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SKBI > SEC Filings for SKBI > Form 10-K on 1-Apr-2013All Recent SEC Filings

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Form 10-K for SKYSTAR BIO-PHARMACEUTICAL CO


1-Apr-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our results of operations and financial condition for the fiscal years ended December 31, 2012 and 2011 should be read in conjunction with our financial statements and the notes thereto that are included elsewhere in this report. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations, and intentions. Please see the section in this report titled "Caution Regarding Forward-Looking Information."

Overview

Our financial statements are prepared in U.S. Dollars and in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). See "Exchange Rates" below for information regarding the exchanges rates at which Renminbi ("RMB") were translated into U.S. Dollars ("USD") at various pertinent dates and for pertinent periods.

Critical Accounting Policies

In preparing the consolidated financial statements in accordance with U.S. GAAP, we make estimates and assumptions about the effect of matters that are inherently uncertain and may change in subsequent periods. The resulting accounting estimates will, by definition, vary from the related actual results. We consider the following to be the most critical accounting policies:

Principles of consolidation

The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The consolidated financial statements include the financial statements of our company, our wholly-owned subsidiaries, and our VIEs. All significant inter-company transactions and balances between our company, its subsidiaries, and its VIEs have been eliminated in consolidation.

We have evaluated the relationship with Xi'an Tianxing and Xi'an Tianxing's wholly owned subsidiaries, Xi'an Sikaida and Shanghai Siqiang. As a result of the contractual arrangements which obligate Sida to absorb all of the risk of loss from Xi'an Tianxing's activities and enable Sida to receive all of its expected residual returns, the Company accounts for Xi'an Tianxing, Xi'an Sikaida and Shanghai Siqiang as VIEs under the Financial Accounting Standards Board's ("FASB") interpretation on consolidation of variable interest entities. Accordingly, the Company consolidates the results, assets, and liabilities of Xi'an Tianxing, Xi'an Sikaida and Shanghai Siqiang.

Revenue recognition

Our revenue is primarily from the sales of veterinary healthcare and medical care products in China. Sales are recognized when the following four revenue criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured. Sales are presented net of value added tax ("VAT"). No estimated allowance for sales returns is reflected in these consolidated financial statements as sales returns are de minimus based on historical experience.

There are two types of sales upon which revenue is recognized:

a. Credit sales: revenue is recognized when the products have been delivered to the customers.

b. Full payment before delivering: revenue is recognized when the products have been delivered to the customers.

Accounts receivable

Accounts receivable is stated at cost less an allowance for uncollectible accounts, as needed. We use the aging method to estimate the allowance for anticipated uncollectible receivable balances. Under the aging method, a bad debt percentage determined by management, based on historical experience and current economic climate, is applied to customers' balances categorized by the number of months the underlying invoices have remained outstanding. At each reporting period, the allowance balance is adjusted to reflect the amount computed as a result of the aging method. When facts subsequently become available to indicate that the allowance provided requires an adjustment, a corresponding adjustment is made to the allowance account as a change in estimate. The ultimate collection of our accounts receivable may take one year. Delinquent account balances are reserved after management determines that the likelihood of collection is not probable, and known bad debts are written-off against the allowance for doubtful accounts when identified.

Stock based compensation

We record and report stock-based compensation by measuring the cost of services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which services are received. Stock compensation for stock granted to non-employees is determined as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.

Recently Issued Accounting Pronouncements

In July 2012, the FASB issued 2012-02 Intangibles - Goodwill and Other (Topic 350): The amendments in this update will allow an entity to first assess qualitative factors to determine whether it is necessary to perform a quantitative impairment test. Under these amendments, an entity would not be required to calculate the fair value of an indefinite-lived intangible asset unless the entity determines, based on a qualitative assessment, that it is not more likely than not, the indefinite-lived intangible asset is impaired. The amendments include a number of events and circumstances for an entity to consider in conducting the qualitative assessment. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if a public entity's financial statements for the most recent annual or interim period have not yet been issued. We do not expect to have a material impact on our consolidated financial statements.

In February 2013, the FASB issued Accounting Standards Update No. 2013-02 Comprehensive Income (Topic 220): The objective of this update is to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments in this update seek to attain that objective by requiring an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. generally accepted accounting principles (GAAP) to be reclassified in its entirety to net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is reclassified to a balance sheet account (for example, inventory) instead of directly to income or expense in the same reporting period. For public entities, the amendments are effective prospectively for reporting periods beginning after December 15, 2012. For nonpublic entities, the amendments are effective prospectively for reporting periods beginning after December 15, 2013. Early adoption is permitted. We do not expect the adoption of the provisions in this update will have a significant impact on our consolidated financial statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company's consolidated financial statements upon adoption.

Results of Operations - Comparison of Two Years Ended December 31, 2012 and 2011



The following table summarizes our results of operations for the years ended
December 31, 2012 and 2011.



                                                               Years Ended December 31,
                                                      2012                                  2011
                                                          Percentage of                         Percentage of
                                           Amount         total revenue          Amount         total revenue
Revenues                                $ 33,586,791               100.0 %    $ 52,788,279               100.0 %
Gross Profit                            $ 18,491,787                55.1 %    $ 26,225,531                49.7 %
Operating Expense                       $  9,940,806                29.6 %    $ 10,975,607                20.8 %
Income from Operations                  $  8,550,981                25.5 %    $ 15,249,924                28.9 %
Other Income (Expenses)                 $   (170,428 )              (0.5 )%   $  1,279,015                 2.4 %
Income Tax Expenses                     $  2,168,125                 6.5 %    $  2,871,299                 5.4 %
Net Income                              $  6,212,428                18.5 %    $ 13,657,640                25.9 %

Revenues. All of our revenues are derived from the sale of veterinary healthcare and medical care products in the PRC. For the year ended December 31, 2012, we had revenues of $33,586,791 as compared to revenues of $52,788,279 for the year ended December 31, 2011, a decrease of $19,201,488 or 36.4% due to temporary suspension of production at the Huxian veterinary medication plant during the first three quarters as a result of the GMP re-examination. We generate revenue from sales of four product lines: veterinary medications, micro-organism, feed additives, and vaccines. The selling prices of our products increased more than 4.3% on average in the year ended December 31, 2012 compared to 2011. The decrease in revenue was primarily due to the decrease of sales volume.

Revenue - Veterinary Medications. Revenue from sales of our veterinary medications decreased by $23,102,865 or 68.4% from $33,761,224 for the year ended December 31, 2011 to $10,658,359 for the year ended December 31, 2012. The decrease of revenue was primarily due to temporary suspension of production at Huxian plant for the first three quarters of 2012. On January 7, 2012, the GMP certification of Huxian veterinary medications facility expired and its production was temporarily suspended. On September 26, 2012, China's Ministry of Agriculture (MOA) renewed our GMP certificate which is valid for another five years until September 2017 and we resumed the production at Huxian veterinary medications facility in October 2012. We currently have two veterinary medications plants located in Huxian and Jingzhou with Huxian historically being our main facility. The Jingzhou plant completed its GMP re-examination in 2011 and resumed its normal production in 2012. Of the total revenues from veterinary medications during the year ended December 31, 2012, approximately 63.7% of total revenue resulted from the sale of products from the Huxian facility. The selling prices of our veterinary medication products for the year ended December 31, 2012 increased approximately 13.7% on average from last year. The decrease in revenue was primarily due to the decrease of sales volume.

Revenue - Micro-Organism. Revenue from sales of our micro-organism products increased by $1,208,528 or 8.5% from $14,146,939 for the year ended December 31, 2011 to $15,355,467 for the year ended December 31, 2012. The increase was primarily due to a growing concern for food safety and increasing market demand for organic and green food products in China resulting in increasing the utilization of non-drug feed additives in the animal husbandry industry and our increased sales efforts to respond to this market trend. Currently we have a micro-organism plant located in Sanqiao. The revenue from sales of our micro-organism products was the largest revenue contributor for the entire company and contributed 45.7% of total revenue during the year ended December 31, 2012. The selling prices of our micro-organism products for the year ended December 31, 2012 have not materially changed on average from last year. The increase in revenue was mainly due to the increase of sales volume.

Revenue - Feed Additives. Revenue from sales of our feed additives product line increased by $1,461,653 or 57.1% from $2,559,914 for the year ended December 31, 2011 to $4,021,567 for the year ended December 31, 2012. The increase was primarily the result of increased sales efforts despite the slowing economy in China. Due to the temporary reduction of veterinary medication production in the first nine months of 2012, we were able to shift some of our veterinary medication production and sales forces to focus on the manufacturing and selling of feed additives products and penetrate the market. Currently we have a feed additive plant located in Sanqiao. The selling prices of our feed additives products for the year ended December 31, 2012 have not materially changed on average from last year. The increase in revenue was primarily due to the increase of sales volume.

Revenue - Vaccines. Revenue from sales of our vaccines increased by $1,231,196 or 53.1% from $2,320,202 for the year ended December 31, 2011 to $3,551,398 for the year ended December 31, 2012. The increase was primarily the result of increased sales efforts despite the slowing economy in China. We completed the construction of a new vaccine facility at our Huxian plant in 2010. On September 20 and 21, 2012, MOA physically inspected this new facility and deemed the facility GMP compliant. Following physical inspection, the MOA's inspection team recommended that the Office of the Working Committee proceed with Stage 2 of its GMP certification process. The Company expects the GMP certification process to be completed by the third quarter of 2013, and to commence production shortly thereafter. The selling prices of our vaccine products increased approximately 0.3% on average for the year ended December 31, 2012 compared to those in 2011. The increase in revenue was primarily due to the increase of sales volume.

Cost of Sales. Cost of sales was $15,095,004 for the year ended December 31, 2012, as compared to $26,562,748 for the year ended December 31, 2011, a decrease of $11,467,744 or 43.2%, as a result of decreased sales of our veterinary medications product line. For the year ended December 31, 2012, raw material costs comprised the majority or approximately 77.3% of total cost of sales, packing material costs comprised approximately 13.8% of total cost of sales, and labor costs and manufacturing overhead comprised approximately 8.9% of total cost of sales. The increased gross margins for the year ended December 31, 2012 was mainly because the majority of our revenue during the year came from highly profitable micro-organism and vaccine product lines, while the relatively less profitable veterinary medications product line significantly reduced its production, and therefore sales, during the year, as described above.

Cost of Sales - Veterinary Medications. Cost of sales of our veterinary medications product line decreased from $20,684,170 for the year ended December 31, 2011 to $6,087,300 for the year ended December 31, 2012, a decrease of $14,596,870 or 70.6%. This decrease was mainly due to the decrease in corresponding sales as a result of temporary suspension of production at the Huxian facility for the first three quarters of 2012.

Cost of Sales - Micro-Organism. Cost of sales of our micro-organism product line increased from $4,034,629 for the year ended December 31, 2011 to $5,498,463 for the year ended December 31, 2012, an increase of $1,463,834 or 36.3%. This increase was mainly due to the corresponding increased sales. The changes of formula to manufacture some of our micro-organism products in 2012 also contributed to an increase in raw material costs.

Cost of Sales - Feed Additives. Cost of sales of our feed additives product line increased from $1,542,022 for the year ended December 31, 2011 to $3,074,301 for the year ended December 31, 2012, an increase of $1,532,279 or 99.4%. This increase in cost of sales was mainly due to the corresponding increase in feed additive sales and a significant increase in raw material costs of yeast extract, the main raw material used in the manufacture of feed additive products. We are searching for potential substitutes for certain main raw materials to manufacture our feed additives products in order to control rising costs.

Cost of Sales - Vaccines. Cost of sales of our vaccines product line increased from $301,927 for the year ended December 31, 2011 to $434,940 for the year ended December 31, 2012, an increase of $133,013 or 44.1%. This increase was the result of the corresponding increase of vaccine product sales.

Operating Expenses



                                                                  Years Ended December 31,
                                                         2012                                 2011
                                                              Percentage
                                                                  of                              Percentage of
                                              Amount         total revenue         Amount         total revenue
Research and Development Costs              $ 2,154,241                 6.4 %   $  2,814,328                 5.3 %
Selling Expenses                              3,040,036                 9.1        4,062,126                 7.7
General and Administrative Expenses           4,746,529                14.1        4,099,153                 7.8
Total Operating Expenses                    $ 9,940,806                29.6 %   $ 10,975,607                20.8 %

Research and Development Costs. Research and development costs totaled $2,154,241 for the year ended December 31, 2012 as compared to $2,814,328 for the year ended December 31, 2011, a decrease of $660,087 or 23.5%. The decrease was primarily due to less R&D efforts undertaken during 2012.

Selling Expenses. Selling expenses totaled $3,040,036 for the year ended December 31, 2012 as compared to $4,062,126 for the year ended December 31, 2011, a decrease of $1,022,090 or 25.2%. This decrease is mainly due to decreased sales commission expenses as the Huxian veterinary medication facility was temporarily closed for the first three quarters of 2012 resulting in a significant decrease in veterinary medication sales in 2012. Sales commission expenses totaled $904,279 and $1,558,013 during the year ended December 31, 2012 and 2011, respectively, a decrease of $653,734 or 42.0%. Shipping and handling costs decreased $130,508 or 6.8% as the number of product units shipped to our customers dropped during the year. However, the rising unit cost for transportation and delivery services partially offset the impact of the decrease in shipping volume as we continued to expand our market to remote areas. Travelling expenses also decreased $145,210 or 77.5% as we temporarily closed the Huxian veterinary medication facility for its GMP re-certification resulting in less veterinary medicine sales activities during the year.

General and Administrative Expenses. General and administrative expenses totaled $4,746,529 for the year ended December 31, 2012 as compared to $4,099,153 for the year ended December 31, 2011, an increase of $647,376 or 15.8%. The increase was mainly due to the stock based compensation expense of $1,037,911 for the stock grants on May 4, 2012 to the Company's employees and members of the Board of Directors, all of which grants were made pursuant to the terms and provisions of the 2010 Stock Incentive Plan.

Other Income (Expenses) Other income net of expenses were $(170,428) for 2012 as compared to $1,279,015 for 2011. The net gain in 2011 was mainly a result of a gain in fair value change of warrant/purchase option liability of $1,346,239, and such gain for 2012 was $37,800. Our common stock price experienced a volatile downward movement in 2011, thus we recorded a higher gain on these derivative liabilities. All of our warrants expired in February 2012. On the other hand, interest expenses were $706,842 in 2012, as compared to $140,920 in 2011 due to average higher interest rates on borrowing in 2012.

Provision for Income Taxes Other tax expenses were $2,168,125 for 2012 as compared to $2,871,299 for 2011, representing an effective tax rate of 25.9% and 17.4% in 2012 and 2011, respectively. In 2012 and 2011, Xi'an Tianxing was subject to a preferential income tax rate of 15% while other PRC subsidiaries were subject to statutory tax rate of 25%. In 2012 and 2011, Xi'an Tianxing contributed 91.5% and 100.0% of consolidated profits in China, respectively. In 2012, Xi'an Tianxing's Huxian veterinary medication production had been temporarily suspended for nine months for GMP re-certification.

Liquidity

For the year ended December 31, 2012, cash provided by operating activities was $5,612,124 compared to cash used in operating activities of $1,658,937 for the year ended December 31, 2011. The major operating activities that provided cash during the year ended December 31, 2012 were net income of $6,212,428, a decrease in prepayment to suppliers of $6,027,718, and an increase in accounts payable of $2,307,066. The major operating activities that used cash during the year ended December 31, 2012 were an increase of accounts receivable of $6,394,244, and a build-up in inventory that used $7,985,875. The inflation rate in China was 2.5% in December 2012 as compared to the 2011 peak of over 4%. According to our observation of the raw material marketplace, the raw material prices in our sector were becoming more stable in 2012 as compared to the same period of last year. However, Chinese inflation rose to 3.2% in February 2013, hitting a 10-month high. We will monitor the market situation closely and continue the strategy of prepaying our suppliers to ensure the supply of raw materials at relatively lower cost levels. As of December 31, 2012, we had 59 suppliers as compared to 55 suppliers as of December 31, 2011 that we made advances to secure our raw material needs and to obtain favorable pricing. We will continue to closely manage these advances to balance the need for lower materials cost and sufficient cash flow.

Cash used in investing activities for the year ended December 31, 2012 was $544,950, as compared to cash used in investing activities of $1,654,637 for the year ended December 31, 2011. Cash provided by investing activities for the year ended December 31, 2012 was primarily the result of collection of loans made to third parties of $1,916,651. Cash used in investing activities for the year ended December 31, 2012 was primarily the result of loans made to third parties of $2,023,393.

Cash used in financing activities for the year ended December 31, 2012 was $779,285, as compared to cash provided by financing activities of $4,085,714 for the year ended December 31, 2011. Cash provided by financing activities for the year ended December 31, 2012, was primarily the result of proceeds from short-term and long-term loans of $5,774,860. Cash used in financing activities for the year ended December 31, 2012 was primarily the result of repayment of short-term loans of $7,488,280.

As of December 31, 2012, we had cash of $11,321,848. Our total current assets were $71,652,265, and our total current liabilities were $17,205,920, which resulted in a net working capital of $54,446,345.

Capital Resources

We finance our ongoing operating activities by using funds from our operations and external credit or financing arrangements. We routinely monitor current and expected operational requirements and financial market conditions to evaluate the use of available financing sources. We secured $5,774,860 in short-term and long term loans and repaid short-term loans of $7,488,280 during the year ended December 31, 2012. Considering our existing working capital position and our ability to access debt funding sources, we believe that our operations and borrowing resources are sufficient to provide for our current and foreseeable capital requirements to support our ongoing operations for at least the next twelve months.

Plan of Operations

Over the next 12 months, we plan to continue to market and sell our current products and to develop new products.

Xi'an Tianxing completed the veterinary medicine facility in Huxian during 2007 and the facility was certified by GMP standard and has been fully operational since then. According to MOA's regulation, our facility is required to have a GMP re-examination every five years. On January 7, 2012, the GMP certification of Huxian veterinary medications facility expired after five years and its production was temporarily suspended. In June 2012, the MOA inspected Huxian veterinary medications facility and published its recommendation to renew its GMP certificate on the China Institute of Veterinary Drug Control's website. On September 26, 2012, the MOA renewed our GMP certificate which is valid for another five years and we resumed the production at Huxian facility in October, 2012 and expect to get back to full production in 2013. We currently have two veterinary medications factories located in Huxian and Jingzhou with Huxian being our main facility. Skystar Jingzhou veterinary medicine plant started production in the third quarter of 2010 after the asset acquisition was completed. During 2011, the Jingzhou plant completed its GMP re-examination and resumed its normal production in 2012. We expect that Jingzhou will continue its normal production in 2013 and generate more revenue as more production permits were received. Jingzhou's veterinarian medicine products include aquaculture medicines.

We completed the construction of a new vaccine facility at our Huxian plant in 2010. On September 20 and 21, 2012, the MOA physically inspected this new facility and deemed the facility GMP compliant. Following physical inspection, the MOA's inspection team recommended that the Office of the Working Committee proceed with Stage 2 of its GMP certification process. The Company expects the GMP certification process to be completed by the third quarter of 2013, and to commence production shortly thereafter.

Xi'an Tianxing also leases a manufacturing facility in Sanqiao to produce feed additive and micro-organism products and the facility is currently fully operational.

Skystar Kunshan micro-organism plant's asset acquisition was completed in September 2011. Its facility renovation construction project was completed in 2012, and inspection was completed and accepted in March 2013. However, the facility has only completed partial equipment installation, tooling and testing; thus is not operational at this point. We anticipate that Kunshan plant will start small-scale production later 2013. However, we do not expect that will bring significant impact to our revenue in 2013 as a whole.

Skystar intends to continue developing new products, including animal immunization products, non-pathogenic micro-organisms for the cure and prevention of livestock disease, complex enzyme preparations as animal feed additives, pet drugs, animal disease specific transfer factor, vaccine biological agents and other veterinary medicine products within the next 12 months. If we succeed in developing new products and are able to obtain the regulatory approvals or clearances that are necessary to commercialize our products, we will have additional revenue than expected.

Contractual Obligations and Off-Balance Sheet Arrangements



Contractual Obligations



                                                             Payments Due by Period
                                                Less than                                            More than
Contractual Obligations           Total          1 year         1 - 3 years       3 - 5 years         5 years
R&D Project Obligation          $  302,356     $   302,356     $           -     $           -     $            -
Operating Lease Obligations        318,449         112,075           141,624            64,750                  -
Government Grant Obligation        158,700         158,700                 -                 -                  -
Total                           $  779,505     $   573,131     $     141,624     $      64,750     $            -

. . .

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