)
(UNAUDITED)
 
   
Synutra International, Inc. Stockholders’ Equity
             
   
Common Stock
                               
   
Shares
   
Amount
   
Additional
paid-in capital
   
Retained
earnings (accumulated
deficit)
   
Accumulated
other comprehensive
income
   
Noncontrolling
Interest
   
Total equity
 
Balance, March 31, 2011
   
57,301
   
$
6
   
$
135,440
   
$
(88,357
)
 
$
28,204
   
$
633
   
$
75,926
 
Net income (loss)
   
0
     
0
     
0
     
(1,071
   
0
     
242
     
(829
Currency translation adjustments
   
0
     
0
     
0
     
0
     
2,926
     
12
     
2,938
 
Other
   
0
     
0
     
0
     
0
     
0
     
49
     
49
 
Balance, September 30, 2011
   
57,301
   
$
6
   
$
135,440
   
$
(89,428
)
 
$
31,130
   
$
936
   
$
78,084
 
Balance, March 31, 2012
   
57,301
   
$
6
   
$
135,440
   
$
(71,620
)
 
$
32,201
   
$
1,065
   
$
97,092
 
Net loss
   
0
     
0
     
0
     
(53,885
   
0
     
(234
   
(54,119
Currency translation adjustments
   
0
     
0
     
0
     
0
     
(1,285
   
(2
   
(1,287
Disposal of subsidiaries
   
0
     
0
     
0
     
0
     
(2,190
)
   
(381
)
   
(2,571
)
Other
   
0
     
0
     
0
     
0
     
0
     
74
     
74
 
Balance, September 30, 2012
   
57,301
   
$
6
   
$
135,440
   
$
(125,505
)
 
$
28,726
   
$
522
   
$
39,189
 
 
 The accompanying notes are an integral part of the consolidated financial statements.
 
 
4

 
 
SYNUTRA INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Dollars in thousands)
(UNAUDITED)
 
   
Six Months Ended September 30,
 
   
2012
   
2011
 
Operating activities:
           
Net loss
 
$
(54,119
)
 
$
(829
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
               
Depreciation and amortization
   
6,531
     
5,708
 
Bad debt expense
   
1,451
     
4,741
 
Deferred income tax
   
25,378
     
14
 
Foreign currency translation gain on disposal of subsidiaries
   
(2,190
)
   
0
 
Other
   
(341
   
122
 
                 
Changes in assets and liabilities:
               
Accounts receivable
   
(9,407
   
1,624
 
Inventories
   
(2,331
)
   
(4,340
)
Due from related parties
   
4,621
     
5,421
 
Other assets
   
(3,232
)
   
(8,027
)
Accounts payable
   
(21,537
   
(882
Due to related parties
   
344
     
1,166
 
Advances from customers
   
330
     
(196
Income tax receivable
   
190
     
8
 
Other liabilities
   
6,784
     
4,295
 
Net cash provided by (used in) operating activities
   
(47,528
)
   
8,825
 
                 
Investing activities:
               
Acquisition of property, plant and equipment
   
(6,830
)
   
(6,742
)
Change in restricted cash
   
(23,188
)
   
(24,038
)
Proceeds from assets disposal
   
1,808
     
0
 
Payment to minority shareholder
   
(386
   
0
 
Net cash used in investing activities
   
(28,596
)
   
(30,780
)
                 
Financing activities:
               
Proceeds from short-term debt
   
174,287
     
126,967
 
Repayment of short-term debt
   
(104,472
)
   
(137,739
)
Proceeds from long-term debt
   
58,503
     
53,601
 
Repayment of long-term debt
   
(41,777
)
   
(34,499
)
Payment on capital lease obligations
   
(453
)
   
0
 
Net cash provided by financing activities
   
86,088
     
8,330
 
                 
Effect of exchange rate changes on cash and cash equivalents
   
(236
   
1,537
 
                 
Net change in cash and cash equivalents
   
9,728
     
(12,088
)
Cash and cash equivalents, beginning of period
   
64,793
     
48,741
 
Cash and cash equivalents, end of period
 
$
74,521
   
$
36,653
 
                 
Supplemental cash flow information:
               
Interest paid
   
7,203
     
7,261
 
Income tax paid
   
535
     
81
 
                 
Non-cash investing and financing activities:
               
Purchase of property, plant and equipment by accounts payable
   
(3,476
   
(699
)

The accompanying notes are an integral part of the consolidated financial statements.
 
 
5

 
 
SYNUTRA INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1.
ORGANIZATION AND PRINCIPAL ACTIVITIES
 
Synutra International, Inc. (the “Company” or “Synutra”) manufactures, distributes and sells dairy based nutritional products under the “Shengyuan” or “Synutra” line of brands in the People’s Republic of China (“China” or “PRC”). The Company focuses on selling infant formula products, which are supplemented by other nutritional products, such as adult powdered milk formula and prepared baby food, and certain nutritional ingredients and supplements.

2.
BASIS OF PRESENTATION

The Company is responsible for the unaudited consolidated financial statements included in this document, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) and include all normal and recurring adjustments that management of the Company considers necessary for a fair presentation of its financial position and operating results. The Company prepared these statements following the requirements of the U.S. Securities and Exchange Commission (the “SEC”) for interim reporting. As permitted under those rules, the Company condensed or omitted certain footnotes or other financial information that are normally required by US GAAP for annual financial statements. These statements should be read in combination with the consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2012.

The Company had a high asset liability ratio as of March 31, 2012. In addition, the Company suffered loss and cash outflows from operations for the six months ended September 30, 2012 and maintained a high asset liability ratio as of September 30, 2012. However, considering the following facts, the Company regards the going concern assumption as appropriate: 1) the Company has obtained new loans from banks; and 2) the first half’s net loss is mainly caused by allowance established on deferred tax assets, cyclicality, the short term effect of a substantial price increase beginning April 1, 2012 and management’s effort on rectifying sales channel. Accordingly, management believes the Company will be able to realize its assets and satisfy its liabilities in the normal course of business. As a result, the accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern.

The unaudited consolidated financial statements include the financial statements of Synutra International, Inc. and its subsidiaries, its consolidated variable interest entity, Beijing Shengyuan Huimin Technology Service Co., Ltd., its subsidiaries and Heilongjiang Shengyuan Huiren Clinical Examination Co., Ltd., in which it has a controlling financial interest. A controlling financial interest is typically determined when a company holds a majority of the voting equity interest in an entity. US GAAP provides guidance on the identification and financial reporting for entities over which control is achieved through means other than voting interests, which requires certain VIEs to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Through the contractual arrangements between the Company and the VIEs, the Company controls the operating activities and holds all the beneficial interests of the VIEs and has been determined to be the primary beneficiary of the VIEs. The Company has concluded that such contractual arrangements are legally enforceable. The operations associated with the consolidated VIEs are insignificant and hold deminimis assets and liabilities.

All inter-company accounts and transactions have been eliminated in consolidation.

The operating results for interim periods are not necessarily indicative of results that may be expected for any other interim period or for the full year.
 
 
6

 
 
3.
INVENTORIES
 
The Company’s inventories at September 30, 2012 and March 31, 2012 are summarized as follows:
 
(In thousands)
 
September 30, 2012
   
March 31, 2012
 
Raw materials
 
$
54,248
   
$
51,844
 
Work-in-progress
   
13,565
     
6,073
 
Finished goods
   
9,361
     
17,582
 
Total
 
$
77,174
   
$
75,499
 
 
The value of goods-in-transit included in raw materials was $8.7 million and $21.4 million as of September 30, 2012 and March 31, 2012, respectively, which mainly represented the overseas purchase of milk powder and whey protein.

4.
DUE FROM (TO) RELATED PARTIES AND RELATED PARTY TRANSACTIONS

A.
Classification of related party balances by name

a.
Due from related parties
 
(In thousands)
 
September 30, 2012
   
March 31, 2012
 
Sheng Zhi Da Dairy Group Corporation
 
$
1,861
   
$
1,874
 
Beijing Honnete Dairy Co., Ltd.
   
936
     
3,181
 
St. Angel (Beijing) Business Service Co. Ltd.
   
3,786
     
5,987
 
Beijing Ao Naier Feed Stuff Co., Ltd.
   
870
     
1,220
 
Total
 
$
7,453
   
$
12,262
 

b.
Due to related parties
 
(In thousands)
 
September 30, 2012
   
March 31, 2012
 
Sheng Zhi Da Dairy Group Corporation
 
$
1,245
   
$
1,156
 
Beijing Honnete Dairy Co., Ltd.
   
519
     
499
 
Beijing St. Angel Cultural Communication Co., Ltd.
   
121
     
0
 
Beijing Kelqin Dairy Co., Ltd.
   
3
     
0
 
Total
 
$
1,888
   
$
1,655
 

The Company had certain related party borrowings which were recorded in long-term debt. See Note 6. Except for the related party borrowings, the amount due to and due from related parties were unsecured and interest free.
 
 
7

 
  
B.
Sales to related parties
 
In the three and six months ended September 30, 2012, the Company’s sales to related parties mainly included whey protein powder to Honnete, feed grade milk powder to Ao Naier, and powdered formula products to St. Angel (Beijing) Business Service. In the three and six months ended September 30, 2011, the Company’s sales to related parties included whey protein to Honnete, powdered formula products to St. Angel (Beijing) Business Service, and feed grade milk powder to Ao Naier.

  
 
Three Months Ended
   
Six Months Ended
 
  
 
September 30,
   
September 30,
 
(In thousands)
 
2012
   
2011
   
2012
   
2011
 
Beijing Honnete Dairy Co., Ltd.
 
$
445
   
$
711
   
$
773
   
$
1,079
 
St. Angel (Beijing) Business Service Co., Ltd.
   
9
     
2,578
     
2,498
     
2,624
 
Qingdao Lvyin Waste Disposal Investment Management Co., Ltd.
   
1
     
0
     
1
     
0
 
Beijing Ao Naier Feed Stuff Co., Ltd.
   
56
     
91
     
56
     
131
 
Total
 
$
511
   
$
3,380
   
$
3,328
   
$
3,834
 

Before September 2011, St. Angel (Beijing) Business Service Co., Ltd. also acted as a sub-distributor of the Company's products. From September 2011, St. Angel (Beijing) Business Service Co., Ltd. began to make all the purchases directly from the Company. Sales of powdered formula products from independent distributors to St. Angel (Beijing) Business Service were $3.5 million for the fiscal quarter ended September 30, 2011, and $7.5 million for six months ended September 30, 2011, which were not included in the amounts disclosed above.

C.
Purchases from related parties
 
In the fiscal quarter ended September 30, 2012, the Company purchased Lactose from Honnete, St. Angel Cultural Communication developed and implemented certain marketing strategies for the Company, and the Company purchased supplies for the employee canteen from Kelqin.
 
  
 
Three Months Ended
   
Six Months Ended
 
  
 
September 30,
   
September 30,
 
(In thousands)
 
2012
   
2011
   
2012
   
2011
 
Beijing St. Angel Cultural Communication Co. Ltd.
 
$
169
   
$
0
   
$
339
   
$
0
 
Beijing Honnete Dairy Co., Ltd.
   
1,779
     
0
     
4,489
     
0
 
Beijing Kelqin Dairy Co., Ltd.
   
3
     
0
     
7
     
0
 
Total
 
$
1,951
   
$
0
   
$
4,835
   
$
0
 
 
 
8

 
 
5.
PROPERTY, PLANT AND EQUIPMENT, NET

(In thousands)
 
September 30, 2012
   
March 31, 2012
 
Property, plant and equipment, cost:
           
Capital lease of building
 
$
5,573
   
$
4,321
 
Buildings and renovations
   
83,390
     
84,558
 
Plant and machinery
   
82,101
     
83,387
 
Office equipment and furnishings
   
7,846
     
7,986
 
Motor vehicles
   
2,938
     
2,951
 
Others
   
642
     
636
 
Total cost
 
$
182,490
   
$
183,839
 
Less: Accumulated depreciation:
               
Capital lease of building
   
532
     
530
 
Buildings and renovations
   
13,797
     
12,240
 
Plant and machinery
   
35,874
     
33,338
 
Office equipment and furnishings
   
3,318
     
2,792
 
Motor vehicles
   
2,031
     
1,909
 
Others
   
460
     
431
 
Total accumulated depreciation
   
56,012
     
51,240
 
Construction in progress
   
3,271
     
2,303
 
Property, plant and equipment, net
 
$
129,749
   
$
134,902
 

Construction in progress mainly represents headquarter renovation and manufacturing equipments.
 
The Company recorded depreciation expense for owned assets and capital leased assets of $3.4 million and $2.9 million for the fiscal quarters ended September 30, 2012 and 2011, respectively, and $6.8 million and $5.7 million for the six months ended September 30, 2012 and 2011, respectively.
 
 
9

 
 
6.
DEBT

As of September 30, 2012 and March 31, 2012, the Company had short-term debt from PRC banks in the amount of $155.8 million and $86.6 million, respectively.  The maturity dates of the short-term debt outstanding range from October 2012 to August 2013. The weighted average interest rate on short-term debt outstanding at September 30, 2012 and March 31, 2012 was 5.0% and 5.7%, respectively. Certain portion of these debts use floating interest rates, which are calculated based on the benchmark lending interest rate published by China’s central bank. The short-term debt at September 30, 2012 and March 31, 2012 were secured by the pledge of certain fixed assets totaling $13.4 million and $5.6 million, respectively; the pledge of the Company’s land use right of $1.4 million and $0.5 million, respectively; and the pledge of restricted cash deposits of $41.9 million and $15.8 million, respectively.
 
As of September 30, 2012 and March 31, 2012, the Company had long-term debt, including current portion, from banks in the amount of $146.6 million and $130.7 million, respectively. The maturity dates of the long-term debt outstanding range from November 2012 to June 2015. The weighted average interest rate of outstanding long-term debt at September 30, 2012 and March 31, 2012 was 5.9% and 6.6%, respectively. Certain portion of these debts use floating interest rates, which are calculated based on the benchmark lending interest rate published by China’s central bank. The indebtedness at September 30, 2012 and March 31, 2012 was secured by the pledge of certain fixed assets with net book value of $16.2 million and $17.4 million, respectively; the pledge of land use right of $1.2 million and $1.2 million, respectively; and the pledge of restricted cash deposits of $32.1 million and $21.0 million, respectively.

As of September 30, 2012 and March 31, 2012, the Company had long-term loan from a related party of $2.9 million. The maturity date of the long-term related party loan principal and interest is in November 2013, and the loan is extendable on the same terms upon maturity as agreed by both parties. The interest rate of the long-term loan at September 30, 2012 and March 31, 2012 was 10.0%. The interest expense of related party loans for the quarters ended September 30, 2012 and 2011 was $72,000 and $97,000, respectively, and for six months ended September 30, 2012 and 2011 was $143,000 and $193,000, respectively.

Maturities on long-term debt are as follows:

(In thousands)
 
Year Ending March 31,
 
2013
 
$
5,362
 
2014
   
92,696
 
2015
   
38,009
 
2016
   
13,404
 
   
$
149,471
 

7.
OTHER CURRENT LIABILITIES

(In thousands)
 
September 30, 2012
   
March 31, 2012
 
Accrued rebate and slotting fee
 
$
10,158
   
$
3,242
 
Accrued product replacement cost
   
2,367
     
3,556
 
Payroll and bonus payables
   
6,255
     
7,978
 
Accrued selling expenses
   
3,621
     
3,750
 
Accrued advertising and promotion expenses
   
10,697
     
10,708
 
Other tax payable
   
0
     
2,358
 
Accrued rental fee
   
3,286
     
4,819
 
Others
   
4,120
     
4,149
 
Total
 
$
40,504
   
$
40,560
 
 
 
10

 
 
8.
INCOME TAXES
 
The effective tax rate is based on expected income (loss), statutory tax rates and incentives available in the various jurisdictions in which the Company operates. For interim financial reporting, the Company estimates the annual tax rate based on projected taxable income for the full year and records a quarterly income tax provision (benefit) in accordance with the ASC No. 740-270, “Income tax – Interim reporting” (previously FIN 18, " Accounting for Income Taxes in Interim Period "). As the year progresses, the Company refines the estimates of the year’s taxable income as new information becomes available. This continual estimation process often results in a change to the expected effective tax rate for the year. When this occurs, the Company adjusts the income tax provision (benefit) during the quarter in which the change in estimate occurs so that the year-to-date provision reflects the expected annual tax rate.

For the six months ended September 30, 2012, additional valuation allowance of approximately $25.4 million was provided on the deferred tax assets arising from the net operating loss carryforward of the Company's PRC subsidiaries. The Company considers positive and negative evidence to determine whether some portion or all of the deferred tax assets will more likely than not be realized. This assessment considers, among other matters, the nature, frequency and severity of recent losses, forecasts of future profitability, the duration of statutory carryforward periods, the Company's experience with tax attributes expiring unused and tax planning alternatives. Valuation allowances have been established for deferred tax assets based on a more-likely-than-not threshold. The Company's ability to realize deferred tax assets depends on its ability to generate sufficient taxable income within the carryforward periods provided for in the tax law.
 
9.
EARNINGS (LOSS) PER SHARE

For purposes of calculating basic and diluted earnings per share, the Company used the following weighted average common stocks outstanding:

  
 
Three Months Ended
   
Six Months Ended
 
  
 
September 30,
   
September 30,
 
(In thousands except for per share data)
 
2012
   
2011
   
2012
   
2011
 
Net income (loss) attributable to common stockholders
 
$
(44,186
 
$
8,525
   
$
(53,885
 
$
(1,071
Weighted average common stock outstanding – basic and diluted
   
57,301
     
57,301
     
57,301
     
57,301
 
Earnings (loss) per share - basic and diluted
 
$
(0.77
 
$
0.15
   
$
(0.94
)
 
$
(0.02
)

The Company granted ABN AMRO Bank N.V., Hong Kong Branch (now known as The Royal Bank of Scotland N.V. ("RBS")) warrants to purchase 400,000 shares of common stock in connection with the RBS Loan in fiscal year 2008. These warrants were excluded from the computation of diluted earnings per share for all periods presented as they would be anti-dilutive.
  
10.
CONTINGENCIES

The Company is subject to legal proceedings and claims which arise in the ordinary course of business. Claims have been made against the Company from time to time. The Company intends to contest each lawsuit vigorously. The Company is not involved in any legal proceedings which it believes will have the potential for a materially adverse impact on the Company’s business or financial condition, results of operations or cash flows.
 
 
11

 
 
11.
SEGMENT REPORTING

The Company focuses on selling infant formula products, which are supplemented by other nutritional products, such as adult powdered formula and prepared baby food, and certain nutritional ingredients and supplements. The activities of each segment are as follows:
 
Powdered Formula - Sales of powdered infant and adult formula products.
 
Baby Food - Sales of prepared baby food for babies and children.
 
Nutritional Ingredients and Supplements - Sales of nutritional ingredients and supplements such as chondroitin sulfate, and microencapsulated Docosahexanoic Acid (“DHA”) and Arachidonic Acid (“ARA”).
 
“All Other” includes non-core businesses such as sales of ingredients and materials to industrial customers.
 
The Company’s underlying accounting records are maintained on a legal entity basis for government and public reporting requirements. Segment disclosures are on a performance basis consistent with internal management reporting.

  
 
Three Months Ended
   
Six Months Ended
 
  
 
September 30,
   
September 30,
 
(In thousands)
 
2012
   
2011
   
2012
   
2011
 
NET SALES TO EXTERNAL CUSTOMERS
                               
Powdered formula
 
$
50,090
   
$
79,109
   
$
100,545
   
$
119,272
 
Baby food
   
45
     
108
     
110
     
173
 
Nutritional ingredients and supplements
   
1,350
     
160
     
3,476
     
613
 
All other
   
14,615
     
19,676
     
15,555
     
22,752
 
Net sales
 
$
66,100
   
$
99,053
   
$
119,686
   
$
142,810
 
INTERSEGMENT SALES
                               
Powdered formula
 
$
12
   
$
0
   
$
12
   
$
0
 
Baby food
   
45
     
61
     
281
     
180
 
Nutritional ingredients and supplements
   
1,858
     
2,761
     
4,099
     
4,940
 
All other 
   
0
     
623
     
51
     
1,139
 
Intersegment sales
 
$
1,915
   
$
3,445
   
$
4,443
   
$
6,259
 
GROSS PROFIT
                               
Powdered formula
 
$
21,345
   
$
38,845
   
$
39,778
   
$
55,781
 
Baby food
   
(522
)
   
(436
)
   
(875
)
   
(692
)
Nutritional ingredients and supplements
   
(654
)
   
(624
)
   
(1,694
)
   
(756
)
All other 
   
(2,695
   
4,214
     
(2,434
   
3,745
 
Gross profit
 
$
17,474
   
$
41,999
   
$
34,775
   
$
58,078
 
Selling and distribution expenses
   
14,298
     
12,328
     
27,415
     
24,789
 
Advertising and promotion expenses
   
10,186
     
8,042
     
16,990
     
15,050
 
General and administrative expenses
   
7,162
     
6,672
     
15,019
     
13,251
 
Other operating income, net
   
80
     
70
     
965
     
180
 
Income (loss) from operations
   
(14,092
   
15,027
     
(23,684
   
5,168
 
Interest expense
   
3,934
     
3,872
     
7,490
     
7,284
 
Interest income
   
590
     
612
     
1,077
     
923
 
Other income net
   
2,111
     
107
     
2,093
     
572
 
Income (loss) before income tax expense
 
$
(15,325
 
$
11,874
   
$
(28,004
 
$
(621

(In thousands)
 
September 30, 2012
   
March 31, 2012
 
TOTAL ASSETS
           
Powdered formula
 
$
519,749
   
$
436,284
 
Baby food
   
24,277
     
24,928
 
Nutritional ingredients and supplements
   
83,378
     
33,292
 
All other
   
133,290
     
170,386
 
Intersegment elimination
   
(304,092
)
   
(216,977
)
Total
 
$
456,602
   
$
447,913
 
 
 
12

 
 
ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Sections of this Quarterly Report on Form 10-Q (the “Form 10-Q”) including, in particular, the Company’s Management’s Discussion and Analysis of Financial Condition and Results of Operations contain forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict; therefore, actual results may differ materially from those expressed, implied or forecasted in any such forward-looking statements.

Expressions of future goals and expectations or similar expressions including, without limitation, “may,” “should,” “could,” “expects,” “does not currently expect,” “plans,” “anticipates,” “intends,” “believes,” “estimates,” “predicts,” “potential,” “targets,” or “continue,” reflecting something other than historical fact are intended to identify forward-looking statements. The factors described in the Company’s Annual Report on Form 10-K under Part I. Item 1A. Risk Factors and below in Part II. Other Information – Item 1A. Risk Factors could cause the Company’s actual results to differ materially from those described in the forward-looking statements. Unless required by law, the Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. However, readers should carefully review the reports and documents the Company files from time to time with the SEC, particularly its Quarterly Reports on Form 10-Q, Annual Report on Form 10-K , Current Reports on Form 8-K and all amendments to those reports.

Available Information

The Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are filed with the SEC. Such reports and other information filed by the Company with the SEC are available on the Company’s website at http://www.synutra.com when such reports are available on the SEC website. The public may read and copy any materials filed by the Company with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at http://www.sec.gov. The contents of these websites are not incorporated into this filing. Further, the Company’s references to the URLs for these websites are intended to be inactive textual references only.
 
 
13

 
 
Overview of Our Business
 
We are a leading infant formula company in China. We principally manufacture, distribute and sell dairy based nutritional products under the “Shengyuan” or “Synutra” brand, together with sub brands in mainland China. We focus on selling infant formula products, which are supplemented by other nutritional products, such as adult powdered milk formula and prepared baby food, and certain nutritional ingredients and supplements. We sell our products through an extensive nationwide sales and distribution network covering all provinces and provincial-level municipalities in mainland China. As of September 30, 2012, this network comprised over 680 independent distributors and over 730 independent sub-distributors who sell our products in over 63,000 retail outlets.
 
We currently have three reportable segments which are:

Powdered formula segment: Powdered formula segment covers the sale of powdered infant and adult formula products. Major brands include Super, U-Smart, My Angel and Helanruniu;
   
Baby food segment: Baby food segment covers the sale of prepared baby food for babies and children. It includes the brand of Huiliduo;
   
Nutritional ingredients and supplements segment: Nutritional ingredients and supplements segment covers the production and sale of nutritional ingredients and supplements such as chondroitin sulfate, and microencapsulated Docosahexanoic Acid (“DHA”) and Arachidonic Acid (“ARA”).

Our Other business includes non-core businesses such as sales of surplus milk powder and whey protein to industrial customers.

Executive Summary

We initiated a “gold miner” marketing strategy (“the Strategy“) in September 2012 to strengthen our management of sales channel, aiming at more effective use of the marketing and promotional expenditures and improving net profit. In the past, we provided discounts to distributors to offset part of the marketing and promotional expenditures incurred at retail outlets. As part of the Strategy, we are now centrally monitoring the spending in each retail outlet to ensure more efficient allocation of marketing and promotional expenditures. We will terminate our relationship with those retail outlets with low sales volume and low yield rate on the slotting fees, and focus our resources on those retail outlets with high sales volume and high yield rate on the slotting fees. In order to strengthen our management of sales channel, we are also setting up an inventory tracking system to track our products from factory all the way to the retail outlets to prevent distributors from selling out of their permitted area. We aim to complete the implementation of the Strategy by December 2012 or January 2013, and we estimate, by then, we will keep less than half of the existing retail outlets.

We started to communicate the Strategy to our distributors in August 2012. While most distributors welcome the Strategy as it strengthens our control on sales channel and promotes more orderly competition among distributors, some of them have reduced their recent order amount as the Strategy may have negative short term impact on their performance. The reduced order from distributors as we implement the Strategy, together with the significant purchases by distributors prior to our price increase effective on April 1, 2012 resulted in the lower sales volume of the fiscal quarter ended September 30, 2012 compared to the prior year period. We estimate the Strategy will continue to negatively impact our short term performance, as gross sales may decrease and we may incur expenses in terminating relationship with certain retail outlets, but we believe the successful implementation of the Strategy is vital to the health of our sales channel system and hence our long term performance.
 
 
14

 

Three Months Results of Operations
 
Below is a summary of selected comparative results of operations for the quarters ended September 30, 2012 and 2011:

   
Three Months Ended September 30,
       
(In thousands, except per share data)
 
2012
   
2011
   
% Change
 
Net sales
 
$
66,100
   
$
99,053
     
-33%
 
 - Powdered formula segment
   
50,090
     
79,109
     
-37%
 
Cost of sales
   
48,626
     
57,054
     
-15%
 
 - Powdered formula segment
   
28,745
     
40,264
     
-29%
 
Gross profit
   
17,474
     
41,999
     
-58%
 
 - Powdered formula segment
   
21,345
     
38,845
     
-45%
 
Gross Margin
   
26%
     
42%
         
 - Powdered formula segment
   
43%
     
49%
         
Income (loss) from operations
   
(14,092
)
   
15,027
     
-194%
 
Interest expense, net
   
3,344
     
3,260
     
3%
 
Income (loss) before income tax expense (benefit)
   
(15,325
)
   
11,874
     
-229%
 
Income tax expense
   
29,018
     
3,257
     
791%
 
Net income (loss)
   
(44,343
)
   
8,617
     
-615%
 
Net income (loss) attributable to common stockholders
 
$
(44,186
)
 
$
8,525
     
-618%
 
Weighted average common stock outstanding – basic and diluted
   
57,301
     
57,301
         
Income (loss) per share – basic and diluted
 
$
(0.77
)
 
$
0.15
     
-618%
 

Unless otherwise noted, all translations from Renminbi to U.S. dollars were made at the mid rate published by the People’s Bank of China, or the mid rate, as of September 30, 2012, which was RMB 6.3410 to $1.00. We make no representation that the Renminbi amounts referred to in this Quarterly Report on Form 10-Q could have been or could be converted into U.S. dollars at any particular rate or at all. On November 2, 2012, the mid rate was RMB 6.3045 to $1.00.
 
 
15

 
 
Net Sales
 
Our net sales by reportable segments are shown in the table below:

   
Three Months Ended September 30,
         
% Change in
 
(In thousands, except percentage data)
 
2012
   
2011
   
% Change
   
Volume
   
Price
 
Powdered formula
 
$
50,090
   
$
79,109
     
-37%
     
-36%
     
-1%
 
Baby food
   
45
     
108
     
-58%
                 
Nutritional ingredients and supplements
   
1,350
     
160
     
744%
                 
All other
   
14,615
     
19,676
     
-26%
                 
Net sales
 
$
66,100
   
$
99,053
     
-33%
                 

Net sales of our powdered formula segment include powdered formula products for infants, children and adults. The decrease of net sales of our powdered formula products was mainly due to the following factors:
 
 
Sales volume of powdered formula products for the fiscal quarter ended September 30, 2012 was 4,605 tons, as compared to 7,228 tons for the same period in the previous year, due primarily to the significant purchase by distributors prior to our price increase effective on April 1, 2012, and the reduced order from distributors as we implement the Strategy as discussed above.
 
 
The average selling price of our powdered formula products for the fiscal quarter ended September 30, 2012 was $10,877 per ton, compared to $10,945 per ton for the same period in the previous year. Average selling price is calculated as net sales of powdered formula segment, after deducting sales discounts, divided by sales volume. The constant average selling price was the result of the price increase we instituted on April 1, 2012, reduced by increased discount per ton. We provided sales discounts to offset part of the marketing and promotional expenditures incurred at retail outlets. The discount does not fluctuate directly with current period sales because it is based on a prorated annual estimate.
 
The sales volume and average selling price exclude the amount of free products provided to customers, which is recorded as a cost of sales in the period. The prior year period sales volume and average selling price had been adjusted for consistency.
 
The product mix in baby food segment is comprised mainly of prepared baby food, such as cooked meat and vegetables. We currently focus our efforts on the powdered formula segment, and did not develop the baby food segment as planned.
 
The product mix in nutritional ingredients and supplements segment is comprised of external sales of chondroitin sulfate to third parties, and inter-segment sales of microencapsulated DHA and ARA to the powdered formula segment. While the international market price of chondroitin sulfate is at a historically low level compared to our cost and we incurred gross loss on our chondroitin sulfate sales, we have experienced a significant increase in sales to certain international pharmaceutical companies in the fiscal quarter ended September 30, 2012.

Our Other business mainly includes sales of surplus milk powder, whey protein and feed grade milk powder. The decrease is mainly due to the decrease in sales of imported milk powder to industrial customers to $12.1 million in the fiscal quarter ended September 30, 2012, from $16.0 million in the same period in the prior year, and the decrease in sales of raw milk to nil in the fiscal quarter ended September 30, 2012, from $1.4 million in the same period in the prior year.
 
 
16

 
 
Cost of Sales
 
Our cost of sales by reportable segments is shown in the table below:

   
Three Months Ended September 30,
       
(In thousands, except percentage data)
 
2012
   
2011
   
% Change
 
Powdered formula
 
$
28,745
   
$
40,264
     
-29%
 
Baby food
   
567
     
544
     
4%
 
Nutritional ingredients and supplements
   
2,004
     
784
     
156%
 
All other
   
17,310
     
15,462
     
12%
 
Cost of sales
 
$
48,626
   
$
57,054
     
-15%
 

The decrease in the cost of sales of the powdered formula segment was mainly due to the decrease in sales volume, partially offset by the increased cost of whey protein powder. 

The increase in the cost of sales of nutritional ingredients and supplements segment was mainly due to the sales of chondroitin sulfate to certain international pharmaceutical companies as discussed above.

The increase in cost of Other business was mainly due to the increase in the cost of whey protein powder to $1.8 million for the fiscal quarter ended September 30, 2012 from $0.3 million for the prior year period, partially offset by the decrease in the cost of imported milk powder to $14.4 million in the fiscal quarter ended September 30, 2012 from $14.9 million in the fiscal quarter ended September 30, 2011.

Gross Profit and Gross Margin

   
Three Months Ended September 30,
       
(In thousands, except percentage data)
 
2012
   
2011
   
% Change
 
Gross profit
 
$
17,474
   
$
41,999
     
-58%
 
- Powdered formula
   
21,345
     
38,845
     
-45%
 
Gross Margin
   
26%
     
42%
         
- Powdered formula
   
43%
     
49%
         

The decrease in gross margin of powdered formula segment was mainly due to increased cost of whey protein powder in the fiscal quarter ended September 30, 2012.

The gross loss and negative gross margin of Other business was mainly due to that we sold surplus imported milk powder at current low market price, while we purchased at a higher price.
 
Expenses

   
Three Months Ended September 30,
       
(In thousands, except percentage data)
 
2012
   
2011
   
% Change
 
Selling and distribution expenses
 
$
14,298
   
$
12,328
     
16%
 
Advertising and promotion expenses
   
10,186
     
8,042
     
27%
 
 - Advertising expenses
   
3,877
     
3,174
     
22%
 
 - Promotion expenses
   
6,309
     
4,868
     
30%
 
General and administrative expenses
   
7,162
     
6,672
     
7%
 
Other operating income, net
   
80
     
70
     
14%
 
 
 
17

 
 
Selling and distribution expenses primarily include compensation expense for sales staff, freight charges, travel expense and service charge for our customer loyalty program. The increase in selling and distribution expenses in the fiscal quarter ended September 30, 2012 from the same period in the previous year was mainly due to the increase in a service charge for our consumer loyalty program administered by a third party since the fourth quarter of fiscal year 2012.

Advertising expenses primarily include media expenses paid to national and local TV stations. The increase in advertising expenses in the fiscal quarter ended September 30, 2012 was due to our decision to pull back our advertising efforts in the same period in the previous year. Promotion expenses primarily include promotional products to end customers. The increase in promotion expenses in the fiscal quarter ended September 30, 2012 was mainly due to more consumer loyalty program expenses for end customers.

General and administrative expenses primarily include salaries for staff and management, headquarter rental expense, and bad debt expense. The increase in general and administrative expenses in the fiscal quarter ended September 30, 2012 from the same period in the previous year was mainly due to the increased depreciation expense related to the new headquarter renovation.

Other operating income represented the receipt of general purpose subsidies from local governments.
 
Interest Expense and Interest Income
 
Interest expense remained constant in the fiscal quarter ended September 30, 2012 compared to the same period in the previous year, as a result of increased loan balance, and decreased average interest rate as we used more trade financing with lower interest rates.

Interest income remained constant in the fiscal quarter ended September 30, 2012 compared to the same period in the previous year.

Other Income, Net

Other income for the fiscal quarter ended September 30, 2012 mainly include foreign currency translation gains of $2.2 million reclassified from accumulated comprehensive income as a result of substantial completion of the disposal of Heilongjiang Baoquanling Shengyuan Dairy Co., Ltd. and Heilongjiang Baoquanling Shengyuan Dairy Cow Breeding Co., Ltd.

Income Tax Expense

The increase in income tax expense was primarily due to $25.4 million charge from the increase in the valuation allowance for deferred tax assets attributable to net operating loss carryforwards of certain PRC subsidiaries and derecogntion of $3.6 million income tax benefit for the loss incurred for the three months ended June 30, 2012.

Net Income (Loss) Attributable to Noncontrolling Interest

Net income (loss) attributable to noncontrolling interest mainly represents the interest held by third parties in Meitek Technology (Qingdao) Co., Ltd.

Net Income (Loss) Attributable to Common Stockholders
 
As a result of the foregoing, net loss attributable to common stockholders for the fiscal quarter ended September 30, 2012 was $44.2 million, compared to a net income of $8.5 million for the same period in the previous year.
 
 
18

 
 
Six Months Results of Operations
 
Below is a summary of selected comparative results of operations for the six months ended September 30, 2012 and 2011:

   
Six Months Ended September 30,
       
(In thousands, except per share data)
 
2012
   
2011
   
% Change
 
Net sales
 
$
119,686
   
$
142,810
     
-16%
 
 - Powdered formula segment
   
100,545
     
119,272
     
-16%
 
Cost of sales
   
84,911
     
84,732
     
0%
 
 - Powdered formula segment
   
60,767
     
63,491
     
-4%
 
Gross profit
   
34,775
     
58,078
     
-40%
 
 - Powdered formula segment
   
39,778
     
55,781
     
-29%
 
Gross Margin
   
29%
     
41%
         
 - Powdered formula segment
   
40%
     
47%
         
Income (loss) from operations
   
(23,684
)
   
5,168
     
-558%
 
Interest expense, net
   
6,413
     
6,361
     
1%
 
Loss before income tax expense
   
(28,004
)
   
(621
)
   
*
 
Income tax expense
   
26,115
     
208
     
*
 
- Effective tax rate
   
-93.3%
     
-33.5%
         
Net loss
   
(54,119
)
   
(829
)
   
*
 
Net loss attributable to common stockholders
 
$
(53,885
)
 
$
(1,071
)
   
*
 
Weighted average common stock outstanding – basic and diluted
   
57,301
     
57,301
         
Loss per share – basic and diluted
 
$
(0.94
)
 
$
(0.02
)
   
*
 

*  not meaningful 
 
 
19

 
 
Net Sales
 
Our net sales by reportable segments are shown in the table below:

   
Six Months Ended September 30,
         
% Change in
 
(In thousands, except percentage data)
 
2012
   
2011
   
% Change
   
Volume
   
Price
 
Powdered formula
 
$
100,545
   
$
119,272
     
-16%
     
-19%
     
4%
 
Baby food
   
110
     
173
     
-36%
                 
Nutritional ingredients and supplements
   
3,476
     
613
     
467%
                 
All other
   
15,555
     
22,752
     
-32%
                 
Net sales
 
$
119,686
   
$
142,810
     
-16%
                 

Net sales of our powdered formula segment include powdered formula products for infants, children and adults. The decrease of net sales of our powdered formula products was mainly due to the following factors:
 
 
Sales volume of powdered formula products for the six months ended September 30, 2012 was 8,985 tons, as compared to 11,137 tons for the same period in the previous year, due primarily to the significant purchase by distributors prior to our price increase effective on April 1, 2012, and the reduced order from distributors as we implement the Strategy as discussed above.
 
 
The average selling price of our powdered formula products for the six months ended September 30, 2012 was $11,190 per ton, compared to $10,710 per ton for the same period in the previous year. Average selling price is calculated as net sales of powdered formula segment, after deducting sales discounts, divided by sales volume. The increase in average selling price was mainly due to the price increase we instituted on April 1, 2012, partially offset by increased discount per ton. We provided sales discounts to offset part of the marketing and promotional expenditures incurred at retail outlets. The discount does not fluctuate directly with current period sales because it is based on a prorated annual estimate.
 
The sales volume and average selling price exclude the amount of free products provided to customers, which is recorded as cost of sales in the period. The prior year period sales volume and average selling price had been adjusted for consistency.
 
The product mix in baby food segment is comprised mainly of prepared baby food, such as cooked meat and vegetables. We currently focus our efforts on the powdered formula segment, and did not develop the baby food segment as planned.
 
The product mix in nutritional ingredients and supplements segment is comprised of external sales of chondroitin sulfate to third parties, and inter-segment sales of microencapsulated DHA and ARA to the powdered formula segment. While the international market price of chondroitin sulfate is at a historically low level compared to our cost and we incurred gross loss on our chondroitin sulfate sales, we have experienced a significant increase in sales to certain international pharmaceutical companies in the six months ended September 30, 2012.

Our Other business mainly includes sales of surplus milk powder, whey protein and feed grade milk powder. The decrease in sales of Other business was mainly due to decrease in imported milk powder sales from $16.0 million for six months ended September 30, 2011 to $12.2 million for the six months ended September 30, 2012, and decreased raw milk sales from $2.9 million for six months ended September 30, 2011 to nil for the six months ended September 30, 2012.
 
 
20

 
 
Cost of Sales
 
Our cost of sales by reportable segments is shown in the table below:

   
Six Months Ended September 30,
       
(In thousands, except percentage data)
 
2012
   
2011
   
% Change
 
Powdered formula
 
$
60,767
   
$
63,491
     
-4%
 
Baby food
   
985
     
865
     
14%
 
Nutritional ingredients and supplements
   
5,170
     
1,369
     
278%
 
All other
   
17,989
     
19,007
     
-5%
 
Cost of sales
 
$
84,911
   
$
84,732
     
0%
 
                         

The decrease in the cost of sales of the powdered formula segment was mainly due to the decrease in sales volume, partially offset by the increased cost of whey protein powder. 

The increase in the cost of sales of nutritional ingredients and supplements segment was mainly due to the sales of chondroitin sulfate to certain international pharmaceutical companies as discussed above.

Our Other business mainly includes sales of surplus milk powder, whey protein and feed grade milk powder. The decrease in cost of Other business was mainly due to decreased imported milk powder cost of $14.5 million for the six months ended September 30, 2012, compared to $15.1 million for the six months ended September 30, 2011, and decreased raw milk cost of zero for the six months ended September 30, 2012, compared to $2.8 million for the six months ended September 30, 2011, partially offset by the increase in whey protein powder cost and feed grade milk powder cost.

Gross Profit and Gross Margin

   
Six Months Ended September 30,
       
(In thousands, except percentage data)
 
2012
   
2011
   
% Change
 
Gross profit
 
$
34,775
   
$
58,078
     
-40%
 
- Powdered formula
   
39,778
     
55,781
     
-29%
 
Gross Margin
   
29%
     
41%
         
- Powdered formula
   
40%
     
47%
         

The decrease in gross margin of powdered formula segment was mainly due to increased cost of whey protein powder for the six months ended September 30, 2012.

The gross loss and negative gross margin of Other business was mainly due to that we sold surplus imported milk powder at current low market price, while we purchased at a higher price.
 
Expenses

   
Six Months Ended September 30,
       
(In thousands, except percentage data)
 
2012
   
2011
   
% Change
 
Selling and distribution expenses
 
$
27,415
   
$
24,789
     
11%
 
Advertising and promotion expenses
   
16,990
     
15,050
     
13%
 
 - Advertising expenses
   
6,748
     
5,461
     
24%
 
 - Promotion expenses
   
10,242
     
9,589
     
7%
 
General and administrative expenses
   
15,019
     
13,251
     
13%
 
Other operating income, net
   
965
     
180
     
436%
 
 
 
21

 

Selling and distribution expenses primarily include compensation expense for sales staff, freight charges, travel expense and service charge for our customer loyalty program. The increase in selling and distribution expenses in the six months ended September 30, 2012 from the same period in the previous year was mainly due to the increase in a service charge for our consumer loyalty program administered by a third party since the fourth quarter of fiscal year 2012.

Advertising expenses primarily include media expenses paid to national and local TV stations. The increase in advertising expenses in the six months ended September 30, 2012 was due to our decision to pull back our advertising efforts in the same period in the previous year. Promotion expenses primarily include promotional products to end customers. The increase in promotion expenses in the six months ended September 30, 2012 was mainly due to more customer loyalty program expenses for end customers.

General and administrative expenses primarily include salaries for staff and management, headquarter rental expense, and bad debt expense. The increase in general and administrative expenses in the six months ended September 30, 2012 from the same period in the previous year was mainly due to the increased office supplies expense as we moved into our new headquarters, and the increased depreciation expense related to the new headquarter renovation.

Other operating income represented the receipt of general purpose subsidies from local governments.
 
Interest Expense and Interest Income
 
The increase in interest expense in the six months ended September 30, 2012 from the same period in the previous year was mainly due to an increase in average borrowing balance, partially offset by decreased average interest rate as we used more trade financing with lower interest rates.

The increase in interest income in the six months ended September 30, 2012 from the same period in the previous year was mainly due to an increase in average restricted cash balance, which earned a higher interest rate than cash and cash equivalents.

Other income, net

Other income for the six months ended September 30, 2012 mainly include foreign currency translation gains of $2.2 million reclassified from accumulated comprehensive income as a result of substantial completion of the disposal of Heilongjiang Baoquanling Shengyuan Dairy Co., Ltd. and Heilongjiang Baoquanling Shengyuan Dairy Cow Breeding Co., Ltd.

Income Tax Expense
 
The increase in income tax expense was primarily due to $25.4 million charge from the increase in the valuation allowance for deferred tax assets attributable to net operating loss carryforwards of certain PRC subsidiaries and loss incurred for the six months ended September 30, 2012.

Net Income (Loss) Attributable to Noncontrolling Interest

Net income (loss) attributable to noncontrolling interest mainly represents the interest held by third parties in Meitek Technology (Qingdao) Co., Ltd..

Net Loss Attributable to Common Stockholders
 
As a result of the foregoing, net loss attributable to common stockholders for the six months ended September 30, 2012 was $53.9 million, compared to a net loss of $1.1 million for the same period in the previous year.
 
 
22

 
 
Liquidity and Capital Resources

Overview

Our primary sources of liquidity are cash on hand, cash from operations and available borrowings. Cash flows from operating activities represent the inflow of cash from our customers and the outflow of cash for inventory purchases, manufacturing, operating expenses, interest and taxes. Cash flows used in investing activities primarily represent capital expenditures for equipment and buildings. Cash flows from financing activities primarily represent proceeds and repayments of borrowings.

Cash and cash equivalents totaled $74.5 million at September 30, 2012, of which $73.8 million was held outside of the United States.

The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. Under that assumption, it is expected that assets will be realized and liabilities will be satisfied in the normal course of business. Management believes the Company has the ability to meet its financial obligations as they come due, for at least the next twelve months and will continue as a going concern.

On September 17, 2012, the Company entered into a partnership agreement, a milk supply agreement, a whey supply agreement, a whey powder supply agreement, and a technical assistance agreement with Sodiaal Union, a French agricultural cooperative company (“Sodiaal”), and Euroserum SAS (“Euroserum”), a French subsidiary of Sodiaal, relating to a long-term industrial and commercial partnership between Sodiaal and the Company. Under these agreements, the Company will build a new drying facility in Carhaix, France, intended to manufacture powdered milk and fat-enriched demineralized whey. Pursuant to the partnership agreement, the operational commissioning of the Site will take place no later than January 2, 2015. In the event of a delay beyond January 2, 2015 and save for limited exceptions, the Company undertakes to compensate, according to the circumstance, Sodiaal or Euroserum for the loss incurred as a result of such delay. The loss incurred by Sodiaal or Euroserum in case of a delay of the operational commissioning of the new drying facility beyond January 2, 2015 shall amount to the loss of profits actually suffered, as the case may be, by Sodiaal or Euroserum under the milk supply agreement or the whey supply agreement. The estimated cost to build is € 90 million (approximately $117 million). The Company is still negotiating with the banks and plans to finance a major part of the amount with long-term borrowings from the banks, and the remaining amount with its own funds. The Company committed to purchase, and Sodiaal and Euroserum committed to sell, 288 million liters of milk per year for ten years, an amount of whey equivalent to 24,000 tons of 70% demineralized pre-concentrated dry whey extract per year for ten years, and 6,000 tons of 70% demineralized whey powder per year, or an equivalent quantity of liquid whey, for ten years, to satisfy the production needs of the new drying facility. If the Company purchased less than the agreed amount, the Company should compensate Sodiaal or Euroserum for the loss suffered. The Company shall obtain approvals of the Chinese government within six months of the execution of the partnership agreement, failing which, the agreement shall be deemed terminated without penalty. As of November 9, 2012, the Company is in the process of obtaining approvals from the Chinese government.

Cash Flows

The following table sets forth, for the periods indicated, certain information relating to our cash flows:

   
Six Months Ended September 30,
 
(In thousands)
 
2012
   
2011
 
Cash flow provided by/(used in):
           
Operating activities
               
Net loss
 
$
(54,119
)
 
$
(829
)
Depreciation and amortization
   
6,531
     
5,708
 
Bad debt expense
   
1,451
     
4,741
 
Deferred income tax
   
25,378
     
14
 
Foreign currency translation gain on disposal of subsidiaries
   
(2,190
)
   
0
 
Other
   
(341
)
   
122
 
Changes in assets and liabilities
   
(24,238
)
   
(931
)
Total operating activities
   
(47,528
)
   
8,825
 
Investing activities
   
(28,596
)
   
(30,780
)
Financing activities
   
86,088
     
8,330
 
Effect of foreign currency translation on cash and cash equivalents
   
(236
   
1,537
 
Net increase/(decrease) in cash and cash equivalents
 
$
9,728
   
$
(12,088
 
 
23

 
 
Cash flow used in operating activities in the period is a result of the net loss incurred, non-cash expense and income, and changes in working capital. The changes in working capital for the six months ended September 30, 2012 were primarily related to $21.5 million decrease in accounts payable, $9.4 million increase in accounts receivable, and $6.8 million increase in other liabilities. In the six months ended September 30, 2012, we spent $142.0 million to purchase raw materials and other production materials, $26.0 million in staff compensation and social welfare, $13.2 million in income and other taxes, $34.7 million in operating expenses, $7.2 million in interest, and received $175.6 million from our customers.

Cash flow used in investing activities represents $6.8 million payment for our new headquarter renovation and purchase of equipment, $23.2 million outflow for restricted cash required as a pledge for new loans and as a collateral for new letters of credit, $1.8 million in proceeds from disposed assets, and $0.4 million payment to minority interest shareholders during the six months ended September 30, 2012.

Cash flow used in financing activities mainly represents net cash inflow of $69.8 million of short-term loans and net cash inflow of $16.7 million of long-term loans, and $0.5 million payment for capital leased assets.
 
Outstanding Indebtedness
 
For information on our short-term and long-term borrowings, see “Item 1. Financial Statements—Note 6”.

Capital Expenditures
 
Our capital expenditures were $3.0 million and the corresponding cash outflow was $6.8 million for the six months ended September 30, 2012, which mainly represented expenditure for our new headquarter renovation and purchase of equipment.

Off-Balance Sheet Arrangements
 
We do not have off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
 
 
24

 
 
ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
There is no material change in the information reported under Item 7A, “Foreign Exchange Risk”, “Inflation”, “Interest Rate Risk”, “Concentration of Credit Risk” and “Commodities Risk” contained in our Form 10-K for the fiscal year ended March 31, 2012.

ITEM 4.  CONTROLS AND PROCEDURES

Conclusion Regarding Effectiveness of Disclosure Controls and Procedures
 
The Company’s management, with the participation of the Company’s Chief Executive Officer and Interim Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act) as of September 30,2012.

Based on such evaluation, the Company’s Chief Executive Officer and Interim Chief Financial Officer have concluded that, as of September 30, 2012, the Company’s disclosure controls and procedures were not effective to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is (a) recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and (b) accumulated and communicated to the Company’s management, including its Chief Executive Officer and Interim Chief Financial Officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. The Chief Executive Officer and Interim Chief Financial Officer’s conclusion regarding the Company’s disclosure controls and procedures is based solely on management’s conclusion that the Company’s internal control over financial reporting was not effective, as described below.

As of September 30, 2012, we had the following material weakness:

The Company lacks a Chief Financial Officer with requisite skills to perform a sufficient review of the US GAAP consolidated financial statements and related footnote disclosures. As a result, the Company was unable to effectively operate period-end financial reporting and disclosure controls related to unusual and complex transactions.
 
Changes and Proposed Changes in Internal Control over Financial Reporting

The Company is in the process of developing and implementing remediation plans to address the material weakness in our internal control over financial reporting. We intend to implement measures during the year ending March 31, 2013 to address the material weakness. This includes our continued effort to search for a qualified candidate to replace the Chief Financial Officer who resigned on August 29, 2011, and implement alternative controls on period-end financial reporting and disclosure process related to unusual and complex transactions.

Other than as described above, there have not been any other changes in the Company’s internal control over financial reporting during the quarter ended September 30, 2012, which were identified in connection with management’s evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting. As described above, we plan to implement changes to our internal controls over financial reporting for the year ending March 31, 2013.
 
 
25

 
 
 PART II OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS
 
 As of September 30, 2012, the end of the period covered by this report, the Company was subject to various legal proceedings and claims that have not been fully resolved and that have arisen in the ordinary course of business. In the opinion of management, the Company does not have a potential liability related to any current legal proceedings and claims that would individually or in the aggregate have a material adverse effect on its financial condition or operating results. However, the results of legal proceedings cannot be predicted with certainty. The Company intends to contest each lawsuit vigorously but should the Company fail to prevail in any of these legal matters or should several of these legal matters be resolved against the Company in the same reporting period, the operating results of a particular reporting period could be materially and adversely affected.

ITEM 1A. RISK FACTORS

For information regarding the risks and uncertainties affecting our business, please refer to “Part I, Item 1A Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended March 31, 2012. There have been no material changes to these risks and uncertainties during the quarter ended September 30, 2012.
  
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.

ITEM 6.  EXHIBITS
 
Exhibit
Number
 
Description
10.1
 
Partnership framework agreement among Sodiaal Union, Shengyuan Nutritional Food Co., Ltd. and Synutra France International SAS, dated September 17, 2012
10.2
 
Milk supply agreement among Sodiaal Union, Shengyuan Nutritional Food Co., Ltd. and Synutra France International SAS, dated September 17, 2012
10.3
 
Whey supply agreement among Euroserum SAS, Sodiaal Union, Shengyuan Nutritional Food Co., Ltd. and Synutra France International SAS, dated September 17, 2012
10.4
 
Fat-enriched or non fat-enriched demineralized whey powder supply agreement among Euroserum SAS, Shengyuan Nutritional Food Co., Ltd. and Synutra France International SAS, dated September 17, 2012
31.1
 
Certification of Principal Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities and Exchange Act of 1934, as amended
31.2
 
Certification of Principal Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities and Exchange Act of 1934, as amended
32.1
 
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer)
32.2
 
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial Officer)
101
 
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets—September 30, 2012 and March 31, 2012, (ii) the Consolidated Statements of Operations—Three and Six Months Ended September 30, 2012 and 2011, (iii) the Consolidated Statements of Comprehensive Income(Loss)—Three and Six Months Ended September 30, 2012 and 2011, (iv) the Consolidated Statements of Equity—Six Months Ended September 30, 2012 and 2011, (v) the Consolidated Statements of Cash Flows—Six Months Ended September 30, 2012 and 2011, and (vi) Notes to Consolidated Financial Statements.*
 

*
As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.
 
 
26

 
 
SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
   
SYNUTRA INTERNATIONAL, INC.
 
       
       
Date:  November 9, 2012 
By:
/s/ Liang Zhang
 
       
Name:
Liang Zhang
 
       
Title:
Chief Executive Officer and Chairman
 
           
     
By:
/s/ Weiguo Zhang
 
       
Name:
Weiguo Zhang
 
       
Title:
Interim Chief Financial Officer and President
 
 
 
 27