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KEYP > SEC Filings for KEYP > Form 10-K on 22-May-2014All Recent SEC Filings

Show all filings for KEYUAN PETROCHEMICALS, INC.

Form 10-K for KEYUAN PETROCHEMICALS, INC.


22-May-2014

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) a Styrene-Butadience-Styrene (the "SBS") production facility with a designed annual production capacity of 70,000 MT, (iii) facilities for the storage and loading of raw materials and finished goods and (iv) 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 January 2012, we signed a cooperation agreement with Fangchenggang City to build a new petrochemicals production facility for Guangxi Project. According to the cooperation agreement, the government of Fangchenggang City is responsible for providing the land use rights for the facility. 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. In August, 2013, we commenced engineering and facility construction. We are currently in the process of land leveling which is expected to be completed in the second quarter of 2014. According to the current schedule, construction of facilities and installation of pipe lines will be complete by the end of 2014. However, our schedule is subject to further adjustment pending the status of financing. The total investment amount to construct this new production facility is approximately USD $300 million. 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.

Our Facility and Equipment

Facility

As of December 31, 2013, we have invested a total of approximately $62.6 million in the construction and improvement of our production facility. Our current production facility encompasses approximately 1.3 million square feet, including 594,000 square feet for production and 19,500 square feet for laboratories and offices. We also acquired the land use right of an additional 1.2 million square feet of land in August 2010 for our expansion.

We have a total of 100,000 MT of storage capacity, consisting of 50,000MT of storage capacity for raw materials and 50,000 MT for finished products. As a part of our expansion plan, we intend to add 50,000 MT of new storage capacity in 2014, after which our total storage capacity will be 150,000 MT. We completed construction of two new tanks with approximately 34,000 MT of storage capacity in June 2013 and the installation of pilings and pumps was completed at the end of October 2013. At the date of this Report, we are waiting for the local environmental department to conduct its inspection. Once we obtain the approval from the local environmental department, the two storage tanks can become operational. We expect that the operation will commence by the end of May, 2014. For the rest of approximately 16,000 MT of new storage capacity, we are planning to start the construction in June, 2014 and expect to complete the work at the end of September, 2015.


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. During the first three months of 2014, we started the application to the local government in Ningbo to upgrade the classification of our own dock so that we can unload foreign cargo vessels under the 50,000 MT cargo capacity to our dock directly. We expect that the upgrading will be completed by the end of 2016 and we will be able to save additional logistics costs and storage fees once it is completed.

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.

Expansion Plan

As a part of our expansion plan, we intend to add 50,000 MT of new storage capacity in 2014, after which our total storage capacity will be 150,000 MT. We finished construction of two new tanks in the second quarter of 2013 and installation of piling and pumps in the fourth quarter of 2013. We are currently waiting for the local environmental department to conduct inspection and we expect to obtain its approval for operation in late May, 2014. For the rest of approximately 16,000 MT of new storage capacity, we are planning to start the construction in June, 2014 and expect to complete the work at the end of September, 2015.

Our SBS facility was completed in September 2011 as a part of our expansion plan. It currently has two production lines in commercial production. SBS has a higher product margin compared to other petrochemical products we are producing and a wide range of applications in the footwear, adhesive, polymer modification and modified asphalt industries. Our SBS facility achieved a 41% utilization rate in 2012, the first full year of production, and generated approximately $71 million in sales and $5.9 million in profits. We achieved a 63% utilization rate in 2013 annual production plan of 63,000 MT of; and generated approximately $78 million in sales and $5.6 million in profits.

We expect to generate net profit margins of 10% from our production of SBS once the facility reaches normal production levels, which means the actual production volume exceeds 80% of the design capacity. However, market conditions, the volatility of feedstock and SBS product prices can significantly impact the estimated profitability and we cannot guarantee that our SBS production will achieve 80% or more of the designed capacity in the future.


We acquired the approval to start our catalytic oil processing facility and transformer oil plant with the Ningbo local government in February 2013. The foundation piling work was completed in July 2013 and as of the date of this filing we have completed 95% of the construction of the main body of the facility and infrastructure. We expect to start trial operation in late May, 2014, at which time we will be able to produce medical use and edible products such as tubes and chewing gum. As of December 31, 2013, the amounts invested for the catalytic oil processing facility was $15.9 million USD.

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:

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

Expansion Project                   Expected Completion Date
Oil Catalytic Processing Facility       End of Q4, 2014
Ethylene-Styrene Facility               End of Q2, 2015
Transformer Oil Facility                End of Q3, 2014
SSBR production facility                End of Q4, 2015
ABS Production Facility                 End of Q4, 2016
New storage capacity of 50,000 MT       End of Q3, 2015

The total estimated cost of our expansion plan is approximately $491.8 million, including $300 million for Guangxi Project, $19.8 million for the catalytic cracking processing equipment, $30 million for transformer oil facility and $99.5 million for the SSBR production facility, $40 million for the increased annual design capacity of ethylene- styrene, and $2.5 million for additional storage capacity. Upon full completion of our expansion, our total production capacity will reach 1,723,000 MT per year including, but not limited to, our current petrochemical production of 720,000 MT, styrene of 200,000 MT, catalytic cracking oil of 200,000 MT, ABS of 400,000 MT, SSBR of 150,000 MT and transformer oil of 100,000 MT. The following chart depicts the breakdown of our planned production capacity of 1,723,000 MT.

Going concern and management's plans

For the year ended December 31, 2013, we reported net income of approximately $4.6 million and cash flow used in operations of approximately $53 million. At December, 31, 2013, we had a working capital deficit of approximately $209.7 million.

The Report of the Independent Registered Public Accounting Firm on our consolidated financial statements as of and for the year ended December 31, 2013 includes a going concern explanatory paragraph which means that the accounting firm has expressed substantial doubt about the Company's ability to continue as a going concern.

Although the Company continues to finance its operations primarily through short-term bank borrowings, management's realignment of product profiles, along with the general stabilization of the petrochemical industry in China resulted in a net income of $ 4.6 million in 2013 compared to a net loss of $5.8 million in 2012.

Short-term bank borrowings and bills payable amounted to approximately $686 million at December 31, 2013. Management expects that short-term bank financing will continue to be available through at least December 31, 2014. Furthermore, as management expects that the petrochemical industry in China will continues to stabilize and that demand for downstream products (such as auto, home appliances and dyes) grow following several years of contraction, as such Management expects that the company's overall profits will also grow.

As reported in our financial statements for the years ended December 31, 2013 and 2012, we continue to benefit from favorable PRC tax policies related to consumption tax. As of December 31, 2013, we had a consumption tax refund receivable of approximately $46.1 million. In April 2014, approximately $36.1 million was refunded and management expects that additional consumption tax deposits of approximately $0.4 million will be refunded in May 2014, and that approximately $9.6 million will be deductible against future consumption tax obligations.


In order to improve our operational results and financial situation, we are adjusting our product portfolio to include SEBS which will yield a higher gross margin than some of our current products. SEBS is a product similar to SBS but with more durable product feature, and can be produced by our current SBS facility. In order to achieve a stable production value, we started trial production of 200 MT per month from March 2013, and will start bulk production when the result of our lab analysis shows the condition of SEBS produced is suitable for sale. In addition, since late 2013, our industry has been steadily developing after a period of depression. We believe that the undertaking of our expansion plan ensures a sustainable and long-term growth. We are also exploring sources of additional financing, including short-term financing from our vendors and other parties. In addition, we are closely monitoring cash balances, cash needs and expense levels.

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

Our ability to continue as a going concern is dependent upon management's ability to implement our 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 us, if at all.

Manufacturing and Sales

Our total production of finished products during the 12 months ended December 31, 2013 was 568,939 MT and revenue totaled $647 million, based on the sale of 566,916 MT of petrochemical products including 36,959 MT of SBS products. Our total production of finished products for fiscal year 2012 was 688,821 MT and revenue totaled $751 million from the sale of 675,484 MT of petrochemical products. The decrease in total production of finished products and revenues in 2013 was mainly due to 41 days of production suspension

During the second quarter of 2013, we conducted routine maintenance of our entire production facilities and suspended production for 41 days. This routine maintenance is standard and necessary in the petrochemical production industry and is undertaken every two years, depending on the condition of the facilities. As a result of the suspension, our total production was decreased by approximately 98,000 MT and revenue was decreased by approximately $110 million.

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, 2013 and 2012.


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 20 years
Vehicles                       5 years

Office equipment and furniture 3 to 10 years

During January 2013, management performed an assessment of the useful lives of certain machinery and equipment. In evaluating the useful lives, management considered the historical life of the assets, operational strategy, and related functionality. Management concluded that machinery and equipment would remain in service longer than the depreciable life assigned. Effective February 1, 2013, the Group changed the time period over which it depreciates machinery and equipment to 20 years from 15 years. Management believes that this change more clearly and appropriately reflects the state of the machinery and equipment and thus, more reasonably and accurately reports the value of the machinery and equipment on the balance sheet. This change is being accounted for as a change in estimate. This change in estimate resulted in a reduction of depreciation expense of approximately $3.1 million or approximately $0.05 per share for the year ended December, 2013.

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.

Bills 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, 2013 and 2012 (amounts in thousands, except production and per metric ton amounts):

                                              For the Year Ended December 31             Year to Year Comparison
                                                                                       Increase/          Percentage
                                                2013                  2012             (decrease)           Change
Sales
Third Parties                              $       646,549       $       750,628     $     (104,079 )           (13.9 %)
Related Parties                                          -

Total Sales                                        646,549               750,628           (104,079 )           (13.9 %)

Cost of Sale
Third Parties                                      620,040               721,519           (101,479 )           (14.1 %)
Related Parties                                          -

Cost of Sales                                      620,040               721,519           (101,479 )           (14.1 %)

Gross Profit                                        26,509                29,109             (2,600 )            (8.9 %)

Operating Expenses
Selling Expenses                                     1,563                 1,132                431              38.1 %
General and administrative Expenses                 14,736                12,510              2,226              17.8 %
Total Operating Expenses                            16,299                13,642              2,657              19.5 %

Income from Operations                              10,210                15,467             (5,257 )             (34 %)

Other Income(Expense)
Interest Income                                      8,422                 5,940              2,482              41.8 %
Interest Expense                                   (18,809 )             (25,065 )            6,256               (25 %)
Foreign Exchange gain, net                          10,118                (1,319 )           11,437             867.1 %
Liquidated damages expenses                              -
Other income (expense), net                         (1,833 )                 (79 )           (1,754 )          2220.3 %
Total other expenses                                (2,102 )             (20,523 )           18,421             (89.8 %)

Loss before provision for income taxes               8,108                (5,056 )           13,164             260.4 %
Income tax expense                                   3,476                   794              2,682             337.8 %
Net Income                                           4,632                (5,850 )           10,482             179.2 %

Other comprehensive income
Foreign currency translation adjustment              2,754                   945              1,809             191.4 %
. . .
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