U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2011
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission File Number
Keyuan Petrochemicals, Inc.
(Exact name of registrant as specified in its charter)
Nevada | 45-0538522 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) |
Qingshi Industrial Park
Ningbo Economic & Technological Development Zone
Ningbo, Zhejiang Province
P.R. China 315803
(86) 574-8623-2955
(Issuer's telephone number)
(Former address)
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Sec. 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one)
Large Accelerated Filer | o | Accelerated Filer | o | |
Non-accelerated filer | o | Smaller reporting company | x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934) Yes o No x
As of November 1, 2011, the Registrant has 57,579,490 shares of common stock outstanding and 5,400,010 shares of Series B Preferred Stock outstanding.
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION | |
Item 1. Financial Statements | 1 |
Condensed Consolidated Balance Sheets | 3 |
Condensed Consolidated Statements of Operations and Comprehensive Income (loss) | 4 |
Condensed Consolidated Statements of Cash Flows | 5 |
Notes to Condensed Consolidated Financial Statements | 6 – 19 |
Item 2. Management’s Discussion and Analysis or Plan of Operation | 20 |
Item 3. Quantitative and Qualitative Disclosures About Market Risk | 26 |
Item 4. Controls and Procedures | 26 |
PART II – OTHER INFORMATION | 28 |
Item 1. Legal Proceedings | 28 |
Item 1A. Risk Factors | 28 |
Item 2. Unregistered Sales of Equity Securities And Use Of Proceeds | 28 |
Item 3. Defaults Upon Senior Securities | 28 |
Item 4. (Removed and Reserved) | 28 |
Item 5. Other Information | 28 |
Item 6. Exhibits | 28 |
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INTRODUCTORY NOTE
Except as otherwise indicated by the context, references in this interim report on Form 10-Q (this “Form 10-Q”) to the “Company,” “Keyuan” “we”, “us” or “our” are references to the combined business of Keyuan Petrochemicals, Inc. and its consolidated subsidiaries. References to “Keyuan International” are references to our wholly-owned subsidiary, Keyuan International Group Limited”; references to “Keyuan HK” are references to our wholly-owned subsidiary, Keyuan Group Limited; references to “Ningbo Keyuan” are references to our wholly-owned subsidiary, Ningbo Keyuan Plastics Co.,Ltd.; references to “Ningbo Keyuan Petrochemicals” are to our wholly-owned subsidiary, Ningbo Keyuan Petrochemicals Co., Ltd. References to “China” or “PRC” are references to the People’s Republic of China. References to “RMB” are to Renminbi, the legal currency of China, and all references to “$” and dollar are to the U.S. dollar, the legal currency of the United States.
Special Note Regarding Forward-Looking Statements
This report contains forward-looking statements and information that are based on the beliefs of our management as well as assumptions made by and information currently available to us. Such statements should not be unduly relied upon. When used in this report, forward-looking statements include, but are not limited to, the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan” and similar expressions, as well as statements regarding new and existing products, technologies and opportunities, statements regarding market and industry segment growth and demand and acceptance of new and existing products, any projections of sales, earnings, revenue, margins or other financial items, any statements of the plans, strategies and objectives of management for future operations, any statements regarding future economic conditions or performance, uncertainties related to conducting business in China, any statements of belief or intention, and any statements or assumptions underlying any of the foregoing. These statements reflect our current view concerning future events and are subject to risks, uncertainties and assumptions. There are important factors that could cause actual results to vary materially from those described in this report as anticipated, estimated or expected, including, but not limited to: competition in the industry in which we operate and the impact of such competition on pricing, revenues and margins, volatility in the securities market due to the general economic downturn; Securities and Exchange Commission (the “SEC”) regulations which affect trading in the securities of “penny stocks,” and other risks and uncertainties. Except as required by law, we assume no obligation to update any forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward- looking statements, even if new information becomes available in the future. Depending on the market for our stock and other conditional tests, a specific safe harbor under the Private Securities Litigation Reform Act of 1995 may be available. Notwithstanding the above, Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) expressly state that the safe harbor for forward-looking statements does not apply to companies that issue penny stock. Because we may from time to time be considered to be an issuer of penny stock, the safe harbor for forward-looking statements may not apply to us at certain times.
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PART I – FINANCIAL INFORMATION
KEYUAN PETROCHEMICALS, INC. AND SUBSIDIAIRES
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, | December 31, | |||||||||||
Note | 2011 | 2010 | ||||||||||
(Unaudited) | ||||||||||||
ASSETS | ||||||||||||
Current assets: | ||||||||||||
Cash | 3 | $ | 5,783,010 | $ | 29,336,241 | |||||||
Pledged bank deposits | 152,745,891 | 98,053,146 | ||||||||||
Bills receivable | 3,652,467 | 9,194,513 | ||||||||||
Inventories | 4 | 103,216,904 | 86,831,556 | |||||||||
Prepayments to suppliers | 5 | 8,399,486 | 14,071,219 | |||||||||
Consumption tax refund receivable | 6 | 34,406,640 | 39,144,688 | |||||||||
Amounts due from related parties | 23 | 38,675 | 5,332,193 | |||||||||
Other current assets | 7 | 48,477,204 | 28,608,833 | |||||||||
Deferred income tax assets | 479,207 | 469,914 | ||||||||||
Total current assets | 357,199,484 | 311,042,303 | ||||||||||
Property, plant and equipment, net | 8 | 163,015,224 | 129,781,304 | |||||||||
Intangible assets, net | 9 | 1,013,929 | 1,045,466 | |||||||||
Land use rights | 10 | 11,099,122 | 11,099,875 | |||||||||
Prepayments for property, plant and equipment | 5 | 4,516,760 | - | |||||||||
Total assets | $ | 536,844,519 | $ | 452,968,948 | ||||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||||
Current liabilities: | ||||||||||||
Short-term bank borrowings | 11 | $ | 168,068,315 | $ | 135,768,634 | |||||||
Bills payable | 51,747,150 | 60,224,900 | ||||||||||
Current portion of long-term bank borrowings | 12 | 4,641,000 | 17,445,500 | |||||||||
Accounts payable | 149,772,489 | 92,225,936 | ||||||||||
Advances from customers | 13 | 12,092,013 | 10,479,217 | |||||||||
Accrued expenses and other payables | 14 | 32,974,995 | 18,205,110 | |||||||||
Income taxes payable | 18 | 1,385,813 | 10,699,778 | |||||||||
Dividends payable | 2,969,935 | 234,393 | ||||||||||
Amounts due to related parties | 23 | 3,104,306 | 115,535 | |||||||||
Total current liabilities | 426,756,016 | 345,399,003 | ||||||||||
Long-term bank borrowings | 12 | 15,470,000 | 15,170,000 | |||||||||
Total liabilities | 442,226,016 | 360,569,003 | ||||||||||
Series B convertible preferred stock: | ||||||||||||
Par value: $0.001; Authorized: 5,400,010 shares | ||||||||||||
6% cumulative dividend with liquidation preference | ||||||||||||
over common stock | ||||||||||||
Issued and outstanding: 5,400,010 shares | ||||||||||||
liquidation preference of $20,250,000 | 16,701,565 | 16,701,565 | ||||||||||
Commitments and contingencies | 19 | - | - | |||||||||
Stockholders’ equity: | ||||||||||||
Series M convertible preferred stock: | ||||||||||||
Par value: $0.001; Authorized: 47,658 shares; | ||||||||||||
Issued and outstanding: nil at June 30, 2011 | ||||||||||||
and December 31,2010 | - | - | ||||||||||
Common stock: | ||||||||||||
Par value: $0.001; Authorized: 100,000,000 shares; | ||||||||||||
Issued and outstanding: 57,579,490 shares on June 30, 2011 | ||||||||||||
and 57,577,840 shares on December 31, 2010 | 57,580 | 57,578 | ||||||||||
Additional paid-in capital | 48,237,349 | 47,012,061 | ||||||||||
Statutory reserve | 3,075,356 | 3,075,356 | ||||||||||
Accumulated other comprehensive income | 5,042,587 | 3,310,416 | ||||||||||
Retained earnings | 21,504,066 | 22,242,969 | ||||||||||
Total stockholders’ equity | 77,916,938 | 75,698,380 | ||||||||||
Total liabilities and stockholders' equity | $ | 536,844,519 | $ | 452,968,948 | ||||||||
See accompanying notes to the condensed consolidated financial statements.
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KEYUAN PETROCHEMICALS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
Note | For the Three Months Ended | For the Six Months Ended | ||||||||||||||
June 30, | June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Sales | ||||||||||||||||
Third parties | 115,281,945 | 105,627,764 | 239,436,744 | 202,182,241 | ||||||||||||
Related parties | 23 | 35,607,658 | 26,369,453 | 58,217,477 | 47,186,862 | |||||||||||
Total Sales | $ | 150,889,603 | $ | 131,997,217 | $ | 297,654,221 | $ | 249,369,103 | ||||||||
Cost of sales | ||||||||||||||||
Third parties | 111,055,933 | 98,516,344 | 224,870,131 | 187,429,672 | ||||||||||||
Related parties | 23 | 37,977,326 | 24,835,031 | 58,276,685 | 44,478,145 | |||||||||||
Total Cost of sales | 149,033,259 | 123,351,375 | 283,146,816 | 231,907,817 | ||||||||||||
Gross profit | 1,856,344 | 8,645,842 | 14,507,405 | 17,461,286 | ||||||||||||
Operating expenses | ||||||||||||||||
Selling expenses | 215,548 | 258,901 | 754,680 | 343,413 | ||||||||||||
General and administrative expenses | 4,529,744 | 1,213,080 | 7,764,824 | 2,018,612 | ||||||||||||
Total operating expenses | 4,745,292 | 1,471,981 | 8,519,504 | 2,362,025 | ||||||||||||
(Loss) income from operations | (2,888,948 | ) | 7,173,861 | 5,987,901 | 15,099,261 | |||||||||||
Other income (expenses): | ||||||||||||||||
Interest income | 781,941 | 44,123 | 1,688,885 | 62,355 | ||||||||||||
Interest expense | (2,638,734 | ) | (1,634,060 | ) | (5,835,364 | ) | (2,725,817 | ) | ||||||||
Foreign exchange gain (loss), net | 3,200,356 | - | 2,052,713 | 293,028 | ||||||||||||
Liquidated damages expense | 15 | (1,300,730 | ) | (1,300,730 | ) | |||||||||||
Non-operating income (expenses) | 17 | 1,689,404 | 118,802 | 3,716,178 | (283,429 | ) | ||||||||||
Total other income (expenses) | 1,732,237 | (1,471,135 | ) | 321,682 | (2,653,863 | ) | ||||||||||
(Loss) income before income taxes | (1,156,711 | ) | 5,702,726 | 6,309,583 | 12,445,398 | |||||||||||
Income tax expense | 18 | 665,828 | 1,504,063 | 2,917,979 | 3,191,577 | |||||||||||
Net income (loss) attributable to Keyuan | ||||||||||||||||
Petrochemicals Inc. stockholders | (1,822,539 | ) | 4,198,663 | 3,391,604 | 9,253,821 | |||||||||||
Dividends to Series A convertible | ||||||||||||||||
Preferred stockholders | - | 288,497 | 288,497 | |||||||||||||
Dividends to Series B convertible | ||||||||||||||||
preferred stockholders | 15 | 306,247 | - | 602,507 | - | |||||||||||
Net (loss) income attributable to Keyuan | ||||||||||||||||
Petrochemicals Inc. common stockholders | $ | (2,128,786 | ) | $ | 3,910,166 | $ | 2,789,097 | $ | 8,965,324 | |||||||
Net (loss) income attributable to Keyuan | ||||||||||||||||
Petrochemicals Inc. stockholders | $ | (1,822,539 | ) | $ | 4,198,663 | $ | 3,391,604 | $ | 9,253,821 | |||||||
Other comprehensive income | ||||||||||||||||
Foreign currency translation adjustment | 617,550 | 192,224 | 1,174,874 | 193,948 | ||||||||||||
Comprehensive (loss) income | $ | (1,204,989 | ) | $ | 4,390,887 | $ | 4,566,478 | $ | 9,447,769 | |||||||
(Loss)earnings per share: | ||||||||||||||||
Attributable to common stock: | ||||||||||||||||
- Basic | 20 | $ | (0.04 | ) | $ | 0.08 | $ | 0.05 | $ | 0.18 | ||||||
- Diluted | 20 | $ | (0.04 | ) | $ | 0.08 | $ | 0.05 | $ | 0.18 | ||||||
Weighted average number of shares of common stock used in calculation | ||||||||||||||||
Basic | 20 | 57,579,239 | 50,045,451 | 57,578,896 | 48,858,321 | |||||||||||
Diluted | 20 | 57,579,239 | 54,930,660 | 63,836,892 | 51,314,420 |
See accompanying notes to the condensed consolidated financial statements.
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KEYUAN PETROCHEMICALS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended June 30, | ||||||||
2011 | 2010 | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 3,391,604 | $ | 9,253,821 | ||||
Adjustments to reconcile net income to net cash | ||||||||
provided by (used in) operating activities: | ||||||||
Loss on disposal of property, plant and equipment | 3,504 | - | ||||||
Depreciation | 4,671,566 | 4,071,010 | ||||||
Amortization | 51,675 | 49,508 | ||||||
Land use rights amortization | 217,999 | 84,236 | ||||||
Deferred income tax expense | - | 3,191,577 | ||||||
Share-based compensation expense | 1,285,185 | 124,824 | ||||||
Changes in operating assets and liabilities: | ||||||||
Bills receivable | 5,665,046 | (9,895,257 | ) | |||||
Inventories | (14,517,420 | ) | (34,628,566 | ) | ||||
Prepayments to suppliers | 11,118,823 | (6,190,211 | ) | |||||
Consumption tax refund receivable | 5,455,515 | (11,182,419 | ) | |||||
Other current assets | (23,036,081 | ) | 1,175,434 | |||||
Accounts payable | 44,000,832 | 57,283,692 | ||||||
Advances (to) from customers | 4,320,196 | (3,078,476 | ) | |||||
Income taxes payable | (9,427,659 | ) | - | |||||
Accrued expenses and other payables | 1,500,872 | 19,826 | ||||||
Net cash provided by operating activities | 34,701,757 | 10,278,999 | ||||||
Cash flows from investing activities: | ||||||||
Proceeds from disposal of property, plant and equipment | 10,512 | - | ||||||
Purchase of property, plant and equipment, | (11,574,245 | ) | (17,084,658 | ) | ||||
Net cash used in investing activities | (11,563,733 | ) | (17,084,658 | ) | ||||
Cash flows from financing activities: | ||||||||
Pledged bank deposits used for bank borrowings | (52,211,458 | ) | (27,655,715) | |||||
Proceeds from short-term bank borrowings | 74,477,809 | 59,923,457 | ||||||
Repayment of short-term bank borrowings | (45,167,450 | ) | (59,190,007 | ) | ||||
Proceeds from bills payable | 51,215,295 | 18,923,010 | ||||||
Repayment of bills payable | (60,784,670 | ) | (13,718,199 | ) | ||||
Repayments of long-term bank borrowings | (13,014,350 | ) | (1,466,900 | ) | ||||
Short-term financing from related parties | 13,144,234 | 4,400,700 | ||||||
Short-term financing to related parties | (13,144,234 | ) | (4,400,700 | ) | ||||
Repayment to Ningbo Litong | (95,094 | ) | (953,485 | ) | ||||
Repayments to unrelated parties | - | (733,450 | ) | |||||
Proceeds from warrant exercises | 7,332 | 23,132,089 | ||||||
Dividends paid | (1,396,964 | ) | - | |||||
Net cash used in financing activities | (46,969,550 | ) | (1,739,200 | ) | ||||
Effect of foreign currency exchange rate changes on cash | 278,295 | 36,879 | ||||||
Net decrease in cash | (23,553,231 | ) | (8,507,980 | ) | ||||
Cash at beginning of the period | 29,336,241 | 14,030,655 | ||||||
Cash at end of the period | $ | 5,783,010 | $ | 5,522,675 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Income taxes paid | $ | 12,345,638 | $ | - | ||||
Interest paid, net of interest capitalized | 5,835,363 | 2,725,817 | ||||||
Dividends accrued | - | - | ||||||
Non-cash financing activities: | ||||||||
Payable for purchase of property, plant and equipment | 24,433,051 | (14,864,749 | ) |
See accompanying notes to the condensed consolidated financial statements.
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1 ORGANIZATION, NATURE OF BUSINESS, AND RECENT EVENTS
(a) Organization
Keyuan Petrochemicals, Inc. (the “Company”) was incorporated in the State of Texas on May 4, 2004 in the former name of “Silver Pearl Enterprises, Inc”.
On April 22, 2010, Silver Pearl Enterprises, Inc., a U.S. public shell company (now known as the Company) entered into a share exchange agreement (the “Exchange Agreement”) with Keyuan International Group Limited (“Keyuan International”), a privately held investment holding company organized on June 11, 2009 under the laws of the British Virgin Islands, Delight Reward Limited (“Delight Reward”), the sole stockholder of Keyuan International and Denise D. Smith (“Smith”), the Company’s former principal stockholder. Pursuant to the terms of the Exchange Agreement, Delight Reward transferred to the Company all of its shares of Keyuan International in exchange for 47,658 shares of the Company’s Series M convertible preferred stock (the “Share Exchange”). The Series M convertible preferred stock voted with the common stock on an “as converted basis“ and were converted into 47,658,000 shares of the Company’s common stock upon the Company’s stockholders approving an increase in authorized common stock to at least 100,000,000 shares. As a result of the Share Exchange, Keyuan International became a wholly-owned subsidiary of the Company and Delight Reward became the controlling stockholder of the Company. On April 22, 2010, the Company repurchased and cancelled 3,264,000 shares of common stock from Smith for cash consideration of $400,000. The consideration paid in excess of par value of the repurchased shares amounting to $396,736 was charged to additional paid-in capital in the consolidated statement of stockholders’ equity and comprehensive income (loss). After giving effect to the repurchase and conversion of the Series M Preferred Stock, the former stockholders of Keyuan International hold 95.2% of the Company’s common stock.
The Share Exchange has been accounted for as a reverse acquisition and recapitalization whereby Keyuan International is deemed to be the accounting acquirer (and the legal acquiree). Accordingly, Keyuan International’s historical statements for the periods prior to the reverse acquisition became those of the Company retroactively restated for, and giving effect to, the number of shares received in the Share Exchange. The assets and liabilities, and revenues and expenses of the Company are included in the accompanying financial statements effective from April 22, 2010. The total net liabilities assumed by Keyuan International as of the date of the Share Exchange were not significant. The Company is deemed to be a continuation of the business of Keyuan International.
On May 12, 2010, the Company formed a business combination related shell company under the laws of the State of Nevada called Keyuan Petrochemicals, Inc. and on the same day, acquired 100% of the entity’s stock for cash. As such, the entity became the Company’s wholly-owned subsidiary (the “Merger Subsidiary”).
Effective as of May 17, 2010, the Merger Subsidiary was merged with and into the Company. As a result of the merger, the Company’s name was changed to “Keyuan Petrochemicals, Inc.”. Prior to the merger, the Merger Subsidiary had no liabilities and nominal assets and, as a result of the merger, the separate existence of the merger subsidiary ceased. The Company is the surviving corporation in the merger and, except for the name change, there was no change in the Company’s directors, officers, capital structure or business.
The Company, through its wholly-owned subsidiary, Keyuan International and its indirect subsidiaries Keyuan Group Limited (“Keyuan HK”) and Ningbo Keyuan Plastics Co.,Ltd. (“Ningbo Keyuan”) , is engaged in the manufacture and sale of petrochemical products.
On November 16, 2009 Keyuan HK acquired 100% of Ningbo Keyuan. At the time of the acquisition, Keyuan HK and Ningo Keyuan were controlled by Mr. Tao Chunfeng, the Company’s Chief Executive Officer. Accordingly, the acquisition was accounted for as a common control transaction in a manner similar to a pooling of interests.
On August 8, 2010, Keyuan HK established a wholly owned subsidiary in the People’s Republic of China (“PRC”), Ningbo Keyuan Petrochemicals Co., Ltd (“Ningbo Keyuan Petrochemicals”), which is engaged in the sale of petrochemical products in the PRC.
(b) Nature of business
The Company, through its PRC operating subsidiaries, Ningbo Keyuan and Ningbo Keyuan Petrochemicals, is engaged in the manufacture and sale of petrochemical products in the PRC.
(c) Recent Events
The Company’s former auditor, KPMG, LLP (“KPMG”), brought certain issues to the Company’s Audit Committee’s attention through a March 28, 2011 memorandum and an April 18, 2011 letter (collectively, the “KPMG Memoranda”). KPMG requested that the Company’s Audit Committee conduct an independent investigation (the “Investigation”) into those issues. On March 31, 2011, the Audit Committee elected to commence such independent Investigation and engaged the services of independent counsel, Pillsbury Winthrop Shaw Pittman LLP (“Pillsbury”), which in turn engaged the services of Deloitte Financial Advisory Services LLP (“Deloitte”), as independent forensic accountants, and King & Wood, as Audit Committee counsel in the People’s Republic of China (“PRC”). Pillsbury, Deloitte and King & Wood are collectively referred to herein as the “Investigation Team.” On September 28, 2011 the Investigation was completed. The Investigation identified possible violations of PRC laws and U.S. Securities laws, including the maintenance of an off-balance sheet cash account that was used primarily to pay service providers and other Company related expenses. Total activity in the off-balance sheet cash account amounted to approximately $800,000 through December 31, 2010 with a net income statement effect of approximately $12,000, and $400,000 for the period from January 1, 2011 to March 31, 2011, with a net income statement effect of approximately $192,000, at which time the Company ceased its use. The Investigation identified certain other issues that could result in potential violations of PRC or U.S. laws. The Company is working with its legal counsel to evaluate the matters identified in the Investigation and to determine the extent to which the Company may be exposed to fines and penalties. In addition, the Company has retained a Foreign Corrupt Practices Act (“FCPA”) expert to review potentially relevant transactions and to assist the Company with the design and implementation of a detailed FCPA program. The Company has preliminarily concluded that the extent to which it may be exposed in the PRC is limited. However, management is currently unable to determine the final outcome of these matters and their possible effects on the consolidated financial statements.
On October 7, 2011, trading of the Company’s common stock was delisted by NASDAQ, and is currently quoted on the Pink Sheets (symbol: KEYP.PK).
The Company’ s management believes that the Company’s cash, working capital, and access to cash through its bank loans provide adequate capital resources to fund its operations and working capital needs for at least the next twelve months.
2 BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. general accepted accounting principles (U.S. GAAP) and include the financial statements of the Company and its subsidiaries (the “Group”). All intercompany balances and transactions are eliminated in consolidation. The financial statements have been prepared in accordance with GAAP applicable to interim financial information and the requirements of Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. These interim financial statements should be read in conjunction with the audited financial statements for the years ended December 31, 2010 and 2009, as not all disclosures required by generally accepted accounting principles for annual financial statements are presented. The interim financial statements follow the same accounting policies and methods of computation as the audited financial statements for the years ended December 31, 2010 and 2009. Interim results are not necessarily indicative of results for a full year. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the financial position and the results of operations and cash flows for the interim periods have been included.
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3 CASH
Cash consists of cash on hand and cash at banks. As of June 30, 2011 and December 31, 2010, cash of $5,391,622 and $26,857,729, respectively, was held in major financial institutions located in the PRC. Management performs periodic evaluations of the relative credit standings of those financial institutions, and believes that these major financial institutions have high credit ratings.
4 INVENTORIES
Inventories consist of the following:
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
Raw materials | $ | 48,847,003 | $ | 53,160,604 | ||||
Finished goods | 52,556,490 | 30,024,896 | ||||||
Work-in-process | 1,813,411 | 3,646,056 | ||||||
Total | $ | 103,216,904 | $ | 86,831,556 |
5 PREPAYMENTS TO SUPPLIERS
As of June 30, 2011 and December 31, 2010, prepayments to suppliers are made in connection with the purchase of raw materials and the construction of the Group’s facilities. Prepayments to suppliers are reclassified to inventories or construction-in-progress, when the Group applies the prepayments to related purchases of materials, after the related invoice are received, which is generally within six months.
6 CONSUMPTION TAX REFUND RECEIVABLE
The PRC government enacted a regulation that provides that domestically purchased heavy oil to be used for producing ethylene and aromatics products would be exempted from a consumption tax. In addition, the consumption tax paid for imported heavy oil would be refunded if it was used for producing ethylene and aromatics products. Given all the Group’s purchased heavy oils are, or are to be, used for the production of ethylene and aromatics products, the Group recognizes a consumption tax refund receivable when the consumption tax has been paid and the relevant heavy oils have been used in production.
In January 2011, a consumption tax refund of $24,919,354 was received, and in March 2011 the balance of $14,225,334 from 2010 was approved for payment by the PRC tax authorities. Claims for consumption tax of $10,512,132 paid in the three months ended March 31, 2011 and $10,007,158 paid in the three months ended June 30, 2011are being submitted to the PRC tax authorities and are expected to be approved and refunded by December 31, 2011.
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7 OTHER CURRRENT ASSETS
Other current assets consist of the following:
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
VAT recoverable | $ | 15,432,317 | $ | 21,953,590 | ||||
Receivable from Ningbo Litong (Note 23) | - | 2,217,854 | ||||||
Customs deposits for imported inventories | 30,027,270 | 1,972,682 | ||||||
Others | 3,017,617 | 2,464,707 | ||||||
$ | 48,477,204 | $ | 28,608,833 | |||||
8 PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
Buildings | $ | 3,821,536 | $ | 3,733,116 | ||||
Machinery and equipment | 140,846,247 | 130,513,767 | ||||||
Vehicles | 558,255 | 560,440 | ||||||
Office equipment and furniture | 132,614 | 130,043 | ||||||
Construction-in-progress | 30,914,539 | 3,117,935 | ||||||
176,273,191 | 138,055,301 | |||||||
Less: Accumulated depreciation | (13,257,967 | ) | (8,273,997 | ) | ||||
$ | 163,015,224 | $ | 129,781,304 | |||||
Depreciation expense on property, plant and equipment is allocated to the following items:
Three months ended June 30, | Six months ended June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Cost of sales | $ | 2,246,111 | $ | 2,014,407 | $ | 4,589,859 | $ | 4,020,737 | ||||||||
Selling, general and administrative expenses | 40,473 | 27,129 | 81,707 | 50,273 | ||||||||||||
$ | 2,286,584 | $ | 2,041,536 | $ | 4,671,566 | $ | 4,071,010 | |||||||||
9 INTANGIBLE ASSETS
Intangible assets consist of the following:
Amortization | June 30, | December 31, | ||||||||||
Period | 2011 | 2010 | ||||||||||
Years | ||||||||||||
Licensing agreements | 10-20 | $ | 1,469,650 | $ | 1,441,150 | |||||||
Less: Accumulated amortization | (455,721 | ) | (395,684 | ) | ||||||||
$ | 1,013,929 | $ | 1,045,466 | |||||||||
For the six months ended June 30, 2011 and 2010, amortization expense for intangible assets amounted to $51,675 and $49,508, respectively. For the three months ended June 30, 2011 and 2010, amortization expense for intangible assets amounted to $25,995 and $24,761, respectively. Estimated amortization expense for each of the next five years is estimated to be approximately $100,000.
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10 LAND USE RIGHTS
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
Land use rights | $ | 11,973,131 | $ | 11,740,943 | ||||
Less: Accumulated amortization | (874,009 | ) | (641,068 | ) | ||||
$ | 11,099,122 | $ | 11,099,875 | |||||
For the six months ended June 30, 2011 and 2010, amortization expense related to land use rights was $217,999 and $84,236, respectively. For the three months ended June 30, 2011 and 2010, amortization expense related to land use rights was $109,677 and $42,129, respectively.
11 SHORT-TERM BANK BORROWINGS
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
Bank borrowings-secured/guaranteed | $ | 168,068,315 | $ | 135,768,634 |
The short−term bank borrowings outstanding as of June 30, 2010 carry a weighted average interest rate of 5.32% (2010: 5.18%) regarding bank loans in RMB; a weighted average interest rate of 3.42% (2010: 3.46%) regarding bank loans in USD, and have maturity terms ranging from one to twelve months and interest rates ranging from 2.97% to 4.30% (2010: 2.97% to 5.56%).
Included in short term bank borrowings at June 30, 2011 are $3,867,500 and $22,025,443 payable to Shanghai Pudong Development Bank, which are secured by Ningbo Keyuan's rights to use sea areas and a one-year fixed term deposit with a carrying amount of $23,808,330, respectively; In addition, $74,307,343 payable to Bank of China is secured by Ningbo Keyuan's one-year fixed term deposit and pledged deposits with carrying amounts of $80,992,936 and as of June 30, 2011. Among the rest of the Group's short term borrowings, $67,795,553 is guaranteed by related-party, third-party entities and individuals, including $30,940,000 which is guaranteed by the Group’s Chief Executive Officer.
12 LONG-TERM BANK BORROWINGS
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
Loan from China Construction Bank | $ | 15,470,000 | $ | 15,170,000 | ||||
Loan from Industrial and Commercial Bank of China | 4,641,000 | 4,551,000 | ||||||
Loan from Bank of China | - | 12,894,500 | ||||||
20,111,000 | 32,615,500 | |||||||
Less: current portion | (4,641,000 | ) | (17,445,500 | ) | ||||
$ | 15,470,000 | $ | 15,170,000 |
As of June 30, 2011 and December 31, 2010, all of the Group's long-term bank loans are guaranteed by related-party entities, bear interest from 5.76% to 6.98% and are due on various date through August 2012. There were no additional bank borrowings in the six months ended June 30, 2011.
2011 | $ | 4,641,000 | ||
2012 | 15,470,000 | |||
$ | 20,111,000 |
13 ADVANCES FROM CUSTOMERS
The Group requires a prepayment of 100% of the sales contract price from its customers shortly before products are delivered. Such prepayment is recorded as “advances from customers” in the Group’s consolidated balance sheets, until the products are delivered and the customer takes ownership and assumes the risk of loss.
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14 ACCRUED EXPENSES AND OTHER PAYABLES
Accrued expenses and other payables as of June 30, 2011 and December 31, 2010 consist of:
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
Purchase of property, plant and equipment | $ | 29,969,918 | $ | 17,217,958 | ||||
Accrued payroll and welfare | 344,632 | 690,831 | ||||||
Other accruals and payables | 2,660,445 | 296,321 | ||||||
$ | 32,974,995 | $ | 18,205,110 |
15 STOCKHOLDERS’ EQUITY AND RELATED FINANCING AGREEMENTS
Dividends
Fixed dividends, are accrued and cumulative for one year from the date of the initial issuance of the Series A and Series B convertible preferred stocks, and are payable on a quarterly basis.
Annual dividends are determined as 6% of $3.50 for each share of the Series A convertible preferred stock, and 6% of $3.75 for each share of the Series B convertible preferred stock.
As of December 31, 2010, all of the Series A convertible preferred stock had been converted into the Company’s common stock. No shares of Series B convertible preferred stock have been converted into the Company’s common stock.
On January 27, 2011, the Company’s Board of Directors approved the distribution of an annual cash dividend of $0.36 per share for 2010 to be paid quarterly to its common stock stockholders at the assigned dates of record. The first quarter dividend of $0.09 per share is declared to be paid to stockholders of record as of March 1, 2011, with the actual distribution occurring on April 15, 2011. Certain stockholders of the Company have announced the waiver of their rights to receive such cash dividends. In addition, PRAX Capital, the primary Series B convertible stockholder agreed to waive their rights to receive cash dividends for 2010 should they choose to convert their preferred stock before the record date. The estimated dividends to be distributed and the dividends waived are approximately $3.5 million and $17.2 million respectively. Approximately $0.9 million has been distributed to the common stockholders as dividends of the second quarter.
In connection with the Series A private placement, the Company entered into a registration rights agreement with the Series A investors, in which the Company agreed to file a registration statement with the Securities and Exchange Commission (“SEC”) to register for resale the issued common stock, the common stock issuable upon conversion of the Series A convertible preferred stock, and the common stock underlying the Series A and Series B Warrants, and the common stock underlying the placement agent warrants within 30 calendar days of April 22, 2010 and to have this registration statement declared effective within 150 calendar days of April 22, 2010 or within 180 calendar days of April 22, 2010 in the event of a full review of the registration statement by the SEC. If the Company doesn’t comply with the foregoing obligations under the registration rights agreement, the Company will be required to pay liquidated damages in cash to each investor, at the rate of 1% of the applicable subscription amount for each 30 day period in which the Company is not in compliance; provided, that such liquidated damages will be capped at 10% of the subscription amount of each investor and will not apply to any registrable securities that may be sold pursuant to Rule 144 under the Securities Act if all of the conditions in Rule 144(i)(2) are satisfied at the time of the proposed sale, or are subject to an SEC comment with respect to Rule 415 promulgated under the Securities Act. At December 31, 2010, all of the Series A convertible preferred stock has been converted into the Company’s common stock. The Company did not incur any liquidated damages in 2010.
In connection with the Series B private placement, the Company entered into a registration rights agreement with the Series B Investors, in which the Company agreed to file a registration statement with the SEC to register for resale the common stock issuable upon the conversion of the Series B convertible preferred stock, common stock underlying the Series C and Series D warrants, and common stock underlying the placement agent warrants, within 30 calendar days following the later of (i) the closing date of the offering or (ii) the effective date of the prior registration statement for resale the Issued Common Stock and common stock issuable upon the conversion of the Series A preferred stock, Series A and Series B warrants, and placement agent warrants issued in the Series A private placement (the “Prior Registration Statement”), and to have the registration statement declared effective within 150 calendar days ( or 180 calendar days of the Closing Date in the event of a full review of the registration statement by the SEC) following the later to occur of (i) the closing date of the Series B private placement or (ii) the effective date of the Prior Registration Statement. If the Company does not comply with the foregoing obligations under the registration rights agreement, the Company will be required to pay cash liquidated damages to each Series B Investor, at the rate of 1% of the applicable subscription amount for each 30 day period in which the Company is not in compliance; provided, that such liquidated damages will be capped at 10% of the subscription amount of each investor and will not apply to any registrable securities that may be sold pursuant to Rule 144 under the Securities Act if all of the conditions in Rule 144(i)(2) are satisfied at the time of the proposed sale, or are subject to an SEC comment with respect to Rule 415 promulgated under the Securities Act.
Liquidated damages are also payable in the event that the registration statement is not maintained continuously effective for approximately 180 days, or if trading of the Company’s common stock is suspended or if the Company’s common stock is delisted from the principal exchange on which it is traded for more than three days.
As the required Registration Statements were declared effective in the specified time frame, management determined that a liability for liquidated damages had not been incurred as of December 31, 2010. On April 1, 2011, trading of the Company’s common stock was suspended. In addition, management determined that, as of April 15, 2011, the Registration Statements were no longer effective. Accordingly, in the quarter ended June 30, 2011, the period in which it became probable that the Company will be required to remit liquidated damages to the Investors, an estimated contingent liability for $1,300,730 was accrued with a corresponding charge to earnings, as per the guidance in ASC 825-20, “Registration Payment Arrangements”.
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16 SHARE-BASED PAYMENTS
(a) Employee stock option grants
Effective June 30, 2010, the Board of Directors approved the Company’s 2010 Equity Incentive Plan (the “Plan”). The maximum number of shares of common stock of the Company issuable pursuant to the Plan is 6,000,000 shares. The Plan shall be administered by the Board; provided however, that the Board may delegate such administration to the Committee.
Subject to the provisions of the Plan, the Board and/or the Committee shall have authority to determine the type or types of awards to be granted to each participant under the Plan. The exercise price per share of each option shall be determined by the Board or the Committee; provided, however, that such exercise price per share under any incentive stock option shall not be less than 100% of the fair market value of a share on the date of grant of such incentive stock option. The term of each option shall be fixed by the Board or the Committee, provided that no incentive stock option shall have a term greater than 10 years.
On June 30, 2010, the Company granted a total of 3,000,000 stock options to certain senior management employees with a contractual term of 5 years. The exercise price of these stock options is $4.20 per share and the grant-date fair value of these stock options amounted to $3,347,298. A total of 2,810,000 stocks options vest over three years as follow: 30% shall vest and become exercisable one year after grant date, 40% shall vest and become exercisable two years after grant date, and 30% shall vest and become exercisable three years after grant date. For the remaining 190,000 stock options: 40% shall vest and become exercisable one year after the grant date and 60% shall vest and become exercisable two years after the grant date. The related expense was $286,986 for the three months ended June 30, 2010.
On July 1, 2010, the Company granted a total of 80,000 stock options to two independent directors with contractual terms of 5 years. The exercise price of these stock options is $4.20 per share and the grant-date fair value of these stock options amounted to $91,348. A total of 40,000 of the options shall vest and become exercisable one year after the grant date and the remaining 40,000 of the stock options shall vest and become exercisable two years after the grant date, provided that the independent directors are re-elected for successive one year terms one year after the stock options issuance date. The related expense was $11,422 for the three months ended June 30, 2010.
On August 4, 2010, the Company granted 700,000 stock options to employees with a contractual term of 5 years. The exercise price of these stock options was $4.50 per share and the grant-date fair value of these stock options amounted to $1,338,761. These stock options vest over three years as follows: 30% shall vest and become exercisable one year after the grant date, 40% shall vest and become exercisable two years after the grant date and 30% shall vest and become exercisable three years after the grant date.
On December 29, 2010, 600,000 stock options granted to certain employees on August 4, 2010, were cancelled. As compensation for such cancellation, the Company committed to pay these employees incremental cash payments during the period through August 2013. The fair value of the committed cash payment on December 29, 2010 was approximately $400,000 and no incremental compensation costs resulted from the cancellation of these stock options. The related expense for the remaining outstanding options as well as cancellation was $111,520 for the three months ended June 30, 2010.
No options were granted during the three and six months ended June 30, 2011.
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For the three months ended June 30, 2011 and 2010, share-based compensation expenses related to employee stock options charged to general and administrative expenses in the consolidated statements of operations were $409,928 and nil, respectively. For the six months ended June 30, 2011 and 2010, share-based compensation expenses related to employee stock options charged to general and administrative expenses in the consolidated statements of operations were $816,528 and nil, respectively.
As of June 30, 2010, unrecognized compensation cost related to employee stock options was approximately $2,386,382. These costs are expected to be recognized on a straight-line basis over the remaining weighted average service period of 1.94 years.
(b) Non-employee stock option grants
On April 19, 2010, the Company issued 88,000 shares of common stock to Hayden Communications International, for the investor related services they will provide for a 12-month period. The related expense was approximately US$52,000 and $103,285 for the three and six months ended June 30, 2011, respectively.
On July 1, 2010, the Company granted 40,000 stock options to an external HR consultant with a contractual term of 5 years in exchange for its services completed prior to the grant date. The exercise price of these stock options is $4.20 per share and the grant-date fair value is $45,675. These stock options vested and became exercisable immediately on the grant date.
On July 27, 2010, the Company granted 420,000 stock options to a consultant. The options expire on April 21, 2013. The exercise price of these stock options is $4.20 per share. A total of 70,000 of the stock options vested and became exercisable immediately on the grant date, 31,818 vested monthly from September 1, 2010 through April 1, 2011, and the remaining balance of 95,456 vested on May 1, 2011. Management considers that the vesting dates are concurrent with the respective service completion dates. The grant date fair value of the options was $520,441 and related compensation expense was $151,392 and $297,882 for the three and six months ended June 30, 2011, respectively.
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16 SHARE-BASED PAYMENTS (CONTINUED)
For the three months ended June 30, 2011, share-based compensation expenses related to non-employee stocks and stock options recorded in general and administrative expenses in the consolidated statements of operations were $51,643 and $155,188, respectively. For the six months ended June 30, 2011, share-based compensation expenses related to non-employee stocks and stock options recorded in general and administrative expenses in the consolidated statements of operations were $170,775 and $297,882, respectively. For the three and six months ended June 30, 2010, share-based compensation expenses related to non-employee stocks and stock options were nil.
As of June 30, 2011, unrecognized compensation costs related to service providers stocks and stock options were approximately nil and $34,288, respectively. The remaining costs related to stock options are expected to be recognized over a remaining service period of 2.0 years.
17 SUBSIDY INCOME
In April and June a total of approximately $3.1 million of subsidy income was received from the local government. Subsidy income is recognized when it is received. The local government has agreed to pay a subsidy equal to 40% of income tax paid in 2010 and 2011, and 20% of income tax to be paid in 2012, 2013 and 2014 as subsidy income. Subsidy income is subject to income tax.
18 INCOME TAXES
The Company and its subsidiaries file separate income tax returns.
The United States of America
The Company is incorporated in the State of Nevada in the U.S., and is subject to the U.S. federal corporate income tax at progressive rates ranging from 15% to 35%. The state of Nevada does not impose any state corporate income tax. The Company is also liable to state taxes in North Carolina due to the existence of its U.S. office in North Carolina.
British Virgin Islands
Keyuan International is incorporated in the British Virgin Islands (“BVI”). Under the current laws of British Virgin Islands, Keyuan International is not subject to tax on income or capital gains. In addition, upon payments of dividends by Keyuan International, no BVI withholding tax is imposed.
Hong Kong
Keyuan HK is incorporated in Hong Kong. Keyuan HK did not earn any income that was derived in Hong Kong for the six months ended June 30, 2011 and 2010 and therefore was not subject to Hong Kong Profits Tax. The payments of dividends by Hong Kong companies are not subject to any Hong Kong withholding tax.
PRC
Ningbo Keyuan and Ningbo Keyuan Petrochemicals are both incorporated in the PRC and the applicable PRC statutory income tax rate for both companies is 25%.
Components of income (loss) before income tax expense arose in the following jurisdictions:
Three months ended June 30, | Six months ended June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
PRC | $ | 3,309,794 | $ | 6,016,251 | $ | 11,939,586 | $ | 12,766,308 | ||||||||
U.S. | (3,765,742 | ) | (211,807 | ) | (4,704,077 | ) | (211,807 | ) | ||||||||
Hong Kong and BVI | (700,763 | ) | (101,718 | ) | (925,926 | ) | (109,103 | ) | ||||||||
(Loss) income before income taxes | $ | (1,156,711 | ) | $ | 5,702,726 | $ | 6,309,583 | $ | 12,445,398 |
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The Group’s income tax expense in the consolidated statements of operations consists of the following:
PRC: | Three months ended June 30, | Six months ended June 30, | ||||||||||||||
2011 | 2010 | 2011 | 2011 | |||||||||||||
Current income tax expense | $ | 665,828 | $ | - | $ | 2,917,979 | $ | - | ||||||||
Deferred income tax expense (benefit) | - | 1,504,063 | - | 3,191,577 | ||||||||||||
Total income tax expense (benefit) | $ | 665,828 | $ | 1,504,063 | $ | 2,917,979 | $ | 3,191,577 | ||||||||
18 INCOME TAXES (CONTINUED)
Reconciliation between income tax expense (benefit) and the amounts computed by applying the PRC statutory income tax rate of 25% to income (loss) before income taxes is as follows:
Three months ended June 30, | Six months ended June 30, | |||||||||||||||||||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||||||||||||||||||
(Loss) income before income taxes | $ | (1,156,711 | ) | $ | 5,702,726 | $ | 6,309,583 | $ | 12,445,398 | |||||||||||||||||||||||
Computed income tax (benefit) expense | (289,178 | ) | 25.0 | % | 1,425,681 | 25.0 | % | 1,577,396 | 25.0 | % | 3,111,350 | 25.0 | % | |||||||||||||||||||
NOLs from overseas subsidiaries not recognized | 1,433,636 | (123.9 | %) | 72,292 | 1.3 | % | 1,799,204 | 28.5 | % | 74,138 | 0.6 | % | ||||||||||||||||||||
Others | (478,630 | ) | 41.4 | % | 6,090 | 0.1 | % | (458,622 | ) | (7.3 | %) | 6,089 | 0.0 | % | ||||||||||||||||||
Actual income tax expense | $ | 665,828 | (57.6 | %) | $ | 1,504,063 | 26.4 | % | $ | 2,917,978 | 46.2 | % | $ | 3,191,577 | 25.6 | % |
The PRC income tax rate has been used because the majority of the Group’s consolidated income (loss) before income taxes arises in the PRC.
According to the prevailing PRC income tax law and its relevant regulations, non-PRC-resident enterprises are levied withholding tax at 10%, unless reduced by tax treaties or similar arrangements, on dividends from their PRC-resident investees for earnings accumulated beginning on January 1, 2008, and undistributed earnings generated prior to January 1, 2008 are exempt from such withholding tax. Further, the Company’s distributions from its PRC subsidiaries are subject to the U.S. federal income tax at 35%, less any applicable qualified foreign tax credits. Due to the Company’s policy of permanently reinvesting substantially all of its earnings in its PRC business, the Company has not provided for deferred income tax liabilities for U.S. federal income tax purposes on its PRC subsidiaries’ undistributed earnings of $33.9 million and $26.3 million as of June 30, 2011 and December 31, 2010, respectively.
The Group mainly files income tax returns in the United States and the PRC. The Company is subject to U.S. federal income tax examination by tax authorities for tax years beginning in 2004. According to the PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational errors made by the taxpayer or the withholding agent. The statute of limitations is extended to five years under special circumstances where the underpayment of taxes is more than RMB100,000 ($15,000). In the case of transfer pricing issues, the statute of limitation is ten years. There is no statute of limitation in the case of tax evasion. The PRC tax returns for the Company’s PRC subsidiaries are open to examination by the PRC state and local tax authorities for the tax years beginning in 2008.
19 CONTINGENCY
In connection with the shipping of finished products, inaccurate product information was provided to the PRC Port authority. In consultation with PRC legal counsel, management has evaluated the contingencies associated with the provision of inaccurate information and expects that the penalty, if any, will not be significant and will not have a material impact on the consolidated financial statements.
Ningbo Keyuan failed to withhold income tax of approximately $50,000 from payments to certain external service providers and employees. Ningbo Keyuan has asked these external service providers and employees to pay the related income tax to the tax bureau. However at this time it is uncertain if such payments will be made. If such payments are not made, in accordance with PRC income tax law, Ningbo Keyuan may be subject to fines ranging from 50% to three times of the amount of tax that Ningbo Keyuan failed to withhold. Management expects that the resolution of this matter will not have a material impact on the Group’s consolidated financial statements.
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20 EARNINGS (LOSS) PER SHARE
Earnings per share for the period of the Share Exchange have been restated to reflect the recapitalization under the Share Exchange. The following table sets forth the computation of basic net income (loss) per share:
For the three months ended | For the six months ended | |||||||||||||||
June 30 | June 30 | June 30 | June 30 | |||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net (loss) income attribute to Keyuan | ||||||||||||||||
Petrochemicals, Inc. stockholders | $ | (1,822,539 | ) | $ | 4,198,663 | $ | 3,391,604 | $ | 9,253,821 | |||||||
Less: Dividend attributable to preferred | ||||||||||||||||
stockholders | 306,247 | 288,497 | 602,507 | 288,497 | ||||||||||||
Net (loss) income attributable to Keyuan Petrochemical Inc. common shareholders | $ | (2,128,786 | ) | $ | 3,910,166 | $ | 2,789,097 | $ | 8,965,324 | |||||||
Weighted average common shares | ||||||||||||||||
(Denominator for basic income per share) | 57,579,239 | 50,045,451 | 57,578,896 | 48,858,321 | ||||||||||||
Effect of diluted securities: | ||||||||||||||||
- Series A convertible preferred stock | - | 4,885,209 | - | 2,456,099 | ||||||||||||
- Series B convertible preferred stock | - | 5,400,010 | ||||||||||||||
- Series M convertible preferred stock | - | - | ||||||||||||||
- Warrants | 390,647 | |||||||||||||||
- Options | - | - | 467,429 | - | ||||||||||||
Weighted average common shares | ||||||||||||||||
(denominator for diluted income per share) | 57,579,239 | 54,930,660 | 63,836,982 | 51,314,420 | ||||||||||||
Basic net (loss) income per share | $ | (0.04 | ) | $ | 0.08 | $ | 0.05 | $ | 0.18 | |||||||
Diluted net (loss) income per share | $ | (0.04 | ) | $ | 0.08 | $ | 0.05 | $ | 0.18 |
21 FAIR VALUE MEASUREMENTS
The Company did not have any assets and liabilities that are measured at fair value on a recurring basis as of June 30, 2011 and 2010.
The fair values of cash, pledged bank deposits, bills receivable, consumption tax refund receivable, short-term bank borrowings, bills payable, current portion of long-term borrowings, and accounts payable approximate their respective carrying amounts due to their short-term nature. Amounts due to related parties are not practicable to estimate due to the related party nature of the underlying transactions. The Group’s long-term debt, secured by various assets, bears interest at rates commensurate with market rates and therefore management believes carrying values approximate fair values.
22 SIGNIFICANT CONCENTRATIONS AND RISKS
As of June 30, 2011 and December 31, 2010, the Group held cash and pledged bank deposits in financial institutions of approximately $158,473,795 and $127,260,081, respectively. They were primarily held in major financial institutions located in mainland China and the Hong Kong Special Administrative Region, which management believes have high credit ratings.
Sales to major customers, which individually exceeded 5% of the Group’s total net revenues, are as follows:
For three months ended June 30, 2011 | For three months ended June 30, 2010 | ||||||||||||||||
Largest | Amount of | % Total | Largest | Amount of | % Total | ||||||||||||
Customers | Sales | Sales | Customers | Sales | Sales | ||||||||||||
Customer A | $ | 35,607,254 | 24 | % | Customer A | $ | 22,427,477 | 17 | % | ||||||||
Customer B | 14,540,619 | 10 | % | Customer G | 15,945,016 | 12 | % | ||||||||||
Customer C | 14,278,678 | 10 | % | Customer H | 10,370,906 | 8 | % | ||||||||||
Customer D | 13,517,410 | 9 | % | Customer I | 8,654,805 | 7 | % | ||||||||||
Customer E | 6,314,579 | 4 | % | Customer J | 7,392,662 | 6 | % | ||||||||||
Total | $ | 84,258,540 | 57 | % | Total | $ | 64,790,866 | 49 | % | ||||||||
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For six months ended June 30, 2011 | For six months ended June 30, 2010 | ||||||||||||||||
Largest | Amount of | % Total | Largest | Amount of | % Total | ||||||||||||
Customers | Sales | Sales | Customers | Sales | Sales | ||||||||||||
Customer A | $ | 58,150,912 | 20 | % | Customer A | $ | 43,228,614 | 17 | % | ||||||||
Customer D | 42,284,552 | 14 | % | Customer G | 31,465,335 | 13 | % | ||||||||||
Customer B | 28,430,114 | 10 | % | Customer I | 20,274,680 | 10 | % | ||||||||||
Customer C | 14,278,678 | 5 | % | Customer B | 11,598,392 | 7 | % | ||||||||||
Customer F | 13,176,798 | 4 | % | Customer H | 10,370,907 | 5 | % | ||||||||||
Total | $ | 156,321,054 | 53 | % | Total | $ | 116,937,928 | 47 | % |
The Group currently buys a majority of its heavy oil, an important component of its products, from three suppliers. Although there are a limited number of suppliers of the particular heavy oil used in production, management believes that other suppliers could provide similar heavy oil on comparable terms. A change in suppliers, however, could cause a delay in manufacturing and a possible loss of sales, which would affect operating results adversely. Purchases (net of VAT) from the largest three suppliers for the three months ended June 30, 2011 and 2010 were $153,035,430 and $58,127,240, respectively. These purchases represented 83% and 73% respectively of all of the Company’s purchases for three months end June 30, 2011 and 2010. Purchases (net of VAT) from the largest three suppliers for the six months ended June 30, 2011 and 2010 were $231,995,919 and $130,508,430 respectively. These purchases represented 80% and 64%, respectively, of all of the Group’s purchases for the six months end June 30, 2011 and 2010. The Company’s largest supplier accounted for approximately $124.7 million and $23.1 million, or 68% and 29% of total purchases for the three months ended June 2011 and 2010, and $190.1 million and $56.3 million, or 65% and 28% of total purchases for the six months ended June 2011 and 2010.
The Group’s operations are carried out in the PRC. Accordingly, the Group’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC as well as by the general state of the PRC’s economy. The business may be influenced by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.
23 RELATED PARTY TRANSACTIONS AND RELATIONSHIPS AND TRANSACTIONS WITH CERTAIN OTHER PARTIES
(1) Related Party Transactions
The Company considers all transactions with the following parties to be related party transactions.
Name of parties | Relationship | |
Mr. Chunfeng Tao | Majority stockholder | |
Mr. Jicun Wang | Principal stockholder | |
Mr. Peijun Chen | Principal stockholder | |
Ms. Sumei Chen | Member of the Company’s Board of Supervisors and spouse of Mr. Wang | |
Ms. Yushui Huang | Vice President of Administration, Ningbo Keyuan | |
Mr. Weifeng Xue | Vice President of Accounting, Ningbo Keyuan through August 2011 | |
Mr. Hengfeng Shou | Vice President of Sales, Ningbo Keyuan | |
Petrochemical | ||
Ningbo Kewei Investment Co., Ltd. | A company controlled by Mr. Tao | |
(Ningbo Kewei) | ||
Ningbo Pacific Ocean Shipping Co., Ltd | 100% ownership by Mr. Wang | |
(Ningbo Pacific) | ||
Ningbo Hengfa Metal Product Co., Ltd | 100% ownership by Mr. Chen | |
(Ningbo Hengfa, former name "Ningbo Tenglong") | ||
Shandong Tengda Stainless Steel Co., Ltd | 100% ownership by Mr. Chen | |
(Shandong Tengda) | ||
Ningbo Xinhe Logistic Co., Ltd | ||
(Ningbo Xinhe) | 10% ownership by Ms. Huang | |
Ningbo Kunde Petrochemical Co, Ltd. | Mr. Tao’s mother was a 65% nominee shareholder | |
(Ningbo Kunde) | for Mr. Hu, a third party through September 2011 | |
Ningbo Jiangdong Jihe Construction Materials | Controlled by Mr. Xue’s Brother-in-law | |
Store (Jiangdong Jihe) | ||
Ningbo Wanze Chemical Co., Ltd | Mr. Tao’s sister-in-law is the legal representative | |
(Ningbo Wanze) | ||
Ningbo Zhenhai Jinchi Petroleum Chemical | Controlled by Mr. Shou | |
Co., Ltd (Zhenhai Jinchi) | ||
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Related party transactions and amounts outstanding with related parties as of and for the three and six months ended June 30, 2011 and 2010 are summarized as follows:
Three Months ended June 30, | Six Months ended June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Sales of products (a) | $ | 35,607,658 | $ | 26,369,453 | $ | 58,217,477 | $ | 47,186,862 | ||||||||
Purchase of raw material (b) | $ | 42,920 | $ | - | $ | 7,066,055 | $ | 5,734,319 | ||||||||
Purchase of transportation services (c) | $ | 316,506 | $ | 1,593,080 | $ | 927,879 | $ | 3,044,389 | ||||||||
Credit line of guarantee provision for bank borrowings (d) | $ | - | $ | 4,400,700 | $ | - | $ | 124,686,500 | ||||||||
Loan guarantee fees (d) | $ | 419,665 | $ | - | $ | 756,919 | $ | - | ||||||||
Short-term financing from related parties (e) | $ | 5,406,139 | $ | 2,934,200 | $ | 13,144,234 | $ | 4,400,700 | ||||||||
Short-term financing to related parties (e) | $ | 5,535,234 | $ | 2,934,200 | $ | 13,144,234 | $ | 4,400,700 |
June 30, | December 31, | |||||||
2011 | 2010 | |||||||
Amounts due from related parties (f) | $ | 38,675 | $ | 5,332,193 | ||||
Amounts due to related parties (g) | $ | 3,104,306 | $ | 115,535 | ||||
(a) During the three months ended June 30, 2011 and 2010, the Group sold finished products of $35,607,658 and $22,427,477 to Ningbo Kunde, and nil and $3,941,976 to Zhenhai Jinchi, respectively. During the six months ended June 30, 2011 and 2010, the Group sold finished products of $58,150,912 and $43,228,614 to Ningbo Kunde, and $66,565 and $3,958,248 to Zhenhai Jinchi, respectively. Amounts received in advance from Kunde as of June 30, 2011 were $3,077,199.
(b) The Group purchased raw materials of $42,920 and nil from Ningbo Kunde during the three months ended June 30, 2011 and 2010, respectively. The Group purchased raw materials of nil and $4,427,831 from Ningbo Kewei during the six months ended June 30, 2011 and 2010 with no outstanding amount payable to Ningbo Kewei at June 30, 2011 in respect of these purchase transactions. The Group purchased raw materials of $7,066,055 and $1,306,488 from Ningbo Kunde during the six months ended June 30, 2011 and 2010, respectively.
(c) The Group purchased transportation services of $316,506 and $1,593,080 from Ningbo Xinhe during the three months ended June 30, 2011 and 2010, respectively. The Group purchased transportation services of $927,879 and $3,044,389 from Ningbo Xinhe during the six months ended June 30, 2011 and 2010, respectively, and amounts owed to Ningbo Xinhe as of June 30, 2011 in respect of these purchase transactions were $27,107.
(d) Guarantees for Bank Loans
Guarantee provided during | Guarantee provided during | |||||||||||||||
the three months ended June 30 | the six months ended June 30 | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Mr. Tao | $ | - | $ | - | $ | - | $ | 79,212,600 | ||||||||
Ningbo Kewei | - | - | - | 41,073,200 | ||||||||||||
Ningbo Pacific | - | 4,400,700 | - | 4,400,700 |
Guaranteed Bank Loans | ||||
as of June 30 | ||||
2011 | ||||
Mr. Tao | $ | 46,410,000 | ||
Jicun Wang and Chen | $ | 9,783,053 | ||
Ningbo Kewei | $ | 3,867,500 | ||
Ningbo Pacific | $ | 14,523,979 | ||
Ningbo Hengfa | $ | 23,823,800 | ||
Shangdong Tengda | $ | 928,200 | ||
Beginning in 2011, loan guarantee fees of 0.3% of the loan principal guaranteed are to be paid quarterly. In the three months ended June 30, 2011, loan guarantee fees were $73,644, $178,367 and $167,654 for Ningbo Hengfa, Ningbo Pacific and Ningbo Kewei, respectively. In the six months ended June 30. 2011, loan guarantee fees were $150,116, $301,247 and $305,556 for Ningbo Hengfa, Ningbo Pacific and Ningbo Kewei, respectively.
-17-
(e) Short-term financing transactions with related parties
Three Months Ended June 30 | ||||||||||||||||||||||||
2011 | 2010 | |||||||||||||||||||||||
From(i) | To(i) | Balance(ii) | From(i) | To(i) | Balance(ii) | |||||||||||||||||||
Ningbo Kewei | $ | 5,358,850 | $ | (5,358,850 | ) | $ | - | $ | 400 | $ | (400 | ) | $ | - | ||||||||||
Ningbo Kunde | 32,550 | (32,550 | ) | - | 2,933,800 | (2,933,800 | ) | - | ||||||||||||||||
Jiangdong Jihe | 14,739 | 143,834 | - | - | - | - | ||||||||||||||||||
$ | 5,406,139 | $ | (5,247,566 | ) | $ | - | $ | 2,934,200 | $ | (2,934,200 | ) | $ | - | |||||||||||
Six Months Ended June 30 | ||||||||||||||||||||||||
2011 | 2010 | |||||||||||||||||||||||
From(i) | To(i) | Balance(ii) | From(i) | To(i) | Balance(ii) | |||||||||||||||||||
Ningbo Kewei | $ | 5,358,850 | $ | (5,358,850 | ) | $ | - | $ | 1,466,900 | $ | (1,466,900 | ) | $ | - | ||||||||||
Ningbo Kunde | 5,358,850 | (5,358,850 | ) | - | 2,933,800 | (2,933,800 | ) | - | ||||||||||||||||
Jiangdong Jihe | 2,426,534 | (2,426,534 | ) | - | - | - | - | |||||||||||||||||
$ | 13,144,234 | $ | (13,144,234 | ) | $ | - | $ | 4,400,700 | $ | (4,400,700 | ) | $ | - | |||||||||||
(i) Transactions during the year are translated at average exchange rates.
(ii) Balances at year end are translated at the balance sheet exchange rate.
(f) Amounts due from related parties consist of the following:
June 30, | December 31, | |||||||
Related Party | 2011 | 2010 | ||||||
Ningbo Kunde | $ | - | $ | 5,181,809 | ||||
Jiangdong Jihe | - | 112,459 | ||||||
Mr. Tao | 38,675 | 37,925 | ||||||
$ | 38,675 | $ | 5,332,193 | |||||
Amounts due from Mr. Tao represent advances made for business expenses which are unsecured, interest free and due on demand.
(g) Amounts due to related parties consist of the following:
June 30, | December 31, | |||||||
Related Party | 2011 | 2010 | ||||||
Ningbo Kunde | $ | 3,077,199 | $ | - | ||||
Ningbo Jinchi | - | 115,416 | ||||||
Ninbo Xinhe | 27,107 | 119 | ||||||
$ | 3,104,306 | $ | 115,535 | |||||
Amounts due to related parties represent balances due for raw materials purchase and freight.
(2) Relationships and transactions with certain other parties
The Group has the following relationships and transactions with certain other parties:
Name of parties | Relationship | |
Ningbo Litong Petrochemical Co., Ltd | Former 12.75% nominee shareholder of Ningbo | |
(Ningbo Litong) | Keyuan | |
Ningbo Jiangdong Haikai Construction | Controlled by cousin of Mr. Weifeng Xue, Vice | |
Materials Store (Jiangdong Haikai) | President of Accounting through August 2011 | |
Ningbo Jiangdong Deze Chemical Co., Ltd | Controlled by cousin of Mr. Weifeng Xue, Vice | |
(Jiangdong Deze) | President of Accounting through August 2011 | |
Ningbo Anqi Petrochemical Co., Ltd | Controlled by cousin of Mr. Weifeng Xue, Vice | |
(Ningbo Anqi) | President of Accounting through August 2011 | |
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Transactions and amounts outstanding with these parties for the three and six months ended June 30, 2011and 2010, are summarized as follows:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Sales of products (h) | $ | - | $ | 1,257,446 | $ | 772,762 | $ | 6,487,029 | ||||||||
Purchase of raw material (i) | $ | 9,536,282 | $ | 1,671,025 | $ | 9,536,282 | $ | 12,089,432 | ||||||||
Credit line of guarantee for bank borrowings (j) | $ | - | $ | - | $ | - | $ | - | ||||||||
Loan guarantee fees (j) | $ | 302,674 | $ | - | $ | 505,626 | $ | - | ||||||||
Short-term financing from theses parties (k) | $ | 12,862,621 | $ | 17,231,971 | $ | 47,612,617 | $ | 17,227,272 | ||||||||
Short-term financing to these parties (k) | $ | (7,142,275 | ) | $ | (17,231,971 | ) | $ | (45,374,149 | ) | $ | (17,227,272 | ) | ||||
Amounts due from these parties | $ | - | $ | 2,144,247 | $ | - | $ | 2,144,247 | ||||||||
Amounts due to these parties | $ | 17,851 | $ | 1,489,203 | $ | 17,851 | $ | 1,489,203 |
(h) The Group sold finished products to Ningbo Litong for $1,257,446 in the three months ended June 30, 2010. The Group sold finished products of $772,762 to Ningbo Litong for the six months ended June 30, 2011. Sales to Ningbo Litong were $6,487,029 for six months ended June 30, 2010. Amounts received in advance from Litong were $17,851 as of June 30, 2011, and are included in advances from customers on the consolidated balance sheet.
(i) The Group purchased raw materials of $9,536,282 from Ningbo Litong during the three months ended June 30, 2011. During the three months ended June 30, 2010, the Group purchased raw materials of $1,671,025 from Ningbo Litong.
The Group purchased raw materials of $9,536,282 from Ningbo Litong during the six months ended June 30, 2011. During the six months ended June 30, 2010, the Group purchased raw materials of $12,089,432 from Ningbo Litong.
(j) Guarantees for Bank Loans
Guaranteed Bank Loans | ||||||||
as of June 30 | ||||||||
2011 | 2010 | |||||||
Ningbo Litong | $ | 44,863,000 | $ | - |
No new guarantees were obtained from these parties during the three and six months ended June 30, 2011. Guarantee fees paid to Litong were $302,674 and $505,626 for the three and six months ended June 30, 2011, respectively.
(k) Short-term financing transactions
Historically the Group and these parties have provided each other with short-term financing, typically, in the form of cash, bills receivable and bills payable.
In connection with the Group’s financing transactions, the Group has obtained bills receivable in exchange for cash or other payables. These bills are sold for cash at a discount prior to maturity. At maturity, the counter parties honor their obligations under the bills by paying the bill amount to the accepting bank, at which time, or shortly thereafter, the Group repays the counter parties. Short-term financing obtained and repayments made under these agreements were as follows for the three and six months ended June 30, 2011 and 2010.
Three Months Ended June 30 | ||||||||||||||||||||||||
2011 | 2010 | |||||||||||||||||||||||
From(i) | To(i) | Balance(ii) | From(i) | To(i) | Balance(ii) | |||||||||||||||||||
Ningbo Litong | $ | 12,862,621 | $ | (7,142,275 | ) | $ | - | $ | 17,231,971 | $ | (17,231,971 | ) | $ | - | ||||||||||
Jiangdong Deze | - | - | - | - | - | - | ||||||||||||||||||
Ningbo Anqi | - | - | - | - | - | - | ||||||||||||||||||
$ | 12,862,621 | $ | (7,142,275 | ) | $ | - | $ | 17,231,971 | $ | (17,231,971 | ) | $ | - | |||||||||||
Six Months Ended June 30 | ||||||||||||||||||||||||
2011 | 2010 | |||||||||||||||||||||||
From(i) | To(i) | Balance(ii) | From(i) | To(i) | Balance(ii) | |||||||||||||||||||
Ningbo Litong | $ | 38,142,763 | $ | (35,904,295 | ) | $ | - | $ | 17,227,272 | $ | (17,227,272 | ) | $ | - | ||||||||||
Jiangdong Deze | 2,602,870 | (2,602,870 | ) | - | - | - | - | |||||||||||||||||
Ningbo Anqi | 6,866,984 | (6,866,984 | ) | - | - | - | - | |||||||||||||||||
$ | 47,612,617 | $ | (45,374,149 | ) | $ | - | $ | 17,227,272 | $ | (17,227,272 | ) | $ | - | |||||||||||
(i) Transactions during the year are translated at average exchange rates.
(ii) Balances at year end are translated at the balance sheet exchange rate.
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and result of operations contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those described in the "Risk Factors" section of the other reports we file with the Securities and Exchange Commission. Actual results may differ materially from those contained in any forward-looking statements.
The following discussion and analysis of financial condition and results of operations relates to the operations and financial condition reported in the financial statements of Keyuan for the six months ended June 30, 2011 and 2010 and should be read in conjunction with such financial statements and related notes included in this report and the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.
Overview
Operating through our wholly-owned subsidiaries, Ningbo Keyuan and Ningbo Keyuan Petrochemicals, our operations include (i) a production facility with an annual petrochemical production capacity of 550,000 metric tons (MT) of a variety of petrochemical products (such capacity was expanded to 720,000 MT in April 2011), (ii) facilities for the storage and loading of raw materials and finished goods and (iii) a manufacturing technology that can support our manufacturing process with relatively low raw material costs and high utilization and yields, all of which are led by a management team consisting of petrochemical experts with proven track records from some of China’s largest state-owned enterprises in the petrochemical industry.
Our Facility and Equipment
Facility
As of June 30, 2011, we have invested a total of approximately $163 million in the construction and improvement of our production facility. Our current production facility encompasses roughly 1.3 million square feet, including 594,000 square feet for production and 19,500 square feet for laboratories and offices. We also acquired additional 1.2 million square feet of land in August 2010 for our future expansion.
We have a total of 100,000 MT of storage capacity, consisting of 50,000 MT of storage capacity for raw materials and 50,000 MT for finished products. As part of our expansion plan, we intend to add 180,000 MT of new storage capacity in 2011, after which our total storage capacity will be 280,000 MT.
We have an on-site ocean shipping dock with 5,000 MT of shipping capacity and a 10-truck loading facility. Approximately 90% of our feedstock and finished products use this shipping dock. We also have adjacent access to another shipping dock with an additional 50,000 MT of shipping capacity.
Equipment
Our major processing equipment includes the following:
● Heavy oil catalytic pyrolysis processing equipment- risers/generators/precipitators, fuel gas boilers, fractionating tower, absorbing re-absorbing and desorbing towers, heat exchangers, pumps, a stabilizing tower; |
● Gas fractionation processing equipment- de-propanizing tower, refining propylene tower, de-ethanizination tower, heat exchangers, pumps; |
● Ethylbenzene processing equipment- alkylation reactor, anti-alkylation reactor, dehydrogenation reactor, propylene absorbing tower, de-ethylene tower, ethylbenzene recovering tower, heating furnace for benzene, heating furnace for gas, steam overheating furnace, tail gas compressor, washing tower; and |
● Liquefied petroleum gas (LPG) and sulfur recovery process- LPG desulfurization extraction tower, dry gas desulfurization tower, regenerating tower, LPG de-mecaptan extraction tower. |
-20-
Our Products
We manufacture and supply a variety of petrochemical products, including BTX aromatics, propylene, styrene, LPG, MTBE and other petrochemicals.
● BTX Aromatics: consisting of benzene, toluene, xylene and other chemical components for further processing into plastics, gasoline and solvents materials widely used in paint, ink, construction coating and pesticide. |
● Propylene: a chemical intermediate as one of the building blocks for an array of chemical and plastic products that are commonly used to produce polypropylene, acrylonitrile, oxo alcohols, propylene oxide, cumene, isopropyl alcohol, acrylic acid and other chemicals for paints, household detergents, automotive brake fluids, indoor/outdoor carpeting, textile, insulating materials, auto parts and electrical appliances. |
● Styrene: a precursor to polystyrene and several copolymers widely used for packaging materials, construction materials, electronic parts, home appliances, household goods, home furnishings, toys, sporting goods and others. |
● LPG: a mixture of hydrocarbon gases used as fuel in heating appliances and vehicles. A replacement for chlorofluorocarbons as an aerosol propellant and a refrigerant which reduces damage to the ozone layer. |
● MTBE & Other Chemicals: MTBE, oil slurry, sulphur and others are used for a variety of applications including fuel components, refrigeration systems, fertilizers, insecticides and fungicides, etc. |
Expansion Plan
In order to meet the increasing market demands, we have completed the expansion of our 550,000 MT production capacity to 720,000 MT in April 2011. We also completed building an SBS production facility with 70,000 MT production capacities in September 2011. We are planning to expand our facility to include additional storage capacity, a raw material pre-treatment facility and an asphalt production facility by the end of 2012.
Our annual designed manufacturing capacity was 550,000 metric tons of a variety of petrochemical products at the end of 2010. We upgraded the catalytic pyrolysis processing equipment used in production facilities to expand the capacity from 550,000 MT to 720,000 MT. This capacity expansion project started in March 2011 and was completed in April 2011.
In September 2011, we completed building a new facility designed for producing SBS, one of the Styreneic Block Copolymers. SBS is a product with higher product margin with major application for footwear, adhesive, polymer modification and modified asphalt industries. The SBS facility was built on part of the 1.2 million square feet of land for which we obtained the use of right in August 2010 The construction started in September, 2010 and was completed according to planned schedule in September 2011. The project is currently in the stage of equipment optimization and alignment. Trial production is expected to start in late October. The designed capacity of the SBS facility would allow for production of up to 70,000 metric tons per year.. We expect to generate net profit margins of 10% from our production of SBS once the facility reaches normal production levels. The SBS facility is anticipated to achieve an 80% utilization rate in 2012, the first full year of production, and generate approximately $107 million in sales and $10 million to $11 million in profit in 2012.
In addition to the SBS production facility, we plan to increase our current 100,000 MT storage capacity to 280,000 MT. Management believes that the increased storage capacity will allow the Company to take better advantage of price variations to raw material and product sales prices, as well as to support the storage needs of the increased overall production capacity after our expansion projects are completed. We also plan to build a pretreatment facility and an asphalt facility on the land we acquired in August 2010. The pretreatment facility will allow us to handle lower grade raw materials thereby helping to further decrease raw material costs. In addition, this facility will improve efficiency in current production process as well as provide the necessary feedstock for our planned asphalt production. Once completed, the new asphalt facility will be capable of producing as much as 300,000 MT annually. We estimate that the new asphalt facility will generate approximately $298 million in sales and approximately $30 million of additional profits a year.
The actual and estimated schedule of our expansion plan is as follows:
l | Completed SBS facility in September 2011 |
l | Begin SBS production and sales in the fourth quarter of 2011 |
l | Complete storage capacity expansion, pretreatment facility and asphalt by December 31, 2012 |
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On August 18, 2010, we acquired four parcels of land adjacent to the Company's current facilities totaling approximately 1.2 million square feet. The total cost of the land was approximately $5.8 million. Aside from the cost of the land acquisition, the estimated cost of the storage expansion and construction of the pretreatment and asphalt facilities is approximately $70 million , including $20 million for facility construction, $40 million for new equipment, and $10 million for working capital.
We plan to fund this proposed expansion through debt financing, cash from operations, proceeds from prior financings, warrant exercises, and potential equity financing. However, we may not be able to obtain additional financing at acceptable terms, or at all, and, as a result, our ability to increase our production capacity and to expand our business could be adversely affected.
Manufacturing and Sales
Our total production of finished products was 152,915 MT for the three months ended June 30, 2011 and we generated $149 million in revenue based on the sale of 135,827 MT of petrochemical products, including 9,795 MT of products produced by third parties. For the first six months of 2011, our total production was 282,058 MT and revenue generated from sales was $296 million, which represented an 18.6% increase from the same period of 2010. Due to our low-cost and flexible manufacturing process, we are able to change the mix of raw materials and quality of products we produce based on market conditions. Management believes that the Company’s technology advantage in using heavy oil as feedstock will sustain and continue to yield attractive margins.
In the second quarter of 2011, we incurred production interruptions, mainly as a result of the expansion of our production capacity. In April 2011, we lost a combined 25 days of production, equating to approximately 54,000 tons of production, approximately $45 million of revenues and $2.4 million in net income.
-22-
Results of Operations
The following table shows the results of operations of our business.
Comparison of the three and six months ended June 30, 2011 and 2010
For the three months | Year to Year Comparison | For the six months | Year to Year Comparison | ||||||||||||||||||||||||||||
Ended June 30, | Increase | Percentage | Ended June 30, | Increase | Percentage | ||||||||||||||||||||||||||
2011 | 2010 | /(Decrease) | change | 2011 | 2010 | /(Decrease) | change | ||||||||||||||||||||||||
Sales | |||||||||||||||||||||||||||||||
Third parties | 115,281,945 | 105,627,764 | 9,654,181 | 9% | 239,436,744 | 202,182,241 | 37,254,503 | 18% | |||||||||||||||||||||||
Related Parties | 35,607,658 | 26,369,453 | 9,238,205 | 35% | 58,217,477 | 47,186,862 | 11,030,615 | 23% | |||||||||||||||||||||||
Total sales | $ | 150,889,603 | $ | 131,997,217 | $ | 18,892,386 | 14% | $ | 297,654,221 | $ | 249,369,103 | $ | 48,285,118 | 19% | |||||||||||||||||
Cost of sales | |||||||||||||||||||||||||||||||
Third parties | 111,055,933 | 98,516,344 | 12,539,589 | 13% | 224,870,131 | 187,429,672 | 37,440,459 | 20% | |||||||||||||||||||||||
Related Parties | 37,977,326 | 24,835,031 | 13,142,295 | 53% | 58,276,685 | 44,478,145 | 13,798,540 | 31% | |||||||||||||||||||||||
Total cost of sales | 149,033,259 | 123,351,375 | 25,681,884 | 21% | 283,146,816 | 231,907,817 | 51,238,999 | 22% | |||||||||||||||||||||||
Gross profit | 1,856,344 | 8,645,842 | (6,789,498) | (79%) | 14,507,405 | 17,461,286 | (2,953,881) | (17%) | |||||||||||||||||||||||
Operating expenses | |||||||||||||||||||||||||||||||
Selling expenses | 215,548 | 258,901 | (43,353) | (17%) | 754,680 | 343,413 | 411,267 | 120% | |||||||||||||||||||||||
General and administrative expenses | 4,529,744 | 1,213,080 | 3,316,664 | 273% | 7,764,824 | 2,018,612 | 5,746,212 | 285% | |||||||||||||||||||||||
Total operating expenses | 4,745,292 | 1,471,981 | 3,273,311 | 222% | 8,519,504 | 2,362,025 | 6,157,479 | 261% | |||||||||||||||||||||||
(Loss) Gain from operations | (2,888,948) | 7,173,861 | (10,062,809) | (140%) | 5,987,901 | 15,099,261 | (9,111,360) | (60%) | |||||||||||||||||||||||
Other income (expenses): | |||||||||||||||||||||||||||||||
Interest expense, net | (1,856,793) | (1,589,937) | (266,856) | 17% | (4,146,479) | (2,663,462) | (1,483,017) | 56% | |||||||||||||||||||||||
Foreign exchange gain (loss), net | 3,200,356 | - | 3,200,356 | - | 2,052,713 | 293,028 | 1,759,685 | 601% | |||||||||||||||||||||||
Liquidated damage expenses | (1,300,730) | - | (1,300,730) | n/a | (1,300,730) | - | (1,300,730) | n/a | |||||||||||||||||||||||
Non-operating income (expenses) | 1,689,404 | 118,802 | 1,570,602 | 1322% | 3,716,178 | (283,429) | 3,999,607 | (1411%) | |||||||||||||||||||||||
Total other Income(expenses) | 1,732,237 | (1,471,135) | 3,203,372 | (218%) | 321,682 | (2,653,863) | 2,975,545 | (112%) | |||||||||||||||||||||||
(Loss) Income before provision for income tax | (1,156,711) | 5,702,726 | (6,859,437) | (120%) | 6,309,583 | 12,445,398 | (6,135,815) | (49%) | |||||||||||||||||||||||
Provision for income tax | 665,828 | 1,504,063 | (838,235) | (56%) | 2,917,979 | 3,191,577 | (273,598) | (9%) | |||||||||||||||||||||||
Net (Loss) Income | (1,822,539) | 4,198,663 | (6,021,202) | (143%) | 3,391,604 | 9,253,821 | (5,862,217) | (63%) | |||||||||||||||||||||||
Other comprehensive income | |||||||||||||||||||||||||||||||
Foreign currency translation adjustment | 617,550 | 192,224 | 425,326 | 221% | 1,174,874 | 193,948 | 980,926 | 506% | |||||||||||||||||||||||
Comprehensive (loss) income | $ | (1,204,989) | $ | 4,390,887 | $ | (5,595,876) | (127%) | $ | 4,566,478 | $ | 9,447,769 | $ | (4,881,291) | (52%) | |||||||||||||||||
Sales: Sales for the three months ended June 30, 2011 were approximately $150.9 million compared to sales of $132.0 million for the three months ended June 30, 2010, an increase of $18.9 million, or 14.3%. The substantial increase in our sales was due to the higher capacity utilization coupled with higher average sales price for our products. In the three months ended June 30, 2011 we sold 155,954 metric tons of chemical products at an average price of $1,087 per metric ton, as compared to sales of 135,826 metric tons of chemical products at an average price of $819 per metric ton in the three months ended June 30, 2010. This represents an increase of approximately 32.7% in average sales price and an increase of approximately 14.8% increase in overall products sold.
Our overall sales for the three months ended June 30, 2011 included approximately $35.6 million of sales to related parties as compared to roughly $26.4 million in the same period in 2010. Pricing for sales to related parties was determined on the same basis as sales to non-related parties. For additional informational on related party sales, please refer to Footnote 23 of the financial statements.
Sales for the six months ended June 30, 2011 were approximately $297.7 million compared to sales of $249.4 million for the six months ended June 30, 2010, an increase of $48.3 million, or 19.4%. The substantial increase in our sales was due to the higher capacity utilization coupled with higher average sales price of our products. In the six months ended June 30, 2011 we sold 284,595 metric tons of chemical products at an average price of $1,039 per metric ton, as compared to sales of 300,701 metric tons of chemical products at an average price of $829 per metric ton in the six months ended June 30, 2010. This represents an increase of approximately 25.3% in average sales price and a decrease of approximately 5.4% in overall chemical products sold.
Our overall sales for the first six months of 2011 included approximately $58.2 million of sales to related parties as compared to approximately $47.1 million in same period in 2010. Pricing for sales to related parties adopts the same principles as that to non-related parties. For additional informational on related party sales, please refer to Footnote 23 of the financial statements.
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Cost of Sales: Overall cost of sales was approximately $149.0 million for the three months ended June 30, 2011, or 98.8% of sales, as compared to cost of sales of approximately $123.4 million, or 93.5% of sales for the three months ended June 30, 2010. Our cost of sales are primarily composed of the costs of direct raw materials (mainly heavy oil, benzene and carbinol), labor, depreciation and amortization of manufacturing equipment and facilities, and other overhead. In the three months ended June 30, 2011 our average cost of finished product was $1,013 per metric ton, as compared to an average cost of $788 per metric ton in the three months ended June 30, 2010, an increase of 28.6%. In April 2011, production was suspended for 25 days during which we still incurred estimated expenses of US1.2 million including depreciation, labor cost and various other manufacturing overhead.
Our overall cost of sales was approximately $283.1 million for the six months ended June 30, 2011, or 95.1% of sales, as compared to cost of sales of approximately $231.9 million, or 93.0% of sales for the three months ended June 30, 2010. In the six months ended June 30, 2011 our average cost of finished product was $1,034 per metric ton, as compared to an average cost of $768 per metric ton in the six months ended June 30, 2010, an increase of 34.6%.
Gross Profit: Gross profit for the three months ended June 30, 2011 was approximately $1.9 million as compared to $8.6 million for the comparable period in 2010. Our gross margin has decreased from 6.5% for the three months ended June 30, 2010 to 1.26% for the three months ended June 30, 2011. The main reason for the decrease in the gross margin is the increase in our raw material prices. The average Brent oil price in the three months ended June 30, 2011 was $117 per barrel, as compared to $79 in the same period of 2010, an increase of 47%. Additionally, the suspension of production had a negative impact of approximately 0.9% on the gross margin for the three months ended June 30, 2011.
Gross profit for the six months ended June 30, 2011 was approximately $14.5 million as compared to $17.5 million for the comparable period in 2010. Our gross margin has decreased from 7.0% for the six months ended June 30, 2010 to 4.9% for the six months ended June 30, 2011. The main reason for the decrease in the gross margin is the increase in our raw material prices. Additionally, the suspension of production had a negative impact of approximately 0.4% on the gross margin for the six months ended June 30, 2011.
Going forward, management believes that major fluctuations in prices of raw materials will continue to have a major impact on our gross margins, although management continues to improve efficiency in our manufacturing processes.
Operating Expenses: Operating expenses, including selling expenses, and general and administrative expenses, were approximately $4.7 million, or 3.1% of sales for the three months ended June 30, 2011 as compared to $1.5 million, or 1.1% of sales for the three months ended June 30, 2010, an increase of approximately $3.6 million. The increase of these expenses was due to various public company expenses including share-based compensation and various legal and consulting services. The share-based compensation for the three months ended June 30, 2011 was $0.6 million, as compared to share-based compensation of $0.1 million for the three months ended June 30, 2010. In the three months ended June 30, 2011, we also incurred expenses of approximately US$1.7 million in connection with the independent investigation.
Operating expenses, including selling expenses and general and administrative expenses, were approximately $8.5 million, or 2.9% of sales for the six months ended June 30, 2011 as compared to $2.4 million, or 0.9% of sales for the comparable period in 2010, an increase of approximately $6.1 million. The increase was due to various public company expenses including share-based compensation, and various legal and consulting services. The share-based compensation for the six months ended June 30, 2011 was $1.3 million, as compared to share-based compensation of $0.1 million for the six months ended June 30, 2010. In the six months ended June 30, 2011, we also incurred expenses of US$1.7 million in connection with the independent investigation.
General and administrative expenses will likely substantially increase in 2011 as a result of various legal, consulting and internal expenses related to the Company’s independent investigation and efforts to address NASDAQ’s delisting decision, which we are appealing. Aside from the legal fees and consulting expenses related to the investigation, management also expects increased expenses as a result of the implementation of subsequent corrective policies related to various aspects of internal controls and accounting policies.
Interest Expense: For the three months ended June 30, 2011, interest expense was approximately $2.6 million, as compared to interest expense of approximately $1.6 million for the comparable period in 2010. For the six months ended June 30, 2011, interest expense was approximately $5.8 million, as compared to interest expense of approximately $2.7 million for the comparable period in 2010. We capitalized certain portions of our interest as part of the costs of fixed assets during the construction period. After full-scale production commenced, interest on our short-term bank loans used to fund our working capital is expensed as incurred. In addition, the interest rate on one year bank loans has increased from 5.32% as of June 30, 2010 to 6.06% as of June 30, 2011. Management believes that interest expense will stay at the current level for the rest of our 2011 fiscal year.
Liquidated damages expense: For the three months ended June 30, 2011, we accrued a liquidated damages expense of $1.3 million. On April 1, 2011, trading of the Company’s common stock was suspended. In addition, management determined that, as of April 15, 2011, the Registration Statements were no longer effective. Accordingly, in the quarter ended June 30, 2011, it became probable that the Company will be required to remit liquidated damages to the Investors, an estimated contingent liability for $1.3 million was accrued with a corresponding charge to earnings.
Net Income/loss: We incurred a loss of approximately $1.8 million for the three months ended June 30, 2011, as compared to net income of approximately $4.2 million in the same period in 2010. The loss was mainly due to the higher cost of sales and the increase in legal, consulting and investigation expenses, in addition to the suspension of production.
Net income for the six months ended June 30, 2011 was approximately $3.4 million, as compared to net income of $9.3 million for the same period in 2010, a reduction of $5.9 million. The decrease is mainly due to the loss in the second quarter, which was due to the increase in raw material prices, the increase in legal, consulting and investigation expenses and the suspension of production.
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Foreign Currency Translation Adjustment: Our reporting currency is the U.S. dollar. Our local currency, Renminbi (RMB), is our functional currency. Results of operations and cash flow are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by the People’s Bank of China at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of shareholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.
Currency translation adjustments resulting from this process are included in accumulated other comprehensive income in the consolidated statement of shareholders' equity and amounted to $0.6 million for the three months ended June 30, 2011. The balance sheet amounts, at June 30, 2011 and 2010, with the exception of equity, were translated at RMB6.46412 and RMB6.78887 to 1.00 U.S. dollar respectively. The equity accounts were translated at their historical rates. The average translation rates applied to income statement accounts for the three months ended June 30, 2011 and 2010 were RMB6.53125 and RMB6.81710, respectively, to 1.00 U.S. dollar.
Liquidity and Capital Resources
The following table sets forth a summary of our cash flows for the periods indicated:
For the Six Months Ended June 30, | ||||||||
2011 | 2010 | |||||||
Net cash provided by operating activities | 34,701,757 | 10,278,999 | ||||||
Net cash used in investing activities | (11,563,733 | ) | (17,084,658 | ) | ||||
Net cash used in financing activities | (46,969,550) | (1,739,200) |
Net cash provided by operating activities was approximately $34.7 million for the six months ended June 30, 2011 as compared to net cash provided by operations of approximately $10.3 million for the same period in 2010. The increase in cash provided by operations was primarily due to the increase in accounts payable and prepayments to suppliers and offset by the reduction in inventory and prepaid tariffs for the six months ended in June 30, 2011. For the six months ended in June 30, 2010, the net cash provided by operations was primarily due to profits generated from the commencement of normal production and the increase in accounts payable and the decrease in inventory and consumption tax refund receivable.
Net cash used in investing activities was approximately $11.6 million and $17.1 million for the six months ended June 30, 2011 and 2010, respectively. Net cash used in investing activities was primarily focused on payments for the infrastructure construction and the expansion of our facility. As we move forward with our expansion, it is expected that net cash used in investing activities will increase for the rest of our 2011 fiscal year.
Net cash used in financing activities amounted to approximately $47.0 million for the six months ended June 30, 2011. Net cash used in financing activities amounted to approximately $1.7 million for the same period in 2010. Financing cash used in 2011 was mainly the result of settlement of bills payable, repayment of bank loans and the increase in pledged deposits at banks. Financing cash provided in 2011 was primarily due to the increase in short-term bank loans. In 2010, the net cash used in financing activities was primarily the result of settlement of bills payable and repayment of long-term bank loans.
We have entered into loan agreements with our primary lenders, Bank of China, China Construction Bank, Agricultural Bank of China, etc. under which we have term loans. As of June 30, 2011, we had an aggregate principal amount of approximately $188 million bank loans outstanding under the loan agreements, with maturity dates from July 2011 to October 2012 and interest rates from 2.97% to 8.13% per annum. $168 million is classified as short-term bank loans, $4.6 million as current portion of long-term bank loans and $15.5 million as long-term bank loans. The loan agreements contain customary affirmative and negative covenants and were guaranteed by third parties and individual persons or secured by a lien on our property and equipment. Beginning in January 2011, certain individual loan guarantors, some of whom are related parties, were paid a monthly fee of approximately 0.1% of the outstanding loan balances as compensation for their guarantees. Through December 31, 2010, no compensation was paid in respect of these guarantees. Historically, all debts have been repaid by the Company in a timely manner. All are revolving loans whose terms (at due date of payment) are extended by the lender. As of June 30, 2011, we were in compliance with the terms of our loan agreements. Management expects all unpaid loan balances will be extended at their due date. Depending on capital needs, the Company evaluates whether to apply for additional long-term bank loans. The Company currently has sufficient lines of credit with the banks for both short-term and long-term borrowings.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable to smaller reporting companies.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures |
Our management maintains disclosure controls and procedures designed to provide reasonable assurance that material information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that the information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. We performed an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures were ineffective in ensuring that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission, and were ineffective in providing reasonable assurance that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
We do not expect that our disclosure controls and procedures will prevent all errors and all instances of fraud. Disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Further, the design of disclosure controls and procedures must reflect the fact that there are resource constraints, and the benefits must be considered relative to their costs. Because of the inherent limitations in all disclosure controls and procedures, no evaluation of disclosure controls and procedures can provide absolute assurance that we have detected all our control deficiencies and instances of fraud, if any. The design of disclosure controls and procedures also is based partly on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
(b) Changes in internal control over financial reporting |
In our Form 10-Q for the period ended September 30, 2010, we disclosed that we had the following material weaknesses with regard to our internal controls and procedures over financial reporting:
1) Reliance on financial reporting consultants for review of critical accounting areas and disclosures, and material non-standard transactions; and
2) Lack of sufficient accounting staff, which results in a lack of segregation of duties necessary for a good system of internal control.
In connection with the preparation of our Form 10-K for the period ended December 31, 2010, our former auditors, KPMG, raised certain issues, which were primarily related to issues regarding certain cash transactions and recorded sales. As a result, our Audit Committee elected to commence an independent investigation and engaged the services of independent counsel, Pillsbury Winthrop Shaw Pittman LLP, which in turn engaged the services of Deloitte Financial Advisory Services LLP, as independent forensic accountants, and King & Wood, as Audit Committee counsel in China. As a result of the investigation, the Audit Committee identified a number of issues that may have a material impact on our internal controls and procedures over financial reporting.
As a result of the findings of the Audit Committee and its review of our controls and procedures, management has concluded that the Company continues to have material weaknesses. A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected. Management identified the following material weaknesses during its assessment of our internal control over financial reporting as of June 30, 2011:
1) Lack of sufficient knowledge of U.S. GAAP reporting by our existing accounting staff;
2) Lack of sufficient accounting staff which results in a lack of segregation of duties necessary for an efficient internal control system;
3) Lack of a sufficient number of personnel appropriately qualified to perform control monitoring activities;
4) Lack of internal control consciousness and awareness by individuals responsible for certain key control activities, including:
a) Lack of sufficient documentation of our existing financial processes, risk assessment and internal controls;
b) Inadequate procedures for identifying and disclosing related party transactions;
c) Inadequate controls with regard to certain banking and loan transactions; and
d) Inadequate disclosure and accounting for certain off balance sheet transactions.
5) Inadequate training and training programs;
6) A Chief Financial Officer (CFO) for Chinese operations that did not report to the Company’s CFO;
7) Lack of Audit Committee oversight prior to its formation in July 2010; and
7) Lack of necessary senior management oversight and monitoring of the accounting functions of the organization, and because the company completed a reverse merger in April 2010, senior management lacked the background, skills and experience to meet the reporting requirements of a US listed company.
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As a result, the Company has taken and has begun to take the following measures to remediate the material weaknesses:
1) A review of the responsibilities of senior management and a restructuring of our organization chart in order to provide for proper segregation of duties, including but not limited to:
a) | Restructuring of our accounting department, and streamlining the department’s roles to ensure that the CFO maintains adequate oversight; and |
b) | Termination of Mr. Xue in August 2011, our former Vice President of Accounting/ PRC CFO and hiring of Mr. Fan Zhang as Vice President of Accounting/PRC CFO. |
2) Continued and careful evaluation of control processes and systems by the Audit Committee, the Board of Directors and Management, including but not limited to:
a) | Engagement of a compliance officer to monitor the Company’s corporate governance and compliance, reporting directly to the Audit Committee; |
b) | Evaluation of the duties and responsibilities of the CEO and his role in day-to-day operations of the Company and the control environment; |
c) | Engagement of an outside consultant to assist with SOX 404 compliance; and |
d) | The addition of one or one or more additional independent, bilingual Chinese-speaking directors to facilitate the Board oversight and assist and augment the efforts of the current independent directors. |
3) Implementation of additional controls and procedures to ensure the preparation and review of complete and transparent US GAAP financial statements in a timely and efficient manner, including but not limited to:
a) | Additional training in U.S. GAAP for our accounting staff; and |
b) | Hiring of additional qualified accounting personnel, including an experienced controller. |
4) Cessation of the use of an off-balance sheet cash account and the adoption of policies and procedures to prevent the future use of off balance sheet accounts;
5) Implementation of new procedures for the identification and approval of and appropriate disclosure of potential related party transactions;
6) Implementation of new policies and procedures to ensure that all transactions are supported by sufficient documentation;
7) Development and implementation of policies and procedures that provide continuous risk assessment of legal and regulatory considerations related to business activities;
8) Development of policies to ensure that all identified contingencies are evaluated completely and in a timely manner;
9) Development and implementation of policies and procedures to ensure that revenues are properly recorded and all invoices are appropriately reviewed by accounting personnel;
10) Implementation of policies and procedures to ensure inventory purchases are properly recorded;
11) Implementation of policies and procedures to ensure that all liabilities are recorded on the proper period;
12) Development and implementation of policies and procedures to ensure that financial information is appropriately shared during inter-departmental meetings; and
13) Planned adoption of a Corporate Best Practices Manual;
We believe that the remediation measures we are taking, if effectively implemented and maintained, will remediate the material weaknesses discussed above.
Except as described above, there have been no changes in our internal controls over financial reporting that occurred during the fiscal period to which this Quarterly Report on Form 10-Q relates that have materially affected, or are reasonably likely to materially affect our internal controls over financial reporting.
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PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
We may from time to time become a party to various legal or administrative proceedings arising in the ordinary course of our business.
We are currently not a party to any material legal or administrative proceedings and are not aware of any pending or threatened legal or administrative proceedings against us.
Item 1A. Risk Factors
Not applicable to smaller reporting companies.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) Not Applicable.
(b) Not Applicable.
(c ) Not Applicable
ITEM 3. Defaults upon Senior Securities
(a) Not Applicable.
(b) Not Applicable.
ITEM 4. (Removed and Reserved)
ITEM 5. OTHER INFORMATION
(a) Not applicable.
(b) Not applicable.
ITEM 6. EXHIBITS
(a) The following exhibits are filed as part of this report.
2.1 | Share Exchange Agreement dated April 22, 2010 (incorporated by reference to Exhibit 2.1 of the Registrant’s Form 8-K filed on April 28, 2010) |
2.2 | Agreement and Plan of Merger (incorporated by reference to Exhibit 2.1 of the Registrant’s Form 8-K filed on May 19, 2010) |
3.1 | Amended Articles of Incorporation of Keyuan Petrochemicals, Inc. (f/k/a Silver Pearls, Inc.), filed with the Secretary of State of Nevada (incorporated by reference to Exhibit 3.1 of the Registrant’s Form S-1 filed on December 29, 2010). |
3.2 | Articles of Merger (incorporated by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on May 19, 2010) |
3.3 | Amended Bylaws of Keyuan Petrochemicals, Inc. dated June 29, 2010 (incorporated by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on July 7, 2010) |
4.1 | Certificate of Designation of Rights and Preferences of Series A Preferred Stock (incorporated by reference to Exhibit 4.1 of the Registrant’s Form 8-K filed on April 28, 2010) |
4.2 | Certificate of Designation of Rights and Preferences of Series M Preferred Stock (incorporated by reference to Exhibit 4.2 of the Registrant’s Form 8-K filed on April 28, 2010) |
4.3 | Certificate of Designation of Rights and Preference of Series B Preferred Stock (incorporated by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on September 30, 2010) |
31.1 | Certification of Chief Executive Officer required by Rule 13a-14/15d-14(a) under the Exchange Act |
31.2 | Certification of Chief Financial Officer required by Rule 13a-14/15d-14(a) under the Exchange Act |
32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
32.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: November 1, 2011 | Keyuan Petrochemicals, Inc. |
By: /s/ Chunfeng Tao | |
Chunfeng Tao | |
Chief Executive Officer & President | |
By: /s/ Fan Zhang | |
Fan Zhang Acting Chief Financial Officer/Vice President of Accounting |
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