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 December 31, 2008




or




 ̈
            Transition
      Report Pursuant to Section 13 of 15(d) of the Securities Exchange Act of
      1934




For the
Transition Period From to




Commission
File number: 000-50601





SYNUTRA
INTERNATIONAL, INC.


DELAWARE
              
              13-4306188(State or other jurisdiction of
                incorporation or organization)
              
              (IRS 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)





Check
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  ̈




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
definition of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.





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





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2of the Exchange Act).





Yes  ̈    
No x





As of
February 6, 2009, there were 54,000,713 shares of Common Stock issued and
outstanding.










TABLE OF
CONTENTS




PagePART
      IItem
      1. Financial Statements (unaudited)
                3Item
      2. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
                16Item
      3. Quantitative and Qualitative Disclosures About Market
    Risk
                30Item
      4. Controls and Procedures
                30PART
      IIItem
      1. Legal Proceedings
                32Item
      1A. Risk Factors
                32Item
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
                39Item
      3. Defaults Upon Senior Securities
                39Item
      4. Submission of Matters to a Vote of Security Holders
                39Item
      5. Other Information
                39Item
      6. Exhibits
                40Signatures
                41




2


PART
I


FINANCIAL
INFORMATION




ITEM
1. FINANCIAL STATEMENTS.




SYNUTRA
INTERNATIONAL, INC.


CONSOLIDATED
BALANCE SHEETS


(in
thousands, except share par value)


(unaudited)





December 31,
                                                                    2008
                                                                  
                                                                  
                                                                  March 31,
                                                                    2008ASSETSCurrent
      Assets:Cash
      and cash equivalents
                                                                  
                                                                  $
                                                                  55,660
                                                                  
                                                                  
                                                                  $
                                                                  97,425Restricted
      cash
                                                                  
                                                                  
                                                                  41,491
                                                                  
                                                                  
                                                                  
                                                                  9,744Accounts
      receivable, net of allowance of nil and $185, respectively
                                                                  
                                                                  
                                                                  21,404
                                                                  
                                                                  
                                                                  
                                                                  11,325Inventories
                                                                  
                                                                  
                                                                  95,361
                                                                  
                                                                  
                                                                  
                                                                  61,853Due
      from related parties
                                                                  
                                                                  
                                                                  3,120
                                                                  
                                                                  
                                                                  
                                                                  -Deferred
      tax assets
                                                                  
                                                                  
                                                                  1,027
                                                                  
                                                                  
                                                                  
                                                                  1,448Income
      tax receivable
                                                                  
                                                                  
                                                                  28,030
                                                                  
                                                                  
                                                                  
                                                                  -Prepaid
      expenses and other current assets
                                                                  
                                                                  
                                                                  16,692
                                                                  
                                                                  
                                                                  
                                                                  12,701Assets
      held for sale
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  1,316Total
      current assets
                                                                  
                                                                  
                                                                  262,785
                                                                  
                                                                  
                                                                  
                                                                  195,812Property,
      plant and equipment, net
                                                                  
                                                                  
                                                                  141,164
                                                                  
                                                                  
                                                                  
                                                                  85,719Land
      use rights, net
                                                                  
                                                                  
                                                                  6,408
                                                                  
                                                                  
                                                                  
                                                                  4,496Intangible
      assets, net
                                                                  
                                                                  
                                                                  3,157
                                                                  
                                                                  
                                                                  
                                                                  -Goodwill
                                                                  
                                                                  
                                                                  1,435
                                                                  
                                                                  
                                                                  
                                                                  -Deferred
      tax assets
                                                                  
                                                                  
                                                                  2,526
                                                                  
                                                                  
                                                                  
                                                                  2,077Other
      assets
                                                                  
                                                                  
                                                                  5,434
                                                                  
                                                                  
                                                                  
                                                                  8,115TOTAL
      ASSETS
                                                                  
                                                                  $
                                                                  422,909
                                                                  
                                                                  
                                                                  $
                                                                  296,219LIABILITIES
      AND SHAREHOLDERS’ EQUITYCurrent
      Liabilities:Short-term
      debt
                                                                  
                                                                  $
                                                                  158,699
                                                                  
                                                                  
                                                                  $
                                                                  21,228Long-term
      debt and capital lease obligations - current portion
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  1,923Accounts
      payable
                                                                  
                                                                  
                                                                  98,050
                                                                  
                                                                  
                                                                  
                                                                  26,438Due
      to related parties
                                                                  
                                                                  
                                                                  2,683
                                                                  
                                                                  
                                                                  
                                                                  2,970Advances
      from customers
                                                                  
                                                                  
                                                                  22,934
                                                                  
                                                                  
                                                                  
                                                                  9,465Income
      tax payable
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  4,168Product
      recall provision
                                                                  
                                                                  
                                                                  15,006
                                                                  
                                                                  
                                                                  
                                                                  -Other
      current liabilities
                                                                  
                                                                  
                                                                  19,190
                                                                  
                                                                  
                                                                  
                                                                  18,390Total
      current liabilities
                                                                  
                                                                  
                                                                  316,562
                                                                  
                                                                  
                                                                  
                                                                  84,582Long-term
      debt and capital lease obligations
                                                                  
                                                                  
                                                                  5,510
                                                                  
                                                                  
                                                                  
                                                                  34,184Deferred
      revenue
                                                                  
                                                                  
                                                                  4,682
                                                                  
                                                                  
                                                                  
                                                                  4,559Other
      long-term liabilities
                                                                  
                                                                  
                                                                  1,607
                                                                  
                                                                  
                                                                  
                                                                  1,250Total
      liabilities
                                                                  
                                                                  
                                                                  328,361
                                                                  
                                                                  
                                                                  
                                                                  124,575Minority
      interest
                                                                  
                                                                  
                                                                  474
                                                                  
                                                                  
                                                                  
                                                                  385Shareholders’
      equity:Common
      stock, $.0001 par value: 250,000 authorized; 54,001 issued and outstanding
      at December 31, 2008 and March 31, 2008, respectively
                                                                  
                                                                  
                                                                  5
                                                                  
                                                                  
                                                                  
                                                                  5Additional
      paid-in capital
                                                                  
                                                                  
                                                                  76,607
                                                                  
                                                                  
                                                                  
                                                                  76,607Retained
      earnings (Accumulated deficit)
                                                                  
                                                                  
                                                                  (6,503
                                                                  )
                                                                  
                                                                  
                                                                  76,875Accumulated
      other comprehensive income
                                                                  
                                                                  
                                                                  23,965
                                                                  
                                                                  
                                                                  
                                                                  17,772Total
      shareholders’ equity
                                                                  
                                                                  
                                                                  94,074
                                                                  
                                                                  
                                                                  
                                                                  171,259TOTAL
      LIABILITIES AND SHAREHOLDERS’ EQUITY
                                                                  
                                                                  $
                                                                  422,909
                                                                  
                                                                  
                                                                  $
                                                                  296,219





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




3


SYNUTRA
INTERNATIONAL, INC.


CONSOLIDATED
STATEMENTS OF INCOME


AND
COMPREHENSIVE INCOME


(in
thousands except earnings per share data)


(unaudited)





Three Months Ended
                                                                                    
                                                                                    
                                                                                    Nine Months EndedDecember 31,
                                                                                    
                                                                                    
                                                                                    December 31,2008
                                                                                    
                                                                                    
                                                                                    2007
                                                                                    
                                                                                    
                                                                                    2008
                                                                                    
                                                                                    
                                                                                    2007Net
      sales
                                                                                    
                                                                                    $
                                                                                    17,658
                                                                                    
                                                                                    
                                                                                    $
                                                                                    100,205
                                                                                    
                                                                                    
                                                                                    $
                                                                                    239,829
                                                                                    
                                                                                    
                                                                                    $
                                                                                    253,899Cost
      of sales
                                                                                    
                                                                                    
                                                                                    27,418
                                                                                    
                                                                                    
                                                                                    
                                                                                    49,627
                                                                                    
                                                                                    
                                                                                    
                                                                                    209,417
                                                                                    
                                                                                    
                                                                                    
                                                                                    119,633Gross
      profit (loss)
                                                                                    
                                                                                    
                                                                                    (9,760
                                                                                    )
                                                                                    
                                                                                    
                                                                                    50,578
                                                                                    
                                                                                    
                                                                                    
                                                                                    30,412
                                                                                    
                                                                                    
                                                                                    
                                                                                    134,266Selling
      and distribution expense
                                                                                    
                                                                                    
                                                                                    11,347
                                                                                    
                                                                                    
                                                                                    
                                                                                    10,301
                                                                                    
                                                                                    
                                                                                    
                                                                                    33,428
                                                                                    
                                                                                    
                                                                                    
                                                                                    26,191Advertising
      and promotion expenses
                                                                                    
                                                                                    
                                                                                    34,582
                                                                                    
                                                                                    
                                                                                    
                                                                                    18,974
                                                                                    
                                                                                    
                                                                                    
                                                                                    85,315
                                                                                    
                                                                                    
                                                                                    
                                                                                    59,428General
      and administrative expenses
                                                                                    
                                                                                    
                                                                                    8,197
                                                                                    
                                                                                    
                                                                                    
                                                                                    5,942
                                                                                    
                                                                                    
                                                                                    
                                                                                    18,917
                                                                                    
                                                                                    
                                                                                    
                                                                                    12,489Total
      operating expenses
                                                                                    
                                                                                    
                                                                                    54,126
                                                                                    
                                                                                    
                                                                                    
                                                                                    35,217
                                                                                    
                                                                                    
                                                                                    
                                                                                    137,660
                                                                                    
                                                                                    
                                                                                    
                                                                                    98,108Income
      (loss) from operations
                                                                                    
                                                                                    
                                                                                    (63,886
                                                                                    )
                                                                                    
                                                                                    
                                                                                    15,361
                                                                                    
                                                                                    
                                                                                    
                                                                                    (107,248
                                                                                    )
                                                                                    
                                                                                    
                                                                                    36,158Interest
      expense
                                                                                    
                                                                                    
                                                                                    1,378
                                                                                    
                                                                                    
                                                                                    
                                                                                    1,388
                                                                                    
                                                                                    
                                                                                    
                                                                                    2,444
                                                                                    
                                                                                    
                                                                                    
                                                                                    6,156Interest
      income
                                                                                    
                                                                                    
                                                                                    110
                                                                                    
                                                                                    
                                                                                    
                                                                                    339
                                                                                    
                                                                                    
                                                                                    
                                                                                    494
                                                                                    
                                                                                    
                                                                                    
                                                                                    1,539Other
      income (expense), net
                                                                                    
                                                                                    
                                                                                    (361
                                                                                    )
                                                                                    
                                                                                    
                                                                                    (545
                                                                                    )
                                                                                    
                                                                                    
                                                                                    18
                                                                                    
                                                                                    
                                                                                    
                                                                                    (587
                                                                                    )Income
      (loss) before provision (benefit) for income tax and minority
      interests
                                                                                    
                                                                                    
                                                                                    (65,515
                                                                                    )
                                                                                    
                                                                                    
                                                                                    13,767
                                                                                    
                                                                                    
                                                                                    
                                                                                    (109,180
                                                                                    )
                                                                                    
                                                                                    
                                                                                    30,954Provision
      (benefit) for income tax
                                                                                    
                                                                                    
                                                                                    (16,147
                                                                                    )
                                                                                    
                                                                                    
                                                                                    2,571
                                                                                    
                                                                                    
                                                                                    
                                                                                    (25,778
                                                                                    )
                                                                                    
                                                                                    
                                                                                    4,634Net
      income (loss) before minority interests
                                                                                    
                                                                                    
                                                                                    (49,368
                                                                                    )
                                                                                    
                                                                                    
                                                                                    11,196
                                                                                    
                                                                                    
                                                                                    
                                                                                    (83,402
                                                                                    )
                                                                                    
                                                                                    
                                                                                    26,320Minority
      interests
                                                                                    
                                                                                    
                                                                                    (26
                                                                                    )
                                                                                    
                                                                                    
                                                                                    (7
                                                                                    )
                                                                                    
                                                                                    
                                                                                    (24
                                                                                    )
                                                                                    
                                                                                    
                                                                                    5Net
      income (loss) attributable to shareholders
                                                                                    
                                                                                    $
                                                                                    (49,342
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    11,203
                                                                                    
                                                                                    
                                                                                    $
                                                                                    (83,378
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    26,315Other
      comprehensive income (loss)
                                                                                    
                                                                                    
                                                                                    (359
                                                                                    )
                                                                                    
                                                                                    
                                                                                    4,198
                                                                                    
                                                                                    
                                                                                    
                                                                                    6,193
                                                                                    
                                                                                    
                                                                                    
                                                                                    6,796Total
      comprehensive income (loss)
                                                                                    
                                                                                    $
                                                                                    (49,701
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    15,401
                                                                                    
                                                                                    
                                                                                    $
                                                                                    (77,185
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    33,111Earnings
      (loss) per share - basic
                                                                                    
                                                                                    $
                                                                                    (0.91
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    0.21
                                                                                    
                                                                                    
                                                                                    $
                                                                                    (1.54
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    0.50Earnings
      (loss) per share - diluted
                                                                                    
                                                                                    $
                                                                                    (0.91
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    0.21
                                                                                    
                                                                                    
                                                                                    $
                                                                                    (1.54
                                                                                    )
                                                                                    
                                                                                    $
                                                                                    0.49Weighted
      average common share outstanding - basic
                                                                                    
                                                                                    
                                                                                    54,001
                                                                                    
                                                                                    
                                                                                    
                                                                                    54,001
                                                                                    
                                                                                    
                                                                                    
                                                                                    54,001
                                                                                    
                                                                                    
                                                                                    
                                                                                    52,890Weighted
      average common share outstanding - diluted
                                                                                    
                                                                                    
                                                                                    54,001
                                                                                    
                                                                                    
                                                                                    
                                                                                    54,304
                                                                                    
                                                                                    
                                                                                    
                                                                                    54,001
                                                                                    
                                                                                    
                                                                                    
                                                                                    53,206





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


4


SYNUTRA
INTERNATIONAL, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(in
thousands)


(unaudited)




Nine Months Ended
                                              December 31,2008
                                            
                                            
                                            2007Cash
      flow from operating activities:Net
      income (loss)
                                            
                                            $
                                            (83,378
                                            )
                                            
                                            $
                                            26,315Adjustments
      to reconcile net income (loss) to net cash (used in) provided
      by operating activities:Amortization
      of debt discount
                                            
                                            
                                            -
                                            
                                            
                                            
                                            2,586Amortization
      of debt issuance costs
                                            
                                            
                                            241
                                            
                                            
                                            
                                            539Depreciation
      and amortization
                                            
                                            
                                            6,190
                                            
                                            
                                            
                                            3,352Bad
      debt expense
                                            
                                            
                                            541
                                            
                                            
                                            
                                            19Loss
      on disposal of property, plant and equipment
                                            
                                            
                                            12
                                            
                                            
                                            
                                            239Impairment
      of property, plant and equipment
                                            
                                            
                                            -
                                            
                                            
                                            
                                            168Deferred
      income tax
                                            
                                            
                                            66
                                            
                                            
                                            
                                            (1,071
                                            )Minority
      interest
                                            
                                            
                                            89
                                            
                                            
                                            
                                            5Changes
      in operating assets and liabilities, net of acquisition:Accounts
      receivable
                                            
                                            
                                            (9,408
                                            )
                                            
                                            
                                            (4,154
                                            )Inventories
                                            
                                            
                                            (31,255
                                            )
                                            
                                            
                                            (30,456
                                            )Due
      from related parties
                                            
                                            
                                            (4,124
                                            )
                                            
                                            
                                            11,990Prepaid
      expenses and other current assets
                                            
                                            
                                            (3,508
                                            )
                                            
                                            
                                            (9,396
                                            )Accounts
      payable
                                            
                                            
                                            58,945
                                            
                                            
                                            
                                            12,009Due
      to related parties
                                            
                                            
                                            2,389
                                            
                                            
                                            
                                            (3,237
                                            )Advances
      from customers
                                            
                                            
                                            12,972
                                            
                                            
                                            
                                            1,864Income
      tax receivable
                                            
                                            
                                            (31,740
                                            )
                                            
                                            
                                            1,673Product
      recall provision
                                            
                                            
                                            15,006
                                            
                                            
                                            
                                            -Other
      liabilities
                                            
                                            
                                            359
                                            
                                            
                                            
                                            3,805Net
      cash (used in) provided by operating activities
                                            
                                            
                                            (66,603
                                            )
                                            
                                            
                                            16,250Cash
      flow from investing activities:Purchase
      of property, plant and equipment
                                            
                                            
                                            (38,445
                                            )
                                            
                                            
                                            (14,354
                                            )Purchase
      of intangible assets
                                            
                                            
                                            (2,474
                                            )
                                            
                                            
                                            -Disposal
      of investment in a subsidiary
                                            
                                            
                                            -
                                            
                                            
                                            
                                            (1,046
                                            )Change
      in restricted cash
                                            
                                            
                                            (30,906
                                            )
                                            
                                            
                                            2,784Advance
      to related companies
                                            
                                            
                                            -
                                            
                                            
                                            
                                            (3,324
                                            )Advance
      repaid by related companies
                                            
                                            
                                            -
                                            
                                            
                                            
                                            3,324Business
      acquisitions, net of cash acquired
                                            
                                            
                                            (5,088
                                            )
                                            
                                            
                                            190Net
      cash used in investing activities
                                            
                                            
                                            (76,913
                                            )
                                            
                                            
                                            (12,426
                                            )Cash
      flow from financing activities:Proceeds
      from bank loans
                                            
                                            
                                            146,362
                                            
                                            
                                            
                                            98,523Repayment
      of borrowings
                                            
                                            
                                            (45,860
                                            )
                                            
                                            
                                            (101,670
                                            )Payment
      on capital lease obligations
                                            
                                            
                                            (530
                                            )
                                            
                                            
                                            -Proceeds
      from issuance of common stock, net of issuance costs of
    $145
                                            
                                            
                                            -
                                            
                                            
                                            
                                            65,857Net
      cash provided by financing activities
                                            
                                            
                                            99,972
                                            
                                            
                                            
                                            62,710Effect
      of exchange rate changes on cash and cash equivalents
                                            
                                            
                                            1,779
                                            
                                            
                                            
                                            3,205Net
      change in cash and cash equivalents
                                            
                                            
                                            (41,765
                                            )
                                            
                                            
                                            69,739Cash
      and cash equivalents, beginning of period
                                            
                                            
                                            97,425
                                            
                                            
                                            
                                            20,836Cash
      and cash equivalents, end of period
                                            
                                            $
                                            55,660
                                            
                                            
                                            $
                                            90,575Supplemental
      cash flow information:Interest
      paid
                                            
                                            $
                                            3,002
                                            
                                            
                                            $
                                            3,475Income
      tax paid
                                            
                                            $
                                            6,138
                                            
                                            
                                            $
                                            2,810Non-cash
      investing and financing activities:Purchase
      of property, plant and equipment by accounts payable
                                            
                                            $
                                            8,466
                                            
                                            
                                            $
                                            2,973Assets
      acquired under capital lease
                                            
                                            $
                                            5,350
                                            
                                            
                                            $
                                            -Business
      acquisitions by accounts payable
                                            
                                            $
                                            2,400
                                            
                                            
                                            $
                                            -Disposal
      of property by due from related parties
                                            
                                            $
                                            1,726
                                            
                                            
                                            $
                                            -





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


5


SYNUTRA
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





1.
            ORGANIZATION
      AND PRINCIPAL ACTIVITIES




Directly
or through its wholly owned subsidiary, Synutra Inc., an Illinois corporation
(“Synutra Illinois”), Synutra International, Inc. (collectively with
its subsidiaries, the “Company” or “Synutra”) owns all or majority of the
equity interests of the companies in the People’s Republic of China (“China” or
“PRC”) that are principally engaged in the production, marketing and
distribution of dairy based nutritional products under the Company’s own
brands in China. The Company is a leader in sales of infant formula products in
China.




The
Company produces, markets and sells nutritional products under “Sheng Yuan”, or
“Synutra”, its master brand, and several sub-brands, including “Super”,
“U-Smart”, “Mingshan”, and “He Lan Ru Niu” or “Holsteina”. The Company focuses
on selling premium infant formula products, which are supplemented by more
affordable infant formula products targeting the mass market as well
as other nutritional products, such as adult powdered 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
(“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 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
and its subsequent amendments, if any, for the fiscal year ended March 31,
2008.




These
statements include the accounts of the Company and its subsidiaries, which
include Beijing Sheng Yuan Huimin Technology Service Co., Ltd., a variable
interest entity, and its subsidiaries. All significant inter-company
accounts and transactions have been eliminated in consolidation.




Revenues,
expenses, assets and liabilities can vary during each quarter of the year.
Therefore, the results and trends in these interim financial statements may not
be the same as those for the full year.





3.
            RECENTLY
      ADOPTED ACCOUNTING PRONOUNCEMENTS




On
April 1, 2008, the Company adopted Financial Accounting Standards Board
(FASB) Statement of Financial Accounting Standards (SFAS) No. 157,
“Fair Value Measurements” (FAS 157) with respect to financial assets and
liabilities and elected to defer the adoption of FAS 157 for nonfinancial assets
and liabilities, except those that are recognized or disclosed at fair value in
the financial statements on a recurring basis (at least annually), to fiscal
years, and interim periods within those fiscal years as permitted by Financial
Accounting Standards Board (FASB) Staff Position No. SFAS 157-2 (FSP
157-2). SFAS 157 defines fair value, establishes a framework for measuring fair
value and expands disclosures about fair value measurements. The adoption of
SFAS 157 for financial assets and liabilities had no effect on the financial
position, results of operations or cash flows. The Company will adopt FSP 157-2
for nonfinancial assets and liabilities on April 1, 2009, and is currently
evaluating the impact such adoption will have on the financial
statements.





In
February 2007, the FASB issued SFAS No.159, “The Fair Value Option for Financial
Assets and Financial Liabilities”. The standard requires unrealized gains and
losses to be included in earnings for items reported using the fair value
option. SFAS No.159 permits companies to choose to measure many financial
instruments and certain other items at fair value. SFAS No.159 is effective for
financial statements issued for fiscal years beginning after November 15, 2007.
The Company did not elect the fair value option described in SFAS No.159 for
financial instruments and certain other items.


6


4.
            RECENTLY
      ISSUED ACCOUNTING PRONOUNCEMENTS





In
December 2007, the FASB issued SFAS No. 141 (R), “Business
Combinations” (“SFAS No. 141(R)”).
SFAS No. 141(R) requires an entity to recognize the assets
acquired, liabilities assumed, contractual contingencies, and contingent
consideration at their fair value on the acquisition date.  Subsequent
changes to the estimated fair value of contingent consideration will be
reflected in earnings until the contingency is settled. 
SFAS No. 141(R) also requires acquisition-related costs and
restructuring costs to be expensed as incurred rather than treated as part of
the purchase price. The adoption of SFAS No. 141(R) will change
the Company’s accounting treatment for business combinations for which the
acquisition date is on or after April 1, 2009. SFAS 141R amends
SFAS109,
“Accounting for Income
Taxes,”such that
adjustments made to valuation allowances on deferred taxes and acquired tax
contingencies associated with acquisitions that closed prior to the effective
date of SFAS 141R would also apply theprovisions of
SFAS 141R.




In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements” to improve the relevance, comparability, and
transparency of financial information provided to investors by requiring all
entities to report noncontrolling (minority) interests in subsidiaries in the
same way as required in the consolidated financial statements. Moreover, SFAS
No. 160 eliminates the diversity that currently exists in accounting for
transactions between an entity and noncontrolling interests by requiring they be
treated as equity transactions. SFAS No. 160 is effective for fiscal years,
and interim periods within those fiscal years, beginning on or after
December 15, 2008. Earlier adoption is prohibited. The Company is currently
evaluating whether the adoption of SFAS No. 160 will have a significant
effect on its consolidated financial position, results of operations or cash
flows.




In
March 2008, the FASB issued SFAS No. 161, “Disclosures about
Derivative Instruments and Hedging Activities - an Amendment of FASB Statement
133.” SFAS No. 161 provides new disclosure requirements for an entity’s
derivative and hedging activities. SFAS No. 161 is effective for periods
beginning after November 15, 2008. The Company has not yet determined the
impact on its consolidated financial statements of adopting
SFAS No. 161.




In
April 2008, the FASB issued Staff Position No. FAS 142-3,
“Determination of the Useful Life of Intangible Assets” (FSP FAS 142-3). This
position amends the factors an entity should consider when developing renewal or
extension assumptions used in determining the useful life over which to amortize
the cost of a recognized intangible asset under SFAS No. 142, “Goodwill and
Other Intangible Assets.” FSP FAS 142-3 requires an entity to consider its own
historical experience in renewing or extending similar arrangements in
determining the amortizable useful life. Additionally, this position requires
expanded disclosures related to the determination of intangible asset useful
lives. FSP FAS 142-3 is effective for fiscal years beginning after
December 15, 2008, and may impact any intangible assets the Company
acquires in future transactions. The guidance for determining the useful life of
a recognized intangible asset must be applied prospectively to intangible assets
acquired after the effective date. The disclosure requirements, though, shall be
applied prospectively to all intangible assets recognized as of the effective
date. Early adoption is prohibited. The Company expects to adopt FSP FAS 142-3
as of April 1, 2009.





In May
2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted
Accounting Principles" (FAS 162). FAS 162 identifies the sources of accounting
principles and the framework for selecting the principles used in the
preparation of financial statements.  FAS 162 is effective 60 days
following SEC approval.





In June
2008, the FASB issued Staff Position No. Emerging Issue Task Force (EITF)
03-6-1, "Determining Whether Instruments Granted in Share-Based Payment
Transactions Are Participating Securities" (FSP EITF 03-6-1), which requires
entities to apply the two-class method of computing basic and diluted earnings
per share for participating securities that include awards that accrue cash
dividends (whether paid or unpaid) any time common shareholders receive
dividends and those dividends will not be returned to the entity if the employee
forfeits the award. FSP EITF 03-6-1 is effective for fiscal years beginning
after December 15, 2008, and the interim periods within those years. Early
adoption is prohibited and retroactive disclosure is required. The Company
expects to adopt FSP EITF 03-6-1 on April 1, 2009 and is currently evaluating
the effect its adoption will have on the results of operations, financial
positions and cash flows.





In June
2008, the FASB ratified EITF Issue 07-5,“Determining Whether an Instrument (or Embedded
Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-5”). This
Issue addresses the determination of whether an instrument (or an embedded
feature) is indexed to an entity’s own stock. The EITF will be effective
for years beginning after December 15, 2008.  The Company is
evaluating the impact of adopting the provisions of this EITF.




7


5.
            BUSINESS
      ACQUISITION





On
October 8, 2008, the Company acquired certain assets from Beijing Huilian Food
Co., Ltd. (“Huilian”) which is a provider of prepared baby food in mainland
China, with total consideration of RMB 45 million (approximately US$ 6.6
million). As a result of the acquisition, the Company is expected to expand into
the production of prepared baby food. For accounting purposes, the acquisition
has been accounted for as a business combination in accordance with SFAS No.
141. Under the purchase method of accounting, the assets acquired and
liabilities assumed from Huilian are recorded at the date of acquisition at
their respective fair values. Financial statements and reported results of
operations of the company will reflect these values, with the results of Huilian
included from October 8, 2008, in the statement of income.





The
following table summarizes the estimated fair values of the assets acquired and
liabilities assumed at the date of acquisition.





(In thousands)Property,
      plant and equipment
                              
                              $
                              1,870Land
      use right
                              
                              
                              1,697Intangible
      assets
                              
                              
                              1,582Goodwill
                              
                              
                              1,435Total
                              
                              $
                              6,584





The
allocation of purchase price for Huilian has been recorded on a preliminary
basis and reasonable changes are expected as additional information becomes
available. A number of assumptions have been made with respect to assigned
intangible assets. To the extent that these assumptions are revised, the
preliminary allocation of the purchase price could be different from that
identified above.





Of the
$1.6 million of intangible assets acquired, $0.3 million was assigned to
registered trademarks that are not subject to amortization; $0.4 million was
assigned to know-how that have a useful life of approximately 5 years; $0.9
million was assigned to a customer relationship that was written off at the date
of acquisition as the Company did not intend to utilize such asset and the
write-off was included in selling and distribution expense. Acquired
identifiable intangible assets have been allocated to the Baby Food reporting
segment.





A
goodwill of $1.4 million arising from this acquisition was assigned to the Baby
Food segment. The impairment test of goodwill will be performed at the last day
of each fiscal year or upon the occurrence of certain events and change in
circumstances as required by SFAS 142.


8


6.
            PRODUCT
      RECALL





On
September 16, 2008, the Company announced a compulsory recall on certain lots of
U-Smart products and a voluntary recall of other products that were contaminated
or suspected to be contaminated by melamine, a substance not approved for use in
food and linked to recent illnesses among infants and children in China. The
initial estimated cost of this action was $77.4 million which was recognized as
a charge to cost of sales and selling and distribution expenses in the Company’s
consolidated statement of income for the fiscal quarter ended September 30,
2008, of which $38.0 million was recorded as a product recall provision in the
consolidated balance sheet as of September 30, 2008. During the three months
ended December 31, 2008, the Company recognized additional product replacement
expenses of $9.9 million in cost of sales and additional freight charges of $0.3
million in selling and distribution expenses. The Company also contributed a net
amount of $2.3 million to a compensation fund set up by the China Dairy Industry
Association to settle existing and potential claims arising in China from
families of infants affected by the melamine contamination. This contribution
was recorded in general and administrative expenses for the fiscal quarter ended
December 31, 2008. The Company had a product recall provision of $15.0 million
in its consolidated balance sheet as of December 31, 2008. These costs represent
the Company’s estimate of probable costs based on available data and take into
account factors such as expected return rates for the affected units, unit
replacement costs, logistical expenses and expenses relating to the hiring of
temporary contractors to assist with the Company’s recall efforts.





Should
actual product recall costs differ from the estimated costs, the Company would
have to reassess the impact of the product recall on the Company’s financial
results and revise the estimated product recall accrual accordingly. Following
is a summary of the liabilities related to the product recall that were recorded
during the fiscal quarter ended December 31, 2008:




Balance
      at September 30, 2008
                            
                            $
                            37,987Product
      recall expenses
                            
                            
                            12,502Replacement
      of products
                            
                            
                            (31,195
                            )Payment
      of cash, net
                            
                            
                            (4,197
                            )Foreign
      currency translation
                            
                            
                            (91
                            )Balance
      at December 31, 2008
                            
                            $
                            15,006





7.
            INVENTORIES




The
Company’s inventories at December 31, 2008 and March 31, 2008 are summarized as
follows:





December 31,
                              2008
                            
                            
                            March 31,
                              2008(In
      thousands)Raw
      materials
                            
                            $
                            60,689
                            
                            
                            $
                            30,550Work-in-progress
                            
                            
                            15,401
                            
                            
                            
                            16,786Finished
      goods
                            
                            
                            19,271
                            
                            
                            
                            14,517Total
      Inventories
                            
                            $
                            95,361
                            
                            
                            $
                            61,853




9


8.
            DUE
      FROM/TO RELATED PARTIES AND RELATED PARTY
  TRANSACTIONS




A.
            Classification
      of related party balances by name





a.
            Due
      from related parties





December 31,
                                2008
                              
                              
                              March 31,
                                2008(In thousands)Beijing
      Honnete Dairy Co., Ltd.
                              
                              $
                              1,394
                              
                              
                              $
                              -Sheng
      Zhi Da Dairy Group Corporation
                              
                              $
                              1,726
                              
                              
                              $
                              —Total
      Due from Related Parties
                              
                              $
                              3,120
                              
                              
                              $
                              —




In June
2008, the Company sold two commercial buildings to Sheng Zhi Da Dairy Group
Corporation, an entity 100% controlled by the Company's CEO, at the carrying
value of $1.7 million. The balance due from Sheng Zhi Da Dairy Group Corporation
at December 31, 2008 represents the unpaid amount as a result of such sale.





b.
            Due
      to related parties




December 31,
                            2008
                          
                          
                          March 31,
                            2008(In
      thousands)Sheng
      Zhi Da Dairy Group Corporation
                          
                          $
                          2,111
                          
                          
                          $
                          2,404St.
      Angel (Beijing) Business Service Co., Ltd.
                          
                          
                          3
                          
                          
                          
                          4Beijing
      Honnete Dairy Co., Ltd.
                          
                          
                          569
                          
                          
                          
                          562Total
      Due to Related Parties
                          
                          $
                          2,683
                          
                          
                          $
                          2,970





As of
December 31, 2008, the Company also had short term loans of $2.9 million and
$4.3 million from Honnete Dairy Hong Kong Co., Ltd. (“Honnete Hong Kong”) and
Qingdao Luyin Environment Co., Ltd. (“Luyin”), respectively. Both Honnete Hong
Kong and Luyin are entities controlled by the Company’s CEO and are related
parties of the Company. See Note 11.





B.
            Sales
      to related parties




In the
three and nine months ended December 31, 2008, the Company’s sales to the
related parties included whey protein sold to Beijing Honnete Dairy Co.,
Ltd.  In the three and nine months ended December 31, 2007, the
Company’s sales to the related parties included milk fat and non-fat dry milk to
Kelqin and the Company’s name brand products to Luding Xueyuan for direct sales,
catalogue sales, and regional retail outlets distribution





The
following tables categorize sales to related companies as main product sales and
ancillary product sales as presented in the income statements:




a.
            Main
      product sales to related parties




Three Months Ended
                          
                          Nine Months EndedDecember 30,
                          
                          September 30,2008
                          
                          2007
                          
                          2008
                          
                          2007(In
      thousands)Beijing
      Kelqin Dairy Co., Ltd.
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          1,293Beijing
      Luding Xueyuan Trading Co., Ltd.
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          1,057Total
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          2,350





b.
            Ancillary
      product sales to related parties





Three Months Ended
                                
                                Nine Months EndedDecember 31,
                                
                                December 31,2008
                                
                                2007
                                
                                2008
                                
                                2007(In
      thousands)Beijing
      Honnete Dairy Co., Ltd.
                                
                                $
                                815
                                
                                
                                $
                                -
                                
                                
                                $
                                815
                                
                                
                                $
                                -Beijing
      Luding Xueyuan Trading Co., Ltd.
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -Beijing
      Kelqin Dairy Co., Ltd.
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                199Total
                                
                                $
                                815
                                
                                
                                $
                                -
                                
                                
                                $
                                815
                                
                                
                                $
                                199Total
      of main product and ancillary product sales to related
      companies
                                
                                $
                                815
                                
                                
                                $
                                -
                                
                                
                                $
                                815
                                
                                
                                $
                                2,549




10






C.
            Purchases
      from related parties




In the
three and nine months ended December 31, 2008 and 2007, the Company’s purchases
from related parties included whey protein powders from Kelqin and Honnete, and
catalogues, brochures, and marketing materials from St. Angel and Sheng Long
Media.





Three Months Ended
                          
                          Nine Months EndedDecember 31,
                          
                          December 31,2008
                          
                          2007
                          
                          2008
                          
                          2007(In
      thousands)Beijing
      Kelqin Dairy Co., Ltd.
                          
                          $
                          -
                          
                          
                          $
                          25
                          
                          
                          $
                          -
                          
                          
                          $
                          3,286Beijing
      Honnete Dairy Co., Ltd.
                          
                          
                          459
                          
                          
                          
                          19
                          
                          
                          
                          8,459
                          
                          
                          
                          2,674St.
      Angel (Beijing) Business Service Co., Ltd.
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          1,639
                          
                          
                          
                          -Beijing
      Sheng Long Media Co., Ltd.
                          
                          
                          -
                          
                          
                          
                          6
                          
                          
                          
                          154
                          
                          
                          
                          839Total
                          
                          $
                          459
                          
                          
                          $
                          50
                          
                          
                          $
                          10,255
                          
                          
                          $
                          6,799




9.
            PROPERTY,
      PLANT AND EQUIPMENT, NET





December 31,
                                  2008
                                
                                
                                March 31,
                                  2008(In thousands)Property,
      plant and equipment, cost:Buildings
                                
                                $
                                46,320
                                
                                
                                $
                                27,004Plant
      and machinery
                                
                                
                                60,363
                                
                                
                                
                                38,430Office
      equipment and furnishings
                                
                                
                                3,010
                                
                                
                                
                                2,534Motor
      vehicles
                                
                                
                                2,941
                                
                                
                                
                                1,340Others
                                
                                
                                506
                                
                                
                                
                                348Total
      cost
                                
                                
                                113,140
                                
                                
                                
                                69,656Less:
      Accumulated depreciation:Buildings
                                
                                
                                3,972
                                
                                
                                
                                2,831Plant
      and machinery
                                
                                
                                10,369
                                
                                
                                
                                6,933Office
      equipment and furnishings
                                
                                
                                1,054
                                
                                
                                
                                705Motor
      vehicles
                                
                                
                                765
                                
                                
                                
                                545Others
                                
                                
                                254
                                
                                
                                
                                197Total
      accumulated depreciation
                                
                                
                                16,414
                                
                                
                                
                                11,211Construction
      in progress
                                
                                
                                44,438
                                
                                
                                
                                27,274Property,
      plant and equipment, net
                                
                                $
                                141,164
                                
                                
                                $
                                85,719




Construction
in progress primarily represents the construction of manufacturing facilities
and the furnishing of administrative buildings.




The
Company recorded depreciation expense of $2.0 million and $1.2 million for the
fiscal quarters ended December 31, 2008 and 2007, respectively, and
recorded depreciation expense of $5.3 million and $3.1 million for the nine
months ended December 31, 2008 and 2007, respectively.





10.
            INTANGIBLE
      ASSETS, NET





December 31, 2008*Gross
                                  Carrying
                                  Amount
                                
                                
                                Accumulated
                                  Amortization
                                  or Write-off
                                
                                
                                Net Carrying
                                  Amount(In thousands)Know-how
      (5-year useful life)
                                
                                $
                                399
                                
                                
                                $
                                20
                                
                                
                                $
                                379Customer
      relationship
                                
                                
                                880
                                
                                
                                
                                880
                                
                                
                                
                                -Registered
      trademark (indefinite life)
                                
                                
                                2,778
                                
                                
                                
                                -
                                
                                
                                
                                2,778$
                                4,057
                                
                                
                                $
                                900
                                
                                
                                $
                                3,157





* Nil
figures for the comparable periods in fiscal year 2008.





The
intangible assets acquired in the three months ended December 31, 2008 included
the know-how, customer relationship and registered trademarks arising from the
acquisition of Huilian’s prepared baby food business discussed in Note 5, and
the registered trademarks of He Lan Ru Niu, or Holsteina, that are being used
for the Company’s powdered adult formula products.





Amortization
expense was $0.9 million for the three and nine months period ended
December 31, 2008.


11


11.
            DEBT
      AND CAPITAL LEASE OBLIGATION





On
October 11, 2007, ABN and another lender provided a three year term loan,
or the New ABN Loan, to the Company in the aggregate amount of $35 million. The
principal amount, and any unpaid accrued interest on the New ABN Loan, will be
due on October 11, 2010 and may be prepaid without penalty. The proceeds of
the New ABN Loan were used to pay the outstanding principal and accrued interest
of a six-month term loan provided to the Company by ABN on April 19, 2007,
or the Original ABN Loan. The New ABN Loan bears interest at LIBOR for deposits
in U.S. dollars plus 3.5% with interest payable on the last day of each
three-month period. The loan is secured by a pledge of 10,000 shares of common
stock, or 100% of the outstanding common stock of Synutra Illinois.





The loan
agreement for the New ABN Loan provides for mandatory prepayment upon the
occurrence of certain events, and contains customary covenants for financings of
this type, including restrictions on the incurrence of liens, payment of
dividends, and disposition of properties. The loan agreement for the New ABN
Loan also contains certain financial covenants, including a requirement to
maintain specified leverage and interest coverage ratio, tangible net worth, and
indebtedness to tangible net worth ratio. The Company has performed an analysis
of the relevant ratios and found that due to the net loss which resulted from
the estimated costs of the product recall, including inventory write-down and
write-off in the fiscal quarters ended September 30, 2008 and December 31, 2008,
the Company was not able to meet all the financial covenant requirements as of
December 31, 2008. Further, the Company anticipates that it may have difficulty
meeting these financial covenant requirements for the next several fiscal
quarters. The Company has requested the lenders to waive these financial
covenants for the next several fiscal quarters. The lenders have proposed waiver
fee which equals to 0.7% of the aggregate principal amount outstanding and an
increase in the interest rate by 200 basis points to LIBOR for deposits in U.S.
dollars plus 5.5%. As of the date of the filing of this 10-Q, the waiver has not
been granted. The Company is currently in discussions with the lenders on the
waiver and is unable to predict when, or if the waiver will be granted.
Accordingly, the Company has reclassified the outstanding balance of $34.4
million under the loan to current liabilities since the Company considers this
debt callable by the bank. The Company may also incur additional expenses in
connection with the modification of loan arrangements.





In
addition to the New ABN Loan, as of December 31, 2008 and March 31, 2008,
the Company had short-term loans from banks in the amount of $117.0 million
(including new borrowings of $102.5 million with a weighted average interest
rate of 4.87% during the three months ended December 31, 2008) and $21.2
million, respectively. The maturity date of the short term loans from banks
outstanding at December 31, 2008 range from February 2009 to December 2009.
The weighted average interest rate on short-term loans outstanding at December
31, 2008 and March 31, 2008 was 5.09% and 7.08%, respectively. The loans
were secured by the pledge of certain fixed assets held by the Company and its
subsidiaries, a pledge of land use right in Qingdao, China and pledge of cash
deposits. The value of fixed assets pledged was $ 30.6 million and $18.1
million as of December 31, 2008 and March 31, 2008, respectively. The
value of land use right pledged was $3.2 million and nil as of December 31, 2008
and March 31, 2008, respectively. The value of cash deposits pledged was $31.5
million which was recorded in restricted cash and nil as of December 31, 2008
and March 31, 2008, respectively.





Apart
from the short-term loans from banks, the Company also had short term loans from
related parties in the amount of $7.2 million and nil as of December 31, 2008
and March 31, 2008 respectively. The maturity date of the short term loans
outstanding from related parties at December 31, 2008 range from March 2009
to November 2009. The weighted average interest rate on the loans from related
parties at December 31, 2008 was 7.28%.





The
Company has a capital lease agreement in place related to office buildings. The
capital lease obligations of $5.5 million are included in long-term
debt.


12





12.
            INCOME
      TAX




The
effective tax rate is based on expected income, 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 in accordance with the FIN 18, “Accounting for Income Taxes in Interim
Period” and APB 18, “Interim Financial Reporting”. 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 during the quarter in which the change in
estimate occurs so that the year-to-date provision reflects the expected annual
tax rate.




The
Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes, an Interpretation of FASB Statement No. 109,” on April 1,
2007. The Company recognizes a tax benefit associated with an uncertain tax
position when, in management's judgment, it is more likely than not that the
position will be sustained upon examination by a taxing authority. For a tax
position that meets the more-likely-than-not recognition threshold, the Company
initially and subsequently measures the tax benefit as the largest amount that
it judges to have a greater than 50% likelihood of being realized upon ultimate
settlement with a taxing authority. The liability associated with unrecognized
tax benefits is adjusted periodically due to changing circumstances, such as the
progress of tax audits, case law developments and new or emerging legislation.
Such adjustments are recognized entirely in the period in which they are
identified. The effective tax rate includes the net impact of changes in the
liability for unrecognized tax benefits and subsequent adjustments as considered
appropriate by management.




The
effective tax rate for the nine months ended December 31, 2008 increased 8.6%
from the 15.0% effective rate for the nine months ended December 31, 2007 to
23.6%. This increase was due primarily to the expiration of the tax holidays
enjoyed by certain subsidiaries in China.




13.
            EARNINGS
      PER SHARE (EPS)





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





Three Months Ended
                                
                                
                                Nine Months EndedDecember 31,
                                
                                
                                December 31,2008
                                
                                
                                2007
                                
                                
                                2008
                                
                                
                                2007(In thousands except for per share data)Net
      income (loss) attributable to common shareholders
                                
                                $
                                (49,342
                                )
                                
                                $
                                11,203
                                
                                
                                $
                                (83,378
                                )
                                
                                $
                                26,315Basic
      weighted average common shares outstanding
                                
                                
                                54,001
                                
                                
                                
                                54,001
                                
                                
                                
                                54,001
                                
                                
                                
                                52,890Dilutive
      potential common shares from warrant
                                
                                
                                -
                                
                                
                                
                                303
                                
                                
                                
                                -
                                
                                
                                
                                316Diluted
      weighted average shares outstanding
                                
                                
                                54,001
                                
                                
                                
                                54,304
                                
                                
                                
                                54,001
                                
                                
                                
                                53,206Earnings
      (loss) per share—basic
                                
                                $
                                (0.91
                                )
                                
                                $
                                0.21
                                
                                
                                $
                                (1.54
                                )
                                
                                $
                                0.50Earnings
      (loss) per share—diluted
                                
                                $
                                (0.91
                                )
                                
                                $
                                0.21
                                
                                
                                $
                                (1.54
                                )
                                
                                $
                                0.49





The
warrants to purchase 400,000 shares of common stock granted to ABN in connection
with the Original ABN Loan were excluded from the computation of diluted
earnings per share for the three and nine months ended December 31, 2008 as they
would be anti-dilutive. There were no anti-dilutive warrants excluded from the
computation of diluted earnings per share for the three and nine months ended
December 31, 2007.


13


14.
            SEGMENT
      REPORTING





During
the three months ended December 31, 2008, Meitek, a PRC subsidiary of the
Company which is engaged in the production of nutritional ingredients and
supplements such as chondroitin, Docosahexanoic Acid (“DHA”) and Arachidonicacid
(“ARA”), completed its construction process and began its operations. In the
same fiscal quarter, the Company acquired the prepared baby food business from
Huilian which the Company expects to begin operating in the fiscal quarter
ending March 31, 2009. Historically the Company reported results as a single
reporting segment in the financial statements since operating segments such as
nutritional ingredients and supplements were under construction with minor
operating expenses and had not met the quantitative threshold as described under
SFAS 131 "Disclosure about Segments of an Enterprise and Related Information".
The chief operating decision maker manages the business, including making
operating decisions (such as allocating resources) and evaluating operating
performance, on a gross profit (loss) basis. The Company expanded the number of
reportable segments from one to three in order to better reflect the manner in
which management analyzes the Company’s performance including powdered formula,
baby food, and nutritional ingredients and supplements. All prior period
segment information has been recast to reflect the current period
presentation. The Company accounts for inter-segment sales and transfers as
if the sales or transfers were to third parties, that is, at current market
prices. 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 and nutritional snacks for babies and children.




Nutritional Ingredients and
Supplements -Sales of nutritional ingredients and supplements such as
chondroitin, DHA and ARA.




"All
Other" includes non-core businesses such as toll packaging, toll drying service
and 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. The intangible
assets which were recognized upon the acquisition of the prepared baby food
business from Huilian in the fiscal quarter ended December 31, 2008 and related
amortization are allocated to the baby food segment. The following segment
information has been prepared in accordance with the internal accounting
policies of the Company, as described above.





Three Months Ended
                                                                                          
                                                                                          
                                                                                          Nine Months EndedDecember 31
                                                                                          
                                                                                          
                                                                                          December 312008
                                                                                          
                                                                                          
                                                                                          2007
                                                                                          
                                                                                          
                                                                                          2008
                                                                                          
                                                                                          
                                                                                          2007(In thousands)NET
      SALESPowdered
      formula
                                                                                          
                                                                                          $
                                                                                          12,384
                                                                                          
                                                                                          
                                                                                          $
                                                                                          91,306
                                                                                          
                                                                                          
                                                                                          $
                                                                                          215,613
                                                                                          
                                                                                          
                                                                                          $
                                                                                          224,519Baby
      food
                                                                                          
                                                                                          
                                                                                          -
                                                                                          
                                                                                          
                                                                                          
                                                                                          -
                                                                                          
                                                                                          
                                                                                          
                                                                                          -
                                                                                          
                                                                                          
                                                                                          
                                                                                          -Nutritional
      ingredients and supplements
                                                                                          
                                                                                          
                                                                                          504
                                                                                          
                                                                                          
                                                                                          
                                                                                          -
                                                                                          
                                                                                          
                                                                                          
                                                                                          504
                                                                                          
                                                                                          
                                                                                          
                                                                                          -All
      other
                                                                                          
                                                                                          
                                                                                          5,274
                                                                                          
                                                                                          
                                                                                          
                                                                                          8,899
                                                                                          
                                                                                          
                                                                                          
                                                                                          24,216
                                                                                          
                                                                                          
                                                                                          
                                                                                          29,380Intersegment
      sales elimination
                                                                                          
                                                                                          
                                                                                          (504
                                                                                          )
                                                                                          
                                                                                          
                                                                                          -
                                                                                          
                                                                                          
                                                                                          
                                                                                          (504
                                                                                          )Net
      sales
                                                                                          
                                                                                          $
                                                                                          17,658
                                                                                          
                                                                                          
                                                                                          $
                                                                                          100,205
                                                                                          
                                                                                          
                                                                                          $
                                                                                          239,829
                                                                                          
                                                                                          
                                                                                          $
                                                                                          253,899GROSS
      PROFIT (LOSS)Powdered
      formula
                                                                                          
                                                                                          $
                                                                                          (11,429
                                                                                          )
                                                                                          
                                                                                          $
                                                                                          49,457
                                                                                          
                                                                                          
                                                                                          $
                                                                                          26,726
                                                                                          
                                                                                          
                                                                                          $
                                                                                          129,378Baby
      food
                                                                                          
                                                                                          
                                                                                          -
                                                                                          
                                                                                          
                                                                                          
                                                                                          -
                                                                                          
                                                                                          
                                                                                          
                                                                                          -
                                                                                          
                                                                                          
                                                                                          
                                                                                          -Nutritional
      ingredients and supplements
                                                                                          
                                                                                          
                                                                                          133
                                                                                          
                                                                                          
                                                                                          
                                                                                          -
                                                                                          
                                                                                          
                                                                                          
                                                                                          133
                                                                                          
                                                                                          
                                                                                          
                                                                                          -All
      other
                                                                                          
                                                                                          
                                                                                          1,669
                                                                                          
                                                                                          
                                                                                          
                                                                                          1,121
                                                                                          
                                                                                          
                                                                                          
                                                                                          3,686
                                                                                          
                                                                                          
                                                                                          
                                                                                          4,888Intersegment
      profit elimination
                                                                                          
                                                                                          
                                                                                          (133
                                                                                          )
                                                                                          
                                                                                          
                                                                                          -
                                                                                          
                                                                                          
                                                                                          
                                                                                          (133
                                                                                          )
                                                                                          
                                                                                          
                                                                                          -Gross
      profit (loss)
                                                                                          
                                                                                          $
                                                                                          (9,760
                                                                                          )
                                                                                          
                                                                                          $
                                                                                          50,578
                                                                                          
                                                                                          
                                                                                          $
                                                                                          30,412
                                                                                          
                                                                                          
                                                                                          $
                                                                                          134,266Selling
      and distribution expenses
                                                                                          
                                                                                          
                                                                                          11,347
                                                                                          
                                                                                          
                                                                                          
                                                                                          10,301
                                                                                          
                                                                                          
                                                                                          
                                                                                          33,428
                                                                                          
                                                                                          
                                                                                          
                                                                                          26,191Advertising
      and promotion expenses
                                                                                          
                                                                                          
                                                                                          34,582
                                                                                          
                                                                                          
                                                                                          
                                                                                          18,974
                                                                                          
                                                                                          
                                                                                          
                                                                                          85,315
                                                                                          
                                                                                          
                                                                                          
                                                                                          59,428General
      and administrative expenses
                                                                                          
                                                                                          
                                                                                          8,197
                                                                                          
                                                                                          
                                                                                          
                                                                                          5,942
                                                                                          
                                                                                          
                                                                                          
                                                                                          18,917
                                                                                          
                                                                                          
                                                                                          
                                                                                          12,489Income
      (loss) from operations
                                                                                          
                                                                                          
                                                                                          (63,886
                                                                                          )
                                                                                          
                                                                                          
                                                                                          15,361
                                                                                          
                                                                                          
                                                                                          
                                                                                          (107,248
                                                                                          )
                                                                                          
                                                                                          
                                                                                          36,158Interest
      expense
                                                                                          
                                                                                          
                                                                                          1,378
                                                                                          
                                                                                          
                                                                                          
                                                                                          1,388
                                                                                          
                                                                                          
                                                                                          
                                                                                          2,444
                                                                                          
                                                                                          
                                                                                          
                                                                                          6,156Interest
      income
                                                                                          
                                                                                          
                                                                                          110
                                                                                          
                                                                                          
                                                                                          
                                                                                          339
                                                                                          
                                                                                          
                                                                                          
                                                                                          494
                                                                                          
                                                                                          
                                                                                          
                                                                                          1,539Other
      income (expense), net
                                                                                          
                                                                                          
                                                                                          (361
                                                                                          )
                                                                                          
                                                                                          
                                                                                          (545
                                                                                          )
                                                                                          
                                                                                          
                                                                                          18
                                                                                          
                                                                                          
                                                                                          
                                                                                          (587
                                                                                          )Income
      (loss) before provision (benefit) for income tax and minority
      interests
                                                                                          
                                                                                          $
                                                                                          (65,515
                                                                                          )
                                                                                          
                                                                                          $
                                                                                          13,767
                                                                                          
                                                                                          
                                                                                          $
                                                                                          (109,180
                                                                                          )
                                                                                          
                                                                                          $
                                                                                          30,954CAPITAL
      EXPENDITUREPowdered
      formula
                                                                                          
                                                                                          $
                                                                                          6,000
                                                                                          
                                                                                          
                                                                                          $
                                                                                          1,557
                                                                                          
                                                                                          
                                                                                          $
                                                                                          39,890
                                                                                          
                                                                                          
                                                                                          $
                                                                                          17,521Baby
      food
                                                                                          
                                                                                          5,587
                                                                                          
                                                                                          
                                                                                          
                                                                                          641
                                                                                          
                                                                                          
                                                                                          
                                                                                          7,969
                                                                                          
                                                                                          
                                                                                          
                                                                                          1,936Nutritional
      ingredients and supplements
                                                                                          
                                                                                          4,680
                                                                                          
                                                                                          
                                                                                          
                                                                                          944
                                                                                          
                                                                                          
                                                                                          
                                                                                          13,907
                                                                                          
                                                                                          
                                                                                          
                                                                                          1,759All
      other
                                                                                          
                                                                                          
                                                                                          15
                                                                                          
                                                                                          
                                                                                          
                                                                                          -
                                                                                          
                                                                                          
                                                                                          
                                                                                          30
                                                                                          
                                                                                          
                                                                                          
                                                                                          -Total
                                                                                          
                                                                                          $
                                                                                          16,282
                                                                                          
                                                                                          
                                                                                          $
                                                                                          3,142
                                                                                          
                                                                                          
                                                                                          $
                                                                                          61,796
                                                                                          
                                                                                          
                                                                                          $
                                                                                          21,216DEPRECIATION
      AND AMORTIZATIONPowdered
      formula
                                                                                          
                                                                                          $
                                                                                          1,744
                                                                                          
                                                                                          
                                                                                          $
                                                                                          1,218
                                                                                          
                                                                                          
                                                                                          $
                                                                                          4,782
                                                                                          
                                                                                          
                                                                                          $
                                                                                          3,142Baby
      food
                                                                                          
                                                                                          
                                                                                          1,018
                                                                                          
                                                                                          
                                                                                          
                                                                                          20
                                                                                          
                                                                                          
                                                                                          
                                                                                          1,135
                                                                                          
                                                                                          
                                                                                          
                                                                                          20Nutritional
      ingredients and supplements
                                                                                          
                                                                                          
                                                                                          168
                                                                                          
                                                                                          
                                                                                          
                                                                                          2
                                                                                          
                                                                                          
                                                                                          
                                                                                          271
                                                                                          
                                                                                          
                                                                                          
                                                                                          3All
      other
                                                                                          
                                                                                          
                                                                                          1
                                                                                          
                                                                                          
                                                                                          
                                                                                          1
                                                                                          
                                                                                          
                                                                                          
                                                                                          2
                                                                                          
                                                                                          
                                                                                          
                                                                                          1Total
                                                                                          
                                                                                          $
                                                                                          2,931
                                                                                          
                                                                                          
                                                                                          $
                                                                                          1,241
                                                                                          
                                                                                          
                                                                                          $
                                                                                          6,190
                                                                                          
                                                                                          
                                                                                          $
                                                                                          3,166






14





December 31,
                          2008
                        
                        
                        March 31,
                          2008(In thousands)TOTAL ASSETSPowdered
      formula
                        
                        $
                        400,185
                        
                        
                        $
                        273,015Baby
      food
                        
                        
                        29,670
                        
                        
                        
                        19,200Nutritional
      ingredients and supplements
                        
                        
                        34,344
                        
                        
                        
                        11,835All
      other
                        
                        
                        121,393
                        
                        
                        
                        119,580Intersegment
      elimination
                        
                        
                        (162,683
                        )
                        
                        
                        (127,411
                        )Total
                        
                        $
                        422,909
                        
                        
                        $
                        296,219LONG
      LIVED ASSETSPowdered
      formula
                        
                        $
                        104,900
                        
                        
                        $
                        68,932Baby
      food
                        
                        
                        20,255
                        
                        
                        
                        12,441Nutritional
      ingredients and supplements
                        
                        
                        22,387
                        
                        
                        
                        8,839All
      other
                        
                        
                        30
                        
                        
                        
                        3Total
                        
                        $
                        147,572
                        
                        
                        $
                        90,215




15


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.





OVERVIEW




We are a
leading infant formula company in China. We principally produce, market and sell
our products under “Sheng Yuan,” or “Synutra,” our master brand, and several
sub-brands, mainly including “Super”, “U-Smart”, “He Lan Ru Niu” or “Holsteina”,
“Mingshan” and “Huiliduo”. We focus on selling premium infant formula products,
which are supplemented by more affordable infant formulas targeting the mass
market as well as other nutritional products and ingredients. We sell our
products through an extensive nationwide sales and distribution network covering
29 provinces and provincial-level municipalities in China. As of December 31,
2008, this network comprised over 430 distributors and over 1,500
sub-distributors who sell our products in over 70,000 retail outlets. Our
extensive sales and distribution network, combined with our strong customer
service and infant nutrition education programs, has helped us build brand
recognition and customer loyalty in our primary markets, which, prior to 2007,
mainly comprised small to mid-size cities and rural areas in China. By
leveraging our strong brand recognition in our primary markets, we have begun to
expand into many of China’s major urban centers, which have historically been
dominated by several large multinational firms.




We have
opportunistically utilized excess capacity and resources to provide toll
packaging services, toll drying services, and sales of ingredients and materials
to industrial customers. These businesses, however, are not our core businesses
and do not contribute significantly to our results of
operations.


16


Historically
we reported our results as a single reporting segment in the financial
statements since operating segments such as the nutritional ingredients and
supplements segment was under construction with minor operating expenses and had
not met the quantitative threshold as described under SFAS 131 "Disclosure about
Segments of an Enterprise and Related Information". In this fiscal quarter, we
expanded the number of reportable segments from one to three in order to better
reflect the manner in which management analyzes the Company’s performance. The
three segments are:





·
            Powdered
      formula segment: Powdered formula segment covers the sale of powdered
      infant and adult formula products. It includes the brands of Super,
      U-Smart, Mingshan which was launched in October 2008 and He Lan Ru Niu
      which was launched in December
2008;


·
            Baby
      food segment: Baby food segment covers the sale of prepared baby food and
      nutritional snacks for babies and children. It includes the brand of
      Huiliduo which we expect to launch in the fiscal quarter ending March 31,
      2009 and the nutritional snacks component which we expect to launch in
      fiscal year 2010


·
            Nutritional
      ingredients and supplements segment: Nutritional ingredients and
      supplements segment covers the sale of nutritional ingredients and
      supplements such as chondroitin, DHA and
  ARA.





On
September 16, 2008, we announced a compulsory recall on certain lots of U-Smart
products and a voluntary recall of other products that were contaminated or
suspected to be contaminated by melamine, a substance not approved for use in
food and linked to recent illnesses among infants and children in China. The
initial estimated cost of this action was $77.4 million, which was recognized as
a charge to cost of sales and selling and distribution expenses in our
consolidated statement of income for the fiscal quarter ended September 30,
2008, of which $38.0 million was recorded as a product recall provision in the
consolidated balance sheet as of September 30, 2008. During the fiscal quarter
ended December 31, 2008, the Company recognized additional product
replacement expenses of $9.9 million in cost of sales and additional
freight charges of $0.3 million in selling and distribution expenses. The
Company also contributed a net amount of $2.3 million to a compensation fund set
up by China Dairy Industry Association to settle existing and potential claims
arising in China from families of infants affected by melamine contamination.
This contribution was recorded in general and administrative expenses for the
fiscal quarter ended December 31, 2008. We recorded a product recall provision
of $15.0 million in our consolidated balance sheet as of December 31, 2008.
These costs represent our estimate of probable costs based on available data and
take into account factors such as expected return rates for the affected units,
unit replacement costs, logistical expenses and expenses relating to the hiring
of temporary contractors to assist with our recall efforts. We estimate that we
have completed substantially all of the product recall in relation to the
melamine contamination incident by December 31, 2008.





Our
product recall does not involve significant cash pay-out to our distributors or
customers. Rather, both distributors and customers receive new products of the
same value in exchange for recalled products. Since the product recall took
place during our second and third fiscal quarters, our financial results for
these quarters were severely impacted and we recognized considerably less
revenue compared to the same periods in the prior year as products shipped
during such quarters were used to replace recalled products. We estimate that
the replacement for recalled products should be substantially completed during
the fiscal quarter ending March 31, 2009.





Although
management is not aware of any additional significant issues associated with the
melamine contamination incident, there can be no assurance that additional
issues will not be identified in the future and this may have an adverse effect
on our results of operations. See Part II. Other Information - Item 1A. Risk Factors - We are highly
dependent upon consumers’ perception of the safety and quality of our products
as well as similar products distributed by other companies in our industry,
particularly as they relate to the health and safety of infants and children.
Any ill effects, product liability claims, recalls, adverse publicity or
negative public perception regarding particular ingredients or products or our
industry in general, or stemming from contamination of our products, or
counterfeiting or other substandard imitations, could harm our reputation and
damage our brand, result in costly and damaging recalls and government sanctions
and possibly litigation and materially and adversely affect our results of
operations.





Since the
beginning of October 2008, all of our manufacturing facilities have been
returned to service, after passing government inspections and obtaining
permission from governing authorities. We continue to comply with random and
unscheduled government testing and to conduct enhanced and systematic testing
in-house.





In order
to regain customer confidence and to ensure products of the highest quality, we
are now using imported milk powder from Europe and New Zealand in our U-Smart,
Super and He Lan Ru Niu, or Holsteina series products. Through our network of
distributors, we have restocked almost all of our contracted shelf space
nationwide with new U-Smart series products and new Super series products
produced after October 1, 2008. All such products have been found free of
melamine and compliant with various government tests.





In
October 2008, we acquired a prepared baby food business from Huilian, the
“Huiliduo” series. We plan to begin its operations in the fiscal quarter ending
March 31, 2009.





In late
October 2008, we launched an entirely new series of infant formula products, the
“Mingshan” series, aimed at the expansive lower and mid-end Chinese markets.
Shipments of Mingshan series products had reached our sales network in December
2008. We began selling the Mingshan series of products in December
2008.





In
December 2008, we launched an entirely new series of powdered adult formula
products, the “He Lan Ru Niu” or “Holsteina” series, aimed at the higher-end
powdered adult formula markets. Shipments of He Lan Ru Niu series products had
reached our sales network in December 2008. We began selling the He Lan Ru Niu
series of products in December 2008.


17


Due to
the significant reduction of sales which was caused by the melamine
contamination incident and replacement of recalled products, our net sales for
the fiscal quarter ended December 31, 2008 was $17.7 million, as compared to
$100.2 million for the same period in the previous year. Our gross loss for the
fiscal quarter ended December 31, 2008 was $9.8 million, as compared to gross
profit of $50.6 million for the same period in the previous year. Our net loss
for the fiscal quarter ended December 31, 2008 was $49.3 million, as compared to
net income of $11.2 million for the same period in the previous
year.




Our net
sales for the nine months ended December 31, 2008 was $239.8 million, as
compared to $253.9 million for the same period in the previous year. Our gross
profit for the nine months ended December 31, 2008 was $30.4 million, as
compared to gross profit of $134.3 million for the same period in the previous
year. Our net loss for the nine months ended December 31, 2008 was $83.4
million, as compared to net income of $26.3 million for the same period in
the previous year.





The net
loss for the three and nine month periods ended December 31, 2008 compared to
the same periods in the previous year was attributable primarily to the
estimated cost of product recall and decreased sales from the second half of
September to December 2008 as we were still in the process of regaining customer
confidence and our production facilities were mainly engaged in the
manufacturing of replacement products in the aftermath of the melamine
contamination incident.





The
Company’s main operations are located in mainland China. Though the recent
disruptions in the overall economy and financial markets is less severe in China
than in the U.S., it could reduce consumer confidence in the economy and
negatively affect consumers’ spending, which could be harmful to our financial
position and results of operations.  See Part II. Other Information -
Item 1A. Risk Factors - The
recent disruptions in the overall economy and the financial markets may
adversely impact our business and results of operations and may limit our access
to additional financing.


18


CRITICAL
ACCOUNTING POLICIES




We follow
certain significant accounting policies when preparing our consolidated
financial statements. A summary of these policies is included in our Annual
Report on Form 10-K for the year ended March 31, 2008 (Form 10-K). The
preparation of these financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make estimates and judgments that affect our reported amounts of assets,
liabilities, revenues and expenses, and the related disclosures of contingent
assets and liabilities at the date of the financial statements. We evaluate
these estimates and judgments on an ongoing basis and base our estimates on
historical experience, current conditions and various other assumptions that are
believed to be reasonable under the circumstances. The results of these
estimates form the basis for making judgments about the carrying values of
assets and liabilities as well as identifying and assessing the accounting
treatment with respect to commitments and contingencies. Our actual results may
differ from these estimates.





We
believe that the estimates, assumptions and judgments involved in the accounting
policies described in the “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” section of our most recent Annual Report on
Form 10-K have the greatest potential impact on our financial statements, so we
consider these to be our critical accounting policies.




In
response to the melamine contamination incident, we have established an
accounting policy for the product recall. We consider our policy of product
recall provision to be a critical accounting policy due to the significant level
of estimates, assumptions and judgment and its potential impact on our
consolidated financial statements. We have included below a description of our
accounting policy for product recall provision.




Product
Recall




We
establish a reserve for product recall on a product-specific basis when
circumstances giving rise to the recall become known. Facts and circumstances
related to the recall, including where the product affected by the recall or
withdrawal is located (e.g., with consumers, in customers’ inventory, or in the
Company’s inventory), the expected product return rates by our distributor and
end-customers, cost estimates for shipping and handling for returns and
estimated replacement costs are considered when establishing a product recall
reserve. These factors are updated and reevaluated each period and the related
reserves are adjusted when these factors indicate that the recall reserve is
either not sufficient to cover or exceeds the estimated product recall
expenses.




19


RESULTS
OF OPERATIONS





Three
months ended December 31, 2008 and 2007





Net
Sales





Powdered
formula segment





Net sales
of our powdered formula products, including infant milk formula and other
powdered formula products for children and adults under our Super, U-Smart,
Mingshan and He Lan Ru Niu brand names, accounted for 70.1% of our total sales
for the fiscal quarter ended December 31, 2008. Net sales of our powdered
formula products for the fiscal quarter ended December 31, 2008 decreased by
86.4% to $12.4 million from $91.3 million for the same period in the previous
year, primarily as a result of the following factors:




·
            Sales
      volume of powdered formula products decreased by 84.9% to 1,855 tons for
      the fiscal quarter ended December 31, 2008 from 12,259 tons for the same
      period in the previous year, due primarily to a slow down in sales
      activities following the melamine contamination incident and our shipments
      in this quarter were mainly used for the replacement of recalled
      products.




·
            The
      average selling price of our powdered formula products for the fiscal
      quarter ended December 31, 2008 decreased by 10.4% to $6,677 per ton from
      $7,448 per ton for the same period in the previous year. This decrease in
      average selling price resulted primarily from an increase in the slotting
      fee per ton, partially offset by an increase of our sales price of Super
      and U-Smart in August 2008. The slotting fee per ton increased because we
      had to continue paying the same amount of slotting fees to super markets
      and malls for selling our products, while there was a significant decrease
      in the volume of products sold during the quarter as our shipments during
      the quarter were mainly used for the replacement of recalled products.
      Such slotting fees are deducted from our net sales, thus decreasing our
      average selling price.





Baby
food segment





Our
prepared baby food business acquired from Huilian on October 8, 2008 was in its
pre-operations stage and hence did not have sales for the fiscal quarter ended
December 31, 2008. We plan to begin its operations in the fiscal quarter ending
March 31, 2009. Our nutritional snack business was also in its pre-operations
stage and hence did not have sales for the fiscal quarter ended December 31,
2008. We plan to begin its operations in the fiscal year 2010.





Nutritional
ingredients and supplements segment





Net sales
of nutritional ingredients and supplements segment for the fiscal quarter ended
December 31, 2008 was $0.5 million, representing inter-segment sales of
ingredients, such as DHA and ARA which was used in production of infant powdered
formula products.




Cost
of Sales





Powdered
formula segment





Cost of
sales for powdered formula for the fiscal quarter ended December 31, 2008
decreased by 43.1% to $23.8 million, as compared to $41.8 million for the same
period in the previous year. The significant decrease in cost of sales was
primarily due to a significant decrease in the volume of products sold in the
quarter as we were still in the process of regaining customer confidence and our
production facilities were mainly engaged in the manufacturing of replacement
products in the aftermath of the melamine contamination incident, partially
offset by an increase in the costs of free products offered to our customers in
order to recover our lost market share and by additional product recall
expenses.





Baby
food segment





Our
prepared baby food business acquired from Huilian on October 8, 2008 was in its
pre-operations stage and hence did not have cost of sales for the fiscal quarter
ended December 31, 2008. We plan to begin its operations in the fiscal quarter
ending March 31, 2009. Our nutritional snack business was also in its
pre-operations stage and hence did not have cost of sales for the fiscal quarter
ended December 31, 2008. We plan to begin its operations in the fiscal year
2010.





Nutritional
ingredients and supplements segment





Cost of
sales of nutritional ingredients and supplements for the fiscal quarter ended
December 31, 2008 was $0.4 million, representing cost of inter-segment sales of
ingredients, such as DHA and ARA which was used in the production of powdered
infant formula products.


20




Gross
Profit (Loss)




As a
result of the foregoing, we recorded a gross loss of $9.8 million for the fiscal
quarter ended December 31, 2008, as compared to a gross profit of $50.6 million
for the same period in the previous year. Gross loss for our powdered formula
products for the fiscal quarter ended December 31, 2008 was $11.4 million, as
compared to gross profit of $49.5 million for the same period in the previous
year primarily due to the significant decrease in sales volume and the increase
in the costs of free products offered to our customers in order to recover our
lost market share and additional product recall expenses we recognized in this
quarter.





Selling
and Distribution Expenses





Selling
and distribution expenses for the fiscal quarter ended December 31, 2008
increased by 9.7% to $11.3 million, as compared to $10.3 million for the same
period in the previous year. This increase was a combined result of a slight
increase in compensation expenses for our sales force, a decrease in shipping
and handling expenses, and an increase in travel and communication expenses.
Total compensation for our sales force for the fiscal quarter ended December 31,
2008 was $5.6 million, as compared to $5.2 million for the same period in the
previous year. The shipping and handling expenses for the fiscal quarter ended
December 31, 2008 decreased by 63.6% to $732,000, as compared to $2.0 million
for the same period in the previous year, due mainly to the reduced sales volume
and most of the shipping and handling expenses for the recalled products being
accrued in the fiscal quarter ended September 30, 2008. Travel and communication
expenses for the fiscal quarter ended December 31, 2008 increased by 90.9% to
$2.1 million from $1.1 million for the same period in the previous year, due
mainly to expenses incurred for a large sales convention held in Beijing in
December 2008.




Advertising
and Promotion Expenses





Advertising
and promotion expenses for the fiscal quarter ended December 31, 2008 increased
by 82.1% to $34.6 million from $19.0 million for the same period in the previous
year. Advertising expenses for the fiscal quarter ended December 31, 2008, which
accounted for 42.0% of total advertising and promotion expenses, increased by
173.6% to $14.5 million from $5.3 million for the same period in the previous
year, due primarily to our intensified efforts to improve our corporate image
and brand name and to recover our lost market share following the melamine
contamination incident. For the same reason, promotion expenses for the fiscal
quarter ended December 31, 2008, which accounted for 58.0% of total advertising
and promotion expenses, increased by 46.0% to $20.0 million from $13.7 million
for the same period in the previous year.





General
and Administrative Expenses




General
and administrative expenses for the fiscal quarter ended December 31, 2008
increased by 39.0% to $8.2 million from $5.9 million for the same period in the
previous year. The increase in general and administrative expenses was due
primarily to a net contribution of $2.3 million made to the compensation fund
set up by China Dairy Industry Association for the settlement of existing and
potential claims in China from families of infants affected by melamine
contamination, an increase of $0.6 million in salary expenses, an increase of
$0.3 million in depreciation and amortization expenses, partially offset by a
decrease of $1.4 million in legal and professional expenses.


21


Interest
Income





Interest
income for the fiscal quarter ended December 31, 2008 decreased to $110,000 from
$339,000 for the same period in the previous year due to decreased bank
deposits.





Interest
Expense




Interest
expense for the fiscal quarter ended December 31, 2008 remains unchanged at $1.4
million as compared to the same period in the previous year. This was primarily
due to a combined effect of amortization of debt discount associated with the
issuance of warrants to ABN which amounted to $0.3 million in the fiscal quarter
ended December 31, 2007 and higher average loan balances outstanding during the
fiscal quarter ended December 31, 2008, partially offset by a lower weighted
average interest rate.




Provision
(Benefit) for Income Tax




As a
result of the net loss arising primarily from the cost of the product recall and
decreased sales, we recorded an income tax benefit of $16.1 million for the
fiscal quarter ended December 31, 2008, as compared to an income tax expense of
$2.6 million for the fiscal quarter ended December 31, 2007. Management believes
that we will be able to utilize such income tax benefit before
expiration.




Net
Income (Loss) Attributable to Stockholders




As a
result of the foregoing, net loss attributable to stockholders for the fiscal
quarter ended December 31, 2008 was $49.3 million, as compared to net income of
$11.2 million for the same period in the previous year.


22


Nine
months ended December 31, 2008 and 2007





Net
Sales





Powdered
formula segment





Net sales
of our powdered formula products, including infant formula and other powdered
formula products for children and adults under our Super, U-Smart, Mingshan and
He Lan Ru Niu brand names, accounted for 90.0% of our total sales for the nine
months ended December 31, 2008. Net sales of our powdered formula products for
the nine months ended December 31, 2008 decreased by 4.0% to $215.6 million from
$224.5 million for the same period in the previous year, primarily as a result
of the following factors:




·
            Sales
      volume of powdered formula products decreased by 21.0% to 23,719 tons for
      the nine months ended December 31, 2008 from 30,035 tons for the same
      period in the previous year. The decrease was primarily due to a slow down
      in sales activities in the second half of September to December 2008,
      following the melamine contamination incident and our shipments in the
      second and third fiscal quarters were mainly used for the replacement of
      recalled products in the quarter ended December 31, 2008, partially offset
      by a significant business growth experienced in the months from April to
      August, 2008.




·
            The
      average selling price of our powdered formula products for the nine months
      ended December 31, 2008 increased by 21.6% to $9,090 per ton from $7,475
      per ton for the same period in the previous year. This increase in average
      selling price was a combined result of a greater proportion of
      higher-priced products in our product mix and a broad increase of our
      sales price in August 2008.





Baby
food segment





Our
prepared baby food business acquired from Huilian on October 8, 2008 was in its
pre-operations stage and hence did not have sales for the nine months ended
December 31, 2008. We plan to begin its operations in the fiscal quarter ending
March 31, 2009. Our nutritional snack business was also in its pre-operations
stage and hence did not have sales for the nine months ended December 31, 2008.
We plan to begin its operations in the fiscal year 2010.





Nutritional
ingredients and supplements segment





Net sales
of nutritional ingredients and supplements segment for the nine months ended
December 31, 2008 was $0.5 million, representing inter-segment sales of
ingredients, such as DHA and ARA which was used in the production of powdered
infant formula products.





Cost
of Sales





Powdered
formula segment





Cost of
sales for the powdered formula products for the nine months ended December 31,
2008 increased by 98.6% to $188.9 million from $95.1 million for the same period
in the previous year. The increase in the cost of sales is due primarily to the
increase of the product recall related cost, partially offset by a decrease in
the sales volume of our powdered formula products. The portion of the estimated
product recall cost, which has been recognized in cost of sales for the nine
months ended December 31, 2008, was $86.6 million, reflecting the cost of
recalled products of $45.9 million and the write-down and write-off of
affected inventory of $40.7 million. The sales volume of powdered formula
products sold for the nine months ended December 31, 2008 decreased by 6,316
tons as compared to the same period in the previous year.





Baby
food segment





Our
prepared baby food business acquired from Huilian on October 8, 2008 was in its
pre-operations stage and hence did not have cost of sales for the nine months
ended December 31, 2008. We plan to begin its operations in the fiscal quarter
ending March 31, 2009. Our nutritional snack business was also in its
pre-operations stage and hence did not have cost of sales for the nine months
ended December 31, 2008. We plan to begin its operations in the fiscal year
2010.





Nutritional
ingredients and supplements segment





Cost of
sales of nutritional ingredients and supplements segment for the nine months
ended December 31, 2008 was $0.4 million, representing cost of inter-segment
sales of ingredients, such as DHA and ARA which was used in production of infant
powdered formula products.





Gross
Profit (Loss)





As a
result of the foregoing, gross profit for the nine months ended December 31,
2008 decreased by 77.4% to $30.4 million from $134.3 million for the same period
in the previous year. Gross profit for our powdered formula products for the
nine months ended December 31, 2008 decreased by 79.4% to $26.7 million from
$129.4 million for the same period in the previous year due primarily to the
estimated costs in relation to product recall including the write-down and
write-off of affected inventory and decreased sales in the fiscal quarter ended
December 31, 2008 following the melamine contamination incident.




Our
overall gross margin decreased to 12.7% for the nine months ended December 31,
2008 from 52.9% for the same period in the previous year. Our gross margin for
powdered formula products was 12.4% for the nine months ended December 31, 2008,
as compared to 57.6% for the same period in the previous year.





The
decrease in our gross margin for powdered formula products was primarily due to
the estimated cost of the product recall and increased free products offered to
our customers in the aftermath of the melamine contamination incident, partially
offset by an increase in the proportion of sales of our higher margin infant
formula products.


23


Selling
and Distribution Expenses





Selling
and distribution expenses for the nine months ended December 31, 2008 increased
by 27.5% to $33.4 million from $26.2 million for the same period in the previous
year. This increase was primarily a result of increased compensation expenses
for our sales force, and an increase in shipping and handling expenses as well
as travel and entertainment expenses. Total compensation for our sales force for
the nine months ended December 31, 2008 increased by 43.5% to $15.5 million from
$10.8 million for the same period in the previous year. This increase was
primarily due to the continuation of our targeted sales incentive programs. In
addition, the increase in the number of sales staff to 2,916 as of December 31,
2008 from 2,198 as of December 31, 2007 also contributed to the increase in
compensation expense relating to our sales force. Shipping and handling expenses
for the nine months ended December 31, 2008 increased by 28.3% to $5.9 million
from $4.6 million for the same period in the previous year, due primarily to
expenses in the amount of $2.2 million incurred for the product recall. Travel
and communication expenses for the nine months ended December 31, 2008 increased
by 74.2% to $5.4 million from $3.1 million for the same period in the previous
year, due mainly to expenses incurred for a large sales convention held in
Beijing in December 2008.





Advertising
and Promotion Expenses





Advertising
and promotion expenses for the nine months ended December 31, 2008 increased by
43.6% to $85.3 million from $59.4 million for the same period in the previous
year. Advertising expenses for the nine months ended December 31, 2008, which
accounted for 53.9% of total advertising and promotion expenses, increased by
117.0% to $46.0 million from $21.2 million for the same period in the previous
year, due primarily to our intensified efforts to improve our corporate image
and brand name and to recover our lost market share following the melamine
contamination incident. Promotion expenses for the nine months ended December
31, 2008, which accounted for 46.1% of total advertising and promotion expenses,
increased by 2.9% to $39.3 million from $38.2 million for the same period in the
previous year.





General
and Administrative Expenses





General
and administrative expenses for the nine months ended December 31, 2008
increased by 51.2% to $18.9 million from $12.5 million for the same period in
the previous year. The increase in general and administrative expenses was
primarily due to a net contribution of $2.3 million made to the compensation
fund set up by China Dairy Industry Association for the settlement of existing
and potential claims in China from families of infants affected by melamine
contamination, an increase of $1.4 million in salary and social insurance in
result of the increased headcount, an increase of $1.1 million in rental
expenses for new office space, partially offset by a decrease of $0.3 million in
legal and professional expenses associated with our cancelled public
offering.


24


Interest
Income





Interest
income for the nine months ended December 31, 2008 decreased to $0.5 from $1.5
million for the same period in the previous year due to decreased bank
deposits.




Interest
Expense





Interest
expense for the nine months ended December 31, 2008 decreased to $2.4 million
from $6.2 million for the same period in the previous year, due primarily to the
amortization of debt discount associated with the issuance of warrants to ABN
which amounted to $2.6 million in the nine months ended December 31, 2007, and
interest capitalization amounted to $1.1 million in the nine months ended
December 31, 2008.





Provision
(Benefit) for Income Tax





As a
result of the net loss arising primarily from the cost of the product recall, we
recorded an income tax benefit of $25.8 million for the nine months ended
December 31, 2008, as compared to an income tax expense of $4.6 million for the
nine months ended December 31, 2007. Our effective tax rate increased to 23.6%
for the nine months ended December 31, 2008 from 15.0% for the same period in
the previous year. This increase in our effective income tax rate was primarily
due to the expirations of tax holidays enjoyed by certain subsidiaries in China.
Management believes that we will be able to utilize such income tax benefit
before expiration.





Net
Income (Loss) Attributable to Stockholders





As a
result of the foregoing, net loss attributable to stockholders for the nine
months ended December 31, 2008 was $83.4 million, as compared to net income of
$26.3 million for the same period in the previous year.


25


LIQUIDITY
AND CAPITAL RESOURCES





The
recent melamine contamination incident has significantly impacted our liquidity.
Since the products shipped during the third fiscal quarter were used to replace
the recalled products, and the damage to our reputation caused by the melamine
contamination incident will take time to recover, the net sales of our
nutritional products were negatively impacted in the fiscal quarter ended
December 31, 2008. During the fiscal quarter ended December 31, 2008, we had
significantly reduced sales while incurring substantial cash outflow for the
purchase of raw materials and for operating expenses.





Accordingly,
we have had discussions with local banks to obtain short term financing to
support our operational needs. During the fiscal quarter ended December 31,
2008, we obtained new borrowings of $102.5 million with a weighted average
interest rate of 4.87%. The loans were secured by the pledge of certain fixed
assets held by the Company’s subsidiaries, pledge of land use right in Qingdao,
China and pledge of cash deposits which was recorded as restricted cash. The
maturity date of the short term loans from banks outstanding at December 31,
2008 range from February 2009 to December 2009. In addition to the short
term loans from banks, we also borrowed from related parties short term loans
amounting to $7.2 million with a weighted average interest rate of 7.28% to
finance our acquisition of the He Lan Ru Niu trademarks and to support our
normal operating needs. The maturity date of the short term loans outstanding
from related parties at December 31, 2008 range from March 2009 to November
2009. Prior to the melamine contamination incident, cash generated from our
operation activities were sufficient for normal operating needs, and financing
from banks was normally related to investing activities such as expansion of our
manufacturing plant.




In order
to maintain sufficient funds for our operations, we have postponed the payment
of certain accounts payable and required prepayment from certain customers. The
payment terms of accounts payable were usually three months. We negotiated with
some suppliers and extended the payment terms. Prior to the melamine
contamination incident, we generally required our distributors to pay the full
purchase price when they made an order, and we gave no more than 60 days of
credit to selected distributors. To improve our liquidity position, we now
require certain advance payments from our distributors with respect to potential
orders they expect to place with us. We expect that we will resume our original
policy with distributors when we recover from our tightened liquidity
position.





We expect
that we will have cash inflow from sales of products in the fiscal quarter
ending March 31, 2009. Such cash inflow will significantly improve our liquidity
situation. However we can not provide assurance in this regard.





We do not
expect significant cash outflow in relation to the product recall and subsequent
replacement for future fiscal quarters other than the cash outflow for the
accrued freight charge of $275,000 at December 31, 2008. However, we can not
provide assurance in this regard.





Our cash
and cash equivalent balance decreased by $41.7 million to $55.7 million at
December 31, 2008, as compared to $97.4 million at March 31,
2008.


26


Cash
Flows from Operating Activities




Net cash
used in operating activities was $66.6 million for the nine months ended
December 31, 2008, as compared to net cash provided by operating activities of
$16.3 million for the same period in the previous year. Net cash used in
operating activities for the nine months ended December 31, 2008 was mainly due
to net loss of $83.4 million, non-cash items not affecting cash flows of $7.1
million and a $9.6 million increase in working capital. The changes in working
capital for the nine months ended December 31, 2008, were primarily related to a
$31.3 million increase in inventories, a $58.9 million increase in accounts
payable due to delayed payment as a result of our tightened liquidity position,
a $9.4 million increase in accounts receivable due to our extended credit term
to certain distributors, a $31.7 million increase in income tax receivable, and
a $15.0 million increase in product recall provision.





After the
melamine contamination incident, our main line products, such as U-Smart and
Super series, and the newly acquired He Lan Ru Niu branded series, are produced
with imported raw milk powder from Europe and New Zealand. The shipment from
those countries to China usually takes more than one month, resulting in an
increased inventory balance and an increased accounts payable
balance.




Cash
Flows from Investing Activities




Net cash
used in investing activities was $76.9 million for the nine months ended
December 31, 2008, as compared to $12.4 million for the same period in the
previous year. Cash invested in purchases of property and equipment was
$38.4 million and $14.4 million for the nine months ended December 31,
2008, and 2007, respectively. This increase in net cash used in investing
activities is primarily due to our plant expansion to increase our production
capacity prior to the melamine contamination incident, partially offset by the
suspension of major investing projects in the aftermath of such event. We expect
the suspension will slow down our expansion into the nutritional snack business
which we expect to launch in fiscal year 2010, but it will not materially affect
our production capacity to fulfill our customers’ order
requirements.





Restricted
cash increased by $30.9 million for the nine months ended December 31, 2008, as
compared to a decrease of $2.8 million for the same period in the previous
year. Restricted cash represents cash deposited with banks as security against
the issuance of letters of credit for the import of machinery and raw materials
and as pledges for certain short-term borrowings.




Cash
Flows from Financing Activities




Net cash
provided by financing activities was $100.0 million for the nine months ended
December 31, 2008, as compared to net cash provided by financing activities of
$62.7 million for the same period in the previous year. Cash provided by
financing activities during the nine months ended December 31, 2008 resulted
from proceeds from short term borrowing of $146.4 million, partially offset by
the repayment of bank borrowing of $45.9 million.


27


Outstanding
Indebtedness




On
October 11, 2007, ABN and another lender provided a three year term loan,
or the New ABN Loan, to the Company in the aggregate amount of $35 million. The
principal amount, and any unpaid accrued interest on the New ABN Loan, will be
due on October 11, 2010 and may be prepaid without penalty. The proceeds of
the New ABN Loan were used to pay the outstanding principal and accrued interest
of a six-month term loan provided to the Company by ABN on April 19, 2007,
or the Original ABN Loan. The New ABN Loan bears interest at LIBOR for deposits
in U.S. dollars plus 3.5% with interest payable on the last day of each
three-month period. The loan is secured by a pledge of 10,000 shares of common
stock, or 100% of the outstanding common stock of Synutra Illinois.





The loan
agreement for the New ABN Loan provides for mandatory prepayment upon the
occurrence of certain events, and contains customary covenants for financings of
this type, including restrictions on the incurrence of liens, payment of
dividends, and disposition of properties. The loan agreement for the New ABN
Loan also contains certain financial covenants, including a requirement to
maintain specified leverage and interest coverage ratio, tangible net worth, and
indebtedness to tangible net worth ratio. The Company has performed an analysis
of the relevant ratios and found that due to the net loss which resulted from
the estimated costs of the product recall, including inventory write-down and
write-off in the fiscal quarters ended September 30, 2008 and December 31, 2008,
the Company was not able to meet all the financial covenant requirements as of
December 31, 2008. Further, the Company anticipates that it may have difficulty
meeting these financial covenant requirements for the next several fiscal
quarters. The Company has requested the lenders to waive these financial
covenants for the next several fiscal quarters. The lenders have proposed waiver
fee which equals to 0.7% of the aggregate principal amount outstanding and an
increase in the interest rate of 200 basis points to LIBOR for deposits in U.S.
dollars plus 5.5%. As of the date of the filing of this 10-Q, the waiver has not
been granted. The Company is currently in discussions with the lenders on the
waiver and is unable to predict when, or if the waiver will be granted.
Accordingly, the Company has reclassified the outstanding balance of $34.4
million under the loan to current liabilities since the Company considers this
debt callable by the bank. The Company may also incur additional expenses in
connection with the modification of loan arrangements.





In
addition to the New ABN Loan, as of December 31, 2008 and March 31, 2008,
the Company had short-term loans from banks in the amount of $117.0 million
(including new borrowings of $102.5 million with a weighted average interest
rate of 4.87% during the three months ended December 31, 2008) and $21.2
million, respectively.  The maturity date of the short term loans
outstanding from banks at December 31, 2008 range from February 2009 to
December 2009. The weighted average interest rate on short-term loans
outstanding at December 31, 2008 and March 31, 2008 was 5.09% and 7.08%,
respectively. The loans were secured by the pledge of certain fixed assets held
by the Company and its subsidiaries, a pledge of the Company’s land use right
and pledge of cash deposits. The value of fixed assets pledged was $30.6 million
and $18.1 million as of December 31, 2008 and March 31, 2008,
respectively.  The value of land use right pledged was $3.2 million
and nil as of December 31, 2008 and March 31, 2008, respectively. The value of
cash pledged was $31.5 million which was recorded in restricted cash and nil as
of December 31, 2008 and March 31, 2008, respectively.





Apart
from the short-term loans from banks, the Company also had short term loans from
related parties in the amount of $7.2 million and nil as of December 31, 2008
and March 31, 2008 respectively. The maturity date of the short term loans
outstanding from related parties at December 31, 2008 range from March 2009
to November 2009. The
balance as of December 31, 2008 included a US dollar loan of $2.9 million and a
RMB loan of 4.3 million, and the interest rates were 10.0% and 5.5%
respectively. The interest rate of the US dollar loan benched mark to that of US
dollar borrowing from third party. The interest rate of the RMB loan is higher
than the weight average interest rate from third party as of December 31, 2008
mainly due to that Chinese government encouraged PRC banks to lower the interest
rates to dairy industry entities after the melamine
incident.




The
Company has a capital lease agreement in place related to office buildings. The
capital lease obligations of $5.5 million are included in long-term
debt.


28


Contractual
Obligations





For
information on our contractual obligations, please refer to Item 7.
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources - Contractual Obligations.” as
presented in our Annual Report on Form 10-K for the fiscal year ended March 31,
2008.




Capital
Expenditures




Our
capital expenditures for the nine months ended December 31, 2008 was $61.8
million, primarily in connection with expansion of our production plants. In
order to meet our immediate working capital needs in the aftermath of the
melamine contamination incident, we have temporarily postponed projects that are
not urgently needed for our operations such as our baby beverage project and the
furnishing of our head office building. We will consider resuming these projects
when our operations are back to normal.





Off-Balance
Sheet Arrangements




We do not
have off-balance sheet arrangements other than: (1) a guarantee issued to the
Zhangbei Branch of the Agricultural Bank of China related to various bank loans
of $1.1 million to 104 dairy farmers in the Zhangbei area of Hebei Province in
China, which was discussed in our Annual Report on Form 10-K for the fiscal year
ended March 31, 2008; and (2) a lease of certain land and building from Beijing
Dongfang Xueyuan Property Management Co., Ltd. which we use as our office
building. The lease period is from July 26, 2008 to July 25, 2028. The annual
rental fee is $2.2 million. We have the option to renew the contract with the
same term in the future.


29


ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK




There
were no material changes in quantitative or qualitative disclosures about market
risk during the three and nine months ended December 31, 2008. For
additional information, please refer to Item 7A "Quantitative and Qualitative
Disclosures about Market Risk" as presented in our Annual Report on Form 10-K
for the fiscal year ended March 31, 2008.




ITEM
4. CONTROLS AND PROCEDURES




Our
management, including our Chief Executive Officer and Chief Financial Officer,
does not expect that our disclosure controls and procedures or our internal
control over financial reporting will prevent all errors and all fraud. A
control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Further, the design of a control system must reflect the fact that
there are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within the Company have been
detected.




Conclusion Regarding Effectiveness
of Disclosure Controls and Procedures




The
Company’s management, with the participation of the Company’s Chief Executive
Officer and 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 Exchange Act) as of the end of the
period covered by this report. Based on such evaluation, the Company’s Chief
Executive Officer and Chief Financial Officer have concluded that, as of
December 31, 2008, 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 Securities Exchange Act of
1934 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 Chief Financial Officer, or persons performing similar functions, as
appropriate to allow timely decisions regarding required disclosure. The Chief
Executive Officer’s and 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 as
identified in our Management’s Report on Internal Control Over Financial
Reporting included with our Annual Report on Form 10-K for the fiscal year ended
March 31, 2008, continues not to be effective as of December 31,
2008.




In
connection with our Annual Report on Form 10-K for the fiscal year ended March
31, 2008, our management assessed the effectiveness of the Company’s internal
control over financial reporting and concluded that the Company’s internal
control over financial reporting was not effective based on management’s
identification of one material weakness and four deficiencies in the Company’s
internal control over financial reporting, as defined in Auditing Standard
No. 5, “An Audit of Internal Control Over Financial Reporting That Is
Integrated with An Audit of Financial Statements.”




Our
material weakness related to:




·
            
            (i)
      an insufficient complement of personnel in our corporate accounting and
      financial reporting function with an appropriate level of technical
      accounting knowledge, experience, and training in the application of
      generally accepted accounting principles commensurate with the Company’s
      complex financial accounting and reporting requirements and materiality
      thresholds; and (ii) an inadequacy of competent staff in our internal
      audit function to effectively monitor the Company’s operational, financial
      and compliance-oriented controls, including controls over the financial
      closing and reporting process.




Our
deficiencies related to:




·
            
            inadequate
      training of employees, especially new hires, on our antifraud programs and
      code of ethics;




·
            
            inadequate
      segregation of duties related to our stock count process and lack of
      controls to regularly monitor, document and determine the value of certain
      inventories on a timely basis;




·
            
            inadequate
      controls related to managing staff cash advances;
  and




·
            
            failure
      to maintain an appropriate level of security within our computer operating
      systems and applications.




30


Remediation and Changes in Internal
Control over Financial Reporting




The
Company has discussed the material weakness and deficiencies in its internal
control over financial reporting with the Audit Committee of the Board of
Directors. Specific remedial actions have been taken to reorganize and
restructure the Company’s corporate accounting staff (“Corporate Accounting”)
during recent fiscal quarters, which include (1) revising the reporting
structure and establishing clear roles, responsibilities, and accountability,
and (2) training accounting personnel at our subsidiaries to ensure the
right complement of knowledge and skills. The Company has also strived to
continuously improve its period-end closing procedures by (1) ensuring that
account reconciliations and analyses for significant financial statement
accounts are reviewed for completeness and accuracy by qualified accounting
personnel, (2) implementing a process that ensures the timely review and
approval of complex accounting estimates by qualified accounting personnel and
subject matter experts, where appropriate, and (3) developing better
monitoring controls at Corporate Accounting and at our subsidiaries. During the
most recent fiscal quarter, the Company also reinforced the corporate internal
audit team by recruiting a qualified internal audit manager and several internal
audit staff.





In
addition, remediation actions have been implemented to address the deficiencies
described above. These actions included: (1) implementing a formal training
program and training of all key employees, especially new hires, on our
antifraud programs, corporate governance guidelines, and business ethics; (2)
reorganizing the stock count process by including staff from different
departments to ensure adequate segregation of duties; (3) introducing tighter
controls which include regular checks and alerts to manage staff cash advances;
and (4) increasing the level of security within our computer operating system
and applications through keeping a record of audit logs and performing regular
review of such audit logs and implementing adequate password
controls.




Other
than as described above, management does not believe that there have been any
other changes in the Company’s internal control over financial reporting during
the Company’s most recent fiscal quarter, which have materially affected, or are
reasonably likely to materially affect, the Company’s internal control over
financial reporting.


31




PART
II


OTHER
INFORMATION





ITEM
1. LEGAL PROCEEDINGS




We are
not currently a party to any material legal proceedings. From time to time, we
may be subject to various claims and legal actions arising in the ordinary
course of business.




ITEM
1A. RISK FACTORS





The
discussion of our business and operations should be read together with the risk
factors contained in our Annual Report on Form 10-K for the fiscal year ended
March 31, 2008, which was filed with the SEC and describes the various risks and
uncertainties to which we are or may become subject to. At December 31, 2008,
there have been no material changes to the risk factors set forth in our Annual
Report on Form 10-K for the year ended March 31, 2008, except as set forth
below:




We
are highly dependent upon consumers’ perception of the safety and quality of our
products as well as similar products distributed by other companies in our
industry, particularly as they relate to the health and safety of infants and
children. Any ill effects, product liability claims, recalls, adverse publicity
or negative public perception regarding particular ingredients or products or
our industry in general, or stemming from contamination of our products, or
counterfeiting or other substandard imitations, could harm our reputation and
damage our brand, result in costly and damaging recalls and government sanctions
and possibly litigation and materially and adversely affect our results of
operations.




We sell
products for human consumption, which involves risks such as product
contamination, spoilage and tampering. We may be subject to liability if the
consumption of any of our products causes injury, illness or death. Adverse
publicity or negative public perception regarding particular ingredients, our
products, our actions relating to our products, or our industry in general could
result in a substantial drop in demand for our products. This negative public
perception may include publicity regarding the safety or quality of particular
ingredients or products in general, of other companies or of our products or
ingredients specifically. Negative public perception may also arise from
regulatory investigations or product liability claims, regardless of whether
those investigations involve us or whether any product liability claim is
successful against us.




On
September 16, 2008, China’s Administration of Quality Supervision, Inspection
and Quarantine, or China AQSIQ, announced its finding that the formula products
of 22 Chinese formula producers, including certain lots of our U-Smart products,
were contaminated by melamine, a substance not approved for use in food and
linked to the recent illness and deaths of infants and children in China. To
date, there have been six reported deaths and approximately 290,000 children
have suffered kidney-related illness due to the contaminated infant formula of
one of our competitors. This contamination incident has resulted in significant
negative publicity for the entire domestic dairy and formula industries in China
and demand for domestically-produced dairy and formula products, including our
products, has declined significantly. We have recalled our affected U-Smart
products as well as all other products produced at the same facilities in the
Hebei and Inner Mongolia regions of China, where we believe the contaminated
milk supplies originated. We also suspended production at our facilities in
Qingdao, Hebei and Inner Mongolia for two weeks pending government and internal
investigations. The initial estimated cost of this action was $77.4 million
which was recognized as a charge to cost of sales and selling and distribution
expenses in our consolidated statement of income for the fiscal quarter ended
September 30, 2008. During the three months ended December 31, 2008, we
recognized an additional product replacement expenses of $9.9 million in cost of
sales and an additional freight charge of $0.3 million in selling and
distribution expenses. These costs are still subject to finalization, and we
cannot assure you that this will be the total cost for the recall or that the
total cost will not significantly exceed our estimates.




Although
we have not confirmed any cases of kidney-related or other illnesses caused by
our products, we cannot assure you that such cases will not surface in the
future. The Chinese government has provided medical screening, treatment, and
care for consumers affected by melamine contamination in infant formula
products. We have contributed a net amount of $2.3 million to a compensation
fund set up by China Dairy Industry Association to settle existing and potential
claims arising in China from families of infants affected by melamine
contamination. We cannot assure you that the Chinese government will not seek
further reimbursement from dairy and formula product manufacturers, including
us.




We
believe the contamination incident has already negatively impacted our brand and
reputation in China. It has also affected investor confidence in us as reflected
by the sudden significant decrease in our stock price on Nasdaq to a 52-week low
of $10.00 per share during the days shortly following the initial news reports
about the incident. We cannot predict the long term effect this recall and the
negative publicity associated with the contamination incident will have on our
reputation among our customers, consumers and investors. Our results of
operations and financial position would be severely impacted if we have failed
to accurately estimate the costs of this product recall or if our customers and
consumers cease to purchase our products as a result of the contamination
incident.




In the
past, there have also been occurrences of counterfeiting and imitation of
products in China that have been widely publicized. We cannot guarantee that
contamination or counterfeiting or imitation of our or similar products will not
occur in the future or that we will be able to detect it and deal with it
effectively. Any occurrence of contamination or counterfeiting or imitation
could negatively impact our corporate and brand image or consumers’ perception
of our products or similar nutritional products generally, particularly if the
counterfeit or imitation products cause injury or death to consumers. For
example, in April 2004, sales of counterfeit and substandard infant formula in
Anhui, China caused the deaths of 13 infants as well as harming many others.
Although this incident did not involve the counterfeiting of our products, it
caused significant negative publicity for the entire infant formula industry in
China. The mere publication of information asserting that infant formula
ingredients or products may be harmful could have a material adverse effect on
us, regardless of whether these reports are scientifically supported or concern
our products or the raw materials used in our products.




In
addition, we believe that the recent melamine incident and any other adverse
news related to formula products in China will also result in increased
regulatory scrutiny of our industry, which may result in increased costs and
reduce our margins and profitability. The government has enhanced its
regulations on the industry aimed to ensure the safety and quality of dairy
products, including but not limited to compulsory batch by batch inspection.
This is likely to increase our operating costs and capital expenditure.
Moreover, our management may fail to respond effectively to such adverse events
and any such failure could have a material adverse effect on our results of
operations and financial condition.


32


If
we fail to obtain raw materials in the quantity and the quality we need, and at
commercially acceptable prices, our results of operations, financial condition
and business prospects would be materially and adversely affected.




Our
business requires certain key raw materials, such as raw milk and whey protein
powder. We may experience a shortage in the supply of certain raw materials in
the future, which could materially and adversely affect our production and
results of operations. We do not have guaranteed supply contracts with any of
our raw material suppliers, and some of our suppliers may, without notice or
penalty, terminate their relationship with us at any time. We also rely on a
small number of suppliers for some of our raw materials, such as whey protein
powder and imported milk powder. After the melamine contamination incident, we
have started to import milk powder from Europe and New Zealand for our U-Smart
and Super products as consumers have less confidence in domestically-produced
milk powder. If any supplier is unwilling or unable to provide us with high
quality raw materials in required quantities and at acceptable prices, we may be
unable to find alternative sources or at commercially acceptable prices, on
satisfactory terms, in a timely manner, or at all. Our inability to find or
develop alternative sources could result in delays or reductions in production,
product shipments or a reduction in our profit margins. Moreover, these
suppliers may delay material shipments or supply us with inferior quality raw
materials that may adversely impact the timely delivery or the quality of our
products. If any of these events were to occur, our product quality, competitive
position, reputation and business could suffer.




In
addition, some of the raw materials used in our business are imported, such as
whey protein powder and milk powder. Our imported raw materials are subject to
various PRC governmental permit requirements, approval procedures and import
duties, and may also, from time to time, be subject to export controls and other
legal restrictions imposed by foreign countries. Should the PRC government
refuse to issue the necessary permits or approvals to us or our suppliers, or
take any administrative actions to limit imports of certain raw materials, or if
we or our suppliers fail to pay any required import duties, or if governmental
agencies or laws of foreign countries prevent the timely export of certain raw
materials we require to China, our ability to produce and sell our products in
China could be materially and adversely affected. In addition, import duties
increase the cost of our products and may make them less
competitive.




Finally,
certain suppliers of raw materials within our supply chain may intentionally or
inadvertently contaminate our raw material supplies or provide us with
substandard raw material supplies that adversely impact the quality of our
products exposing our customers to health risks and damaging our reputation,
brand and financial condition. For a more detailed description of this risk, and
in particular the impact of the recent melamine contamination incident in China,
see “Risk Factors — We are highly dependent upon consumers’ perception of
the safety and quality of our products as well as similar products distributed
by other companies in our industry, particularly as they relate to the health
and safety of infants and children. Any ill effects, product liability claims,
recalls, adverse publicity or negative public perception regarding particular
ingredients or products or our industry in general, or stemming from
contamination of our products, or counterfeiting or other substandard
imitations, could harm our reputation and damage our brand, result in costly and
damaging recalls and government sanctions and possibly litigation and materially
and adversely affect our results of operations.”




Our
results of operations may be affected by fluctuations in availability and price
of raw materials.




The raw
materials we use are subject to price fluctuations due to various factors beyond
our control, including increasing market demand, inflation, severe climatic and
environmental conditions, commodity price fluctuations, currency fluctuations,
changes in governmental and agricultural regulations and programs and other
factors. For instance, the price of raw milk in China rose by approximately
55.0% in 2007 due to various factors, including rising production costs. We also
expect that our raw material prices will continue to fluctuate and be affected
by inflation in the future. Changes to our raw materials prices may result in
increases in production and packaging costs, and we may be unable to raise the
prices of our products to offset these increased costs in the short-term or at
all. As a result, our results of operations may be materially and adversely
affected.


33


We
may experience problems with product quality or product performance, or the
perception of such problems, which could adversely affect our reputation or
result in a decrease in customers and revenue, unexpected expenses and loss of
market share.




Our
operating results depend, in part, on our ability to deliver high quality
products on a timely and cost-effective manner. Our quality control and food
safety management systems are complex. For example, there are over 1,100 quality
control points throughout the whole production process. If the quality of any of
our products deteriorated, it could result in delays in shipments, cancellations
of orders or customer returns and complaints, loss of goodwill, and harm to our
brand and reputation. In addition, we purchase a portion of our milk powder from
third-party producers. We may be unable to exercise the same degree of quality
control over these third-party production facilities as we can over our own
facilities. Any quality problems associated with the milk powder produced by
these third-party producers would also affect our products’ quality and lead to
negative publicity against us, adversely affecting our reputation and brand, and
causing a decrease in sales of our products and a loss of market share. For
example, the recent melamine contamination incident in China has resulted in
certain of our products being contaminated, impacting our brand and
reputation.




Product
liability claims against us could result in adverse publicity and potentially
significant monetary damages.




As with
other infant formula producers, we are also exposed to risks associated with
product liability claims if the consumption of infant formula products we sell
results in injury or death. We cannot predict what impact such product liability
claims or resulting negative publicity would have on our business or on our
brand image. The successful assertion of product liability claims against us
could result in potentially significant monetary damages, diversion of
management resources and require us to make significant payments and incur
substantial legal expenses. We do not have product liability insurance and have
not made provisions for potential product liability claims. Therefore, we may
not have adequate resources to satisfy a judgment if a successful claim is
brought against us. Even if a product liability claim is not successfully
pursued to judgment by a claimant, we may still incur substantial legal expenses
defending against such a claim and our brand image and reputation would suffer.
Finally, serious product quality concerns could result in governmental action
against us, which, among other things, could result in the suspension of
production or distribution of our products, loss of certain licenses, or other
governmental penalties.




For
example, the recent melamine contamination incident in China has resulted in
certain of our products being contaminated. While we have not, to date, become
subject to any product liability claims in connection with the melamine
contamination incident, we cannot assure you that such claims will not occur in
the future. See “Risk Factors — We are highly dependent upon consumers’
perception of the safety and quality of our products as well as similar products
distributed by other companies in our industry, particularly as they relate to
the health and safety of infants and children. Any ill effects, product
liability claims, recalls, adverse publicity or negative public perception
regarding particular ingredients or products or our industry in general, or
stemming from contamination of our products, or counterfeiting or other
substandard imitations, could harm our reputation and damage our brand, result
in costly and damaging recalls and government sanctions and possibly litigation
and materially and adversely affect our results of operations.”




More
mothers may breastfeed their babies rather than use our products, resulting in
reduced demand for our products and adversely affecting our
revenues.




Our
results of operations are affected by the number of mothers who choose to use
our products rather than breastfeeding their babies. Much publicly available
data suggests that breastfeeding has many health benefits for the baby that
cannot be replicated by dairy-based infant formula products. Additionally,
popular literature, cultural pressure, government policies and medical advice in
China generally promote the benefits of breastfeeding. For example, on
August 1, 2007, China’s Ministry of Health issued an Infant Feeding
Strategy which promoted breastfeeding and requested all local relevant
departments to publicize the benefits of breastfeeding through radio
broadcasting, television and newspapers during World Breastfeeding Week, which
took place in early August 2007. Thus, to the extent that private, public and
government sources increasingly promote the benefits of breastfeeding, there
could be a reduced demand for our products and our revenues could be adversely
affected.




In
addition, we believe the recent melamine contamination incident has deteriorated
customer confidence in the safety and quality of infant formula products and the
number of mothers (and future mothers) who choose to breastfeed their babies may
significantly increase. The overall market demand for infant formula products
may slow or decline and any reduced demand for our products will negatively
impact our revenues and growth prospects.


34


We
operate in a competitive environment, which may lead to declining revenue growth
or other circumstances that would negatively affect our results of
operations.




The
market for pediatric nutritional products is competitive, and we believe that
competition in this market will continue to intensify. We believe that the
principal competitive factors in our markets are brand recognition, perceived
quality, advertising, formulation, packaging, and price. We face significant
competition from a number of competitors, including multinational companies,
such as Abbot Laboratories’ Ross Products Division, Mead Johnson, Nestle, Numico
and Wyeth, and domestic companies, such as Yashili and Yili. See “Item 1.
Business—Competition” in our Annual Report on Form 10-K for the fiscal year
ended March 31, 2008, which was filed with the SEC. Many of our competitors have
longer operating histories, greater name recognition, significantly larger
market shares, access to larger customer bases and significantly greater
economies of scale in financial, sales and marketing, production, distribution,
technical and other resources than we do. Some of these competitors have used,
and we expect will continue to use, more aggressive pricing strategies, greater
amounts of incentives and subsidies for distributors, retailers and customers
and more advanced processes and technologies. Furthermore, consolidation among
industry participants in China may potentially result in stronger domestic
competitors that are better able to compete as end-to-end suppliers as well as
competitors who are more specialized in particular areas and geographic markets.
This could have a material adverse effect on our business, financial condition,
results of operations and prospects. In addition, as a result of the recent
melamine contamination incident, customers have lost confidence in infant
formula produced by domestic companies for the time being, which gives
multinational infant formula companies an advantage over us.




In order
to compete successfully in our markets, we will need to restore customer
confidence in our brand and products, develop new products and enhance our
product offerings while maintaining price competitiveness. Even if we
successfully restore customer confidence, if and to the extent we fail to
develop new products that differentiate us from our competitors, we may need to
compete largely on price, which may cause our operating margins to decline. Our
inability to compete successfully against competitors and pricing pressures
could result in lost customers, loss of market share and reduced operating
margins, which would adversely impact our results of operations.




The
recent disruptions in the overall economy and the financial markets may
adversely impact our business and results of operations and may limit our access
to additional financing.




As widely
reported, financial markets in the United States, Europe and Asia have been
experiencing extreme disruptions in recent months, including, among other
things, extreme volatility in security prices, the failure and near failure of a
number of large financial services companies, severely diminished liquidity and
credit availability, rating downgrades of certain investments and declining
valuations of others.




The
infant formula industry can be affected by macro economic factors, including
changes in national, regional, and local economic conditions, employment levels
and consumer spending patterns.  Though the recent disruptions in the
overall economy and financial markets is less severe in China than in the U.S.,
it could reduce consumer confidence in the economy and negatively affect
consumers’ spending, which could be harmful to our financial position and
results of operations.




In
addition, if the capital and credit markets continue to experience volatility
and the availability of funds remains limited, we will incur increased costs
associated with equity and/or debt financing. It is possible that our ability to
access the capital and credit markets may be limited by these or other factors
at a time when we would like, or need, to do so, which could have an impact on
our ability to refinance maturing debt and/or react to changing economic and
business conditions.


35


As
a result of losses associated with the recent melamine contamination incident in
China, we have not been able to meet certain financial covenants under
our credit facility and may incur additional expenses in connection with the
change of loan arrangements.




As a
result of the recent melamine contamination incident, we have incurred
substantial losses for the quarters ended September 30, 2008 and December 31,
2008 from product recall and inventory write-off. Though we expect this to be a
short-term financial challenge for us, we have not been able to meet the
financial covenants set forth in our credit facility for the quarters ended
September 30, 2008 and December 31, 2008, and will possibly continue to
experience difficulty meeting the financial covenants for the next several
quarters. We are requesting the lenders to grant us a waiver of financial
covenants and amend loan agreements with us. There can be no assurance that we
will be able to obtain such waiver on terms and conditions acceptable to us. We
expect that in consideration for the waiver, we will be subject to increased
interest rates and additional fees as a result of downgrading of our credit
rating by the lenders due to the melamine contamination incident as well as the
current market disruption. If we are unable to obtain the waiver, we will be in
default and may be required to prepay the outstanding loans as a result of the
default. We may not be able to refinance our debt on terms acceptable to us, or
at all, and there can be no assurance that additional lines-of-credit or
financing instruments will be available in amounts or on terms acceptable to us,
if at all, under the current market condition.




Our
business is capital intensive and our growth strategy may require additional
capital that may not be available on favorable terms or at all.




We have,
in the past, obtained loans and sold our common stock to raise additional
capital. Our business requires significant capital and although we believe that
our current cash, and cash flow from operations will be sufficient to meet our
present and reasonably anticipated cash needs, we may, in the future, require
additional cash resources due to changed business conditions, implementation of
our strategy to expand our production capacity or other investments or
acquisitions we may decide to pursue. If our own financial resources are
insufficient to satisfy our capital requirements, we may seek to sell additional
equity or debt securities or obtain additional credit facilities. For example,
the recent melamine contamination incident has significantly impacted our
liquidity due to our product recall and required us to obtain additional funding
through short-term loans for working capital purposes after the incident. In
addition to these short-term loans, we may need to obtain additional private or
public financing including debt or equity financing and there can be no
assurance that such financing will be available as needed or, if available, on
terms favorable to us. Due to the current stock market conditions, we
have terminated our proposed public offering of common stock in the fiscal
quarter ended September 30, 2008. Any additional equity financing may be
dilutive to stockholders and such additional equity securities may have rights,
preferences or privileges that are senior to those of our existing common stock.
The incurrence of indebtedness would result in increased debt service
obligations and could require us to agree to operating and financial covenants
that would restrict our operations. If we are unable to generate sufficient cash
flow from operating activities or obtain funds for required payments of interest
and principal on such additional indebtedness, or if we fail to comply with our
debt covenants, we will be in default. In addition, changes in our debt rating
due to the recent melamine contamination incident could have a material adverse
effect on our interest costs and financing sources. Financing may not be
available in amounts or on terms acceptable to us, if at all. Any failure by us
to raise additional funds on terms favorable to us, or at all, could limit our
ability to expand our business operations and could harm our overall business
prospects.





We
have recently incurred operating losses and our future profitability is
uncertain; this may have a harmful effect on our business and the value of our
common stock.




As
a result of the recent melamine contamination incident, we have incurred
substantial losses for the quarters ended September 30, 2008 and December 31,
2008 from product recall and inventory write-down and write-off. Though we
expect this to be a short-term financial challenge for us, we believe the
contamination incident has negatively impacted our brand and reputation in China
and may impact our future revenues. We have incurred expenses relating to the
melamine contamination incident and we may incur more expenses in the future
relating to expanding our production capacity or other investments or
acquisitions we may decide to pursue. If our revenue does not increase or if we
fail to maintain our expenses at an amount less than our projected revenues, we
will not be able to achieve or sustain operating profitability on a consistent
basis. Given our planned operating and capital expenditures as well as our
overall business plan, for the foreseeable future we expect our results of
operations to fluctuate, and during this period we may continue to incur losses.
Our lack of profitability may have an adverse effect on the market value of our
common stock and on our cash flow and liquidity.


36


We
may face liquidity challenges to meet our debt obligations and may require
additional funding in the future.




We
had positive cash flow from operations of $16.3 million for the nine months
ended December 31, 2007, but we had negative cash flow from operations of
$66.6 million for the nine months ended December 31, 2008. At
December 31, 2008, we had short-term debt of $158.7 million, consisting of
short-term loans from banks in the amount of $117.0 million, an additional $7.2
million in short-terms loans from related parties, and $34.4 million under the
New ABN Loan which has been reclassified as a current liability since we did not
meet our financial covenants under the loan as of December 31, 2008. The
majority of our short-term debt will become due by December 31, 2009. Our
ability to meet our debt obligations will depend on our future performance,
which will be affected by financial, business, domestic and foreign economic
conditions and other factors, many of which we are unable to control. We believe
the contamination incident has negatively impacted our brand and reputation in
China and may impact our future revenues. As a result, we cannot be assured that
our revenues will provide cash flow in excess of our cash needs, and we
therefore may have negative cash flow in the future. If our cash flow is not
sufficient to service our debt, we may be required to obtain additional
financing in the future, and such additional financing may not be available at
times, in amounts or on terms acceptable to us or at all, which would have a
material adverse effect on our business.




We
also purchase milk powder from third-party producers and any disruption in this
source of milk powder could materially and adversely affect our business and
results of operations.




From time
to time, we also purchase milk powder from third-party producers. Approximately
15% of our milk powder was produced by third-party producers for the fiscal year
ended March 31, 2008. While these arrangements help us manage operating
costs and address production capacity constraints, they also reduce our direct
control over a portion of our production. As our third-party producers are not
legally obligated to supply us with milk powder, we cannot assure you that they
will always meet our demand. They may encounter capacity constraints or may be
unable or unwilling to provide us milk powder in required quantities or at
acceptable costs. Our inability to find or develop alternate third-party
producers, if required, could result in delays or reductions in production and
product shipments. Moreover, these third-party suppliers may delay milk powder
shipments or supply us with inferior quality milk powder that may adversely
impact the timely delivery or the quality of our products. For a more detailed
description of risks associated with product quality, see “Risk Factors —
We may experience problems with product quality or product performance, or the
perception of such problems, which could adversely affect our reputation or
result in a decrease in customers and revenue, unexpected expenses and loss of
market share.”





We
have limited insurance coverage and do not carry any business interruption
insurance, third-party liability insurance for our production facilities or
insurance that covers the risk of loss of our products in shipment.




Operation
of our facilities involves many risks, including equipment failures, natural
disasters, industrial accidents, power outages, labor disturbances and other
business interruptions. Furthermore, if any of our products are faulty or
contaminated, then we may become subject to product liability claims or we may
have to engage in a product recall. For details about our recent recall of
contaminated products in connection with the melamine contamination incident,
please see “Item 2. Management’s Discussion and Analysis of Financial Condition
and Results of Operations — Overview.”




We do not
carry any business interruption insurance, product recall or third-party
liability insurance for our production facilities or with respect to our
products to cover claims pertaining to personal injury or property or
environmental damage arising from defects in our products, product recalls,
accidents on our property or damage relating to our operations. Therefore, our
existing insurance coverage may not be sufficient to cover all risks associated
with our business. As a result, we may be required to pay for financial and
other losses, damages and liabilities, including those caused by natural
disasters and other events beyond our control, out of our own funds, which could
have a material adverse effect on our business, financial condition and results
of operations. For examples, all of the costs we have incurred to date and may
incur in the future that are related to our recent product recall in connection
with the melamine contamination incident, may not be covered by our existing
insurance policies.


37


RISKS
ASSOCIATED WITH DOING BUSINESS IN CHINA




PRC
food hygiene and safety laws may become more onerous, which may adversely affect
our operations and financial performance and lead to an increase in our costs
which we may be unable to pass on to our customers.




Operators
within the PRC dairy industry and infant formula sector are subject to
compliance with PRC food hygiene and safety laws and regulations. Such laws and
regulations require all enterprises engaged in the production of dairy and
infant formula products to obtain a hygiene license. They also set out hygiene
standards with respect to food and food additives, packaging and containers, and
labeling on packaging as well as hygiene requirements for food production and
sites, facilities and equipment used for the transportation and the sale of
food. Failure to comply with PRC food hygiene and safety laws may result in
fines, suspension of operations, loss of hygiene license and, in certain cases,
criminal proceedings against an enterprise and its management. Although we are
in compliance with current PRC food hygiene and safety laws and regulations, in
the event that such laws and regulations become more stringent or widen in
scope, we may fail to comply with such laws, or if we comply, our production and
distribution costs may increase, and we may be unable to pass these additional
costs on to our customers. For example, in response to the recent melamine
contamination incident, the PRC State Council abolished the regulations on
inspection exemptions for food on September 18, 2008 so that our products were
to be subject to batch by batch inspection going forward. In addition, the PRC
State Council promulgated with immediate effect the Regulation on Supervision
and Administration of Quality and Safety of Dairy Products on October 9, 2008
which, among other things, imposes more stringent requirements for inspection,
production, packaging, labeling and product recall on dairy product producers.
All these new measures are likely to increase our costs which we may be unable
to pass on to our customers.




Changes
in the regulatory environment for dairy and infant nutrition products in China
could negatively impact our business.




The dairy
and infant nutrition product industries in China are regulated and regulatory
changes may affect both our customers and us. Any changes in regulations that
impose additional requirements for construction of new production lines and
facilities or expansion of existing facilities will require us to secure
additional government approvals for our current production expansion projects.
Similarly, additional safety and quality control regulations could impact our
costs of production. For example, on March 18, 2008, the PRC National
Development and Reform Commission, or NDRC, promulgated the Access Conditions
for Dairy Products Processing Industry, or the Access Conditions, which became
effective on April 1, 2008. The Access Conditions impose new conditions
that an entity must satisfy in order to engage, or continue to engage, in the
dairy products processing business. For a more detailed description of these
requirements, see “Item 1. Business—Regulation” in our Annual Report on Form
10-K for the fiscal year ended March 31, 2008, which was filed with the SEC.
Although we believe our existing entities and facilities meet the Access
Condition requirements, it is possible that our future expansion plans or the
establishment of new entities may fail to meet one or more of the requirements
under the Access Conditions in the future. In addition, in response to the
recent melamine contamination incident, the relevant PRC government authorities
may impose more stringent conditions on entering or remaining in the dairy
products industry. Failure to comply with these or any other changes in
regulations affecting our business could have a material adverse effect on our
business and our results of operations. In addition, the indirect impact of any
such changes could adversely affect our business even if the specific
regulations do not directly apply to our products or us.


38


RISKS
RELATED TO THE MARKET FOR OUR STOCK GENERALLY




The
market price of our common stock is volatile, and its value may be depressed at
a time when you want to sell your holdings.




The
market price of our common stock is volatile, and this volatility may continue.
For instance, between July 1, 2008 and December 31, 2008, the price of our
common stock, as reported on Nasdaq on which our common stock has traded, ranged
between $7.30 and $52.24. Though we believe the recent fluctuation resulted
mainly from the melamine contamination incident and the current worldwide market
disruption, numerous factors, many of which are beyond our control, may cause
the market price of our common stock to fluctuate significantly.




In
addition to market and industry factors, the price and trading volume for our
common stock may be highly volatile for specific business reasons. Factors such
as variations in our revenues, earnings and cash flow, announcements of new
investments, cooperation arrangements or acquisitions, and fluctuations in
market prices for our products could cause the market price for our shares to
change substantially.




Securities
class action litigation is often instituted against companies following periods
of volatility in their stock price. This type of litigation could result in
substantial costs to us and divert our management’s attention and
resources.




Moreover,
the trading market for our common stock will be influenced by research or
reports that industry or securities analysts publish about us or our business.
If one or more analysts who cover us downgrade our common stock, the market
price for our common stock would likely decline. If one or more of these
analysts cease coverage of us or fail to regularly publish reports on us, we
could lose visibility in the financial markets, which, in turn, could cause the
market price for our common stock or trading volume to decline.




Furthermore,
securities markets may from time to time experience significant price and volume
fluctuations for reasons unrelated to operating performance of particular
companies. These market fluctuations may adversely affect the price of our
common stock and other interests in our company at a time when you want to sell
your interest in us.




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




None.




ITEM
3. DEFAULTS UPON SENIOR SECURITIES




None.





ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS




None.




ITEM
5. OTHER INFORMATION




None.


39


ITEM
6. EXHIBITS





EXHIBIT
                NO.
              
              DOCUMENT
      DESCRIPTION3.1
              
              Amended
      and Restated Certificate of Incorporation of Synutra International, Inc.
      (incorporated by reference to Exhibit 3.1 to the Registrant’s Quarterly
      Report on Form 10-Q filed on November 11, 2008)3.2
              
              Amended
      and Restated Bylaws of Synutra International, Inc. (incorporated by
      reference to Exhibit 3.2 to the Registrant’s Quarterly Report on Form 10-Q
      filed on November 11, 2008)31.1
              
              Certification
      of Principal Executive Officer pursuant to Rule 13a-14(a) or Rule
      15d-14(a), promulgated under the Securities Exchange Act of 1934, as
      amended.31.2
              
              Certification
      of Principal Financial Officer pursuant to Rule 13a-14(a) or Rule
      15d-14(a), promulgated under the Securities 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).




40


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:
      February 9, 2009
                    By:
                    /s/ Liang
      ZhangName: 
      Liang ZhangTitle: 
      Chief Executive
Officer




41