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CXDC > SEC Filings for CXDC > Form 10-K on 25-Mar-2013All Recent SEC Filings

Show all filings for CHINA XD PLASTICS CO LTD | Request a Trial to NEW EDGAR Online Pro

Form 10-K for CHINA XD PLASTICS CO LTD


25-Mar-2013

Annual Report


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

We make forward-looking statements in this report, in other materials we file with the Securities and Exchange Commission (the "SEC") or otherwise release to the public, and on our website. In addition, our senior management might make forward-looking statements orally to analysts, investors, the media and others. Statements concerning our future operations, prospects, strategies, financial condition, future economic performance (including growth and earnings) and demand for our products and services, and other statements of our plans, beliefs, or expectations, including the statements contained in this Item 7, "Management's Discussion and Analysis or Plan of Operation," regarding our future plans, strategies and expectations are forward-looking statements. In some cases these statements are identifiable through the use of words such as "anticipate," "believe," "estimate," "expect," "intend," "plan," "project," "target," "can," "could," "may," "should," "will," "would" and similar expressions. We intend such forward-looking statements to be covered by the safe harbor provisions contained in Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and in Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). You are cautioned not to place undue reliance on these forward-looking statements because these forward-looking statements we make are not guarantees of future performance and are subject to various assumptions, risks, and other factors that could cause actual results to differ materially from those suggested by these forward-looking statements. Thus, our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to, changes in: global and domestic economic conditions generally and the automotive modified plastics market specifically, legislative or regulatory changes that affect our business, including changes in environmental regulations and control policies over the domestic automotive industry, the availability of working capital, the introduction of competing products, and other risk factors described herein. These risks and uncertainties, together with the other risks described from time-to-time in reports and documents that we filed with the SEC should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Indeed, it is likely that some of our assumptions will prove to be incorrect. Our actual results and financial position will vary from those projected or implied in the forward-looking statements and the variances may be material. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.


General

China XD Plastics Company Limited ("China XD", "we", and the "Company", and "us" or "our" shall be interpreted accordingly) is one of the leading specialty chemical companies engaged in the research, development, manufacture and sale of modified plastics primarily for automotive applications in China. Through our wholly-owned operating subsidiaries in China, we develop modified plastics using our proprietary technology, manufacture and sell our products primarily for use in the fabrication of automobile parts and components. We have 246 certifications from manufacturers in the automobile industry as of December 31, 2012. We are the only company certified as a National Enterprise Technology Center in modified plastics industry in Heilongjiang province. Our Research and Development (the "R&D") team consists of 118 professionals and 18 consultants, including three consultants who are members of Chinese Academy of Engineering, and one consultant who is the former chief scientist of Specialty Plastics Engineering Institute of Jilin University. As a result of the integration of our academic and technological expertise, we have a portfolio of 69 patents, one of which we have obtained the patent rights and the remaining 68 of which we have applications pending in China as of December 31, 2012.

Our products include seven categories: polypropylene (PP), acrylonitrile butadiene styrene (ABS), modified engineering plastics, polyamides (PA or nylon), environment-friendly plastics, specialty engineering plastics and polyether ether ketone (PEEK). The Company's products are primarily used in the production of exterior and interior trim and functional components of more than 23 automobile brands and 70 automobile models manufactured in China, including Audi, Volkswagen, BMW, GM, Mazda, Toyota, Cherry, Geely and Hafei new energy vehicles. Our research center is dedicated to the research and development of modified plastics, and benefits from its cooperation with well-known scientists from prestigious universities in China. We operate three manufacturing bases in Harbin, Heilongjiang in the PRC. As of December 31, 2012, we had approximately 390,000 metric tons of production capacity across 83 automatic production lines utilizing German twin-screw extruding systems, automatic weighing systems and Taiwan conveyer systems, including the newly launched three additional workshops with 30 production lines completed the trial-run in December of 2012 and further expanded our annual capacity potential by approximately 135,000 metric tons and support our future growth in 2013.

Critical Accounting Policies

We prepare our consolidated financial statements in accordance with U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect (1) the reported amounts of our assets and liabilities; (2) the disclosure of our contingent assets and liabilities at the end of each reporting period; and (3) the reported amounts of revenues and expenses during each reporting period. We continually evaluate these judgments, estimates and assumptions based on our own historical experience, knowledge and assessment of current business and other conditions and our expectations regarding the future based on available information which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application.

When reading our consolidated financial statements, you should consider our selection of critical accounting policies, the judgment and other uncertainties affecting the application of such policies, and the sensitivity of reported results to changes in conditions and assumptions. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our consolidated financial statements.

Long-Lived Assets

Our long-lived assets include property, plant and equipment and land use rights.


We depreciate and amortize our property, plant and equipment and land use rights, using the straight-line method of accounting over the estimated useful lives of the assets. We make estimates of the useful lives of property, plant and equipment, including the salvage values, and land use rights in order to determine the amount of depreciation and amortization expense to be recorded during each reporting period. The estimated useful life is the period over which the long-lived assets are expected to contribute directly or indirectly to the future cash flows of the Company.

We evaluate long-lived assets, including property, plant and equipment, and land use rights for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. We assess recoverability by comparing carrying amount of a long-lived asset or asset group to estimated undiscounted future cash flows expected to be generated by the asset or asset group. If the carrying amount of an asset or asset group exceeds its estimated undiscounted future cash flows, we recognize an impairment charge based on the amount by which the carrying amount exceeds the estimated fair value of the asset or asset group. We estimate the fair value of the asset or asset group through various valuation techniques, including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary. Assets to be disposed are reported at the lower of carrying amount or fair value less costs to sell, and are no longer depreciated.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. In establishing the required allowance, we consider historical losses adjusted to take into account current market conditions, the amount of receivables in dispute, and the current receivables aging and current payment patterns. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. We do not have any off-balance-sheet credit exposure related to our customers.

We extend unsecured credit to customers with good credit history. We review our accounts receivable on a regular basis to determine if the bad debt allowance is adequate at each year-end. We have not experienced any material write-offs in history.

Valuation of Inventories

Our inventories are stated at the lower of cost or market. We routinely evaluate quantities and value of our inventories in light of current market conditions and market trends, and record a write-down against the cost of inventories for a decline in market. Expected demand and anticipated sales price are the key factors affecting our inventory valuation analysis. For purposes of our inventory valuation analysis, we develop expected demand and anticipated sales prices primarily based on sales orders as well as industry trends and individual customer analysis. We also consider sales and sales orders after each reporting period-end but before the issuance of our financial statements to assess the accuracy of our inventory valuation estimates. Historically, actual demand and sales price have generally been consistent with or greater than expected demand and anticipated sales price used for purposes of the our inventory valuation analysis. The evaluation also takes into consideration new product development schedules, the effect that new products might have on the sale of existing products, product obsolescence, customer concentrations, product merchantability and other factors. Market conditions are subject to change and actual consumption of inventories could differ from forecasted demand. Furthermore, the price of plastic resins, our primary raw material, is subject to fluctuations based on global supply and demand. Our management continually monitors the changes in the purchase price paid for plastic resins, including advances to suppliers, and the impact of such change on our ability to recover the cost of inventory and our prepayments to suppliers. Our products have a long life cycle and obsolescence has not historically been a significant factor in the valuation of inventories. We have not experienced any material inventory write-downs before.


Income Tax Uncertainties and Realization of Deferred Income Tax Assets

Our income tax provision, deferred income tax assets and deferred income tax liabilities are recognized and measured primarily based on actual and expected future income, PRC statutory income tax rates, PRC tax regulations and tax planning strategies. Significant judgment is required in interpreting tax regulations in the PRC, evaluating uncertain tax positions, and assessing the realizability of deferred income tax assets. Actual results could differ materially from those judgments, and changes in judgments could materially affect our consolidated financial statements. As of December 31, 2012 and 2011, we had total gross deferred income tax assets of US$556,677 and US$1,005,361, respectively. We record a valuation allowance to reduce our deferred income tax assets if, based on the weight of available evidence, we believe expected future taxable income is not likely to support the use of a deduction or credit in that jurisdiction. We evaluate the level of our valuation allowances quarterly, and more frequently if actual operating results differ significantly from forecasted results. As of December 31, 2012 and 2011, our valuation allowance against deferred income tax assets was US$556,677 and US$1,005,361, respectively. The change in valuation allowance was attributable primarily to deferred income tax assets, consisting primarily of tax losses carryforward of China XD and Favor Sea (US) Inc. which in our judgment, are not more likely than not to be realized as tax benefits in view of the cumulative loss positions of these entities.

We recognize the impact of a tax position if we determine the position is more likely than not to be sustained upon examination, including resolution of any related appeals or litigation processes, based solely on the technical merits of the position. In evaluating whether a tax position has met the more-likely-than-not recognition threshold, it is presumed that the position will be examined by the appropriate tax authority that has full knowledge of all relevant information. In addition, a tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon settlement. The tax positions are regularly re-evaluated based on the results of the examination of income tax filings, statute of limitations expirations and changes in tax law that would either increase or decrease the technical merits of a position relative to the more-likely-than-not recognition threshold. In the normal course of business, we are regularly audited by the PRC tax authorities. The settlement of any particular issue with the applicable tax authority could have a material impact on our consolidated financial statements.

Probability of the redemption of Series D convertible preferred stocks

At the date of issuance, we recognized our redeemable Series D convertible preferred stocks at their fair value. Under the terms of the Series D preferred stock agreement, the redeemable Series D convertible preferred stock becomes redeemable upon the occurrence of certain events, the most significant being if for the years ended December 31, 2011, 2012 and 2013, the Company does not meet the Actual Profit Targets, as defined and prescribed in the Series D preferred stock agreement. Based on the terms of the redeemable Series D preferred stock agreement, the redemption amount would be US$119 million as of December 31, 2012 and US$137 million as of December 31, 2013.

For the years ended December 31, 2011 and 2012, our Actual Profit, as defined in the Series D preferred stock agreement, was RMB379 million and RMB524 million, respectively, which exceeded the 2011 Actual Profit Targets of RMB360 million and the 2012 Actual Profit Targets of RMB468 million. Accordingly, the redeemable Series D convertible preferred stocks are not currently redeemable.

In addition, since we believe the Company will meet the Actual Profit Targets of RMB608 million for the year ending December 31, 2013, we have concluded it is not probable that the redeemable Series D convertible preferred stocks will become redeemable. As a result, we have not adjusted the initial carrying value of the redeemable Series D convertible preferred stocks.

The determination of the probability that the redeemable Series D convertible preferred stocks will become redeemable required us to project a Actual Profit Targets for the year ending December 31, 2013. The calculation of a Actual Profit Targets for the year ending December 31, 2013 required us to consider various estimates and assumptions, including among other things, future market demand and unit selling prices of products and product mix, revenue growth rates of different products, unit costs of raw materials, production capacity and utilization ratio, gross margin percentages, operating expenses to revenues ratio, projected working capital needs, capital expenditures forecasts, interest rate and income tax rate.


Stock Based Compensation

We measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award and recognize the cost over the period the employee is required to provide service in exchange for the award, which generally is the vesting period. We have elected to recognize the compensation cost for an award with only service conditions and a graded vesting schedule on a straight-line basis over the requisite service period for the entire award. However, the cumulative amount of compensation cost recognized at any date equals at least the portion of the grant date value of such award that is vested at that date.

We estimated the fair value of our share options using the Black-Scholes Option Pricing model. The model incorporates subjective assumptions. The expected volatility was based on implied volatilities from traded options and historical volatility of the Company's common stock. The risk free interest rate assumption is determined using the Federal Reserve nominal rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award being valued. There is no expected dividend yield, as the Company has not paid dividend and does not anticipate paying dividend over the term of the grants.

Changes in our estimates and assumptions regarding the expected volatility could significantly impact the estimated fair values of our share options determined under the Black-Scholes valuation model and, as a result, our net income.

Fair Value Measurements

We apply the provisions of ASC Subtopic 820-10, Fair Value Measurements, for fair value measurements of financial assets and financial liabilities and for fair value measurements of nonfinancial items that are recognized or disclosed at fair value in the financial statements. The fair values are measured pursuant to the three levels defined as follow:

? Level 1: inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

? Level 2: inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.

? Level 3: inputs to the valuation methodology are unobservable and significant to the fair value.

The fair values of the warrants outstanding as of December 31, 2012 and 2011 were determined based on the Black-Scholes option pricing model, using the following key assumptions:

                    Series A Investor Warrants             Series A Placement Agent Warrants           Series C Placement Agent Warrants
                           December 31,                              December 31,                                December 31,
                    2012                   2011              2012                     2011               2012                     2011
Exercise
price (per
share)                  4.9                    4.9                5.5                      5.5                7.5                      7.5
Risk-free
interest
rate per
annum                   0.3 %                  0.4 %              0.3 %                    0.4 %              0.1 %                    0.2 %
Expected
volatility             48.8 %                 72.0 %             48.8 %                   72.0 %             77.4 %                   55.4 %
Expected
dividends
yield                     0 %                    0 %                0 %                      0 %                0 %                      0 %
Expected
term (years)            1.9                    2.9                1.9                      2.9                0.5                      1.5

Results of Operations

The following table sets forth, for the periods indicated, statements of income data in thousands of USD:

                                      For the Years Ended December 31,
(in thousands, except                  2012                    2011
percentages)                     Amount         %        Amount         %
Revenues                       $  599,819       100 %   $ 381,625       100 %
Cost of revenues               $  456,012        76 %   $ 285,802        75 %
Gross profit                   $  143,807        24 %   $  95,823        25 %
Total operating expenses       $   31,929         5 %   $  18,961         5 %
O Operating income             $  111,878        19 %   $  76,862        20 %
InIncome before income taxes   $  115,384        19 %   $  78,629        21 %
Income tax expenses            $   29,516         5 %   $  18,110         5 %
Net income                     $   85,868        14 %   $  60,519        16 %


Revenues

Revenues were US$599.8 million, an increase of US$218.2 million, or 57.2%, as compared to US$381.6 million in 2011, due to approximately 48.1% increase in sales volume and 7.5% increase in the average RMB selling price of our products. The increase of sales volume was driven by the strong demand of modified plastics in the PRC market and higher penetration of our business in our existing markets supported by our newly installed twenty production lines in December 2011, as well as the marketing efforts to develop new customers. Such increase in demand was driven by increasing demand for middle and high-end automobiles by Chinese consumers, continuing substitution of imported modified plastics by domestic suppliers, as well as the increase of plastic content on the per-vehicle-basis in China. The increase of average selling price was due to the shift of product mix towards higher-end products as well as higher raw material prices that we have been able to effectively pass through to our customers.

The following table summarizes the breakdown of revenues by categories in millions of US$:

                                             Revenues
(in millions,
except percentage)               For the Years Ended December 31,
                                  2012                       2011
                                                                              Change
                                                                                in
                          Amount           %          Amount         %        Amount    Change in %
Modified Polypropylene
(PP)                        284.3          47.4 %       185.0        48.5 %      99.3         53.7 %

Engineering Plastics        124.5          20.8 %        70.9        18.6 %      53.6         75.6 %

Modified Polyamide (PA)      48.9           8.1 %        26.3         6.9 %      22.6         85.9 %

Alloy Plastics               37.8           6.3 %        28.3         7.4 %       9.5         33.6 %

Environment Friendly
Plastics                     72.1          12.0 %        32.6         8.5 %      39.5        121.2 %

Modified Acrylonitrile
Butadiene Styrene (ABS)      24.7           4.1 %        20.3         5.3 %       4.4         21.7 %

   Sub-total                592.3          98.7 %       363.4        95.2 %     228.9         63.0 %

After-sales service           7.5           1.3 %        18.2         4.8 %    (10.7)       (58.8) %
Total Revenues              599.8           100 %       381.6         100 %     218.2         57.2 %


The following table summarizes the breakdown of metric tons (MT) by product mix:

                                              Sales Volume
(in MTs, except
percentage)                         For the Years Ended December 31,
                                    2012                        2011
                              MT             %            MT             %        Change in MT     Change in %
Modified Polypropylene
(PP)                        136,698          61.0 %      99,051          65.5 %         37,647           38.0 %

Engineering Plastics         25,284          11.3 %      14,885           9.8 %         10,399           69.9 %

Modified Polyamide (PA)      10,228           4.6 %       6,167           4.1 %          4,061           65.9 %

Alloy Plastics               10,753           4.8 %       9,427           6.2 %          1,326           14.1 %

Environment Friendly
Plastics                     31,784          14.2 %      14,368           9.5 %         17,416          121.2 %

Modified Acrylonitrile
Butadiene Styrene (ABS)       9,235           4.1 %       7,373           4.9 %          1,862           25.3 %

Total sales volume          223,982           100 %     151,271           100 %         72,711           48.1 %

The Company has continued its shift of product mix to higher-end product categories such as Environmental Friendly Plastics and Polyamide (PA) as well as enhance gross margin of other product categories, including Modified Polypropylene (PP), Engineering Plastics, Alloy Plastics, and Modified Acrylonitrile Butadiene Styrene (ABS) by focusing on applications used in higher-end car models, primarily due to (i) the increasing demand of advanced modified plastics in luxury automobile models in China, (ii) the stronger demand promoted by Chinese government for clean energy vehicles and (iii) stronger sales of higher-end cars made by automotive manufacturers from China and Germany, US and Japan joint ventures, which tend to use more and higher-end modified plastics in quantity per vehicle in China.

Gross Profit and Gross Margin

                                          For the Years Ended December 31,                     Change
(in millions, except percentage)            2012                      2011             Amount            %
Gross Profit                          $          143.8           $         95.8      $      48.0           50.1 %
Gross Margin                                      24.0 %                   25.1 %                         (1.1) %

Gross profit was US$143.8 million in 2012 compared to US$95.8 million in 2011, representing an increase of 50.1%. Our gross margin decreased to 24.0% in 2012 from 25.1% in 2011 mainly due to the decrease of post-sales service revenue.


General and Administrative Expenses

                                         For the Years Ended
                                             December 31,                   Change
(in millions, except percentage)         2012            2011         Amount         %
General and Administrative Expenses   $     10.0        $    7.1      $   2.9        40.8 %
as a percentage of revenues                  1.7  %          1.8 %                  (0.1) %
. . .
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