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KEYP > SEC Filings for KEYP > Form 10-Q on 8-Jul-2014All Recent SEC Filings

Show all filings for KEYUAN PETROCHEMICALS, INC.

Form 10-Q for KEYUAN PETROCHEMICALS, INC.


8-Jul-2014

Quarterly Report


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 three months ended March 31, 2014 and 2013 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, 2013.

Overview

Operating through our wholly-owned subsidiaries, Ningbo Keyuan, Ningbo Keyuan Petrochemicals, 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 the 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 by the end of August 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 organization chart is as follows:

[[Image Removed]]

Our Facility and Equipment

Facility

As of March 31, 2014, we have invested a total of approximately $72.2 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 in late October 2013. At the date of this Report, we are in the process of preparation of the related documents for submitting to the local environmental department to get the approval and conduct its subsequent 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 in the middle of July, 2014. For the rest of approximately 16,000 MT of new storage capacity, we are planning to start the construction in October, 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.

Our Products

We manufacture and supply a variety of petrochemical products, including BenzeneToluene-Xylene Aromatics (BTX Aromatics), propylene, styrene, liquid petroleum gas (LPG), Methyl Tertiary Butyl Ether (MTBE), SBS and other petrochemicals, each of which is described below:

? 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.

? SBS: consisting of Styrene and butadiene, widely used for waterproofing building material, asphalt modification, furniture, shoe sole material, tubes, tape, auto parts and electrical applicances.


In order to improve our operational results and financial situation, we are adjusting our product portfolio to include Styrene-Ethylene-Butylene-Styrene ("SEBS") which we believe 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 have started trial production of monthly approximately 200 -300 MT per month since March, 2013, and will start bulk production when results of our lab analysis prove the condition of SEBS produced is suitable for sales.

Production Capacity and Expansion

Our annual designed manufacturing capacity is 720,000 MT of a variety of petrochemical products. Our SBS production facility is capable of producing up to 70,000 MT of SBS in full load condition without interruption (100% of utilization rate in ideal conditions). Additionally, 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.

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, in accordance with our annual plan of 63,000 MT of SBS, a 63% utilization rate in 2013; and generated approximately $78 million in sales and $5.6 million in profits. Although we planned to produce 63,000 MT of SBS for the fiscal year 2014, the production in the first quarter of 2014 was 5,127 MT and resulted in revenue of $6.2 million and a loss of $0.8 million. The loss was mainly due to the sales price of SBS products decreased from the $1,915 per MT in December 2013 to $1,731 per MT in March 2014. As a result, we decided to reduce the production of SBS until the market improves.


Breakdown of the total capability of 187,702 MT for main products for the three months ended March 31, 2014
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Other than the utilization rate for SBS facility discussed above, the utilization rates for our other facilities are as follows:

? styrene production: 99%;

? propylene: 82%;

? LPG: 98%;

? BTX Aromatic: 63%; and

? MTBE & others: 91%


Most of our facilities, except for the SBS facility, have been operating since 2009. Therefore, their current utilization rates for each product have been optimized to achieve stable output, less raw material cost and less equipment maintenance. While we are continuing working on existing equipment upgrades to achieve increased stabilized production, we realize that optimizing the utilization rates for our current facilities is not adequate to develop our business to meet increasing customer demands. More specifically, the increasing market demand in tire and auto parts has resulted in increasing market demand for styrene, ABS and Solution Polymerized Styrene Butadiene Rubber ("SSBR"); and higher requirements related to environmental protection imposed by the PRC government have led to higher demand for transformer oil and catalytic cracking oil. Based on these market trends, we have been focusing on the following improvements to our infrastructure to expand our manufacturing capacity:

a) an ABS production facility in Guangxi Province with an annual production capacity of 400,000 MT of ABS. We commenced facility construction in August 2013 and expect to finish the first phase of construction by the end 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 the purchase of raw materials, and improve the stability and efficiency of project production to 200,000 MT of heavy oil per year;

c) an increased annual design capacity of our ethylene-styrene facility from 80,000 MT to 200,000 MT, of which 120,000 MT can be used for producing synthetic materials and 80,000 MT can be sold to downstream petrochemical companies. 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. Construction of the main facility column was completed at the end of October 2013. We are currently in the stage of assembly and installation for the main facilities; and

e) an SSBR production facility with a designed capacity of 150,000 MT per year, using synthetic rubber, styrene and butadiene to produce SSBR by applying our process technology. SSBR can be used as raw material for tires, instead of imported hexakis (methoxymethy) melamine ("HMMM").

We acquired the approval for our catalytic oil processing facility and transformer oil plant from Ningbo local government on February 2013. The foundation piling work was completed in July 2013. As of the date of this Report, we have completed 96% of the construction of the main body of the facility and infrastructure. We expect to start trial operations at the end of July 2014, at which time we will be able to produce medical use and edible products such as tubes and chewing gum. As of March 31, 2014, the capital invested in the catalytic oil processing facility was $20.1 million.

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.


[[Image Removed]]

Capacity Breakdown after expansion projects (1,732,000 MT)

Our current estimate of our expansion schedule is as follows. However, we are continuing our evaluation of timelines for our expansion projects based on our financial situation and market condition.

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

Manufacturing and Sales

Our total production of finished products was 187,702 MT for the three months ended March 31, 2014, and we generated $202 million in revenue based on the sale of 185,538 MT of petrochemical products.


Results of Operations

The following table sets forth information from our statements of comprehensive
income (loss) for the three months ended March 31, 2014 and 2013.

Comparison of the three ended March 31, 2014 and 2013 (in thousands)

                                             For the three months            Year to Year Comparison
                                                Ended March 31,            Increase          Percentage
                                              2014           2013        /(Decrease)           change

Sales                                      $   201,894     $ 209,554     $     (7,660 )            (3.66 ) %

Cost of sales                                  194,751       200.732           (5,981 )            (2.98 ) %

Gross profit                                     7,143         8,822           (1,679 )           (19.03 )%

Operating expenses
Selling expenses                                   318           167              151               17.2 %
General and administrative expenses              3,482         2,970              512               13.8 %
Total operating expenses                         3,800         3,137              663               9.57 %

Income from operations                           3,343         5,685           (2,342 )            (41.2 ) %

Other income (expenses):
Interest income                                  2,791           751            2,040              271.2 %
Interest expense, net                           (4,968 )      (3,396 )          1,572             (46.29 ) %
Foreign exchange gain (loss), net               (2,445 )       1,553           (3,998 )             (972 )%
Non-operating income (expenses)                 (1,460 )        (380 )         (1,080 )           (257.4 ) %
Total other expenses                            (6,082 )      (1,472 )         (7,554 )           (513.2 )%

(Loss) income before income taxes               (2,739 )       4,213           (6,952 )             (165 ) %
Income tax expense                                   0         1,295           (1,295 )                - %
Net (loss) income                               (2,739 )       2,918           (5,657 )          (193.87 ) %
Other comprehensive income /(loss)
Foreign currency translation adjustment           (837 )         531           (1,368 )           (257.6 ) %
Comprehensive (Loss) income                $    (3,576 )       3,449           (7,025 )           (203.7 ) %

Sales: Our sales for the three months ended March 31, 2014 were approximately $201.9 million, compared to sales of $209.6 million for the three months ended March 31, 2014, a decrease of $7.7 million, or 3.66%. The reason for the decrease in our sales was because that the average sale prices decreased by 4.2%, even though our sale quantity increased by 1%, compared to the comparable period in 2013. During the three months ended March 31, 2014, we sold 185,538 metric tons of chemical products at an average price of $1,088 per metric ton, as compared to the sale of 184,581 metric tons of chemical products at an average price of $1,135 per metric ton during the comparable period in 2013.


Cost of Sales: Our overall cost of sales was approximately $194.8 million for the three months ended March 31, 2014, or 96% of sales, as compared to cost of sales of approximately $200.7 million, or 96% of sales for the three months ended March 31, 2013. Our cost of sales are primarily composed of the costs of direct raw materials (mainly heavy oil, benzene, butadiene and carbinol), labor, depreciation and amortization of manufacturing equipment and facilities, and other overhead. Although the market price of raw material decreased compared to the price in the comparable period in 2013, there is no significant change of the cost of sales because the fixed cost such as manufacturing, labor cost remained unchanged.

Energy required for production of our products consists of water, electricity and steam, the costs of which are attributed to cost of sales rather than operating expense. The supply prices of these energy sources in China have historically been very stable as a result of PRC government policy. Accordingly, the potential impact of changing energy costs to our production is minimal. Following are the costs for water, electricity and stream for the three months ended March 31, 2014 and 2013 (amounts in thousands):

For the Three Months Ended

                          March 31,
                  2014                2013
               (Unaudited)         (Unaudited)
Water                   319                 395
Electricity           2,362               3,268
Steam                   980                   -

Total energy cost was approximately $3,661 for the three months ended March 31, 2014, which constituted approximately 1.7% of sales. Total energy cost was approximately $4,159 for the three months ended March 31, 2013, which constituted approximately 2 % of sales.

Gross Profit: Gross profit for the three months ended March 31, 2014 was approximately $7.14 million as compared to $8.82 million for the comparable period in 2013, a decrease of approximately $1.68 million, or 19.03 %. The decrease was mainly due to the decreased sale price of our products compared to the sale price during the comparable period in 2013.

Operating Expenses: Operating expenses, including selling expenses, and general and administrative expenses, were approximately $3.8 million, or 1.9 % of sales for the three months ended March 31, 2014 as compared to $3.1 million, or 1.5 % of sales for the comparable period in 2013, an increase of approximately $0.7 million. The increase was due to increases in rents for warehouse space, accrued guarantee fees and increased R&D expenses caused by the application as a national high-tech enterprise for Ningbo Keyuan Synthetic Rubbers.

Interest Income/Expense (net): For the three months ended March 31, 2014, interest income and interest expense were approximately $2.8 million and $4.97 million, respectively; as compared to interest income and interest expense of approximately $0.75 million and $3.4 million, respectively, for the comparable period in 2013. The increase in interest income / expense was mainly due to the increased deposit for bank loans and increased bank loans.

Net Income/loss: Net loss was approximately $2.2 million for the three months ended March 31, 2014, as compared to net income of approximately $2.9 million in the same period in 2013, a decrease of $5.1 million, or 175.8%. This reason for the loss was mainly due to the decrease in sales and the increase in operating expenses and interest expenses compared to the same period in 2013.

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 loss and amounted to $0.8 million for the three months ended March 31, 2014. The balance sheet amounts, at March 31, 2014 and 2013, with the exception of equity, were translated at RMB6.16143 and RMB 6.27668 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 March 31, 2014 and 2013 were RMB 6.11546 and RMB 6.26566, 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 Three Months Ended
                                                        March 31,
                                                2014                2013
                                             (Unaudited)         (Unaudited)
Net cash used in operating activities               4,544              67,118
Net cash used in investing activities               9,604              11,382
Net cash provided by financing activities          16,237              75,027

Net cash used in operating activities was approximately $4.5 million for the three months ended March 31, 2014, as compared to approximately $67.1 million for the same period in 2013. The decrease was primarily due to the consumption tax refund that was collected as of March 31, 2014.

Net cash used in investing activities was approximately $9.6 million and $11.4 million for the three months ended March 31, 2014 and 2013, respectively. Net cash used in investing activities was primarily focused on payments for the infrastructure construction and the expansion of our facilities. Net cash used in investing activities decreased because we had less investment paymens in our infrastructure construction and facility expansion during the three months ended March 31, 2014 compared to the same period in 2013.

Net cash provided by financing activities amounted to approximately $16.2 million for the three months ended March 31, 2014. Net cash provided by financing activities amounted to approximately $75 million for the same period in 2013. The reason for the decrease was mainly due to the higher repayment of borrowings in the period. For the three months ended March 31, 2013, the net cash provided by financing activities was primarily through the short-term bank borrowings.

Consumption Tax Refund

As of March 31, 2014 and December 31, 2013, we recorded an estimated consumption tax recoverable amounting to approximately $18.8 million and $46.1 million, respectively. In May 2014, a refund of approximately $12.1 million was received. In addition, management expects approximately $0.4 million of consumption tax to be refunded in September 2014, and approximately $6.3 million will be deductible against future consumption tax obligations.


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 July 3,2014, we had an aggregate principal amount of approximately $584 million in bank loans outstanding under the loan agreements, with maturity dates from June 2014 to July 2015 and interest rates from 1% to 6.72% per annum.

Before we enter into loan agreements with a lender, the lender will approve a comprehensive credit line which is the maximum amount of the loans we can obtain from the lender within a certain time period. The comprehensive credit line is usually secured by one or more third party guaranties or liens on our property and equipment, or a security deposit. Once the comprehensive credit line is approved, we will enter into an individual loan agreement with the lender each time we obtain a loan from the lender under the credit line. Therefore, we typically have multiple loan agreements under one comprehensive credit line with one lender as long as the credit limit has not been reached. Though different lenders have different forms for loan agreements, loan agreements usually . . .

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