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KEYP > SEC Filings for KEYP > Form 10-K/A on 29-Aug-2013All Recent SEC Filings

Show all filings for KEYUAN PETROCHEMICALS, INC.

Form 10-K/A for KEYUAN PETROCHEMICALS, INC.


29-Aug-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS

The following discussion and analysis of our financial condition and result of operations should be read in conjunction with our audited consolidated financial statements and the notes to those financial statements appearing elsewhere in this Form 10-K. This discussion 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. Our actual results may differ materially from those contained in any forward-looking statements.

Overview

Operating through our wholly-owned subsidiaries, Ningbo Keyuan, Ningbo Keyuan Petrochemicals, Keyuan Keyuan Synthetic Rubbers and Guangxi Keyuan, our operations include (i) a production facility with an annual petrochemical production capacity of 720,000 metric tons (MT) of a variety of petrochemical products, (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.

In April 2011, we expanded our annual production capacity from 550,000 MT to 720,000 MT. We also completed the construction of a Styrene-Butadience-Styrene (the "SBS") production facility with an annual production capacity of 70,000 MT in September 2011 and we began initial trial production in October and November 2011. One SBS production line began commercial production in December 2011 and second production line began commercial production in August 2012. We plan to construct new devices to refine our original products to produce other high-value added products. Currently these projects are in the pre-construction government approval phase.

In January 2012, we signed a cooperation agreement with Fangchenggang City to build a new petrochemicals production facility in Guangxi Keyuan New Materials Industrial Park, in Guangxi Province. The total investment amount to construct this new production facility is RMB 12.8 billion (approximately USD $2.02 billion). We commenced pre-construction activities in February 2012 and intend to finish the initial stage of construction and begin operations by the end of 2013. However, the timeline is subject to revision pending the status of project financing. This new production facility, as a part of our expansion plan, will improve our competitive position by extending and expanding our supply chain and manufacturing base. Once the facility is fully operational, it is expected to have an annual production capacity of 400,000 metric tons of ABS. We plan to fund the construction and operation of the new production facility through outside financing. If such financing is not available on terms acceptable to us, construction of this facility will be delayed until appropriate financing is available. According to the cooperation agreement, the government of Fangchenggang City will provide the land use right for the facility.

Our Facility and Equipment

Facility

As of December 31, 2012, we have invested a total of approximately $26 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 1.2 million square feet of additional land in August 2010 for our future expansion.

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.

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 oil resin, 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 chemicals, 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.

? Styrene butadiene styrene (SBS): a thermoplastic elastomer with features similar to rubber, widely used in the manufacture of resin, shoes, tape, tubes and asphalt.

Expansion Plan

Our annual designed manufacturing capacity was 550,000 MT of a variety of petrochemical products at the end of 2010. In order to meet the increasing market demands, we upgraded the catalytic pyrolysis processing equipment used in our 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 the production of SBS, one of the Styreneic Block Copolymers. SBS is a product with higher product margin with major applications for the 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 land use right in August 2010 The construction started in September, 2010 and was completed (as planned) in September 2011. We started trial production in October and November, 2011, and one SBS production line began commercial production in December 2011. The design capacity of the SBS facility allows for production of up to 70,000 MT per year. We expect to generate net profit margins of 10% from our production of SBS once the facility reaches normal production levels. In 2012, the facility achieved a 41% utilization and generated approximately $ 71.0 million in sales and approximately $ 5.97 million of income from operations.


In order to develop our business to meet the increasing customer demands, we have been working to expand our manufacturing capacity by focusing on the following improvements to our infrastructure. In anticipation of the market demand for the production of finished goods, environmental protection requirements, we adjusted our original expansion project and are currently working to refining our manufacturing capacity to include:

a) an ABS production facility in Guangxi Province, which will have an annual production capacity of 400,000 MT of ABS. The Company began pre-construction activities in February 2012, and the first phase is expected to be completed by the forth quarter of 2014.

b) an oil catalytic cracking processing facility as an extension of our catalytic pyrolysis processing equipment, as well as the feed way of the main raw materials to produce synthetic rubber. This facility can reduce production costs and the market risk in completely repurchase of raw materials, and improve the stability and efficiency of project production to 200,000 MT of heavy oil per year.

c) Increased the annual production capacity of our ethylbenzene-styrene facility from 80,000 MT to 200,000 MT, among which 120,000 MT can be used for producing synthetic and 80,000 MT can be sold to downstream petrochemical companies. One of the main raw materials, ethylene, can be acquired from the oil catalytic cracking facility. This facility can be considered the bridge between original products and high-value added products and will complete the integration of internal resources;

d) a transformer oil facility using hydrogen from the ethylene-styrene facility to complete a double hydrogenation process on original products (BTX Aromatic) for refining transformer oil, and producing high value transformer oil with a design capability of 100,000 MT per year.

e) an SSBR (Solution Polymerized Styrene Butadiene Rubber )production facility with a design capability of 150,000 MT per year, that will use its own production process technology in synthetic rubber, combining styrene and butadiene, to produce SSBR. This product can be used as raw materials for tires, instead of imported hexakis (methoxymethy) melamine ("HMMM").

We are currently evaluating the timeline for the expansion projects. Our current estimate is as follows:

Expansion Project                            Expected Completion Date
Oil Catalytic Cracking Processing Facility       End of Q4, 2013
Ethylene-Styrene Facility                        End of Q4, 2014
Transformer Oil Facility                         End of Q4, 2014
SSBR production facility                         End of Q4, 2015
ABS Production Facility                          End of Q4, 2014

The total cost of additional processing equipment for products refinement and the SSBR production facility is approximately $149.3 million, including $49.8 million for additional processing equipment and $99.5 million for our SSBR production facility. We are currently going through the governmental approval and design phase of the ABS production facility and estimating the related costs.

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.

Going concern and management's plans

Our audited financial statements for the years ended December 31, 2012 and 2011 have been prepared assuming we will continue as a going concern. We reported a net loss of approximately $5.85 million in 2012 and cash flows used in operations of approximately $7.1 million for the year ended December 31, 2012. At December 31, 2012, we had a working capital deficit of approximately $159 million. The Report of the Independent Registered Public Accounting Firm on our consolidated financial statements as of and for the year ended December 31, 2012 includes a going concern explanatory paragraph which means that the accounting firm has express substantial doubt about the Company's ability to continue as a going concern.

We continue to finance our operations primarily through short-term bank borrowings. Short-term bank borrowings and bills payable amounted to approximately $397.8 million at December 31, 2012, and have increased to approximately $414 million at May 28, 2013. Management expects that short-term bank financing will continue to be available through at least the end of 2013.

We continue to benefit from favorable PRC tax policies related to consumption tax, approximately $51.3 million of which was refundable at December 31, 2012. Management believes that this amount will be refunded by June 30, 2013 and that additional consumption tax deposits of approximately $84.1 million through May 28, 2013 will be refunded more promptly in the second half of 2013.

We are expanding our production line to include Styrene-Ethylene-Butylene-Styrene ("SEBS"). Management expects production and sale of SEBS to commence in the second half of 2013, and that SEBS will yield a higher gross margin than some of the Company's current products.

We are also exploring sources of additional financing, including short-term financing from vendors and other parties. In addition, the Company is closely monitoring its cash balances, cash needs and expense levels.

The ability of the Company to continue as a going concern is dependent upon management's ability to implement its strategic plan, obtain additional capital and generate net income and positive cash flows from operations. There can be no assurance that these plans will be sufficient or that additional financing will be available in amounts or terms acceptable to the Company, if at all.


Manufacturing and Sales

Our total production of finished products for 2012 was 688,821 MT and revenue totaled $750 million, based on the sale of 675,484 MT of petrochemical products included the sale of SBS products which was 28,730MT. Our total production of finished products for 2011 was 535,208 MT and revenue totaled $626.7 million based on the sale of 588,976 MT of petrochemical products. Therefore, we experienced an increase in total production of finished products with an increase in revenue and sales. The lower overall production in 2011 was mainly due to the 44 days of production interruptions.

In the second quarter of 2011, we experienced 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, and approximately $45 million of revenues. In the third quarter of 2011, we incurred production interruptions, mainly as a result of the upgrade of the local power grid. We lost a combined 19 days of production, equating to approximately 41,000 tons of production, and approximately $40 million of revenues. As a result, in 2011 we experienced production interruptions totaling a combined 44 days. These lost days of production equated to approximately 95,000 tons of production and approximately $85 million of revenues.

Critical Accounting Policies and Estimates

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and include the financial statements of the Company and its subsidiaries (the "Group"). The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant items subject to such estimates and assumptions include the useful lives of fixed assets; the fair value determination of financial and equity instruments; the realizability of inventories; and the recoverability of property, plant and equipment. These estimates are often based on complex judgments and assumptions that management believes to be reasonable but are inherently uncertain and unpredictable.

We believe the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:

Inventories. Inventories are stated at the lower of cost or market. Cost is determined using the weighted-average cost method. Provisions are made for excess, slow moving and obsolete inventory as well as inventory whose carrying value is in excess of net realizable value. Management continually evaluates the recoverability based on assumptions about customer demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory reserves or write-downs may be required. The Group did not record any provision for slow-moving and obsolete inventory as of December 31, 2012 and 2011.

Property, Plant and Equipment. Property, plant and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets, taking into consideration the assets' estimated residual value. When items are retired or otherwise disposed of, income is charged or credited for the difference between the net book value and proceeds received thereon. Ordinary maintenance and repairs are charged to expense as incurred.

The estimated useful lives of property, plant and equipment are as follows:

Buildings                      45 years
Machinery and equipment        5 to 15 years
Vehicles                       5 years

Office equipment and furniture 3 to 10 years


Construction-in-progress is stated at cost. Cost comprises nonrefundable prepayments and direct costs of construction as well as interest costs capitalized during the period of the construction of the plant or installation of equipment. Costs included in construction in progress are transferred to their respective categories of property, plant and equipment when the assets are ready for their intended use, at which time depreciation commences.

Long-Lived Assets. The Group reviews the recoverability of its long-lived assets on a periodic basis in order to identify business conditions, which may indicate a possible impairment. The assessment for potential impairment is based primarily on the Group's ability to recover the carrying value of its long-lived assets from expected future discounted cash flows. If the total of the expected future discounted cash flows is less than the total carrying value of the assets, a loss is recognized for the difference between the fair value (computed based upon the expected future discounted cash flows) and the carrying value of the assets.

For certain major customers, the Group accepts their payment for the Group's products by bills receivable. Bills receivable represent short-term notes receivable issued either by the customer or by the customer and an accepting bank that entitles the Group to receive the full face amount from the customer or the accepting bank at maturity, which is generally six months from the date of issuance. Bills receivable are typically sold at a discount prior to maturity, and the discount is included in interest expense. Historically, the Group has experienced no losses on bills receivable.

Bill Receivable. In connection with the Company's financing transactions, the Group may also obtain bills receivable in exchange for cash or payables. These bills, which are sold at a discount prior to maturity, include provisions whereby the Group agrees to reimburse the accepting bank in the event that the related party counterparty fails to honor its liability to the accepting bank.

Bills Payable. Bills payable represent bills issued by an accepting bank in favor of the Group's suppliers. The Group's suppliers receive payments from the accepting bank directly upon maturity of the bills, and the Group is obliged to repay the face value of the bills to the accepting bank. Bills that are not remitted directly by the Group to its suppliers may be sold by the Group to other accepting banks for cash prior to their maturity. Discounts paid are recorded as a component of interest expense.

Revenue Recognition. The Group derives its revenue primarily from the sale of petrochemical products. In accordance with the provisions of the SEC Staff Accounting Bulletin No. 104, codified in FASB ASC Topic 480, revenue is recognized only when it is realized or realizable and earned. Revenues are considered to have been earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues. The Group recognizes revenue when the products are delivered and the customer takes ownership and assumes risks of losses, collection of the relevant receivable is probable, persuasive evidence of an arrangement exists and the sales price is fixed or determinable. Written sales agreements, which specify price, product, and quantity, are generally used as evidence of an arrangement. Customer acceptance is generally evidenced by a carrier signed shipment notification form.

In the PRC, value added tax ("VAT") of 17% on invoiced amounts is collected on behalf of the tax authorities. Revenue is recorded net of VAT. VAT paid for purchases, net of VAT collected from customers, is recorded in "other current assets" in the consolidated balance sheets.

Share-Based Compensation. The Group accounts for share-based payments under the provisions of FASB ASC Topic 718, "Compensation-Stock Compensation", or ASC Topic 718. Under ASC Topic 718, the Group measures the costs of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and recognizes the costs over the period the employee is required to provide service in exchange for the award, which generally is the vesting period.

The Group accounts for equity instruments issued to non-employee vendors in accordance with the provisions of FASB ASC Subtopic 505-50, "Equity-Based Payments to Non-Employees". All transactions in which goods or services are received in exchange for equity instruments are accounted for based on the fair value of the equity instrument issued. The measurement date for the fair value of the equity instruments issued is the date on which the counterparty's performance is completed.


Income Taxes. Income taxes are accounted for under the asset and liability method. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided to reduce the carrying amount of deferred income tax assets if it is considered more likely than not that some portion, or all, of the deferred income tax assets will not be realized.

The Group recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. The Group has elected to classify interest and penalties related to unrecognized tax benefits as part of income tax expense in the consolidated statements of operations.

Contingencies. In the normal course of business, the Group is subject to loss contingencies, such as legal proceedings and claims arising out of its business. An accrual for a loss contingency is recognized when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated.

Results of Operations

The following table and analysis sets forth information from our statements of operations for the years ended December 31, 2012 and 2011(amounts in thousands, except production and per metric ton amounts):

                                               For the Year Ended December 31                 Year to Year Comparison
                                                                                          Increase/            Percentage
                                                2012                    2011              (decrease)             Change
Sales
Third Parties                              $       750,628         $       533,913      $      216,715                40.59 %
Related Parties                                          -                  92,772             (92,772 )               (100 %)

Total Sales                                        750,628                 626,685             123,943                19.78 %

Cost of Sale
Third Parties                                      721,519                 504,872             216,647                42.91 %
Related Parties                                          -                  99,798             (99,798 )               (100 %)

Cost of Sales                                      721,519                 604,670             116,849                19.32 %

Gross Profit                                        29,109                  22,015               7,094                32.22 %

Operating Expenses
Selling Expenses                                     1,132                   1,240                (108 )              (8.71 %)
General and administrative Expenses                 12,510                  17,859              (5,349 )             (29.95 %)
Total Operating Expenses                            13,642                  19.099              (5,457 )             (28.57 %)

Income from Operations                              15,467                   2,916              12,551               430.42 %

Other Income(Expense)
Interest Income                                      5,940                   4,320               1,620                37.50 %
Interest Expense                                   (25,065 )               (15,797 )             9,268                58.67 %
Foreign Exchange gain, net                          (1,319 )                 3,662              (4,981 )               (136 %)
Liquidated damages expenses                              -                  (2,493 )            (2,493 )                100 %
Other income (expense), net                            (79 )                 3,103              (3,182 )             (97.45 %)
Total other expenses                               (20,523 )                (7,205 )            13,318               184.84 %

Loss before provision for income taxes              (5,056 )                (4,289 )               767                17.88 %
Income tax expense                                     794                   2,852              (2,058 )             (72.16 %)
Net loss                                            (5,850 )                (7,141 )            (1,291 )             (18.08 %)

Other comprehensive income
Foreign currency translation adjustment                945                   3,235              (2,290 )             (70.79 %)
. . .
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