ITEM 1. BUSINESS
GENERAL OVERVIEW
(a) Nature of business
We, through our PRC operating subsidiaries, Ningbo Keyuan Plastics Co., Ltd. (“Ningbo Keyuan”), Ningbo Keyuan Petrochemicals Co., Ltd (“Ningbo Keyuan Petrochmicals”), Keyuan Synthetic Rubbers Co., Ltd (“Keyuan Synthetic Rubbers”) and Guangxi Keyuan Co.,Ltd (“Guangxi Keyuan”) , are engaged in the manufacture and sale of petrochemical products in the PRC. 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.
Due to China’s growing demand for refined petrochemical products, we expanded our annual production capacity from 550,000 MT to 720,000 MT in April 2011. 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 began initial trial production in October and November 2011. One SBS production line began commercial production in December 2011 and the second line began commercial production in August, 2012.
In January 2012, we signed a cooperation agreement with Fangchenggang City to build a new petrochemicals production facility, Guangxi Keyuan New Materials Industrial Park, in Guangxi Province (the "Guangxi Project"). Once the facility is fully operational, it is expected to have annual production capacity of 400,000 metric tons of Acrylonitrile Butadiene Styrene (the "ABS") and related products. As the date of this filing, we have been focused on the complex pre-construction government approval work and on research to improve the efficiency of the production of Guangxi Project since the signing of the agreement.
(b) Organization
Keyuan Petrochemicals, Inc. (“Company” or “the Company”, formerly known as “Silver Pearl Enterprises, Inc.”, together with its subsidiaries, herein referred to as “we” “us” and “our”) was incorporated in the State of Texas on May 4, 2004.
On April 22, 2010, the Company entered into a share exchange agreement (the “Exchange Agreement”) with Keyuan International Group Limited (“Keyuan International”), a privately held investment holding company organized on June 11, 2009 under the laws of the British Virgin Islands, Delight Reward Limited (“Delight Reward”), the sole stockholder of Keyuan International and Denise D. Smith (“Smith”), the Company’s former principal stockholder. Pursuant to the terms of the Exchange Agreement, Delight Reward transferred to the Company all of its shares of Keyuan International in exchange for 47,658 shares of the Company’s Series M convertible preferred stock (the “Share Exchange”). On an “as converted” basis, the Series M convertible preferred stock represented approximately 95% of the Company’s outstanding common stock right after the Share Exchange. The Series M convertible preferred stock voted with the common stock on an “as converted basis” and was converted into 47,658,000 shares of the Company’s common stock on December 28, 2010.
As a result of the Share Exchange, Keyuan International became a wholly-owned subsidiary of the Company and Delight Reward became the controlling stockholder of the Company. The Share Exchange was accounted for as a reverse acquisition and recapitalization whereby Keyuan International is deemed to be the accounting acquirer (and the legal acquire). The common stock of the Company continues post the Share Exchange, while the retained deficit of the Company was eliminated as the historical operations are deemed to be those of Keyuan International.
On May 12, 2010, the Company formed a corporation under the laws of the State of Nevada called Keyuan Petrochemicals, Inc. and on the same day, acquired 100% of the entity’s stock for cash. As such, the entity became the Company’s wholly-owned subsidiary (the “Merger Subsidiary”).
Effective as of May 17, 2010, the Merger Subsidiary was merged with and into the Company. As a result of the merger, the Company’s name was changed to “Keyuan Petrochemicals, Inc.”. Prior to the merger, the Merger Subsidiary had no liabilities and nominal assets and, as a result of the merger, the separate existence of the merger subsidiary ceased. The Company is the surviving corporation in the merger and, except for the name change, there was no change in the Company’s directors, officers, capital structure or business.
On August 8, 2010, Keyuan Group Limited (“Keyuan HK”) established a wholly owned subsidiary in the People’s Republic of China (“PRC”), Ningbo Keyuan Petrochemicals, which is engaged in the sale of petrochemical products in the PRC.
On April 4, 2012, Guangxi Keyuan was incorporated by Ningbo Keyuan (75% ownership) and Keyuan HK (25% ownership) in Guangxi province, PRC, as a Sino-Foreign joint venture subsidiary, for the purpose of developing the Guangxi Project.
On June 15, 2012, Ningbo Keyuan Synthetic Rubbers was estiablished as a wholly-owned PRC subsidiary of Ningbo Keyuan to engage in the sales and marketing of various petrochemical products, specifically synthetic rubbers.
On October 15, 2012, Keyuan International Group Limited changed its name to Sinotech Group Limited.
(c) History of Keyuan International before the Share Exchange
Immediately prior to the date of the Share Exchange, the Company was a shell company with no operations and a nominal amount of cash, and Keyuan International, through Keyuan Group Limited (“Keyuan HK”) and its indirect subsidiary, Ningbo Keyuan, was engaged in the manufacturing and sale of petrochemical products.
Keyuan HK was established in Hong Kong in 2009, and is a holding company with no significant assets or operations. On April 26, 2007, Ningbo Keyuan was established as a wholly foreign owned enterprise in Ningbo, PRC by Hong Kong Keyuan PEC Investment Holdings Limited (“Hong Kong Keyuan”, 51%), Hong Kong Development Enterprise Co., Limited (“Hong Kong Development”, 26%) and Wayes International Trading Limited (“Wayes International”, 23%). Hong Kong Keyuan was controlled by Mr. Chunfeng Tao, Hong Kong Development was controlled by Mr. Jicun Wang and Wayes International was controlled by Mr. Peijun Chen. Ningbo Keyuan had an original registered capital of USD $12,000,000. The Ningbo Foreign Trade & Economic Cooperation Bureau approved Ningbo Keyuan’s increase in its registered capital from USD$12,000,000 to USD$20,400,000 on February 27, 2009. The registered capital of Ningbo Keyuan was then increased from USD $20,400,000 to USD$50,400,000 and a new Certificate of Approval was issued by the Ningbo Foreign Trade & Economic Cooperation Bureau on March 22, 2010.
On April 1, 2008 Ningbo Litong Petrochemical (“Ningbo Litong”) acquired 12.75% of the shares of Ningbo Keyuan from Hong Kong Keyuan on behalf of Mr. Chunfeng Tao. On November 25, 2008 Ningbo Kewei Investments Co., Limited (“Ningbo Kewei”), a company controlled by Mr. Tao acquired 12.75% of Ningbo Keyuan from Ningbo Litong. On June 24, 2009, Ningbo Kewei acquired 15.75% of Ningbo Keyuan from Hong Kong Keyuan through a capital increase. On July 17, 2009, Hong Kong Keyuan acquired 28.5% shares from Ningbo Kewei. Through these transactions Mr. Tao’s 51% ownership of Ningbo Keyuan remained unchanged.
In 2009, Apex Smart Limited, Best Castle Investments Limited, Chance Brilliant Holdings Limited, Delight Reward Limited and Keyuan International Group Limited were established in the British Virgin Island (BVI) and Keyuan HK was established in Hong Kong. Delight Reward Limited holds 100% of the equity interests of Keyuan International Group Limited which holds 100% of the equity interests of Keyuan HK. Delight Reward Limited is owned by:
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Apex Smart Limited (45.6132%), which was 100% held by Stewart Shiang Lor, subsequently by Mr. Brian Pak-Lun Mok and subsequently by Mr. Chunfeng Tao.
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Best Castle Investments Limited (23.2523%), which was 100% held by Mr. O. Wing Po and subsequently by Mr. Jicun Wang.
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Chance Brilliant Holdings Limited (20.5694%), which was 100% held by Mr. Lo Kan Kwan and subsequently by Mr. Peijun Chen.
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Harvest Point Limited (5.3896%), which was 100% held by Mr. Brian Pak-Lun Mok and subsequently by Ms. Muxia Duan.
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Strategic Synergy Limited (5.1755%), which was 100% held by Mr. Brian Pak-Lun Mok and subsequently Mr. Mok transfered one third of the ownership to Mr. Xin Yue
On November 16, 2009 Keyuan HK acquired 100% of Ningbo Keyuan from Hong Kong Keyuan, HongKong Development and Wayes International. Mr. Brian Pak-Lun Mok, Mr. O. Wing Po and Mr. Lo Kan Kwan also agreed to support Mr. Chunfeng Tao, Mr. Jicun Wang and Mr. Peijun Chen respectively to retain their controls in Delight Reward Limited and its subsidiaries. The reorganization is considered as restructuring under common control and Mr. Chunfeng Tao, Mr. Jicun Wang and Mr. Peijun Chen remained as the controlling parties.
On April 2, 2010, Mr. Brian Pak-Lun Mok, Mr. O. Wing Po, and Mr. Lo Kan Kwan, who indirectly held 100% of the equity interest in Delight Reward Limited, entered into certain share transfer agreements with Mr. Chunfeng Tao, Mr. Jicun Wang, Mr. Peijun Chen and Mr. Xin Yue, pursuant to which each of these persons agreed to transfer all of its interests in Apex Smart Limited, Best Castle Investments Limited and Chance Brilliant Holdings Limited, Harvest Point Limited and Strategic Synergy Limited (collectively the “BVI Holding Companies”), to Mr. Chunfeng Tao, Mr. Jicun Wang, Mr. Peijun Chen and Mr. Xin Yue respectively, subject to achievement of certain performance targets of Ningbo Keyuan. The performance targets are the Company achieving: at least $39 million of gross revenue for the three months commencing from July 2010 to September 2010; at least $40 million of gross revenue for the three months commencing from October 2010 to December 2010; and, at least $41 million of gross revenue for the three months commencing from January 2011 to March 2011.
Pursuant to the share transfer agreements, (i) Mr. Brian Pak-Lun Mok granted Mr.Chunfeng Tao an option to acquire 100% of the equity of Apex Smart Limited in three installments provided that certain performance targets are met; (ii) Mr. O. Wing Po granted Mr. Jicun Wang an option to acquire 100% of the Best Castle Investments Limited in three installments provided that certain performance targets are met; (iii) Mr. Lo Kan Kwan granted Mr. Peijun Chen an option to acquire 100% of the equity of Chance Brilliant Holdings Limited in three installments provided that certain performance targets are met; (iv) Mr. Brian Pak-Lun Mok granted Mr. Xin Yue an option to acquire 100% of the equity of Harvest Point Limited in three installments provided that certain performance targets are met; and (v) Mr. Brian Pak-Lun Mok granted Mr. Xin Yue an option to acquire 100% of the equity of Strategic Synergy Limited in three installments provided the performance targets are met (the share transfer agreements are herein referred as “Slow Walk Agreement(s)” or “Slow Walk”. Options are herein sometimes referred as “Slow Walk Option(s)”).
(d) Current Shareholding Structure of the Company
On November 4, 2010, the Company exercised its conversion rights under the terms of the Series A Preferred Stock to convert all of outstanding shares of its Series A 6% Cumulative Convertible Preferred Stock into a total of 6,132,032 shares of Common Stock, $0.001 par value per share. As a result, following the conversion, all 6,132,032 shares of Series A Preferred Stock that had been outstanding were cancelled and were automatically converted, without any delivery of conversion notice required on the part of the holders of Series A preferred stock.
On November 15, 2010, one-third of the Slow Walk Options were exercised after the first performance target was met.
On December 28, 2010, the Company exercised its mandatory conversion rights under the terms of the Series M preferred stock to convert all of outstanding shares of its Series M preferred stock into a total of 47,658,000 shares of Common Stock, $0.001 par value per share, all of which are held by Delight Reward Limited.
On April 29, 2011, Harvest Point Limited transferred 1,028 shares of Delight Reward Limited’s stock to Strategic Synergy Limited, changing their ownership of Delight Reward Limited’s stock to 3.334% and 7.232% respectively. On the same day, Mr. Brian Pak-Lun Mok and Mr. Xin Yue transferred 33,333 shares and 16,667 shares of Harvest Point Limited, respectively, to Ms. Muxia Duan thus transferred 100% ownership of Harvest Point Limited to Ms. Muxia Duan.
After the second and third performance targets were met, Mr. Peijun Chen and Mr. Jicun Wang exercised their remaining two-thirds of the Slow Walk Options on February 15, 2012. Mr. Chunfeng Tao exercised his remaining two-thirds of the Slow Walk Options on November 15, 2012.
On April 8, 2012, Strategic Synergy Limited transferred 105 shares of Delight Reward shares to Happyvale Limited. On October 23, 2012, Delight Reward repurchased 105 shares of Delight Reward shares from Happyvale Limited in a consideration of 100,000 shares of common stock of the Company.
On March 25, 2013, Best Castle Investments Limited transferred 11,626 shares of Delight Reward Limited to Apex Smart Limited, increasing Apex Smart Limited’s ownership of Delight Reward Limited from 45.6132% to 68.864%.
As a result, the shareholding structure following the restructuring is as follows:
(e) Independent Investigation and Nasdaq Delisting Decision
During the process of preparing the Company’s Annual Report on Form 10-K for the year ending December 31, 2010, on or about March 24, 2011, KPMG, the Company’s former independent auditor, raised certain issues primarily relating to unexplained issues regarding certain cash transactions and recorded sales and requested that the Audit Committee conduct an independent investigation. Based on the issues raised by KPMG, on March 31, 2011, our Audit Committee elected to commence an independent investigation of the issues raised and engaged the services of independent counsel, Pillsbury Winthrop Shaw Pittman LLP (“Pillsbury”), which in turn engaged Deloitte Financial Advisory Services LLP (“Deloitte”), as independent forensic accountants, and King & Wood, as Audit Committee counsel in the People’s Republic of China (Pillsbury, Deloitte and King & Wood are collectively referred herein as “Investigation Team”).
On September 28, 2011, the Investigation Team completed the investigation. On October 3, 2011, the Company provided the Nasdaq Hearings Panel with a copy of the final investigation report along with a comprehensive list of remedial actions the Company has taken and is committed to taking to remediate the accounting and internal control issues. On October 5, 2011, the Company was notified that the Nasdaq Hearings Panel exercised its discretionary authority pursuant to NASDAQ Listing Rule 5101 to delist the Company’s securities from the Nasdaq Stock Market. As a result, the Company’s shares resumed trading in the pink sheets under the ticker symbol KEYP.PK beginning October 7, 2011. The Company’s common stock is currently traded on the Over-the-Counter Bulletin Board under the symbol KEYP.
(f) SEC Settlement
The Company has reached a settlement in a case filed by the Securities and Exchange Commission (“SEC”) on February 28, 2013 in the United States District Count for the District of Columbia against the Company, alleging the Company violated Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933, Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934, and Rules 12b-20 and 13a-13 thereunder. Under the terms agreed to by the Company and the SEC, the Company, without admitting or denying the allegation of the complaint, will pay a civil penalty of $1million and will be permanently enjoined from violating certain securities law. The settlement remains subject to approval by the United District Court for the District of Columbia, which must approve its terms and enter the final judgment. As the date of this filing, the United District Court for the District of Columbia has not approved the settlement yet.
(g) FINANCINGS
April - May 2010 Private Placement
Following the Share Exchange, we entered into a securities purchase agreement with 122 accredited investors for the issuance and sale of 748,704 Units at a purchase price of $35 per unit, for aggregate gross proceeds of approximately $26,204,640 consisting of, in the aggregate, (a) 6,738,336 shares of Series A convertible preferred stock, par value $0.001 per share convertible into the same number of shares of Common Stock, (b) 748,704 shares of Common Stock, (c) three-year Series A Warrants to purchase up to 748,704 shares of Common Stock, at an exercise price of $4.50 per, and (d) three-year Series B Warrants to purchase up to 748,704 shares of Common Stock, at an exercise price of $5.25 per share (the “April-May 2010 Private Placement”).
In connection with the April-May 2010 Private Placement, we also entered into a registration rights agreement with the investors, in which we agreed to file a registration statement with the SEC to register for resale of the Common Stock, the Common Stock issuable upon conversion of the Series A Preferred Stock, the Series A Warrant Shares and the Series B Warrant Shares issued in the financing, within 30 calendar days of April 22, 2010 and to have such registration statement declared effective within 150 calendar days of April 22, 2010 or within 180 calendar days of April 22, 2010 in the event of a full review of the registration statement by the SEC. If we can not comply with the foregoing obligations under the registration rights agreement, we will be required to pay liquidated damages in cash to each investor, at the rate of 1% of the applicable subscription amount for each 30 day period in which we are not in compliance; provided, that such liquidated damages will be capped at 10% of the subscription amount of each investor and will not apply to any registrable securities that may be sold pursuant to Rule 144 under the Securities Act if all of the conditions in Rule 144(i)(2) are satisfied at the time of the proposed sale, or are subject to an SEC comment with respect to Rule 415 promulgated under the Securities Act.
Accordingly, we filed a registration statement on Form S-1 in connection with the April-May 2010 private placement transaction. Amendment No. 4 to such Form S-1 which we filed on October 15, 2010 was declared effective on October 19, 2010. However, because of the delinquency of the Company’s annual report on Form 10-K for fiscal year ended December 31, 2010 and interim reports on Form 10-Q for three months ended March 31, 2011 and June 30, 2011 respectively, as of April 10, 2012, the Amendment No. 4 to such Form S-1 is no longer effective. As a result, we began to accrue penalties pursuant to the terms of the registration rights agreement from April, 2011 to November 1, 2011, the period that the registerable securities were not able to be sold pursuant to Rule 144 under the Securities Act.
Pursuant to the terms of the securities purchase agreement and the terms of the Certificate of Designation of Series A preferred stock, we exercised our conversion rights to convert all of the outstanding Series A preferred stock into a total of 6,132,032 shares of Common Stock. As a result of the conversation, since November 4, 2010, we have no longer incurred the Series A dividends, payable quarterly, at the rate of 6% per annum for each outstanding share.
September 2010 Private Placement
On September 28, 2010, we closed an offering for $20,250,000 consisting of a total of 540,001 units at a purchase price of $37.50 per unit, each unit consisting of, (a) ten (10) shares of Series B convertible preferred stock of the Company, (b) one and a half (1.5) three year Series C warrants to purchase one and a half (1.5) shares of Common Stock, at an exercise price of $4.50 per share, and (c) one and a half (1.5) three year Series D warrants to purchase one and a half (1.5 ) shares of Common Stock, at an exercise price of $5.25 per share (the “ September 2010 Private Placement”) in reliance upon the exemption from securities registration afforded by Regulation S as promulgated under the Securities Act of 1933.
In connection with the September 2010 Private Placement, we also entered into a Registration Rights Agreement with the investors, in which we agreed to file a registration statement with the Commission to register for resale the Common Stock issuable upon conversion of the Series B Preferred Stock, the Series C Warrant Shares and the Series D Warrant Shares, within 30 calendar days of October 19, 2010 and to have the registration statement declared effective within 150 calendar days of October 19, 2010 or within 180 calendar days of October 19, 2010 in the event of a full review of the registration statement by the Commission. If we do not comply with the foregoing obligations under the registration rights agreement, we will be required to pay cash liquidated damages to each Series B Investor, at the rate of 1% of the applicable subscription amount for each 30 day period in which the Company is not in compliance; provided, that such liquidated damages will be capped at 10% of the subscription amount of each investor and will not apply to any registrable securities that may be sold pursuant to Rule 144 under the Securities Act if all of the conditions in Rule 144(i)(2) are satisfied at the time of the proposed sale, or are subject to an SEC comment with respect to Rule 415 promulgated under the Securities Act.
Accordingly, we filed a registration statement on Form S-1 in connection with the September 2010 private placement transaction. Amendment No. 2 to such Form S-1 which we filed on January 14, 2011 was declared effective on January 19, 2011. However, because of the delinquency of the Company’s annual report on Form 10-K for fiscal year ended December 31, 2010 and interim reports on Form 10-Q for three months ended March 31, 2011 and June 30, 2011 respective, as of April 10, 2012, Amendment No. 2 to such Form S-1 is no longer effective. As a result, we began to accrue penalties pursuant to; the terms of the registration rights agreement from April 2011to November 2011, the period that the registerable securitiess were not able to be sold pursuant to Rule 144 under the Securities Act.
(h) Mandatory Conversion of Series A Preferred Stock and Series M Preferred Stock
On November 4, 2010, we exercised our mandatory conversion rights under the terms of the Series A Preferred Stock to convert all of outstanding shares of its Series A 6% Cumulative Convertible Preferred Stock into a total of 6,132,032 shares of Common Stock. As a result, following the conversion, all 6,132,032 shares of Series A Preferred Stock that had been outstanding were cancelled and automatically converted, without any delivery of conversion notice required on the part of the holders of Series A Preferred Stock. Dividends on the Series A Preferred Stock accrued through November 3, 2010 and amounted to approximately $143,000 and were paid to the holders of Series A Preferred Stock on the regularly scheduled payment date of January 31, 2011.
As a result of foregoing, as of November 4, 2010, we longer incurred the Series A Dividend that was payable quarterly, at the rate of 6% per annum for each outstanding share, payable in cash or common stock dividends, as applicable.
On December 28, 2010, we exercised our mandatory conversion rights under the terms of the Series M preferred stock to convert all of the outstanding shares of the Series M preferred stock into a total of 47,658,000 shares of Common Stock, $0.001 par value per share. As a result, following the conversion, all 47,658 shares of Series M preferred stock that had been outstanding were cancelled and were automatically converted, without any delivery of conversion notice required on the part of the holders of Series M Preferred Stock.
(i) Stock Repurchase Program
On September 17, 2012, our Board of Directors authorized the repurchase of $2 million of the Company’s stock for up to $1.50 per share. On December 31, 2012, the Company engaged TriPoint Global Equities LLC (“TriPoint Global”) as its agent to design and execute the stock repurchase program, that complies with the requirements of Rule 10b5-1(c)(1) and Rule 10b-18 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As of March 31, 2013, the Company has purchased 117,554 shares of common stock through the stock repurchase program. On April 17, 2013, in connection with the delay in filing our Annual Report on Form 10-K for the year ended December 31, 2012, we decided to temporarily suspend the stock repurchase program until we file all periodic reports required under Section 13 or 15(d) of the Securities Exchange Act of 1934.
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), Styrene butadiene styrene (SBS), and other petrochemicals, each of which is described below:
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BTX Aromatics: consists of benzene, toluene, xylene and other chemical components used for further processing into plastics, gasoline and solvent materials widely used in paint, ink, construction coating and pesticide;
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Propylene: a chemical intermediate which is 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;
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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 other products;
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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; and
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MTBE & Other Chemicals: MTBE, oil slurry, sulphur and others which are used for a variety of applications including fuel components, refrigeration systems, fertilizers, insecticides and fungicides.
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Styrene butadiene styrene (SBS): a thermoplastic elastomer with features similar to rubber, widely used in the manufacture of resin, shoes, tape, tubes and asphalt.
Production Capacity and Expansion
Our annual designed manufacturing capacity was 550,000 metric tons of a variety of petrochemical products at the end of 2010. We upgraded the catalytic pyrolysis processing equipment used in production facilities to expand the capacity from 550,000 MT to 720,000 MT. This capacity expansion project started in March 2011 and was completed in April 2011.
In September 2011, we completed building a new facility designed for producing Styrene-Butadience-Styrene (the “SBS”), one of the Styreneic Block Copolymers. SBS is a product with higher product margin with significant applications in 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 right of use in August 2010. The construction started in September, 2010 and was completed as scheduled in September 2011. One SBS production line began commercial production in December 2011 and the second line began commercial production in August, 2012. The designed capacity of the SBS facility allows for production of up to 70,000 metric tons per year. The SBS facility achieved a 41% utilization rate in 2012, as the first full year of production, and generated approximately $71.1 million in sales and $7.7 million in profit. 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 reach more than 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 guaranty that our SBS production will reach more than 80% of the design capacity in the near future.
The following chart depicts our production capacity in 2012:
Breakdown of 2012 Capability of 693,895 (MT)
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 and environmental protection requirements, we adjusted our original expansion project and are currently working to refine 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 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, among which 120,000 MT can be used for producing synthetic and 80,000 MT can be sold to downstream petrochemical companies. Ethylene-styrene is the main raw material (eg. Bezene) from the catalytic cracking oil processing facility to produce styrene. 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 registered our catalytic oil processing facility and transformer oil plant with the Ningbo local government in February 2013, and expect it to be completed and operational in late 2013, at which time, we will be able to produce medical use and edible products such as tubes and chewing gum.
The total estimated cost of processing equipment for product refinement and the SSBR production facility is approximately $149.3 million, including $49.8 million for processing equipment and $99.5 million for the SSBR production facility. We are currently going through the governmental approval and design phase of the ABS production facility and estimating the related costs. Upon full completion of our expansion, our total production capacity will reach 2,443,000 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 2,443,000 MT.
Capacity Breakdown after expansion projects (2,443,000 MT)
We are currently evaluating the timeline for our expansion projects. Our current estimate is as follows:
Petrochemical Manufacturing Process
The following chart illustrates our petrochemical manufacturing process:
The following chart illustrates the manufacturing process of SBS:
Petrochemical Market in China
China has the world’s second largest petrochemical market after the U.S. in terms of production and consumption. China’s petrochemical output value grew from RMB 1,240 billion in 2000 to RMB 11,000 billion in 2011 representing a Compound Annual Growth Rate (CAGR) of 21.95%. China Petrol and Chemical Industry Association (CPCIA) expect that the total profits in the petrochemical industry will increase 12.5% in 2012. (Source: http://www.cu-market.com.cn/hgjj/2013-1-7/15504023.html)
Based on a report from China’s petroleum and chemical industry federation, production for the petroleum and chemical industry will remain stable, based on an assumed total output for 2013 of RMB14.25 trillion, and profits of RMB870 billion . (source:http://www.askci.com/news/201301/21/219524756358.shtml)
China’s increasing domestic demand for petrochemical products has exceeded the domestic supply in the past several years:
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China’s benzene supply grew from 2.13 million MT in 2002 to 6.626 million MT in 2011 representing a CAGR of 13.5%. China’s benzene demand increased from 2.08 million MT in 2002 to 5.609 million MT in 2011, representing a CAGR of 11.65%. (data source http://chem.oilchem.net/chemical/2_3_3662667.html )
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China’s toluene supply grew from 697,000 MT in 2002 to 2.55 million MT in 2011, representing a CAGR of 15.5%. China’s toluene demand increased from 1.56 million MT in 2002 to 2.30 million MT in 2010, representing a CAGR of 5%.(data source: http://info.pcrm.hc360.com/2012/02/020858176690.shtml )
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China’s xylene supply grew from 820,000 MT in 2002 to 6.5 million MT in 2010, representing a CAGR of 30%. China’s xylene demand increased from 1.1 million MT in 2002 to 7.5 million MT in 2009 representing a CAGR of 32%.(data source: www.stats.gov.cn ) (www.chem99.com)
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China’s propylene supply has grown from 3.78 million MT in 2000 to 15.93 million MT in 2012, representing a CAGR of 14.16%. China’s propylene demand has risen from 4.39 million MT in 2000 to 18.60 million MT in 2010, representing a CAGR of 16%.(data source: http://www.oilchem.net/chemical/5_3_37153.html)
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China’s styrene supply has grown from 0.89 million MT in 2002 to 3.806 million MT in 2010, representing a CAGR of 20%. China’s Styrene demand has increased from 2.69 million MT in 2002 to 7.3 million MT in 2010, representing a CAGR of 13%.(data http://chem.chem365.net/Web/jckxx_news/30869.htm, http://static.sse.com.cn/cs/zhs/scfw/gg/ssgs/2010-04-29/600481_20100429_3.pdf )
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China’s LPG supply has grown from 12.56 million MT in 2003 to 21.811 million MT in 2011 representing a CAGR of 7.14%. China’s LPG demand has increased from 18.77 million MT in 2003 to 23.64 million MT in 2010, representing a CAGR of 3%.(data source: http://www.oilchem.net:88/coalchem/2_1_2991360.html,)
As a result, China has imported petrochemical products to meet the domestic demand, which is expected to continue for a number of years (source: Publication by Business Monitor International Ltd.: China Petrochemicals Report, Includes 5 Year Forecast to 2014; Q2 2010):
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China imported 1.862 million MT of benzene between 2003 and 2011.
(data source: http://chem.oilchem.net/chemical/5_3_54578.html)
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China imported 863,000 MT of toluene in 2002 and 659,630 MT in 2011
(data source: http://chem.oilchem.net/chemical/5_3_53435.html)
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China imported 271,000 MT of xylene in 2002 and 477,183 MT in 2012
(data source: http://chem.oilchem.net/chemical/5_3_54074.html)
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China’s imports of propylene increased from 210,000 MT in 2004 to 2.15 million MT in 2012
(data source: http://chem.oilchem.net/chemical/5_3_54205.html))
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China’s imports of styrene increased from 1.79 million MT in 2002 to 3.607 million MT in 2011
(data source: http://chem.oilchem.net/chemical/5_3_53475.html)
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China imported butadiene 344,826MT in 2012, increased 88% compared to butadiene imported in 2011,.
(data source: http://finance.oilchem.net/bulk/108_8697.html,)
Asphalt Market in China and Pretreatment & Asphalt Process
In addition to its use as raw materials for emulsified, diluted and modified asphalt-based products, asphalt is widely used for highways, roads and airport pavements. At the end of 2011, the length of China’s highways has reached 85,000 km (52,816 miles) in the aggregate (http://www.ptbtv.com/news.asp?ID=78058), which made China rank the second in the world in terms of the length of its highway system. According to the PRC government plan, the length of China's highways will reach 100,000 km (62,137 miles) by 2020 (http://www.cngaosu.com/a/2010/1109/71783.html). In November 2008, the PRC Ministry of Communication issued a RMB 5 trillion investment plan and according to this plan, the average annual investment for construction of highways in the next five years will be RMB 980 billion, among which 60% will be used for construction of expressways, 20% for provincial highways and 20% for highways in the countryside.
To ensure the high-quality condition of roads and highways, the PRC government requires regular pavement maintenance every five years. In the past five years, the domestic demand for asphalt in China has exceeded supply with total imports of approximately 5.6 million MT in 2010.
The following chart depicts the pretreatment and asphalt process:
Environmental Protection and Safety Measures
We are committed to environmental protection, facility safety and quality control throughout the design, maintenance and growth of our operation facilities and manufacturing process.
Environmental Protection
We have taken various measures to meet national standards and ensure our environmental compliance. For example, we recycle the water for cooling in our production process and large amounts of water can be saved through recycling. Sulfureted hydrogen generated in production is sent to the facility for sulfur recovery. The waste water and waste gas is treated by our sewage water treatment station and emission control facility to meet the national standards before discharge. The industrial residue and garbage is sent to qualified companies for safe treatment.
Safety Measures
Our safety control measures include:
1.
Distribution control system;
2.
Emergency shutdown mechanism;
3.
Automatic interlocking system;
4.
Detection & alarm system for flammable and toxic gas;
5.
Fire detection & automatic sprinkler system; and
6.
Real-time system and process monitoring system
Quality Control
With our commitment to quality control, our petrochemical products have met all applicable national standards for petrochemical products set by the General Administration of Quality Supervision, Inspection and Quarantine of the PRC. For instance, the purity of our Styrene product exceeded the national standard of 99.7%, and the purity and our Propylene product exceeded the national standard of 99.5%.
Our Competitive Strengths
As an independent petrochemical manufacturer and supplier, our competitive strengths include:
Technology Advantage
We have proprietary manufacturing technologies that allow for better use of raw materials, higher yield rate and enhanced operational efficiency.
Specifically, we possess the technology to use heavy oil, instead of naphtha, which is a commonly used feedstock in the petrochemical production industry. Heavy oil is approximately 15% cheaper per ton and more readily available than naphtha, which provides us with competitive advantage in the selection of raw materials. In addition, we use proprietary catalytic pyrolysis with higher reaction temperatures, which results in a 15% higher Olefin yield rate than that of conventional fluidized catalytic cracking processes. Finally, we use enhanced technologies in our production process that allow for lower capital investment and higher operations efficiency.
Our yield rate in 2010 for our entire production line indicated a yield rate of 87.6% for finished products. The yield rate in 2011 for our entire line was 87.2% for finished products. The yield rate in 2012 for our entire line was 87.3% for finished products. Yield rate represents the percentage of finished product produced from input of raw material and net input of unfinished products and is calculated by dividing the sum of crude oil and net unfinished input into the individual net production of finished products. A yield rate of 87.3% means, for instance, 100 tons of heavy oil can generate approximately 87.3 tons of finished products.
In addition, we use enhanced technologies in our production process that allow for lower capital investment and higher operations efficiency. Our proprietary catalytic pyrolysis process uses a set of dual risers for one precipitator and one regenerator, while the commonly used fluidized catalytic cracking process uses one riser for one precipitator and one regenerator respectively. The dual riser, one precipitator and one regenerator are integrated into one complete process, which provides for ease of operation, higher operation efficiency and higher reaction temperature. It was estimated that the technology generates a 15% higher olefin yield rate than that of the fluidized catalytic cracking process, which allows us to produce more higher-margin olefin products such as styrene and propylene
Furthermore, a catalytic pyrolysis process with high temperatures can produce more olefin hydrocarbon based products compared with other equipment using low temperatures for the same product. In other words, our cost is reduced while producing the same amount of the product.
Our management considers our manufacturing technologies and manufacturing design critical to our business, and has taken steps to protect these technologies. In January 2011, we received the approval for our patent application for MEP technology (Multiple Ethylene Propylene) from the National Intellectual Property Bureau in China, #ZL-2010-2-0191523.6. In addition to patent protection, we also entered into confidentiality and license agreements with certain employees, customers and others to protect the confidentiality of our technologies.
In 2013, we received the patent notices for three devices used in the production process for Acrylonitrile: Fluidization Reaction System of Acrylonitrile (#ZL-2012-2-0381020.4), Cooler of Acrylonitrile Gas (#ZL-2012-2-0382047.5), and Absorption Tower of Acrylonitrile (#ZL-2012-2-0381066.6), respectively. These techniques were developed together with East China University Of Science and Technology (ECUST), and can be used for improving the output capacity and recovery rates, and for decreasing discharge waste to improve production efficiency.
On January 10, 2012, we started an application for a patent called “the synthetic method for transparent segmented copolymer”, which has been accepted and posted on the China patent data website in July 2012. Assuming there is no objection for this patent application during 2013, we will automatically obtain the patent in the end of 2013. Obtaining this patent will not only expand our SBS products range and increase the “K resin” content in the styrene, which will further improve our product portfolio to avoid market risk; but also benefit us for applying for High Tech Company. For more details about this patent application, please ref to the following website:
http://dbpub.cnki.net/Grid2008/Dbpub/Detail.aspx?DBName=SCPD2012&FileName=CN102558466A&QueryID=4&CurRec=1
Elite Workforce
Our management team, composed of seasoned petrochemical experts with proven track records from China’s largest state-owned enterprises, provides us with specialized operating management and technical administration. In addition, we have allied with many industry-renowned technology experts and advisors assisting us to achieve consistent technological improvement.
Ideal Location
Our operation and storage facilities are at the ocean-front and in close proximity to suppliers and customers which provides us with an advantage of lower logistics cost and readily available access to raw materials and target customers. In addition, being located in Qingshi Chemical Park in Ningbo provides us with access to skilled labor and industry resources.
Sales and Pricing
Sales
In selling our products, most of our customers pay cash in advance. For core customers with excellent credit history, we may make an exception by conducting credit sales, which is part of our strategy to maintain customer relationship.
In order to meet customers’ demand, we have improved our manufacturing technologies and streamlined our conversion process to achieve an approximately 30 days’ raw material-to-sales cycle.
In order to facilitate our future growth, Ningbo Keyuan Petrochemicals was incorporated in Ningbo, China with a registered capital of $3 million as a wholly-owned subsidiary of Keyuan HK on August 27, 2010. Ningbo Keyuan Petrochemicals is responsible for the sales and marketing, raw materials sourcing and market analysis for the Company. Dr. Jingtao Ma was appointed as the General Manager of the new entity. Dr. Ma was the head of the former sales and marketing division of Ningbo Keyuan. This new entity will also serve as the “market thermometer” that can better monitor market conditions and obtain first hand market data through buying and selling activities. Management believes that the consolidation of the sales and marketing and raw material procurement function under one business unit will help efficiently manage the future expansion of the Company.
Pricing
Our raw material price fluctuations are primarily attributable to international oil prices and market effects of supply and demand. We set our selling prices based upon benchmark prices published by national petrochemical companies, and/or through individually negotiated prices with customers. Specifically, BTX aromatic prices are influenced by benchmark prices set by National Development and Reform Commission, or NDRC.
Customers
Customers for Petrochemicals Products
Our main customer base is downstream petrochemicals manufacturers and distributors (trading companies) located in and near the Yangtze River Delta and Pearl River Delta. 14% of our sales are direct sales to petrochemical companies that use our products as raw materials for their own products such as polystyrene, isoprene, dicyclopentadiene, acrylic acid, oil fuel products and other chemical products. 86% of our sales are through the trading companies, i.e., distributors who sell our products to petrochemicals derivative companies and manufacturers. We engage distributors as customers mainly because: (1) distributors customarily pay the entire purchase price prior to shipment, while end-users often request credit payment terms; and (2) it decreases our overhead by allowing for a more streamlined sales force as distributors do not require regular client visits, entertaining or a highly specialized sales team to maintain the relationships.
In order to estimate the total orders for a year, we conduct surveys with our major customers to obtain their preliminary orders for the next one or two years and update the information annually. We enter into purchase contracts with customers on an order-to-order basis. In each contract, price is determined based on market price and the quantity is specified based on (1) the customer demand for a particular order and (2) our capability to satisfy that particular order. Our five largest customers accounted for 36% and 44 % of the sales for the years ended December 31, 2012 and 2011, respectively. We anticipate that our overall customer composition and the concentration of our top customers will change as we expand our business and modify our product portfolio to include new products and higher-margin products; however, we can give no assurance that this will be the case.
Customers for SBS Products
The sales for SBS commenced at the end of 2011. 60% of our SBS customers are trading agents and the rest of our customers are end-user factories. Most of our SBS customers are located in the Yangtze River delta, South China and Northern cities in China such as Hebei and Shangdong. The end-user factories purchase our SBS as raw materials for their various products, such as shoe sole material, adhesive, waterproof rolling material, asphalt and plastic modifier.
We currently have 15% of the Chinese market for SBS. We engage agents as our main customers primarily because: (1) trading agents pay 30% in advance when placing their order and pay the rest before shipment, and (2) it decreases our overhead by allowing for a more streamlined sales force as trading agents do not require regular client visits, entertaining or a highly specialized sales team to maintain the relationships.
To maintain and develop our relationship with SBS customers, we set up a customer relationship department to closely monitor and timely respond to customers’ requests and feedback, as well as a technical team in charge of improving product quality and adjusting product chemical features to meet different requirements from customers. We also have monthly meetings with our major customers to obtain their preliminary orders. Because the price of SBS fluctuates monthly, and we do not have a warehouse distribution system, the price of SBS usually includes the shipment cost and profit. Our five largest customers accounted for 23% of the sales of SBS for the year ended December 31, 2012. We anticipate that our overall customer composition and the concentration of our top customers will change as we expand our business and modify our product portfolio to include new products and higher-margin products; however, we can give no assurance that this will be the case.
Intellectual Property
We have a pending trademark application for the Ningbo Keyuan company logo with the State Administration for Industry and Commerce, Trademark Office. On January 25, 2011 we received approval for a patent related to the Company's proprietary production process, called MEP (Multiple Ethylene Propylene). MEP is an exclusive and leading technology used in Keyuan's existing production process. Through the ingenuity of our CEO, Mr. Tao, we have developed this proprietary production process that improves the manufacturing efficiency and flexibility for a wide range of petrochemicals. The utility model patent received, #ZL-2010-2-0191523.6, applies to a processing technology used in the production of ethylene and propylene. This technology allows us to use lower grade feedstock (such as heavy oil) instead of a higher grade feedstock commonly used in other existing petrochemical production processes. It also allow us to improve the yield and utilization rate of its production line, resulting in a 15% cost savings.
In 2013, we received the patent notices for three devices used in the production process for Acrylonitrile: Fluidization Reaction System of Acrylonitrile (#ZL-2012-2-0381020.4), Cooler of Acrylonitrile Gas (#ZL-2012-2-0382047.5), and Absorption Tower of Acrylonitrile (#ZL-2012-2-0381066.6), respectively. These techniques were developed together with ECUST, and can be used for improving the output capacity and recovery rates, and for decreasing discharge waste to improve production efficiency.
On January 10, 2012, we started an application for a patent called “the synthesis for transparent block copolymer”, which has been accepted and posted on the China patent data website in July 2012. Assuming there is no objection to this patent application during 2013, we will automatically obtain the patent at the end of 2013. Obtaining this patent will not only expand our SBS products range and increase the “K resin” content in styrene, which will further improve our product portfolio; but it will also benefit us in our application for status as a High Tech Company. For more details about this patent application, please refer to the following website:
http://dbpub.cnki.net/Grid2008/Dbpub/Detail.aspx?DBName=SCPD2012&FileName=CN102558466A&QueryID=4&CurRec=1
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 its 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.
Government Regulation
In addition to U.S. securities laws, banking laws and laws applicable to all companies, such as The Foreign Corrupt Practices Act, as a China-based entity, we are subject to various Chinese regulations. This section sets forth a summary of the most significant China regulations or requirements that may affect our business activities operated in China or our shareholders’ right to receive dividends and other distributions of profits from the PRC subsidiary.
Foreign Investment in PRC Operating Companies
The Foreign Investment Industrial Catalogue jointly issued by China's Ministry of Commerce (MOFCOM) and NDRC in 2007 classified various industries/businesses into three different categories: (i) encouraged for foreign investment; (ii) restricted to foreign investment; and (iii) prohibited from foreign investment. For any industry/business not covered by any of these three categories, they will be deemed industries/businesses permitted for foreign investment. Except for those expressly provided with restrictions, encouraged and permitted industries/businesses are usually 100% open to foreign investment and ownership. With regard to those industries/businesses restricted to foreign investment, there is always a limitation on foreign investment and ownership. Foreign investment is prohibited in prohibited industries/business. The PRC subsidiary’s business does not fall under the industry categories that are restricted to, or prohibited from foreign investment and is not subject to limitation on foreign investment and ownership.
Regulation of Foreign Currency Exchange
Foreign currency exchange in the PRC is governed by a series of regulations, including the Foreign Currency Administrative Rules (1996), as amended, and the Administrative Regulations Regarding Settlement, Sale and Payment of Foreign Exchange (1996), as amended. Under these regulations, the Renminbi is freely convertible for trade and service-related foreign exchange transactions, but not for direct investment, loans or investments in securities outside the PRC without the prior approval of State Administration of Foreign Exchange (SAFE). Pursuant to the Administrative Regulations Regarding Settlement, Sale and Payment of Foreign Exchange (1996), foreign investment enterprises, or FIEs may purchase foreign exchange without the approval of SAFE for trade and service-related foreign exchange transactions by providing commercial documents evidencing these transactions. They may also retain foreign exchange, subject to a cap approved by SAFE, to satisfy foreign exchange liabilities or to pay dividends. However, the relevant Chinese government authorities may limit or eliminate the ability of FIEs to purchase and retain foreign currencies in the future. In addition, foreign exchange transactions for direct investment, loan and investment in securities outside the PRC are still subject to limitations and require approvals from SAFE.
Regulation of FIEs’ Dividend Distribution
The principal laws and regulations in the PRC governing distribution of dividends by FIEs include:
(i)
The Sino-foreign Equity Joint Venture Law (1979), as amended, and the Regulations for the Implementation of the Sino-foreign Equity Joint Venture Law (1983), as amended;
(ii)
The Sino-foreign Cooperative Enterprise Law (1988), as amended, and the Detailed Rules for the Implementation of the Sino-foreign Cooperative Enterprise Law (1995), as amended;
(iii)
The Foreign Investment Enterprise Law (1986), as amended, and the Regulations of Implementation of the Foreign Investment Enterprise Law (1990), as amended.
Under these regulations, FIEs in the PRC may pay dividends only out of their accumulated profits, if any, determined in accordance with Chinese accounting standards and regulations. In addition, the wholly-owned foreign enterprises in the PRC are required to set aside at least 10% of their respective accumulated profits each year, if any, to fund certain reserve funds unless such reserve funds have reached 50% of their respective registered capital. These reserves are not distributable as cash dividends.
Regulation of a Foreign Currency’s Conversion into RMB and Investment by FIEs
On August 29, 2008, SAFE issued a Notice of the General Affairs Department of the State Administration of Foreign Exchange on the Relevant Operating Issues concerning the Improvement of the Administration of Payment and Settlement of Foreign Currency Capital of Foreign-Invested Enterprises or Notice 142, to further regulate the foreign exchange of FIEs. According to Notice 142, FIEs shall obtain a verification report from a local accounting firm before converting its registered capital in foreign currency into Renminbi, and the converted Renminbi shall be used for the business within its permitted business scope. Notice 142 explicitly prohibits FIEs from using RMB converted from foreign capital to make equity investments in the PRC, unless the domestic equity investment is within the approved business scope of the FIE and has been approved by SAFE in advance. In addition, SAFE strengthened its oversight over the flow and use of Renminbi funds converted from the foreign currency-dominated capital of a FIE. The use of such Renminbi may not be changed without approval from SAFE, and may not be used to repay Renminbi loans if the proceeds of such loans have not yet been used. Violations of Notice 142 may result in severe penalties, including substantial fines as set forth in the SAFE rules.
Regulation of Foreign Exchange in Certain Onshore and Offshore Transactions
In October 2005, SAFE issued the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Return Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or SAFE Notice 75, which became effective as of November 1, 2005. SAFE has also issued implemented rules to SAFE Notice 75. SAFE Notice 75 and its implementation rules require PRC residents (including both corporate entities and natural persons) to register with SAFE or its competent local branch in connection with their direct or indirect shareholding in any company outside of China referred to as an “offshore special purpose company” established for the purpose of raising fund from overseas to acquire assets of, or equity interests in, PRC companies. Under SAFE Notice 75, a “special purpose vehicle”, or SPV, refers to an offshore entity established or controlled, directly or indirectly, by PRC residents for the purpose of seeking offshore equity financing using assets or interests owned by such PRC residents in onshore companies. In addition, any PRC resident that is the shareholder of an offshore special purpose company is required to amend his or her SAFE registration with the SAFE or its competent local branch, with respect to that offshore special purpose company in connection with any of its increase or decrease of capital, transfer of shares, merger, division, equity investment or creation of any security interest over any assets located in China. The SAFE regulations require retroactive approval and registration of direct or indirect investments previously made by PRC residents in offshore special purpose companies. PRC subsidiaries of an offshore special purpose company are required to coordinate and supervise the filing of SAFE registrations by the offshore holding company’s shareholders who are PRC residents in a timely manner. In the event that a PRC resident shareholder with a direct or indirect investment in an offshore parent company fails to obtain the required SAFE approval and make the required registration, the PRC subsidiaries of such offshore parent company may be prohibited from making distributions of profit to the offshore parent and from paying the offshore parent proceeds from any reduction in capital, share transfer or liquidation in respect of the PRC subsidiaries. Further, failure to comply with the various SAFE approval and registration requirements described above, as currently drafted, could result in liability under PRC law for foreign exchange evasion.
There still remain uncertainties as to how certain procedures and requirements under the aforesaid SAFE regulations will be enforced, and it remains unclear how these existing regulations, and any future legislation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant government authorities. Although we have requested PRC residents who, to our knowledge, hold direct or indirect interests in our Company to make the necessary applications, filings and amendments as required under the SAFE Notice 75 and other related rules, our PRC resident beneficial holders have not completed such approvals and registrations required by the SAFE regulations. We will attempt to comply, and attempt to ensure that all of our shareholders subject to these rules comply with the relevant requirements. We cannot, however, assure the compliance of all of our China-resident shareholders. Any current or future failure to comply with the relevant requirements could subject us to fines or sanctions imposed by the Chinese government, including restrictions on certain of our subsidiaries’ ability to pay dividends or hinder our investment in those subsidiaries or affect our ownership structure, which could adversely affect our business and prospects.
Regulations on Employee Stock Option Plans
In December 2006, the People’s Bank of China promulgated the Administrative Measures of Foreign Exchange Matters for Individuals, which set forth the respective requirements for foreign exchange transactions by individuals (both PRC or non-PRC citizens) under either the current account or the capital account. In January 2007, SAFE issued implementing rules for the Administrative Measures of Foreign Exchange Matters for Individuals, which, among other things, specified approval requirements for certain capital account transactions such as a PRC citizen’s participation in the employee stock ownership plans or stock option plans of an overseas publicly-listed company. In March 2007, SAFE promulgated the Application Procedures of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Ownership Plan or Stock Option Plan of Overseas-Listed Company, or the Stock Option Rules. Under these rules, PRC citizens who participate in an employee stock ownership plan or a stock option plan in an overseas publicly-listed company are required to register with SAFE or its local branch and complete certain other procedures. For participants of an employee stock ownership plan, an overseas custodian bank should be retained by the PRC agent, which could be the PRC subsidiary of such overseas publicly-listed company, to hold on trusteeship all overseas assets held by such participants under the employee share ownership plan. In the case of a stock option plan, the PRC agent is required to retain a financial institution with stock brokerage qualification at the place where the overseas publicly-listed company is listed or a qualified institution designated by the overseas publicly-listed company to handle matters in connection with the exercise or sale of stock options for the stock option plan participants. For participants who had already participated in an employee stock ownership plan or stock option plan before the date of the Stock Option Rules, the Stock Option Rules require their PRC employers or PRC agents to complete the relevant formalities within three months of the date of this rule.
Further, a notice concerning the individual income tax on earnings from employee share options jointly issued by Ministry of Finance, or the MOF, and the State Administration of Taxation, or the SAT, and its implementing rules, provide that domestic companies that implement employee share option programs shall (a) file the employee share option plans and other relevant documents to the local tax authorities having jurisdiction over them before implementing such employee share option plans; (b) file share option exercise notices and other relevant documents with the local tax authorities having jurisdiction over them before exercise by the employees of the share options, and clarify whether the shares issuable under the employee share options mentioned in the notice are the shares of publicly listed companies; and (c) withhold taxes from the PRC employees in connection with the PRC individual income tax.
We and our PRC citizen employees who participate in the employee stock incentive plan, which we adopted in 2010, will be subject to these regulations. We and our PRC option grantees have not completed the registrations under these regulations. We cannot assure you that we and our PRC option grantees will be able to complete the required registrations. Any current or future failure to comply with the relevant requirements could subject us to fines or sanctions imposed by the Chinese government, which could adversely affect our business and prospects.
Government Regulations Relating to Taxation
On March 16, 2007, the National People’s Congress or NPC, approved and promulgated the PRC Enterprise Income Tax Law, which we refer to as the New EIT Law. The New EIT Law took effect on January 1, 2008. Under the New EIT Law, FIEs and domestic companies are subject to a uniform tax rate of 25%. The New EIT Law provides a five-year transition period starting from its effective date for those enterprises which were established before the promulgation date of the New EIT Law and which were entitled to a preferential lower tax rate under the then-effective tax laws or regulations.
On December 26, 2007, the State Council issued a Notice on Implementing Transitional Measures for Enterprise Income Tax, or the Notice, providing that the enterprises that have been approved to enjoy a low tax rate prior to the promulgation of the New EIT Law will be eligible for a five-year transition period beginning January 1, 2008, during which time the tax rate will be increased step by step to the 25% unified tax rate set out in the New EIT Law. From January 1, 2008, for the enterprises whose applicable tax rate was 15% before the promulgation of the New EIT Law, the tax rate will be increased to 18% for 2008, 20% for 2009, 22% for 2010, 24% for 2011, and 25% for 2012. For the enterprises whose applicable tax rate was 24%, the tax rate will be changed to 25% from January 1, 2008.
The New EIT Law and Implementation Rules of the New EIT Law provide that an income tax rate of 10% may be applicable to dividends payable to non-PRC investors that are “non-resident enterprises”, which (i) do not have an establishment or place of business in the PRC, or (ii) have such establishment or place of business in the PRC but the relevant income is not effectively connected with the establishment or place of business, to the extent such dividends are derived from sources within the PRC. The income tax for non-resident enterprises shall be subject to withholding at the income source, with the payor acting as the obligatory withholder under the New EIT Law, and therefore such income taxes generally called withholding tax in practice. Such income tax may be exempted or reduced by the State Council of the PRC or pursuant to a tax treaty between the PRC and the jurisdictions in which our non-PRC shareholders reside. For example, the 10% withholding tax is reduced to 5% pursuant to the Double Tax Avoidance Agreement Between Hong Kong and Mainland China if a Hong Kong resident enterprise owns more than 25% of the registered capital in a company in the PRC and is determined by the competent PRC tax authority to have satisfied the other conditions and requirements under such Double Tax Avoidance Agreement Between Hong Kong and Mainland China and other applicable laws. We are a U.S. holding company and substantially all of our income is derived from dividends we receive from our subsidiaries located in the PRC. Thus, if Keyuan HK are considered as a “non-resident enterprise” under the New EIT Law and the dividends paid to Keyuan HK by our subsidiaries in the PRC are considered income sourced within the PRC, such dividends may be subject to a withholding tax at a rate up to 10%.
The new tax law provides only a framework of the enterprise tax provisions, leaving many details on the definitions of numerous terms as well as the interpretation and specific applications of various provisions unclear and unspecified. Any increase in the combined Company’s tax rate in the future could have a material adverse effect on our financial condition and results of operations.
For the years ended December 31, 2012, 2011 and 2010, the Company was subject to the 25% tax rate. In order to support the growth of certain local enterprises, the local government granted certain credit back to Ningbo Keyuan. In the first two profitable years, the local government will credit back to the Company the entire local portion of the income tax which equals to 40% of the whole Enterprise Income Tax the Company paid applying the 25% tax rate.; in the subsequent three profitable years, the local government will credit back 50% of the local income tax the Company paid under the 25% tax rate. The Company will recognize the subsidy related to income tax at the time the cash is received.
Regulations on Work Safety
On June 29, 2002, the Work Safety Law (“WSL”) of the PRC was adopted by Standing Committee of the 9th National People’s Congress and came into effect on November 1, 2002, as amended on August 27, 2009. The WSL provides general work safety requirements for entities engaging in manufacturing and business activities within the PRC. Additionally, Regulation on Work Safety Licenses (“RWSL”), as adopted by the State Council on January 7, 2004 effective on January 13, 2004, requires enterprises engaging in the manufacture of dangerous chemicals to obtain a work safety license with a term of three years. If a work safety license needs to be extended, the enterprise must go through extension procedures with authorities three months prior to its expiration. In addition, on May 17, 2004, the Measures for Implementation of Work Safety Licenses of Dangerous Chemicals Production was promulgated as implementing measures to the Regulation on Work Safety Licenses which provides that entities producing dangerous chemicals are required to obtain work safety licenses pursuant to specific requirements. Without work safety licenses, no entity may engage in the formal manufacture of dangerous chemicals. The Measures for Implementation of Work Safety Licenses of Dangerous Chemicals Production was amended on August 5, 2011 and the amended regulation will become effective on December 1, 2011. The amended regulation provides for more detailed and comprehensive requirements and conditions for obtaining work safety licenses for dangerous chemicals production.
The Regulations on the Safety Administration of Dangerous Chemicals (“RSADC”) was promulgated by the State Council on January 26, 2002, effective as of March 15, 2002. It sets forth general requirements for manufacturing and storage of dangerous chemicals in China. The RSADC requires that companies manufacturing dangerous chemicals establish and strengthen their internal regulations and rules on safety control and fulfill the national standards and other relevant provisions of the State. In addition, according to the RSADC, companies that manufacture, store, transport or use dangerous chemicals shall be required to obtain corresponding approvals or licenses with the State Administration of Work Safety and its local branches and other proper authorities. Companies that manufacture or store dangerous chemicals without approval or registration with the proper authorities can be shut down, ordered to stop manufacturing or ordered to destroy the dangerous chemicals. Such companies can also be subject to fines. If criminal law is violated, the persons chiefly liable, along with other personnel directly responsible for such impropriety, shall be subject to relevant criminal liability. The RSADC was amended on March 2, 2011 and the amended regulation will become effective on December 1, 2011. The amended regulation strengthens the administration of dangerous chemicals production.
The Company has put work place safety as one of the top priorities for our work. In order to comply with the aforementioned rules and regulations, as of December of 2012, we have made considerable investment for major equipment with a total estimated amount of RMB 23.25 million (about USD 3.7 million). We have installed a distribution control system (DCS), emergency shutdown system, electric explosion protection, automatic interlocking system, detecting & alarming system for inflammable and toxic gas, fire fighting and fire detecting system, auto-sprinkling system, pressure release and control system. The Company’s operating subsidiary Ningbo Keyuan has obtained a work safety license effective from March 25, 2011 to March 24, 2014 for producing petrochemical products.
Regulations on Environmental Protection
According to the Prevention and Control of Water Pollution Law, as adopted by the Standing Committee of the 10th National People’s Congress on February 28, 2008 and effective on June 1, 2008, China adopted a licensing system for pollutant discharge. Companies directly or indirectly responsible for discharge of industrial waste water or medical sewage to waters are required to obtain a pollutant discharge license. All companies are prohibited from discharging wastewater and sewage to waters without the license or in violation of the terms of the pollutant discharge license. As Ningbo city is currently working on setting up an inspection system of the pollutant discharge, there is no specific pollutant discharge license for our operating subsidiary Ningbo Keyuan. However, Ningbo Keyuan’s facilities have passed inspection with Ningbo city environmental protection authorities which includes an approval for the pollutant discharge.
The Regulations on the Administration of Construction Projects Environmental Protection (“RACPEP”), as adopted by the State Council on November 18, 1998 and effective on November 29, 1998, governs construction projects and the impact such projects will have on the environment. Pursuant to the RACPEP, the governing body is responsible for supervising the implementation of a three tiered system that includes (i) reviewing and approving a construction project, (ii) overseeing the construction project and (iii) inspecting the finished construction project and ensuring that all harmful pollutants are disposed of correctly. Manufacturing companies are required to apply for inspection with environmental protection authorities upon completion of a construction project. Our facilities have passed the inspection by the environmental protection authorities.
In order to meet the above mentioned requirements for environmental protection, we have invested about RMB 40 million (about USD 6.3 million) and built facilities including a sewage treatment facility, a sulphur recovery facility, a sea water desulphurization facility, a flue gas treatment facility and a real-time monitoring system for environmental protection. With these facilities, we believe we are able to meet all the environmental protection standards set by the government.
Research and Development
We consider ourselves as a technology driven innovative Company. Our senior management combined has over one hundred years of industry experience. We continue to enhance our technology through internal and external research and development.
On January 25, 2011 we received approval for a patent related to the Company's proprietary production process, called MEP (Multiple Ethylene Propylene). MEP is an exclusive and leading technology used in Keyuan's existing production process. The utility model patent received, #ZL-2010-2-0191523.6, applies to a processing technology used in the production of ethylene and propylene. This technology allows us to use lower grade feedstock (such as heavy oil) instead of a higher grade feedstock commonly used in other existing petrochemical production processes. It also allows us to improve the yield and utilization rate of its production line.
On February 1, 2011, we signed an agreement with Ningbo Institute of Technology, an affiliate of Zhejiang University, to jointly develop commercial applications for Butadiene Styrene Resin. This is one component of Keyuan's long-term strategy to invest in technology advancement. Keyuan will work with researchers from the Ningbo Institute of Technology to research and develop synthesis technology for Butadiene Styrene Resin over the next 2 years. Butadiene Styrene Resin is a block co-polymer with excellent transparency and anti-impact properties, including flexibility and durability. It is currently used in packaging and plastic products such as medical instruments and toys. This partnership will focus on developing commercial applications for Butadiene Styrene Resin in synthetic rubber products. We and Ningbo Institute of Technology will share the rights to products and technologies developed from this cooperation.
On January 10, 2012, we started an application for a patent called “the synthesis for transparent block copolymer”, which has been accepted and posted on the China patent data website in July 2012. Assuming there is no objection to this patent application during 2013, we will automatically obtain the patent at the end of 2013. Obtaining this patent will not only expand our SBS products range and increase the “K resin” content in styrene, which will further improve our product portfolio; but it will also benefit us in our application for status as a High Tech Company. For more details about this patent application, please refer to the following website: http://dbpub.cnki.net/Grid2008/Dbpub/Detail.aspx?DBName=SCPD2012&FileName=CN102558466A&QueryID=4&CurRec=1
In 2013, we received the patent notices for three devices used in the production process for Acrylonitrile: Fluidization Reaction System of Acrylonitrile (#ZL-2012-2-0381020.4), Cooler of Acrylonitrile Gas (#ZL-2012-2-0382047.5), and Absorption Tower of Acrylonitrile (#ZL-2012-2-0381066.6), respectively. These techniques were developed together with ECUST, and can be used for improving the output capacity and recovery rates, and for decreasing discharge waste to improve production efficiency.
Description of Property
We have acquired the state-granted use rights to land set forth in the table below.
Employees
As of December 31, 2012, we had 535 full-time employees, including 1 executive officer and 12 other senior management members, 3 engineers, 21 sales people, 8 researchers and developers and 33 administrative staff. The remaining 457 full-time employees are production facility manufacturers. All of the employees have signed labor contracts with us and receive monthly salaries as well as other social benefits including pension insurance, unemployment insurance, accidental insurance, medical insurance and housing funds, etc. We do not have any other employees in addition to our full-time employees.
We are compliant with local prevailing wage, contractor licensing and insurance regulations, and have good relations with our employees.
As required by PRC regulations, we participate in various employee benefit plans that are organized by municipal and provincial governments, including pension, work-related injury benefits, maternity insurance, and medical and unemployment benefit plans. We are required under PRC laws to make contributions to the employee benefit plans at specified percentages of the salaries, bonuses and certain allowances of our employees, up to a maximum amount specified by the local government from time to time. Members of the retirement plan are entitled to a pension equal to a fixed proportion of the salary prevailing at the member’s retirement date.
Executive Offices
Our offices are located at Qingshi Industrial Park, Ningbo Economic & Technological Development Zone, Ningbo, Zhejiang Province, P. R. China 315803.
FOR ADDITIONAL INFORMATION
We are a reporting company and file annual, quarterly and current reports, proxy statements and other information with the SEC. For further information with respect to the Company, you may read and copy its reports, proxy statements and other information, at the SEC public reference rooms at 100 F. Street, N.E., Washington, D.C. 20549. You can request copies of these documents by writing to the SEC and paying a fee for the copying cost. Please call the SEC at 1-800-SEC-0330 for more information about the operation of the public reference rooms. The Company’s SEC filings are also available at the SEC’s web site at http://www.sec.gov.
Copies of Company’s Annual Reports on Form 10K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are all available at our website (http://www.keyuanpetrochemicals.com/) free of charge, within a week after we file same with the SEC or by sending a request for a paper copy to our outside securities counsel: Hunter Taubman Weiss LLP, c/o Keyuan Petrochemicals, Inc., 17 State Street, Suite 2000, New York, NY 10004.
ITEM 1A.
ITEM 1A. RISK FACTORS
THE FOLLOWING MATTERS MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL CONDITION, LIQUIDITY, RESULTS OF OPERATIONS OR PROSPECTS, FINANCIAL OR OTHERWISE. REFERENCE TO THIS CAUTIONARY STATEMENT IN THE CONTEXT OF A FORWARD-LOOKING STATEMENT OR STATEMENTS SHALL BE DEEMED TO BE A STATEMENT THAT ANY ONE OR MORE OF THE FOLLOWING FACTORS MAY CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN SUCH FORWARD-LOOKING STATEMENT OR STATEMENTS.
Risks Related to Our Business
Our independent registered public accounting firm added an emphasis paragraph to their audit report describing an uncertainty related to our ability to continue as a going concern.
Due to our continued losses and limited capital resources our independent registered public accounting firm has issued a report that describes an uncertainty related to our ability to continue as a going concern. The auditors’ report discloses that we incurred a net loss and we consumed cash in operating activities in 2012 and that we had a working capital deficiency at December 31, 2012. These conditions raise substantial doubt about our ability to continue as a going concern and may make it difficult for us to raise capital. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Our limited operating history makes evaluation of our business difficult.
We have a limited operating history and have encountered and expect to continue to encounter many of the difficulties and uncertainties often faced by early stage companies. Our limited operating history makes it difficult to evaluate our future prospects, including our ability to develop a wide customer and distribution network for our services, to expand our operations to include additional services and to control raw material costs, all of which are critical to our success. An investor must consider our business and our prospects in light of the risks, uncertainties and difficulties common to early stage companies. We may encounter unanticipated problems, expenses and delays in developing and marketing our services and securing additional blending and storage facilities. We may not be able to successfully address these risks. If we are unable to address these risks, our business may not grow, our stock price may suffer, and we may be unable to stay in business.
Key employees are essential to growing our business.
Mr.Chunfeng Tao, Mr. Jingtao Ma, Mr. Shifa Wang, and Mr. Mingliang Liu are essential to our ability to continue to grow our business. They have established relationships with customers and suppliers within the industries in which we operate. In addition, in December, 2012, Mr. Shifa Wang was appointed as the new General Manager of Ningbo Keyuan Plastics replacing Dr. Jingtao Ma, with responsibility for daily operations, management and efficiency improvements. If one or more of these key employees were to leave us, our relationships with our customers and suppliers may become strained, and our growth strategy might be hindered, which could limit our ability to increase revenue.
In addition, although we are located in an area with a good supply of skilled labor, we still face competition from other companies located in the same area for attracting skilled personnel. If we fail to attract and retain qualified personnel to meet current and future needs, this could slow our ability to grow our business, which could result in a decrease in market share.
We continue to be dependent on bank loans and other short term financing in order to fund our purchases of raw materials.
In order to operate our business efficiently, we rely on short term bank financing to fund the purchase of raw materials. As of December 31, 2012, we had approximately $295 million of short term debt, and lines of credit from 14 banks. Typically, the term for a short term bank loan is one year. Bank loans are renewable at the banks’ option. In 2012, we paid back approximately $730 million and borrowed approximately $828 million in the form of short terms loans. As of December 31, 2012, we had approximately $295of short term debt. If one or more of these banks were revoke their line of credit or fail to renew such line of credit when it is due, we would be unable to continue to purchase raw materials in the amounts necessary to continue production at our current capacity.
We continue to have significant concentration with regard to our capital sources, revenue and raw material purchases.
At December 31, 2012 and 2011, we held cash and pledged bank deposits in financial institutions of approximately $225 million and $164 million, respectively. They were primarily held in major financial institutions located in mainland China and the Hong Kong Special Administrative Region, which institutions we believe have high credit ratings.
Sales to one major customer accounted for 13% and 18% of our total annual net revenue for the fiscal year 2012 and 2011, respectively.
We currently buy a majority of our heavy oil, an important component of our products, from three suppliers. Although there are a limited number of suppliers of the particular heavy oil used in production, management believes that other suppliers could provide similar heavy oil on comparable terms. A change in suppliers, however, could cause a delay in manufacturing and a possible loss of sales, which would affect operating results adversely. Purchases (net of VAT) from the largest three suppliers for the years ended December 31, 2012 and 2011 were approximately $549 million and $377 million, respectively. These purchases represented 78% and 83%, respectively of all of our purchases for the years ended December 31, 2012 and 2011. Our largest supplier accounted for approximately $473 million and $305 million, or 68% and 67% of total purchases for the years ended December 2012 and 2011, respectively. In addition, the supplier provided short-term financing to us of approximately $29 million during 2012, of which $20 million was included in accounts payable at December 31, 2012 and was repaid in January 21, 2013. Interest paid for this financing amounted to approximately $0.43 million. In addition, on December 27, 2012, the supplier provided a non-interest bearing advance of approximately $10 million to the Company, that was repaid in full on January 8, 2013. These types of short-term financings from vendors bear the risk of possible violation of the terms of our letters of credit. We are planning to establish policies and procedures to provide for the complete and timely analysis of contingencies associated with these transactions and the evaluation of legal and regulatory considerations related to those business activities. However, at present we cannot assure that these short term financings will not result in violations of the terms of our existing credit facilities or PRC law or regulation.
We need additional capital to expand our manufacturing facility and we may not be able to obtain it at acceptable terms, or at all, which could adversely affect our ability to increase our production capacity and expand our business.
The total estimated cost of additional processing equipment for product 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 plan to fund these expansions through short-term borrowings, cash from operations and potential equity financing. However, our ability to obtain additional capital on acceptable terms is subject to a variety of uncertainties, including, but not limited to:
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investors’ perception of, and demand for, securities of petrochemical manufacturing and supply companies;
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conditions of the U.S. and other capital markets in which we may seek to raise funds;
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our future results of operations, financial condition and cash flow;
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PRC governmental regulation of foreign investment in petrochemical manufacturing companies in China;
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economic, political and other conditions in China; and
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PRC governmental policies relating to foreign currency borrowings
Our operations may be adversely affected by the cyclical nature of the petroleum and petrochemical market and by the volatility of prices of our raw materials and petrochemical products.
All of our revenues are attributable to petrochemical products, which have historically been cyclical and sensitive to the availability and price of raw materials and general economic conditions. Markets for many of our products are sensitive to changes in industry capacity and output levels, cyclical changes in regional and global economic conditions, the price and availability of substitute products and changes in consumer demand, which from time to time have had a significant impact on product prices in the regional and global markets. Historically, the markets for these products have experienced alternating periods of tight supply, causing prices and margins to increase, followed by periods of capacity additions, finally resulting in oversupply and declining prices and margins. As tariffs and other import restrictions are reduced and the control of product pricing is relaxed in China, the markets for many of our products have become increasingly subject to the cyclicality of regional and global markets. Raw material costs accounted for more than 90% of our Cost of Goods Sold. Volatility of raw material costs could have significant negative impact on our profitability.
Our operation may be interrupted by weather conditions and power shutdowns and our operating results may therefore be adversely affected
Our operating results depend largely on the uninterrupted operation of our business. Our facilities are located at Beilun, Ningbo, China, by the east coast. Severe weather conditions and natural disasters, such as hurricanes, storms, floods, and other severe weather events could disrupt our operations. Additionally, we are located in an industrial park where the infrastructure such as the electricity grid is in need of periodic upgrade. Disruptions to our operations due to natural conditions discussed above and/or mandatory power shutdowns due to the periodic electricity grid upgrades could significantly affect our ability to manufacture and/or sell products, which would result in a substantial loss of sales and revenues and substantial harm to our operating results.
Our manufacturing processes could expose us to substantial product liability claims, which may negatively impact our profitability.
We face an inherent business risk of exposure to product liability claims in the event that the use of our products is alleged to have resulted in adverse side effects. Side effects or marketing or manufacturing problems pertaining to any of our products could result in product liability claims or adverse publicity. These risks will exist for those products in clinical development and with respect to those products that have received regulatory approval for commercial sale. To date, we have not experienced any product liability claims. However, that does not mean that we will not have any such claims with respect to our products in the future which may negatively impact our profitability.
In the past several years we have derived a significant portion of our revenues from a small group of customers and we have purchased raw material from a small group of suppliers. If we are to remain dependent upon only a few customers and a few raw material suppliers, such dependency could negatively impact our business, operating results and financial condition.
For the year ended December 31, 2012, our five largest customers accounted for 35% of our total sales. For the year ended December 31, 2011, our five largest customers accounted for 44% of our total sales. Sales to one major customer accounted for 13% and 18% of our total annual net revenue for the fiscal years 2012 and 2011, respectively. As our customer base may change from year-to-year, during such years that the customer base is comparatively highly concentrated, the loss of, or reduction of our sales to, any of such major customers could have a material adverse effect on our business, operating results and financial condition.
We currently buy a majority of our heavy oil, an important component of our products, from three suppliers. Although there are a limited number of suppliers of the particular heavy oil used in production, management believes that other suppliers could provide similar heavy oil on comparable terms. A change in suppliers, however, could cause a delay in manufacturing and a possible loss of sales, which would affect operating results adversely. Purchases (net of VAT) from the largest three suppliers for the years ended December 31, 2012 and 2011 were approximately $549 million and $377 million, respectively. These purchases represented 78% and 83%, respectively of all of our purchases for the years ended December 31, 2012 and 2011. Our largest supplier accounted for approximately $473 million and $305 million, or 68% and 67% of total purchases for the years ended December 2012 and 2011, respectively. In addition, the supplier provided short-term financing to us of approximately $29 million during 2012, of which $20 million was included in accounts payable at December 31, 2012 and was repaid in January 21, 2013. Interest paid for this financing amounted to approximately $0.43 million. In addition, on December 27, 2012, the supplier provided a non-interest bearing advance of approximately $10 million to the Company, that was repaid in full on January 8, 2013. These types of short-term financing from vendors bear the risk of possible violation of the terms of our letters of credit. We are planning to establish policies and procedures to provide for the complete and timely analysis of contingencies associated with these transactions and the evaluation of legal and regulatory considerations related to those business activities. However, at present, we cannot assure that these short term financings will not result in violations of the terms of our existing credit facilities or PRC law or regulation.
We may be exposed to risks relating to our disclosure controls and our internal controls and may need to incur significant costs to comply with applicable requirements.
Effective internal controls are necessary for us to provide reliable financial reports and to effectively prevent fraud. We maintain a system of internal controls over financial reporting, which is defined as a process designed by, or under the supervision of, our principal executive officer and principal financial officer, or persons performing similar functions, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
During the process of preparing the Company’s Annual Report on Form 10-K for the year ending December 31, 2010, on or about March 24, 2011, KPMG, the Company’s prior independent auditor, raised certain issues primarily relating to the unexplained issues regarding certain cash transactions and recorded sales and requested that the Audit Committee conduct an independent investigation. Based on the issues raised by KPMG, on March 31, 2011, our Audit Committee elected to commence an independent Investigation of the issues raised and engaged the services of the Investigation Team. Following the Investigation, the Audit Committee identified, among other issues, inadequate disclosure and issues regarding internal control and procedures. In order to improve corporate governance and enhance internal controls, management and our Board of Directors are committed to adopting and implementing the recommendations of the Audit Committee in addition to all of the corrective actions the Company has taken to date. For more details of the corrective actions, please refer to Item 9A Controls and Procedures herein after.
Notwithstanding the foregoing corrective actions, we cannot currently ensure that our controls and procedures will be effective at any time in the immediate future. Moreover, in order to improve our controls and procedures we anticipate that we will continue to incur significant costs. Failure to properly improve our controls and procedures could result in our failure to meet our reporting obligations, result in the restatement of our past financial statements, cause harm to our operating results, subject us to regulatory scrutiny and sanction, cause investors to lose confidence in our reported financial information and have a negative effect on the market price for shares of our common stock, all of which present significant risk to our investors.
Insurance coverage for some of our operations may be insufficient to cover losses.
The insurance industry in China is still at an early stage of its development. Insurance companies in China offer limited business insurance products or offer them at a high price. We do not maintain insurance coverage for various risks, including environmental claims. A significant uninsured claim against us would have a material adverse effect on our financial position and results of operations.
Failure to comply with environmental laws and regulations may have a material adverse effect on our business and results of operations.
We are subject to various environmental laws and regulations that require us to obtain environmental permits for our operations. We have obtained relevant environmental licenses or approvals to conduct the manufacturing of petrochemical products in our operating subsidiary Ningbo Keyuan. If we fail to obtain all required environmental permits for our operations, or comply with the provisions of our permit, we could be subject to fines, criminal charges or other sanctions by regulators, including the suspension or termination of our operations. We are required to comply with extensive and complex environmental laws and regulations at various levels in the PRC relating to, among other things:
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the handling of petrochemical products;
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the operation of petrochemical product storage facilities;
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workplace safety;
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environmental damage; and
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hazardous waste disposal.
If we are involved in a spill or other accident involving hazardous substances, or if we are found to be in violation of environmental laws or regulations, we could be subject to liabilities that could have a material adverse effect on our business, financial condition and results of operations. If we should fail to comply with applicable environmental regulations, we could be subject to substantial fines or penalties and to civil and criminal liability. Our facilities passed inspection by the Ningbo City environmental protection authorities after the completion of construction. However, we cannot assure you that at all times we will be in compliance with environmental laws and regulations or our environmental permits or that we will not be required to expend significant funds to comply with, or discharge liabilities arising under, environmental laws, regulations and permits.
Our failure to protect our technologies could have a negative impact on our business.
Our manufacturing technologies and process, which have or have not been patented or registered as our property, are key components of our competitive advantage and our growth strategy. On January 25, 2011 we received approval for a patent related to the Company's proprietary production process, called MEP (Multiple Ethylene Propylene). MEP is an exclusive and leading technology used in Keyuan's existing production process. The utility model patent received, #ZL-2010-2-0191523.6, applies to a processing technology used in the production of ethylene and propylene. Working with East China University Of Science and Technology (ECUST), we discovered the technique to improve recovery rate and output capacity of Acrylonitrile. Based on that discovery, the Company applied for patents for three devices in the production process in August, 2012, which are Fluidization Reaction System of Acrylonitrile (#ZL-2012-2-0381020.4), Cooler of Acrylonitrile Gas (#ZL-2012-2-0382047.5) and Absorption Tower of Acrylonitrile (#ZL-2012-2-0381066.6). These three technology inventions are used for improving the output capacity and recovery rate, decreasing discharge waste to improve production efficiency. In March 2013, we received the patent notices from Patent Office, which means its application has been approved..We also rely on confidentiality and license agreements with certain of our employees, customers and others to protect the confidentiality of our technologies. If we are unable to adequately protect the confidentiality of these technologies, our business, results of operations, financial condition and prospects could be materially and adversely affected.
We incur increased costs as a result of being a public company.
Though we are currently a smaller reporting company (market cap less than $75,000,000), we have incurred significant legal, accounting and other expenses that we did not incur as a private company. Additionally, from April 2011 to September 2011, we have incurred approximately $5,000,000 in connection with the Independent Investigation commenced by our Audit Committee at the request of our former auditor KPMG. We may continue to incur costs for the various corrective actions we are taking and committed to taking to improve our internal controls and procedures, as well as corporate governance. Furthermore, if the Company’s market cap exceeds $75 million, we will be subject to the requirements of the Sarbanes-Oxley Act Section 404. In addition, the Sarbanes-Oxley Act, as well as new rules subsequently implemented by the SEC, has required changes in corporate governance practices of public companies. We expect these rules and regulations, along with the corrective actions to improve our controls and procedures, to increase our legal, accounting and financial compliance costs and to make certain corporate activities more time-consuming and costly. We are currently evaluating and monitoring developments with respect to these rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs. Additionally, if we are unable to comply with the Sarbanes-Oxley Act’s internal controls requirements, we may not be able to obtain the independent auditor certifications that Sarbanes-Oxley Act requires publicly-traded companies to obtain.
We may be subject to penalties or fines from the Chinese government as a result of possible violations of PRC laws or regulations
Our management and our Board of Directors have reviewed our past practices and have been advised that several of these practices may result in possible violation of PRC laws or regulations. Specifically, a) we maintained an off-balance account to pay service providers who were not able to issue formal invoices, to distribute cash bonus to our key employees and officers, to pay rental for certain officers’ dormitories whose residences are far from our factory, etc. However, we are advised that such practices may result in violation of PRC laws. As a result, we ceased the use of such off-balance account in April 2011 and have recorded, and will record, all transactions in that account into our financial statement in the relevant annual report and interim report. b) In September 2010, we adopted a numbering system to bar scan our products to avoid any misrepresentation of the nature of our products. In the past we sometimes accommodated requests from our customers to change the name of products so that our customers could save on freight costs. c) in the past, in order to overcome the restrictions regarding the use of certain bank loans or to satisfy the banks’ internal requirements to demonstrate the usage of the loans , we engaged with certain related and other parties in short term financings. . Though we are current on our loan payments and as a general rule, the risk of prosecution and or civil liabilities is diminished if the loans have been repaid, we are advised that such practices may have been in violation of PRC banking laws. d) in 2010, RMB 21 million was transferred by Ningbo Keyuan to one of its employees with no collateral or written agreement. The RMB 21 million was subsequently returned by the employee. The funds were used by the employee to assist an investor in the September 2010 Private Placement, in converting RMB to U.S. dollars. Though we have discontinued the above mentioned practices, such action may violate PRC foreign exchange laws and regulations. If Ningbo Keyuan is held responsible for any such violation conducted by the employee and the investor, Ningbo Keyuan may be subject to penalties. Additionally, Ningbo Keyuan discounted and continues to discount bank notes in order to use its effective credit lines and finance our growth. Though Ningbo Keyuan is current on its loan payments and we have been advised by our PRC counsel that as long as payments to bank loans are current, the chance that Ningbo Keyuan will be subject to a fine, penalty or civil liability because of discounting bank notes is remote; there is a risk that such practice may be a potential violation of PRC banking laws. Therefore, we cannot assure you that we may not be subject to penalties or fines from the Chinese regulators if they decide to proceed against us and we cannot assure you that there will be no other violation of any current PRC laws or regulations identified by the relevant government regulators in the future.
We may face litigation and/or regulatory action as a result of recent events.
In November 2011, The Rosen Law Firm filed a class action law suit against us. We believe there is no basis to the law suit and intend to defend the law suit vigorously. Moreover, as a result of recent events, including but not limited to the delisting of our stock from the NASDAQ, our failure to file periodic reports as they are due for approximately six months and our failure to comply with certain registration requirements related to common shares underlying our preferred stock and warrants, we may become subject to litigation from shareholders and other investors. Additionally, we may also become subject to regulatory enforcement actions in either the U.S. and/or China. If we are forced to defend either a civil law suit brought by outside shareholders or investors and/or a regulatory action, we will be required to expend significant additional funds that could otherwise be utilized for business purposes. Additionally, defense of such claims will result in management expending additional time and focus in connection with such defense that may materially impact its ability to effectively run our business.
Risks Relating to Regulation of Our Business
Uncertainties with respect to the governing regulations could have a material and adverse effect on us.
There are substantial uncertainties regarding the interpretation and application of the PRC laws and regulations, including, but not limited to, the laws and regulations governing our business and our ownership of the equity interests in our PRC subsidiaries, both of which are wholly foreign owned enterprise under the PRC laws. These laws and regulations are relatively new and may be subject to change, and their official interpretation and enforcement may involve substantial uncertainty. The effectiveness of newly enacted laws, regulations or amendments may be delayed, resulting in detrimental reliance by foreign investors. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively.
The PRC government has broad discretion in dealing with violations of laws and regulations, including levying fines, revoking business permits and other licenses and requiring actions necessary for compliance. In particular, licenses and permits issued or granted to the PRC subsidiary by relevant governmental bodies may be revoked at a later time by higher regulatory bodies. We cannot predict the effect of the interpretation of existing or new PRC laws or regulations on our businesses. We cannot assure you that our current ownership and operating structure would not be found to be in violation of any current or future PRC laws or regulations. As a result, we may be subject to sanctions, including fines, and could be required to restructure our operations or cease to provide certain services. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. Any of these or similar actions could significantly disrupt our business operations or restrict us from conducting a substantial portion of our business operations, which could materially and adversely affect our business, financial condition and results of operations.
Our PRC subsidiaries will be subject to restrictions on dividend payments.
We conduct all of our business through our consolidated subsidiaries incorporated in the PRC. We rely on dividends paid by these consolidated subsidiaries for our cash needs, including the funds necessary to pay any dividends and other cash distributions to our stockholders, to service any debt we may incur and to pay our operating expenses. The payment of dividends by entities established in the PRC is subject to limitations. Current regulations in the PRC would permit the PRC subsidiary to pay dividends to us only out of its accumulated distributable profits, if any, determined in accordance with Chinese accounting standards and regulations. In addition, our PRC subsidiaries will be required to set aside at least 10% (up to an aggregate amount equal to half of its registered capital) of its accumulated profits each year. Such cash reserve may not be distributed as cash dividends. In addition, if the PRC subsidiary incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other payments to us. Under U.S. GAAP (Financial Accounting Standard Board (“FASB”) Accounting Standard Codification (“ASC”) Topic 740-30, no deferred tax expense is required to be recorded on the earnings of foreign subsidiaries when the parent company establishes that the earnings will be permanently reinvested outside the U.S. If dividend payments are made by our subsidiaries to the US parent, additional U.S. tax could become due in future years. At the time of the repatriation or investment in U.S. property, the U.S. will tax the foreign earnings as a dividend and will allow a foreign tax credit for any foreign taxes previously paid on the earnings. To the extent that dividend payments are made by our PRC subsidiaries to our US Parent additional tax may be due.
PRC regulations on loans and direct investments by overseas holding companies in PRC entities may delay or prevent us to make overseas loans or additional capital contributions to our PRC subsidiary.
Under the PRC laws, foreign investors may make loans to their PRC subsidiaries or foreign investors may make additional capital contributions to their PRC subsidiaries. Any loans to such PRC subsidiaries are subject to the PRC regulations and foreign exchange loan registrations, i.e. loans by foreign investors to their PRC subsidiaries to finance their activities cannot exceed statutory limits and must be registered with the State Administration of Foreign Exchange (the “SAFE”), or its local branch. Foreign investors may also decide to finance their PRC subsidiaries by means of additional capital contributions. These capital contributions must be examined and approved by the Ministry of Commerce of the People’s Republic of China (the “MOFCOM”), or its local branch in advance.
Under the PRC Enterprise Income Tax Law, we may be classified as a “resident enterprise” of China, and such classification would likely result in unfavorable tax consequences to us and our non-PRC stockholders.
On March 16, 2007, the National People’s Congress (the “NPC”), approved and promulgated the PRC Enterprise Income Tax Law (herein referred as the “New EIT Law”). The New EIT Law took effect on January 1, 2008. Under the New EIT Law, Foreign Investment Enterprises (“FIEs”), and domestic companies are subject to a uniform tax rate of 25%. In addition, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise” which means that we may be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes.
Under the New EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. The implementing rules of the New EIT Law define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise. On April 22, 2009, the State Administration of Taxation, or the SAT, issued a circular, or SAT Circular 82, which provides certain specific criteria for determining whether the “de facto management body” of a PRC-controlled enterprise that is incorporated offshore is located in China, which include all of the following conditions: (a) the location where senior management members responsible for an enterprise’s daily operations discharge their duties; (b) the location where financial and human resource decisions are made or approved by organizations or persons; (c) the location where the major assets and corporate documents are kept; and (d) the location where more than half (inclusive) of all directors with voting rights or senior management have their habitual residence. Although the SAT Circular 82 only applies to offshore enterprises controlled by PRC enterprises or PRC enterprise groups, not those controlled by PRC individuals or foreigners, the determining criteria set forth in the SAT Circular 82 may reflect the SAT’s general position on how the “de facto management body” text should be applied in determining the tax resident status of all offshore enterprises, regardless of whether they are controlled by PRC enterprises or individuals. Due to the short history of the New EIT Law and lack of applicable legal precedents, it remains unclear how the PRC tax authorities will determine the PRC tax resident treatment of a foreign company controlled by individuals like us.
If the PRC tax authorities determine that we are “resident enterprises” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as interest on offering proceeds and non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the New EIT Law and its implementing rules, dividends paid to us from our PRC subsidiaries would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax Finally, it is possible that “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC enterprise stockholders and with respect to gains derived by our non-PRC enterprise stockholders from transferring our shares and a 20% withholding tax is imposed on dividends we pay to our non-PRC individual stockholders and with respect to gains derived by our non-PRC individual stockholders from transferring our shares.. We are actively monitoring the possibility of “resident enterprise” treatment for the applicable tax years and are evaluating appropriate organizational changes to avoid this treatment, to the extent possible.
If we were treated as a “resident enterprise” by PRC tax authorities, we would be subject to taxation in both the U.S. and China, and our PRC tax may not be credited against our U.S. tax.
If we receive any dividends from our PRC subsidiaries in the future, the dividends may be subject to PRC withholding tax.
The New EIT Law and the Implementation Rules of the New EIT Law provides that an income tax rate of 10% may be applicable to dividends payable to non-PRC investors that are “non-resident enterprises”, which (i) do not have an establishment or place of business in the PRC, or (ii) have such establishment or place of business in the PRC but the relevant income is not effectively connected with the establishment or place of business, to the extent such dividends are derived from sources within the PRC. The income tax for non-resident enterprises shall be subject to withholding at the income source, with the payer acting as the obligatory withholder under the New EIT Law, and therefore such income taxes are generally called withholding tax in practice. It is currently unclear in what circumstances a source will be considered as located within the PRC. We are an offshore holding company. Thus, if Keyuan HK is considered as a “non-resident enterprise” under the New EIT Law and the dividends paid to us by our subsidiaries in the PRC are considered income sourced within the PRC, such dividends may be subject to a withholding tax at a rate up to 10%.
In January 2009, the State Administration of Taxation, or SAT, promulgated the Provisional Measures for the Administration of Withholding of Enterprise Income Tax for Non-resident Enterprises (“Measures”), pursuant to which, the entities which have the direct obligation to make the following payment to a non-resident enterprise shall be the relevant tax withholders for such non-resident enterprise, and such payment includes: incomes from equity investment (including dividends and other return on investment), interests, rents, royalties, and incomes from assignment of property as well as other incomes subject to enterprise income tax received by non-resident enterprises in China. Given these Measures, our PRC subsidiaries have an obligation to withhold income tax in respect of the dividends paid to non-resident enterprise investors.
The new tax law provides only a framework of the enterprise tax provisions, leaving many details on the definitions of numerous terms as well as the interpretation and specific applications of various provisions unclear and unspecified. Any increase in the combined company’s tax rate in the future could have a material adverse effect on our financial conditions and results of operations.
We face uncertainty from China’s Circular on Strengthening the Administration of Enterprise Income Tax on Non-Resident Enterprises' Share Transfer (Circular 698 that was released in December 2009 with retroactive effect from January 1, 2008.)
The Chinese State Administration of Taxation released a circular (“Circular 698”) on December 10, 2009 that addresses the transfer of shares by nonresident companies. Circular 698, which is effective retroactively to January 1, 2008, may have a significant impact on many companies that use offshore holding companies to invest in China. Pursuant to Circular 698, where the withholding agent does not withhold in accordance with laws or can’t perform the withholding obligation, the non-resident enterprises shall file a tax declaration with the PRC tax authority located at the place of the resident enterprise whose equity has been transferred, within seven days agree the date of the equity transfer provided under the contracts.
Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise by selling the shares in an offshore holding company, and the latter is located in a country or jurisdiction where the effective tax burden is less than 12.5% or where the offshore income of his, her, or its residents is not taxable, the foreign investor is required to provide the tax authority in charge of that Chinese resident enterprise with the relevant information within 30 days of the transfers. Moreover, where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise through an abuse of form of organization and there are no reasonable commercial purposes such that the corporate income tax liability is avoided, the PRC tax authority will have the power to re-assess the nature of the equity transfer in accordance with PRC’s “substance-over-form” principle and deny the existence of the offshore holding company that is used for tax planning purposes.
There is uncertainty as to the application of Circular 698. For example, while the term "indirectly transfer" is not defined, it is understood that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. Moreover, the relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax in the country or jurisdiction and to what extent and the process of the disclosure to the tax authority in charge of that Chinese resident enterprise. In addition, there are no formal declarations with regard to how to decide abuse of form of organization and reasonable commercial purpose, which can be utilized by us to balance if our company complies with the Circular 698. As a result, we may become at risk of being taxed under Circular 698 and we may be required to expend valuable resources to comply with Circular 698 or to establish that we should not be taxed under Circular 698, which could have a material adverse effect on our financial condition and results of operations.
Our PRC subsidiaries are obligated to withhold and pay PRC individual income tax on behalf of our employees who are subject to PRC individual income tax. If we fail to withhold or pay such individual income tax in accordance with applicable PRC regulations, we may be subject to certain sanctions and other penalties and may become subject to liability under PRC laws.
Under PRC laws, Ningbo Keyuan and Ningbo Keyuan Petrochemicals are obligated to withhold and pay individual income tax on behalf of our employees who are subject to PRC individual income tax. If any PRC subsidiary fails to withhold and/or pay such individual income tax in accordance with PRC laws, it may be subject to certain sanctions and other penalties and may become subject to liability under PRC laws. We paid employees, senior management members and outside individual service providers cash compensation or awards totaling approximately RMB 4.8 million (approximately $709,000) in Year 2009, 2010 and first two months of 2011 without withholding individual income tax. Though we have stopped such practice and will follow any compensation recommendation from our compensation committee in the future, we may be subject to certain sanctions and other penalties and may become subject to liability under applicable tax laws in China.
In addition, the SAT has issued several circulars concerning employee stock options. Under these circulars, our employees working in the PRC (which could include both PRC employees and expatriate employees subject to PRC individual income tax) who exercise stock options will be subject to PRC individual income tax. Our PRC subsidiaries have obligations to file documents related to employee stock options with relevant tax authorities and withhold and pay individual income taxes for those employees who exercise their stock options. While tax authorities may advise us that our policy is compliant, they may change their policy, and we could be subject to sanctions
Regulations of Overseas Investments and Listings may increase the administrative burden we face and create regulatory uncertainties.
On August 8, 2006, six PRC regulatory agencies, including the MOFCOM, the China Securities Regulatory Commission (the“CSRC”), the State Asset Supervision and Administration Commission (the “SASAC”), the State Administration of Taxation (the “SAT”), the State Administration for Industry and Commerce (the “SAIC”) and SAFE, amended and released the New M&A Rule, which took effect as of September 8, 2006. This regulation, among other things, includes provisions that purport to require that an offshore company formed for purposes of overseas listing of equity interest in PRC companies and controlled directly or indirectly by PRC companies or individuals (an “SPV”) obtain the approval of CSRC prior to the listing and trading of such SPV’s securities on an overseas stock exchange.
The application of the New M&A Rule with respect to overseas listings of SPVs remains unclear.
It is not clear whether the provisions in the new regulation regarding the offshore listing and trading of the securities of a SPV apply to an offshore company such as us which owns equity interests in Ningbo Keyuan and Ningbo Keyuan Petrochemicals. We believe that the M&A Rules and CSRC approval are not required in the context of the share exchange under our transaction because (i) such share exchange is a purely foreign related transaction governed by foreign laws, not subject to the jurisdiction of PRC laws and regulations; (ii) at the time of Share Exchange, we were not an SPV formed or controlled by PRC companies or PRC individuals; (iii) Ningbo Keyuan was established as a Sino-foreign joint venture by means of direct investment rather than by merger or acquisition of an existing PRC domestic company; (iv) at the time of Share Exchange, we were owned and controlled by foreigners; and (v) there is no clear requirement in the New M&A Rule that would require an application to be submitted to the MOFCOM or CSRC for the approval of the listing and trading of our common stock on the U.S. security market. However, we cannot be certain that the relevant PRC government agencies, including CSRC, would reach the same conclusion, and we still cannot rule out the possibility that CSRC may deem that the transactions effected by the share exchange circumvented the M&A Rules, the PRC Securities Law and other rules and notices.
However, through the Slow Walk Options, we are indirectly owned or substantially controlled by PRC individuals, Mr. Chunfeng Tao, Mr. Jicun Wang and Mr. Peijun Chen. If CSRC or another PRC regulatory agency subsequently determines that CSRC’s approval is required for the transaction, we may face sanctions by CSRC or another PRC regulatory agency. If this happens, these regulatory agencies may impose fines and penalties on our operations in the PRC, limit our operating privileges in the PRC, delay or restrict the repatriation of the proceeds from financings into the PRC, restrict or prohibit payment or remittance of dividends to us or take other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our shares. CSRC or other PRC regulatory agencies may also take actions requiring us, or making it advisable for us, to delay or cancel the transaction.
The M&A Rules, along with foreign exchange regulations discussed in the above subsection, will be interpreted or implemented by the relevant government authorities in connection with our future offshore financings or acquisitions, and we cannot predict how they will affect our business development strategy.
PRC regulations relating to the establishment of offshore holding companies by PRC residents may subject our PRC resident beneficial owners or our PRC subsidiaries to liability or penalties, limit our ability to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to increase their registered capital or distribute profits to us, or may otherwise adversely affect us.
In October 2005, SAFE issued the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Return Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or SAFE Notice 75, which became effective as of November 1, 2005. SAFE has also issued implemented rules to SAFE Notice 75. SAFE Notice 75 and its implementation rules require PRC residents (including both corporate entities and natural persons) to register with SAFE or its competent local branch in connection with their direct or indirect shareholding in any company outside of China referred to as an “offshore special purpose company” established for the purpose of raising funds from overseas to acquire assets of, or equity interests in, PRC companies. Under SAFE Notice 75, a “special purpose vehicle”, or SPV, refers to an offshore entity established or controlled, directly or indirectly, by PRC residents for the purpose of seeking offshore equity financing using assets or interests owned by such PRC residents in onshore companies. In addition, any PRC resident that is the shareholder of an offshore special purpose company is required to amend his or her SAFE registration with the SAFE or its competent local branch, with respect to that offshore special purpose company in connection with any of its increase or decrease of capital, transfer of shares, merger, division, equity investment or creation of any security interest over any assets located in China. The SAFE regulations require retroactive approval and registration of direct or indirect investments previously made by PRC residents in offshore special purpose companies. PRC subsidiaries of an offshore special purpose company are required to coordinate and supervise the filing of SAFE registrations by the offshore holding company’s shareholders who are PRC residents in a timely manner. In the event that a PRC resident shareholder with a direct or indirect investment in an offshore parent company fails to obtain the required SAFE approval and make the required registration, the PRC subsidiaries of such offshore parent company may be prohibited from making distributions of profits to the offshore parent and from paying the offshore parent proceeds from any reduction in capital, share transfer or liquidation in respect of the PRC subsidiaries. Further, failure to comply with the various SAFE approval and registration requirements described above, as currently drafted, could result in liability under PRC law for foreign exchange evasion.
There still remain uncertainties as to how certain procedures and requirements under the aforesaid SAFE regulations will be enforced, and it remains unclear how these existing regulations, and any future legislation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant government authorities. Although we have requested PRC residents who, to our knowledge, hold direct or indirect interests in our company to make the necessary applications, filings and amendments as required under the SAFE Notice 75 and other related rules, our PRC resident beneficial holders have not completed such approvals and registrations required by the SAFE regulations. We cannot assure you that such PRC residents will be able to complete the necessary approval and registration procedures required by the SAFE regulations. We will attempt to comply, and attempt to ensure that all of our shareholders subject to these rules comply with the relevant requirements. We cannot, however, assure the compliance of all of our China-resident shareholders. Any current or future failure to comply with the relevant requirements could subject us to fines or sanctions imposed by the Chinese government, including restrictions on certain of our subsidiaries’ ability to pay dividends or hinder our investment in those subsidiaries or affect our ownership structure, which could adversely affect our business and prospects.
Failure to comply with PRC regulations regarding the registration requirements for employee stock ownership plans or share option plans may subject the PRC plan participants or us to fines and other legal or administrative sanctions.
In December 2006, the People’s Bank of China promulgated the Administrative Measures of Foreign Exchange Matters for Individuals, which set forth the respective requirements for foreign exchange transactions by individuals (both PRC or non-PRC citizens) under either the current account or the capital account. In January 2007, SAFE issued implementing rules for the Administrative Measures of Foreign Exchange Matters for Individuals, which, among other things, specified approval requirements for certain capital account transactions such as a PRC citizen’s participation in the employee stock ownership plans or stock option plans of an overseas publicly-listed company. In March 2007, SAFE promulgated the Application Procedures of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Ownership Plan or Stock Option Plan of Overseas-Listed Company, or the Stock Option Rules. Under these rules, PRC citizens who participate in an employee stock ownership plan or a stock option plan in an overseas publicly-listed company are required to register with SAFE or its local branch and complete certain other procedures. For participants of an employee stock ownership plan, an overseas custodian bank should be retained by the PRC agent, which could be the PRC subsidiary of such overseas publicly-listed company, to hold on trusteeship all overseas assets held by such participants under the employee share ownership plan. In the case of a stock option plan, the PRC agent is required to retain a financial institution with stock brokerage qualification at the place where the overseas publicly-listed company is listed or a qualified institution designated by the overseas publicly-listed company to handle matters in connection with the exercise or sale of stock options for the stock option plan participants. For participants who had already participated in an employee stock ownership plan or stock option plan before the date of the Stock Option Rules, the Stock Option Rules require their PRC employers or PRC agents to complete the relevant formalities within three months of the date of this rule.
Further, a notice concerning the individual income tax on earnings from employee share options jointly issued by Ministry of Finance, or the MOF, and the State Administration of Taxation, or the SAT, and its implementing rules, provide that domestic companies that implement employee share option programs shall (a) file the employee share option plans and other relevant documents to the local tax authorities having jurisdiction over them before implementing such employee share option plans; (b) file share option exercise notices and other relevant documents with the local tax authorities having jurisdiction over them before exercise by the employees of the share options, and clarify whether the shares issuable under the employee share options mentioned in the notice are the shares of publicly listed companies; and (c) withhold taxes from the PRC employees in connection with the PRC individual income tax.
We and our PRC citizen employees who participate in the employee stock incentive plan, which we adopted in 2010, will be subject to these regulations. We and our PRC option grantees have not completed the registrations under these regulations. We cannot assure you that we and our PRC option grantees will be able to complete the required registrations. Any current or future failure to comply with the relevant requirements could subject us to fines or sanctions imposed by the Chinese government, which could adversely affect our business and prospects.
Failure to comply with PRC laws and regulations relating to the environmental protection and safety in production requirements in China may result in severe penalties and liabilities.
The Chinese government has been adopting increasingly stringent regulations relating to the safety and environmental protection, and our business depends upon compliance with the aforesaid regulations and requirements. We completed an as-build acceptance inspection and we obtained relevant safety production permits and approvals from a variety of government authorities upon completion of the aforesaid inspection. The as-build inspection was conducted by the local government to make sure that a company meets all the conditions for normal production. We obtained all the necessary permits and approvals including environmental protection, firefighting and safety production before our trial production and submitted the application for as-build acceptance inspection at the end of 2009. The as-build acceptance inspection needs to be conducted within 12 months after the submission of application and we received the complete set of permits and approvals from relevant government authorities on December 16, 2010. However, there is no assurance that we will obtain or renew all such permits or approvals, which are subject to our fulfillment of the standards and requirements set out by the regulatory authorities. If we fail to pass the as-build acceptance inspection or obtain required licenses, we may be subject to fines, penalties or legal proceedings. Our operations at our production facilities are subject to periodic checks by the relevant authorities in the PRC and they have the power to take action against us, impose fines, withdraw or suspend our relevant licenses or activities or impose other penalties if we fail to comply with relevant regulations, in the event of which our business operations may be adversely affected. In addition, any change in the scope or application of these laws and regulations may limit our production capacity or increase our cost of operation and could therefore have an adverse effect on our business operations, financial condition and operating results. Our failure to comply with these laws and regulations could result in fines, penalties or legal proceedings. There can be no assurance that the Chinese government will not impose additional or stricter laws or regulations, compliance with which may cause us to incur significant capital expenditures, which it may not be able to pass on to our customers.
In September 2011, we completed construction of an SBS production facility which we started in September 2010. The SBS facility was built on part of 1.2 million square feet of land for which we obtained the use right in August 2010. To ensure compliance with national environmental regulation and working safety protection regulations, we underwent an environmental assessment which was conducted by the government environmental bureau. The preliminary environmental assessment permit was obtained in 2009 to enable us to start construction. We constructed our facility based on a design system in compliance with environmental protection, including gas discharge and waste water treatment and recycling. As a result, we passed the environmental assessment in August 2012. However, there can be no assurance that the Chinese government will not impose additional or stricter laws or regulations, compliance with which may cause us to incur significant capital expenditures, which we may not be able to pass on to our customers. Our operations at our production facilities are subject to periodic checks by the relevant authorities in the PRC and they have the power to take action against us, impose fines, withdraw or suspend our relevant licenses or activities or impose other penalties if we fail to comply with relevant regulations, in the event of which our business operations may be adversely affected.
Risks Associated With Doing Business in China
There are substantial risks associated with doing business in China, as set forth in the following risk factors.
Our operations and assets in China are subject to significant political and economic uncertainties.
Changes in PRC laws and regulations, or their interpretation, or the imposition of confiscatory taxation, restrictions on currency conversion, imports and sources of supply, devaluations of currency or the nationalization or other expropriation of private enterprises could have a material adverse effect on our business, results of operations and financial condition. Under its current leadership, the Chinese government has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the Chinese government will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice.
We derive all of our sales from China.
Substantially all of our sales are generated from China. We anticipate that sales of our products in China will continue to represent a substantial proportion of our total sales in the near future. Any significant decline in the condition of the PRC economy could adversely affect consumer demand of our products, among other things, which in turn would have a material adverse effect on our business and financial condition.
Currency fluctuations and restrictions on currency exchange may adversely affect our business, including limiting our ability to convert Chinese Renminbi into foreign currencies and, if Chinese Renminbi were to decline in value, reducing our revenue in U.S. dollar terms.
Our reporting currency is the U.S. dollar and our operations in China use their local currency as their functional currencies. Substantially all of our revenue and expenses are in Chinese Renminbi. We are subject to the effects of exchange rate fluctuations with respect to any of these currencies. For example, the value of the Renminbi depends to a large extent on Chinese government policies and China’s domestic and international economic and political developments, as well as supply and demand in the local market. Since 1994, the official exchange rate for the conversion of Renminbi to the U.S. dollar had generally been stable and the Renminbi had appreciated slightly against the U.S. dollar. However, on July 21, 2005, the Chinese government changed its policy of pegging the value of Chinese Renminbi to the U.S. dollar. Under the new policy, Chinese Renminbi may fluctuate within a narrow and managed band against a basket of certain foreign currencies. As a result of this policy change, Chinese Renminbi depreciated approximately 0.06% against the U.S. dollar in 2009 and appreciated approximately 3.57% in 2010. Chinese Renminbi further appreciated approximately 4.86% in 2011. It is possible that the Chinese government could adopt a more flexible currency policy, which could result in more significant fluctuation of Chinese Renminbi against the U.S. dollar. We can offer no assurance that Chinese Renminbi will be stable against the U.S. dollar or any other foreign currency.
The statements of our operations are translated into U.S. dollars at the average exchange rates in each applicable period. To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currency denominated transactions could result in reduced revenue, operating expenses and net income for our international operations. Similarly, to the extent the U.S. dollar weakens against foreign currencies, the translation of these foreign currency denominated transactions could result in increased revenue, operating expenses and net income for our international operations. We are also exposed to foreign exchange rate fluctuations as we convert the financial statements of our foreign subsidiaries into U.S. dollars in consolidation. If there is a change in foreign currency exchange rates, the conversion of the foreign subsidiaries’ financial statements into U.S. dollars will lead to a translation gain or loss which is recorded as a component of other comprehensive income. In addition, we have certain assets and liabilities that are denominated in currencies other than the relevant entity’s functional currency. Changes in the functional currency value of these assets and liabilities create fluctuations that will lead to a transaction gain or loss. We have not entered into agreements or purchased instruments to hedge our exchange rate risks, although we may do so in the future. The availability and effectiveness of any hedging transaction may be limited and we may not be able to successfully hedge our exchange rate risks.
Although Chinese governmental policies were introduced in 1996 to allow the convertibility of Chinese Renminbi into foreign currency for current account items, conversion of Chinese Renminbi into foreign exchange for capital items, such as foreign direct investment, loans or securities, requires the approval of SAFE which is under the authority of the People’s Bank of China. These approvals, however, do not guarantee the availability of foreign currency conversion. We cannot be sure that we will be able to obtain all required conversion approvals for our operations or that Chinese regulatory authorities will not impose greater restrictions on the convertibility of Chinese Renminbi in the future. Because a significant amount of our future revenue may be in the form of Chinese Renminbi, our inability to obtain the requisite approvals or any future restrictions on currency exchanges could limit our ability to utilize revenue generated in Chinese Renminbi to fund our business activities outside of China, or to repay foreign currency obligations, including our debt obligations, which would have a material adverse effect on our financial condition and results of operations.
We may have limited legal recourse under PRC laws if disputes arise under our contracts with third parties.
The Chinese government has enacted laws and regulations dealing with matters such as corporate organization and governance, foreign investment, commerce, taxation and trade. However, their experience in implementing, interpreting and enforcing these laws and regulations is limited, and our ability to enforce commercial claims or to resolve commercial disputes is unpredictable. If our new business ventures are unsuccessful, or other adverse circumstances arise from these transactions, we face the risk that the parties to these ventures may seek ways to terminate the transactions, or, may hinder or prevent us from accessing important information regarding the financial and business operations of these acquired companies. The resolution of these matters may be subject to the exercise of considerable discretion by agencies of the Chinese government, and forces unrelated to the legal merits of a particular matter or dispute may influence their determination. Any rights we may have to specific performance, or to seek an injunction under PRC law, in either of these cases, are severely limited, and without a means of recourse by virtue of the Chinese legal system, we may be unable to prevent these situations from occurring. The occurrence of any such events could have a material adverse effect on our business, financial condition and results of operations.
Because our funds are held in banks in uninsured PRC bank accounts, the failure of any bank in which we deposit our funds could affect our ability to continue our business.
Funds on deposit at banks and other financial institutions in the PRC are often uninsured. A significant portion of our assets are in the form of cash deposited with banks in the PRC, and in the event of a bank failure, we may not have access to our funds on deposit. Depending upon the amount of money we maintain in a bank that fails, our inability to have access to our cash could impair our operations, and, if we are not able to access funds to pay our suppliers, employees and other creditors, we may be unable to continue in business.
Our business could be severely harmed if the Chinese government changes its policies, laws, regulations, tax structure or its current interpretations of its laws, rules and regulations, relating to our operations in China.
Our business is located in Ningbo, China and virtually all of our assets are located in China. We generate our sales revenue only from customers located in China. Our results of operations, financial state of affairs and future growth are, to a significant degree, subject to China’s economic, political and legal development and related uncertainties. Our operations and results could be materially affected by a number of factors, including, but not limited to:
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Changes in policies by the Chinese government resulting in changes in laws or regulations or the interpretation of laws or regulations,
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changes in taxation,
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changes in employment restrictions,
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import duties, and
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currency revaluation.
Over the past several years, the Chinese government has pursued economic reform policies including the encouragement of private economic activities and greater economic decentralization. If the Chinese government does not continue to pursue its present policies that encourage foreign investment and operations in China, or if these policies are either not successful or are significantly altered, then our business could be harmed. Following the Chinese government’s policy of privatizing many state-owned enterprises, the Chinese government has attempted to augment its revenues through increased tax collection. It also exercises significant control over China’s economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Continued efforts to increase tax revenues could result in increased taxation expenses being incurred by us. Economic development may be limited as well by the imposition of austerity measures intended to reduce inflation, the inadequate development of infrastructure and the potential unavailability of adequate power and water supplies, transportation and communications. In addition, the Chinese government continues to play a significant role in regulating industry by imposing industrial policies.
Failure to comply with the U.S. foreign corrupt practices act and Chinese anti-corruption laws could subject us to penalties and other adverse consequences.
Our executive officers, employees and other agents are subject to anti-corruption and anti-bribery laws including China’s anti-corruption laws and the U.S. Foreign Corrupt Practices Act, or the FCPA, which generally prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. In addition, we are required to maintain records that accurately and fairly represent our transactions and have an adequate system of internal accounting controls. Foreign companies, including some that may compete with us, are not subject to these prohibitions, and therefore may have a competitive advantage over us. The PRC also strictly prohibits bribery of government officials. However, corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in the PRC.
While we intend to implement measures to ensure compliance with the FCPA and China’s anti-corruption laws by all individuals involved with our company, our employees or other agents may engage in such conduct for which we might be held responsible. Since we became a U.S. public company, we have implemented strict requirements to preclude payments to government officials and limits on the amount employees can spend on gifts and entertaining clients. Although prior to our becoming a U.S public company we had given culturally traditional gifts to government officials during Spring Festival and other Chinese traditional holidays, we believe the amounts of such gifts are below the amounts that generally trigger criminal liability under PRC law. The gifts were not made with the intent to bribe or wrongfully influence any such officials. However, if our employees or other agents are found to have engaged in practices that violate either U.S or PRC laws, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations. In addition, our brand and reputation, our sales activities or our stock price could be adversely affected if we become the target of any negative publicity as a result of actions taken by our employees or other agents.
Changes in foreign exchange regulations in the PRC may affect our ability to pay dividends in foreign currency or conduct other foreign exchange business.
The Renminbi is not a freely convertible currency currently, and the restrictions on currency exchanges may limit our ability to use revenues generated in Renminbi to fund our business activities outside the PRC or to make dividends or other payments in United States dollars. The PRC government strictly regulates conversion of Renminbi into foreign currencies. Over the years, foreign exchange regulations in the PRC have significantly reduced the government’s control over routine foreign exchange transactions under current accounts. In the PRC, SAFE regulates the conversion of the Renminbi into foreign currencies. Pursuant to applicable PRC laws and regulations, foreign invested enterprises incorporated in the PRC are required to apply for “Foreign Exchange Registration Certificates.” Currently, conversion within the scope of the “current account” (e.g. remittance of foreign currencies for payment of dividends, etc.) can be effected without requiring the approval of SAFE. However, conversion of currency in the “capital account” (e.g. for capital items such as direct investments, loans, securities, etc.) still requires the approval of SAFE.
The Chinese government exerts substantial influence over the manner in which we must conduct our business activities.
China has only recently permitted provincial and local economic autonomy and private economic activities, and, as a result, we are dependent on our relationship with the local government in the province in which we operate our business. Chinese government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, environmental regulations, land use rights, property and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of these jurisdictions may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations. Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof, and could require us to divest ourselves of any interest we then hold in Chinese properties.
PRC employment contract law and increases in the labor costs in China may hurt our business and profitability.
A Chinese employment contract law that became effective on January 1, 2008, imposes more stringent requirements on employers in relation to entry into fixed-term employment contracts, recruitment of temporary employees and dismissal of employees. In addition, under the Regulations on Paid Annual Leave for Employees, which also became effective on January 1, 2008, employees who have worked continuously for more than one year are entitled to a paid vacation ranging from 5 to 15 days, depending on the length of the employee’s service. Employees who waive such vacation entitlements at the request of the employer will be compensated for three times their normal daily salaries for each vacation day so waived. As a result of the new law and regulations, our labor costs may increase. There is no assurance that disputes, work stoppages or strikes will not arise in the future.
Increases in the labor costs or future disputes with our employees could damage our business, financial condition or operating results. According to PRC labor laws, the employer shall be responsible to deal with and pay social insurances and housing funds for all of its employees based on the actual salary of the employees. In addition, as required by PRC regulations, we participate in various employee benefit plans that are organized by municipal and provincial governments, including pension, work-related injury benefits, maternity insurance, medical and unemployment benefit plans. We are required under PRC laws to make contributions to the employee benefit plans at specified percentages of the salaries, bonuses and certain allowances of our employees, up to a maximum amount specified by the local government from time to time. Members of the retirement plan are entitled to a pension equal to a fixed proportion of the salary prevailing at the member’s retirement date. There is no guarantee that we and our subsidiaries will be able to comply with the relevant requirements. Failure to comply with the various PRC Labor Laws and regulation requirements described above could result in liability under PRC law.
Future inflation in China may inhibit our ability to conduct business in China.
In recent years, the Chinese economy has experienced periods of rapid expansion and high rates of inflation. These factors have led to the adoption by the Chinese government, from time to time, of various corrective measures designed to restrict the availability of credit, or regulate growth and contain inflation. High inflation may in the future cause the Chinese government to impose controls on credit and/or prices, or to take other action, which could inhibit economic activity in China, and thereby harm the market for our products.
We may have difficulty establishing adequate management, legal and financial controls in the PRC.
We may have difficulty in hiring and retaining a sufficient number of qualified employees to work in the PRC. As a result, we may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet Western standards. We may have difficulty establishing adequate management, legal and financial controls in the PRC. Please refer to Item 9A. Controls and Procedures on page 58 for additional information on this matter.
You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based on United States or other foreign laws, against us and our management.
We conduct substantially all of our operations in China and substantially all of our assets are located in China. In addition, some of our directors and executive officers reside within China. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China upon some of our directors and senior executive officers, including with respect to matters arising under U.S. federal securities laws or applicable state securities laws. It would also be difficult for investors to bring an original lawsuit against us or our directors or executive officers before a Chinese court based on U.S. federal securities laws or otherwise. Moreover, China does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement of judgment of courts.
Because Chinese laws govern almost all of our business’ material agreements, we may not be able to enforce our rights within the PRC or elsewhere, which could result in a significant loss of business, business opportunities or capital.
The Chinese legal system is similar to a civil law system based on written statutes. Unlike common law systems, it is a system in which decided legal cases have little precedential value. Although legislation in the PRC over the past 26 years has significantly improved the protection afforded to various forms of foreign investment and contractual arrangements in the PRC, these laws, regulations and legal requirements are relatively new. Due to the limited volume of published judicial decisions, their non-binding nature, the short history since their enactments, the discrete understanding of the judges or government agencies of the same legal provision, inconsistent professional abilities of the judicators, and the inclination to protect local interest in the court room, interpretation and enforcement of PRC laws and regulations involve uncertainties, which could limit the legal protection available to us, and foreign investors, including you. The inability to enforce or obtain a remedy under any of our future agreements could result in a significant loss of business, business opportunities or capital and could have a material adverse impact on our business, prospects, financial condition, and results of operations. In addition, the PRC legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until some time after the violation. In addition, any litigation in the PRC, regardless of outcome, may be protracted and result in substantial costs and diversion of resources and management attention.
Risks Related to our Securities
Insiders have substantial control over us, and they could delay or prevent a change in our corporate control even if our other stockholders wanted it to occur.
Pursuant to a share transfer agreement, Mr. Chunfeng Tao, our Chairman, Chief Executive Officer and President has exercised an option after certain performance targets were met to purchase from Mr. Brian Pak-Lun Mok, the sole shareholder of Apex Smart Limited (the owner of 45.6132% of the share capital of Delight Reward Limited), 100% of Apex Smart Limited’s equity, which entitled Mr. Tao to own 45.6132% of the equity of Delight Reward Limited. Delight Reward Limited holds 47,658,000 shares of our common stock, representing approximately 82.60% of our common stock. Accordingly, Mr. Tao (indirectly controls approximately 56.81% of our common stock) and other insiders are able to control all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This could delay or prevent an outside party from acquiring or merging with us even if our other stockholders wanted it to occur.
There may not be sufficient liquidity in the market for our securities in order for investors to sell their securities.
There is currently only a limited public market for our common stock and there can be no assurance that a trading market will develop further or be maintained in the future.
The market price of our common stock may be volatile.
The market price of our common stock has been and will likely continue to be highly volatile, as is the stock market in general. Some of the factors that may materially affect the market price of our Common Stock are beyond our control, such as changes in financial estimates by industry and securities analysts, conditions or trends in the industry in which we operate or sales of our common stock. Additionally, on April 1, 2011 trading in our common stock was halted by Nasdaq and on October 5, 2011 our common stock was delisted from Nasdaq. On October 7, 2011, our stock began trading on the Pink Sheets and is currently trading on the OTC Bulletin Board. It is likely that our stock will experience significant pressure for some time as a result of the lack of liquidity during the period in which it was halted.
These factors and the event listed above may materially adversely affect the market price of our common stock, regardless of our performance. In addition, the public stock markets have experienced extreme price and trading volume volatility. This volatility has significantly affected the market prices of securities of many companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock.
Because we became public by means of a reverse merger, we may not be able to attract the attention of major brokerage firms.
Since we became public through a “reverse merger,” the newly-issued common shares issued in connection with the “reverse merger” and the private placement are restricted shares. As a result, our common stock will continue to be very thinly traded after the reverse merger, until a considerable number of such shares are registered in an effective registration statement or become sellable under Rule 144 if all of the conditions in Rule 144(i)(2) are satisfied at the time of the proposed sale. Therefore, securities analysts of major brokerage firms may not provide coverage of our Company since there is little incentive to brokerage firms to recommend the purchase of our common stock. No assurance can be given that brokerage firms will want to conduct any secondary offerings on behalf of the Company in the future.
ITEM 1B.
ITEM 1B. UNSOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. DESCRIPTION OF PROPERTY
All land in China is owned by the State. Individuals and companies are permitted to acquire rights to use land or land use rights for specific purposes. In the case of land used for industrial purposes, the land use rights are granted for a certain period no more than 50 years. This period may be renewed at the expiration of the initial and any subsequent terms. Granted land use rights are transferable and may be used as security for borrowings and other obligations. We currently own land use rights to approximately 2.5 million square feet of land, including land for our existing production facility and land for future expansions, and approximately 53,000 square feet of buildings consisting of an employee dormitory in Ningbo, China.
We have acquired the state-granted use rights to land set forth in the table below.
We intend to expand our manufacturing facility over the next few years and believe that we currently have enough land to satisfy such expansion.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We may from time to time become a party to various legal or administrative proceedings arising in the ordinary course of our business.
On November 15, 2011, the Rosen Law Firm filed a class action suit, alleging we had violated federal securities laws by issuing materially false and misleading statements and omitting material facts with regard to disclosure of related party transactions and effectiveness of internal controls in past public filings. The case is currently at the discovery stage and we believe there is no basis to the suit filed by the Rosen Law Firm and intend to contest the case vigorously.
On January 9, 2012, Ningbo Keyuan filed a law suit in Ningbo Beilun District People’s Court against Zhenjiang Kaiyuan Installation Group (now known as Zhenjiang Industry Equipment Installation Group Co., Ltd) in breach of a project construction contract and alleged damages of RMB 98,000. Zhenjiang Industry Equipment filed a counter claim requiring us to pay RMB 9,825,615 of project cost and RMB 1,350,000 of interest. The two parties have settled the case and Ningbo Keyuan agreed to pay Zhenjiang Industry Equipment a total amount of RMB 7,220,000 (approximately $1,144,738).
In June 2012, Ningbo Keyuan filed a law suit in Ningbo Beilun District People’s Court against Ningbo Lianneng Thermo Co., Ltd (“Ningbo Lianneng”) in a dispute over a power supply contract alleging damages of RMB 10,964,366 (approximately $1,740,300). In August 2012, Ningbo Lianneng filed a counter claim in Ningbo Intermediate People’s Court (the “Intermediate Court”) against Ningbo Keyuan for the same dispute for RMB 15,444,539 (approximately $ 2,451,500). A civil trial for the counter claim was held at the Intermediate Court on August 30, 2012, but no decision was made. In addition, Ningbo Keyuan filed the same law suit in the Intermediate Court in late August 2012, and a civil trial for this claim was held on October 18, 2012. No decision has been made as of the date of this filing.
On February 28, 2013, the Company reached a settlement in a case filed by the Securities and Exchange Commission (“SEC”) in the United States District Count for the District of Columbia against the Company, alleging the Company violated Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933, Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934, and Rules 12b-20 and 13a-13 thereunder. Under the terms agreed to by the Company and the SEC, the Company, without admitting or denying the allegation of the complaint, will pay a civil penalty of $1million and will be permanently enjoined from violating certain securities law. The settlement remains subject to approval by the United District Court for the District of Columbia, which must approve its terms and enter the final judgment.
Other than as set forth herein, we are currently not a party to any material legal or administrative proceedings and are not aware of any pending or threatened legal or administrative proceedings against us.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITY
The Company’s common stock is traded on the Over-the-Counter Bulletin Board under the symbol “KEYP”; our cusip number is 493722102. We first began trading on April 22, 2010 on the Over the Counter Bulletin Board. Beginning on September 15, 2010, we began trading on the Nasdaq Capital Market under the symbol “KEYP”. On January 18, 2011, our common stock commenced trading on the Nasdaq Global Market. On April 1, 2011 trading in our stock was halted by Nasdaq and delisted on October 5, 2011 resulting our shares trading on the Pink Sheets commencing on October 7, 2011.
The following table sets forth the quarterly high and low bid prices for the common stock since the quarter ended June 30, 2010. The prices set forth below represent inter-dealer quotations, without retail markup, markdown or commission and may not be reflective of actual transactions.
* For the period from April 1, 2011 to October 6, 2011, trading in our stock was halted by Nasdaq
At June 3, 2013, the closing bid price of the common stock was $0.90 and we had approximately 106 record holders of our commons stock and one record holder of our Series B Preferred Stock. This number excludes any estimate by us of the number of beneficial owners of shares held in street name, the accuracy of which cannot be guaranteed.
As of June 3, 2013 , there are (i) three-year Series A Warrants to purchase up to 807,450 shares of Common Stock, at an exercise price of $4.50 per share; (ii) three-year Series B Warrants to purchase up to 808,600 shares of Common Stock, at an exercise price of $5.25 per share. (iii) three-year Series C Warrants to purchase up to 874,802 shares of Common Stock, at an exercise price of $4.50 per share; and (iv) three-year Series D Warrants to purchase up to 874,802 shares of Common Stock, at an exercise price of $5.25 per share. We also granted warrants to purchase 718,755 shares of Common Stock to TriPoint Global Equities, LLC, the placement agent in the April-May 2010 Financing. In connection with the September 2010 financing, we granted placement agent warrants to purchase up to 561,601 shares of Common Stock to Tripoint Global Equities, Inc.
Effective August 11, 1993, the SEC adopted Rule 15g-9, which established the definition of a "penny stock," for purposes relevant to the Company, as any equity security that has a market price of less than $5.00 per share or with an exercise price of less than $5.00 per share, subject to certain exceptions. For any transaction involving a penny stock, unless exempt, the rules require: (i) that a broker or dealer approve a person's account for transactions in penny stocks; and (ii) that the broker or dealer receive from the investor a written agreement to the transaction, setting forth the identity and quantity of the penny stock to be purchased. In order to approve a person's account for transactions in penny stocks, the broker or dealer must (i) obtain financial information and investment experience and objectives of the person; and (ii) make a reasonable determination that the transactions in penny stocks are suitable for that person and that person has sufficient knowledge and experience in financial matters to be capable of evaluating the risks of transactions in penny stocks. The broker or dealer must also deliver, prior to any transaction in a penny stock, a disclosure schedule prepared by the Commission relating to the penny stock market, which, in highlight form, (i) sets forth the basis on which the broker or dealer made the suitability determination; and (ii) states that the broker or dealer received a signed, written agreement from the investor prior to the transaction. Disclosure also has to be made about the risks of investing in penny stock in both public offerings and in secondary trading, and about commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and the rights and remedies available to an investor in cases of fraud in penny stock transactions. Finally, monthly statements have to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks
Dividend Policy
On January 27, 2011, Keyuan's Board of Directors approved the distribution of an annual cash dividend of $0.36 per share for 2011 to be paid quarterly to its common stock shareholders at the assigned dates of record. Management agreed to waive their rights to receive cash dividends with regards to common stock indirectly owned by them. In addition, PRAX Capital agreed to waive their rights to receive cash dividends should they choose to convert their preferred stock before the record date. The first quarterly dividend of $0.09 per share was paid to shareholders of record as of March 1, 2011; distribution occurred on April 15, 2011. The second quarterly dividend of $0.09 per share was paid to shareholders of record as of June 1, 2011; distribution occurred on July 15, 2011. In October 2011, the Company’s Board of directors suspended the payment of quarterly cash dividends on the Company’s Common Stock while it pursues strategic alternatives including, but not limited to, taking the Company private, a merger or other transaction.
Description of Equity Compensation Plans
On June 29, 2010, the Board of Directors approved the Company’s 2010 Equity Incentive Plan (the “Plan”) to authorize 6,000,000 shares for issuance under equity incentive awards, effective June 30, 2010. On December 6, 2010, we filed Definitive Schedule 14C information statement with the Commission proposing to adopt the Plan. The information statement was mailed to shareholders on December 6, 2010 and it became effective on December 21, 2010
(1)
On June 30, 2010, the Company granted stock options to certain senior management employees to purchase in the aggregate 3,000,000 shares of the Company’s common stock at an exercise price of $4.20 per share and the grant-date fair value of these stock options amounted to $3,347,298. However, options to purchase in the aggregate 150,000 shares of the Company’s common stock were later forfeited in 2010 because two optionees left the Company. A total of 2,810,000 stocks options vest over three years as follows: 30% shall vest and become exercisable one year after the grant date, 40% shall vest and become exercisable two years after the grant date, and 30% shall vest and become exercisable three years after the grant date. For the remaining 190,000 stock options: 40% shall vest and become exercisable one year after the grant date and 60% shall vest and become exercisable two years after the grant date.
(2)
On July 1, 2010, the Company granted stock options to two independent directors with contractual terms of 5 years. The exercise price of these stock options is $4.20 per share and the grant-date fair value of these stock options amounted to $91,349. A total of 40,000 options shall vest and become exercisable one year after the grant date and the remaining 40,000 options shall vest and become exercisable two years after the grant date, provided that the independent directors are re-elected for successive one year terms one year after the stock options issuance date.
(3)
On August 4, 2010, we granted five-year options to 79 managers and employees to purchase in the aggregate 700,000 shares of the Company’s common stock at an exercise price of $4.50 per share, in consideration of their services to the Company. Of these options, 30% of the Options shall vest immediately one year after the issuance, 40% of the options shall vest two years after the issuance and 30% of the options shall vest three years after the issuance. The shares were issued in accordance with the exemption from the registration provisions of the Securities Act of 1933, as amended, provided by Section 4(2) of such Act for issuances not involving any public offering and Regulation S promulgated under the Securities Act of 1933, as amended. We made this determination based upon the representations of the respective Optionees that none of them were “U.S. person[s]” as that term is defined in Rule 902(k) of Regulation S under the Securities Act. Based on feedback received from the employees after the option award which indicated that most of those employees would prefer tangible cash rewards, management proposed canceling 600,000 of these stock options that had been granted to 77 of the 79 employees. On December 29 2010, the Board of Directors approved the proposal to cancel such stock options.
Recent Sales of Unregistered Securities
During the past three years, we effected the following transactions in reliance upon exemptions from registration under the Securities Act as amended. Unless stated otherwise: (i) each of the persons who received these unregistered securities had knowledge and experience in financial and business matters which allowed them to evaluate the merits and risk of the receipt of these securities, and they were knowledgeable about our operations and financial condition; (ii) no underwriter participated in, nor did we pay any commissions or fees to any underwriter in connection with the transactions; (iii) the transactions did not involve a public offerings; and (iv) each certificate issued for these unregistered securities contained a legend stating that the securities have not been registered under the Act and setting forth the restrictions on the transferability and the sale of the securities.
In connection with the Exchange Agreement, on April 22, 2010, we issued an aggregate of 47,568 shares of our Series M Preferred Stock to the Keyuan International Shareholder. We received in exchange from the Keyuan International Shareholder 50,000 shares of Keyuan International, representing 100% of the issued and outstanding shares of Keyuan International, which exchange resulted in Keyuan International becoming our wholly-owned subsidiary. The issuance of such securities was exempt from registration pursuant to Section 4(2) of, and Regulation D and/or Regulation S promulgated under the Securities Act of 1933, as amended (the “Securities Act”).
As more fully described in Item 1.01 above, on April 22, 2010, immediately following the Share Exchange, we consummated the Private Placement for the issuance and sale of Units, consisting of an aggregate of (a) 5,954,058 shares of Series A Preferred Stock, (b) 661,562 Shares of common stock, (c) three-year Series A Warrants to purchase up to 661,562 Series A Warrant Shares, and (d) three-year Series B Warrants to purchase up to 661,562 Series B Warrant Shares, for aggregate gross proceeds of approximately $23.2 million. In connection with the final closing on May 17, 2010, we issued 784,278 shares of Series A Preferred Stock, 87,142 shares of Common Stock, 87,142 Series A Warrants and 87,142 Series B Warrants to the Investors. The issuance of the Units, the Series A Preferred Stock, the Shares, the Series A Warrants, the Series B Warrants and the placement agent warrants pursuant to the Private Placement were exempt from registration pursuant to Section 4(2) of, and Regulation D and/or Regulation S promulgated under the Securities Act.
On April 19, 2010, we issued 88,000 shares of common stock to Hayden Communications International, for the investor related services they will provide to us from April 19, 2010 to April 18, 2011. The shares were issued in accordance with the exemption from the registration provisions of the Securities Act of 1933, as amended, provided by Section 4(2) of such Act for issuances not involving any public offering and Rule 506 of Regulation D promulgated thereunder.
On April 19, 2010, we issued 48,000 shares of common stock to Chesapeake Group, Inc, for the investor related services they will provide to us in a period of 12 months. The shares were issued in accordance with the exemption from the registration provisions of the Securities Act of 1933, as amended, provided by Section 4(2) of such Act for issuances not involving any public offering and Rule 506 of Regulation D promulgated thereunder.
On April 19, 2010, we issued 50,000 shares of common stock to Hampton Growth Resources, LLC, for the investor related services they will provide to us for a 12 months period. The shares were issued in accordance with the exemption from the registration provisions of the Securities Act of 1933, as amended, provided by Section 4(2) of such Act for issuances not involving any public offering and Rule 506 of Regulation D promulgated thereunder.
On July 1, 2010, we granted 80,000 five-year options to two outside directors to purchase up to 80,000 shares of the Company’s common stock at an exercise price of US$4.20 per share, in consideration of their services to the Company. Of these options, 40,000 of the options shall vest after one year of the issuance and the remaining 40,000 of the options shall vest after two years of the issuance, provided that the optionee is re-elected for successive one year terms at the end of 12 months of the issuance. The shares were issued in accordance with the exemption from the registration provisions of the Securities Act of 1933, as amended, provided by Section 4(2) of such Act for issuances not involving any public offering.
On July 1, 2010, we granted 40,000 five-year options to a consultant to purchase an aggregate of 40,000 shares of the Company’s common stock at an exercise price of US$4.20 per share, in consideration of their services to the Company. Of these options, all 40,000 of the options shall vest immediately. The shares were issued in accordance with the exemption from the registration provisions of the Securities Act of 1933, as amended, provided by Section 4(2) of such Act for issuances not involving any public offering.
On July 27, 2010, we granted 420,000 three-year options to a consultant to purchase an aggregate of 420,000 shares of the Company’s common stock at an exercise price of US$4.20 per share, in consideration of their services to the Company. Of these options, 70,000 of the options vested immediately, 31,818 vest monthly beginning on September 1, 2010 and the remaining balance of 95,456 vested on May 1, 2011. The shares were issued in accordance with the exemption from the registration provisions of the Securities Act of 1933, as amended, provided by Section 4(2) of such Act for issuances not involving any public offering and Rule 506 of Regulation D promulgated thereunder.
On August 4, 2010, we granted five-year options to 79 managers and employees to purchase in the aggregate 700,000 shares of the Company’s common stock at an exercise price of US$4.50 per share, in consideration of their services to the Company. Of these options, 30% of the Options shall vest immediately one year after the issuance, 40% of the options shall vest two years after the issuance and 30% of the options shall vest three years after the issuance. The shares were issued in accordance with the exemption from the registration provisions of the Securities Act of 1933, as amended, provided by Section 4(2) of such Act for issuances not involving any public offering and Regulation S promulgated under the Securities Act of 1933, as amended. We made this determination based upon the representations of the respective Optionees that none of them were “U.S. person[s]” as that term is defined in Rule 902(k) of Regulation S under the Securities Act. Based on feedback received from the employees after the option award which indicated that most of those employees would prefer tangible cash rewards , management proposed canceling 600,000 of these stock options that had been granted to 77 of the 79 employees. On December 29 2010, the Board of Directors approved this proposal to cancel such options.
On September 28, 2010 , we closed a private placement of $20,250,000 from offering a total of 540,001 units at a purchase price of $37.5 per unit, consisting of an aggregate of (a) 5,400,010 shares of Series B convertible preferred stock of the Company, (b) three year Series C warrants to purchase up to 810,002 share of Common Stock, at an exercise price of $4.50 per share, and (c) three year Series D warrants to purchase up to 810,002 share of Common Stock, at an exercise price of $5.25 per share. In addition, we issued placement agent warrants to purchase up to 561,601 shares of Common Stock to Tripoint Global Equities, Inc. The issuance of the Units, the Series B Preferred Stock, the Series C Warrants, the Series D Warrants and the Placement Agent Warrants pursuant to the private placement were issued pursuant to the exemption from the registration provisions of the Securities Act of 1933, as amended, provided by Section 4(2) of such Act for issuances not involving any public offering and Regulation S promulgated under the Securities Act of 1933, as amended. We made this determination based upon the representations of the respective Investors that they were not a “U.S. person[s]” as that term is defined in Rule 902(k) of Regulation S under the Securities Act.
On February 24, 2011, two investors in the April-May 2010 Private Placement exercised Series A warrants and purchased 650 shares of common stock and 500 shares of common stock respectively nt at an exercise price of $4.50 per share. As a result, 650 shares of common stock were issued on March 1, 2011 and 500 shares of common stock were issued on April 1, 2011.
On April 1, 2011, one investor in the April-May 2011 Private Placement exercised Series B warrants and purchased 500 shares of common stock at an exercise price of $5.25 per share. As a result, 500 shares of common stock were issued on April 4, 2011.
On November 29, 2011, one investor in the September 2010 Private Placement chose to convert 66,670 shares of Series B preferred stock into common stock. As a result, 66,670 shares of common stock were issued on December 7, 2011.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Not applicable.
ITEM 7.
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:
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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;
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Gas fractionation processing equipment- de-propanizing tower, refining propylene tower, de-ethanizination tower, heat exchangers, pumps;
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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
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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.
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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.
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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.
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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.
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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.
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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.
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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 approximiately $ 71.0 million in sales and approximiately $ 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)
an increased annual design capacity of our ethylene-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. Ethylene-styrene is the main raw material (eg. Bezene) from the catalytic cracking oil processing facility to produce styrene. This facility can be considered the bridge between original products and high-value added products and will complete the integration of our 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:
The total cost of additioal 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):
Sales: Our sales for the year ended December 31, 2012 were $750,628 compared to sales of $533,913 for the year ended December 31, 2011, an increase of $216,715, or 40.59%. The substantial increase in our sales was due to higher production volume of our products, more working days and the operation of our of SBS facility for the 12 months ended December 31, 2012. In 2012, we sold 675,484 metric tons of chemical products at an average price of $1.11 per metric ton, as compared to sales of 588,976 metric tons of chemical products at an average price of $1.07 per metric ton in 2011. This represents an increase of approximately 15% in sold products. Compared with 44 days production suspension in 2011, we lost 15 days of production for inspections during 2012. With the commencement of production in 2012, the SBS facility achieved 41% of its designed capacity (full capacity should be 70,000tons/ year) in its first year which brought an additional 28,730 MT of finished products and sales of $70,992.
We did not incur any sales to related parties for the year ended December 31, 2012 as compared to $92,772 of sales to related parties for the year ended December 31, 2011. Pricing for sales to related parties adopts the same principles as that to non-related parties. For additional information on related party sales, please refer to Footnote 23 of the financial statements.
The breakdown of the 675,484 metric tons products produced is listed below.
Cost of Sales: Cost of sales was $721,519 for the year ended December 31, 2012, or 96% of sales, compared to cost of sales of $504,872, or 95% of sales for the year ended December 31, 2011, an increase of $216,647. Our cost of sales are primarily composed of the costs of direct raw materials (mainly heavy oil, benzene and carbinol), labor, depreciation and amortization of manufacturing equipment and facilities, and other overhead. In 2012, our average cost of finished product was $1.07 per metric ton, as compared to an average cost of $1.03 per metric ton in 2011, an increase of 3%. The increase of the cost of sales is mainly attributable to the SBS facility. Our SBS facility resulted in an additional 28,730 MT of products in 2012 and an additional $63,365 of cost of sales. Moreover, the increasing Chinese labor costs also caused an increase in cost of sales.
Gross Profit: Gross profit for the year ended December 31, 2012 was $29,109, compared to $22,015 for the year ended December 31, 2011. Our gross profit margin has increased from 3.51% for the year ended December 31, 2011 to 3.9% for the year ended December 31, 2012. The main reason for the increase in the gross margin is the increase in sales volume and the new SBS products which yield a higher gross profit margin of 10.74%.
Operating Expenses: Operating expenses, including selling expenses, and general and administrative expenses, were $13,642, or 1.8 % of sales for the year ended December 31, 2012 as compared to $19,100, or 3% of sales for the fiscal year 2011, a decrease of $ 5,457. The decrease was due to expense of $5.8 million in connection with the Independent Investigation for the year ended December 31, 2011. There were no such expenses for the year ended December 31, 2012.
Interest Expense: For the year ended December 31, 2012, interest expense was approximately $25,065 as compared to interest expense of approximately $15,797 for the year ended December 31, 2011. The increase in interest expense is mainly due to the increased interest cost associated with discounting of bank acceptance notes and higher interest rates, together with the increased bank borrowings.
Liquidated damages expense: For the year ended December 31, 2012, we did not accrue any liquidated damages expenses compared to accrued liquidated damages expense of $2,493 for the year ended December 31, 2011. On April 1, 2011, trading of the Company’s common stock was suspended. In addition, management determined that, our Registration Statements were no longer effective since April 15, 2011 and the registrable securities in connection with Series A and B Private Placements were not be able to be sold pursuant to Rule 144 under the Securities Act during the period between April 2011 and November 1, 2011. Accordingly, in the year ended December 31, 2011, it became probable that the Company will be required to remit liquidated damages to investors. Estimated contingent liabilities of $2.5 million were accrued with a corresponding charge to earnings in the year ended December 31, 2011.
Net loss: Net loss for the year ended December 31, 2012 was approximately $5,850 , as compared to a net loss of approximately $7,141 for the year ended December 31, 2011, a decrease of $1,291 or 18.08 %. The decrease in net loss was mainly due to a higher yield rate and decreased legal, consulting and investigation expenses.
Foreign Currency Translation Adjustment: Our reporting currency is the U.S. dollar. Our local currency, Renminbi (RMB), is our functional currency. Results of operations and cash flow are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by the People’s Bank of China at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of shareholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.
Currency translation adjustments resulting from this process are included in accumulated other comprehensive income in the consolidated statement of shareholders' equity and amounted to gain $945 for the year ended December 31, 2012 and $3,235 for the year ended December 31, 2011, respectively. The equity accounts were translated at historical rates. The average translation rates applied to income statement accounts for the years ended December 31, 2012 and 2011 were RMB 6.30318 and RMB6.45328 to 1.00 U.S. dollar.
Liquidity and Capital Resources
The Company's financial statements for the years ended December 31, 2012 and 2011 have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. The Report of our Independent Registration Public Accounting Firm on the Company's financial statements as of and for the year ended December 31, 2012 includes a going concern explanatory paragraph which means that the auditors stated that conditions exist that raise substantial doubt about the Company's ability to continue as a going concern.
The following table sets forth a summary of our approximate cash flows for the periods indicated:
Net cash used in operating activities was $7,095 for the year ended December 31, 2012 as compared to $ 1,731 provided by operating activities for the same period in 2011. The decrease in cash provided by operations was primarily due to increases in accounts receivable, inventories, prepayments to suppliers and other current assets, offset by an increase in advances from customers.
Net cash used in investing activities was approximately $54,417 and $42,313 for the years ended December 31, 2012 and 2011, respectively. Net cash used in investing activities was primarily comprised of payments for our infrastructure construction and the expansion of our facilities.
Net cash provided by financing activities amounted to $77,488 for 2012 and $16,934 for 2011. Cash provided by financing activities in 2012 was primarily due to the increase in short-term bank loans, offset by cash used in the settlement of bills payable, the repayment of bank loans and the increase in pledged deposits at banks.
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 December 31, 2012, we had an aggregate principal amount of approximately $295 million outstanding under the loan agreements, with maturity dates from January 2013 to December 2013 and interest rates from 1.27% to 6.72% per annum. As of March 31, 2013, we had an aggregate principal amount of approximately $284.6 million outstanding under the loan agreements, with maturity date through March, 2014, and interest rates from 1.13% to 6.72% per annum. The loan agreements contain customary affirmative and negative covenants and were mainly guaranteed by third parties and individual persons or secured by a lien on our property and equipment. Beginning in January 2011, certain individual loan guarantors, some of whom are related parties, were paid a monthly fee of approximately 0.1% of the outstanding loan balances as compensation for their guarantees. We paid approximately $1.8 million of compensation in respect of these guarantees for the year ended December 31, 2012. Historically, all debts due have been paid back by the Company in a timely manner. All short-term bank loans are revolving loans whose terms (at due date of payment) are generally extended by the lender. As of December 31, 2012, we were in compliance with the terms of our loan agreements. As such, management expects most unpaid loan balances will be extended at their due dates. Depending on our capital needs, the Company evaluates whether to apply for additional long-term bank loans when they are paid back. The Company currently has sufficient lines of credit with the banks for both short-term and long-term borrowings for our current operations. However, we are working to refining our manufacturing capacity to include an ABS facility, a oil catalytic cracking processing facility, an increased annual design capacity of ethylene-styrene facility to 200,000 MT, a transformer oil facility and a SSBR production facility. The total cost of additioal processing equipment for products refinement and 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.
ITEM 7A
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not Applicable
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Keyuan Petrochemicals, Inc.
We have audited the accompanying consolidated balance sheets of Keyuan Petrochemicals, Inc. and subsidiaries (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of comprehensive loss, stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2012. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Keyuan Petrochemicals, Inc. and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1(c) to the consolidated financial statements, the Company has suffered net losses and cash flows used in operations, and has a working capital deficiency at December 31, 2012 that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1(c). The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Unusually important events occurred in 2011. These events, management’s evaluation, and their potential effects are described in Note 1(b) to the consolidated financial statements.
The Company has significant transactions and relationships with related parties and certain other parties which are described in Note 23 to the consolidated financial statements. It is possible that the terms of these transactions may not be the same as those that would result from transactions among unrelated parties.
/s/ GHP HORWATH, P.C.
Denver, Colorado
June 4, 2013
KEYUAN PETROCHEMICALS, INC. AND SUBSIDIAIRES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
See accompanying notes to the consolidated financial statements.
KEYUAN PETROCHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Amounts in thousands, except share and per share data)
See accompanying notes to the consolidated financial statements.
KEYUAN PETROCHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2012 AND 2011
(Amounts in thousands, except share data)
See accompanying notes to the consolidated financial statements.
KEYUAN PETROCHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands, except share data)
See accompanying notes to the consolidated financial statements.
1 ORGANIZATION AND NATURE OF BUSINESS, RECENT EVENTS, AND GOING CONCERN AND MANAGEMENT’S PLANS
(a) Organization and Nature of business
Keyuan Petrochemicals, Inc. (the “Company”) was incorporated in the State of Texas on May 4, 2004 in the former name of Silver Pearl Enterprises, Inc. The Company, through its wholly-owned subsidiary, Sinotech Group Limited, formerly Keyuan International Group Limited (“Keyuan International”) and its indirect subsidiaries, Keyuan Group Limited (“Keyuan HK”), Ningbo Keyuan Plastics Co., Ltd. (“Ningbo Keyuan”),Ningbo Keyuan Petrochemicals Co., Ltd. (Ningbo Keyuan Petrochemicals), Ningbo Keyuan Synthetic Rubbers Co., Ltd. (“Ningbo Keyuan Synthetic Rubbers”), and Guangxi Keyuan New Materials Co., Ltd. (“Guangxi Keyuan”) (collectively referred herein below as “the Group” ) are engaged in the manufacture and sale of petrochemical and rubber products in the People’s Republic of China (“PRC”).
Keyuan International is an investment holding company and was incorporated in the British virgin Islands in 2009.
Keyuan HK was established in Hong Kong in 2009, and is a holding company with no significant assets or operations.
Ningbo Keyuan was established in April 2007 as a wholly foreign-owned enterprise in Ningbo, PRC.
On August 8, 2010, Keyuan HK established Ningbo Keyuan Petrochemicals, a wholly-owned subsidiary in the PRC.
On March 7, 2012, Keyuan HK and Ningbo Keyuan established Guangxi Keyuan, a wholly-owned subsidiary in the PRC.
On June 15, 2012, Ningbo Keyuan established Ningbo Keyuan Synthetic Rubbers, a wholly-owned subsidiary in the PRC.
(b) Other Events
In 2011, Company’s former auditor, KPMG, LLP (“KPMG”), brought certain issues to the Company’s Audit Committee’s attention through a March 28, 2011 memorandum and an April 18, 2011 letter (collectively, the “KPMG Memoranda”). KPMG requested that the Company’s Audit Committee conduct an independent investigation (the “Independent Investigation”) into those issues. On March 31, 2011, the Audit Committee elected to commence such Independent Investigation and engaged the services of independent counsel, Pillsbury Winthrop Shaw Pittman LLP (“Pillsbury”), which in turn engaged the services of Deloitte Financial Advisory Services LLP (“Deloitte”), as independent forensic accountants, and King & Wood, as Audit Committee counsel in the PRC. Pillsbury, Deloitte and King & Wood are collectively referred to herein as the “Investigation Team”. On September 28, 2011, the Independent Investigation was completed. The Independent Investigation identified possible violations of PRC laws and U.S. Securities laws, including the maintenance of an off-balance sheet cash account that was used primarily to pay service providers and other Company-related expenses. Total activity in the off-balance sheet cash account amounted to approximately $800,000 through December 31, 2010, with a net income statement effect of approximately $12,000, and $400,000 of activity in the off-balance sheet cash account for the period from January 1, 2011 to March 31, 2011, with a net income statement effect of approximately $192,000, at which time the Company ceased its use. The Independent Investigation identified certain other issues that could result in potential violations of PRC or U.S. laws.
On October 7, 2011, trading of the Company’s common stock was delisted by NASDAQ, and is currently quoted on the Over-the-Counter Bulletin Board (symbol: KEYP).
On March 1, 2013, the Company reached a settlement in a case filed by the United States Securities and Exchange Commission on February 28, 2013 in the United States District Court for the District of Columbia against the Company, alleging the Company violated Section 17(a)(2) and 17(a)(3) of the Securities Act of 1933, Section 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934, and Rules 12b-20 and 13a-13 thereunder. Under the settlement terms and without admitting or denying the allegation of the complaint, the Company will pay a $1 million civil penalty and will be permanently enjoined from violating certain securities law. The settlement remains subject to approval by the United District Court for the District of Columbia, which must approve its terms and enter the final judgment.
The Company, with its PRC legal counsel, evaluated the matters identified in the Independent Investigation to determine the extent to which the Company may be exposed to fines and penalties in China. The Company has preliminarily concluded that the extent to which it may be exposed to fines and penalties in the PRC is limited, and to date, has not received any PRC governmental or regulatory communication or inquiry related to these matters. However, management is currently unable to determine the final outcome of these matters and their possible effects on the consolidated financial statements.
(c) Going concern and management’s plans
The consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company reported a net loss of approximately $5.85 million in 2012 and cash flows used in operations of approximately $7.1 million. At December 31, 2012, the Company had a working capital deficit of approximately $159 million. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments relating to the recoverability or classification of assets, or the amounts and classification of liabilities that may result should the Company be unable to continue as a going concern.
The Company continues to finance its 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.
The Company continues to benefit from favorable PRC tax policies related to consumption tax (Note 6), 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.
The Company is expanding its 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.
The Company is also exploring sources of additional financing, including short-term financing from its 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.
2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Principles of consolidation and basis of presentation
The accompanying consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) and include the financial statements of the Group.
All significant intercompany transactions and balances are eliminated on consolidation.
(b) Use of estimates
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 property, plant and equipment; the fair value determination of financial and equity instruments; the realizability of inventories; and the recoverability of property, plant and equipment and accounts receivable. These estimates are often based on complex judgments and assumptions that management believes to be reasonable but are inherently uncertain and unpredictable.
(c) Foreign currency transactions and translation
The functional currency of the Company, Keyuan International and Keyuan HK is the U.S. dollar. The functional currency of the PRC operating subsidiaries is the Renminbi (“RMB”). Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transactions. Monetary assets and liabilities denominated in foreign currencies are translated into the functional currency using the applicable exchange rates at each balance sheet date, and non-monetary items are translated at historical rates. The resulting exchange differences on these transactions are recorded in foreign exchange gain (loss), net in the consolidated statements of comprehensive loss.
The Group’s reporting currency is the U.S. dollar. Assets and liabilities of the PRC operating subsidiaries are translated into the U.S. dollar using the exchange rates at each balance sheet date. Revenue and expenses of the PRC operating subsidiaries are translated at average rates prevailing during the reporting period. Shareholders’ equity is translated of historical rates. Adjustments resulting from translating the financial statements of the PRC operating subsidiaries into the U.S. dollar are recorded as a separate component of accumulated other comprehensive income in stockholders’ equity.
2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(d) Cash
Cash consists of cash on hand and cash at banks. As of December 31, 2012 and 2011, cash of $21.4 million and $7.1 million, respectively, was held in major financial institutions located in the PRC. Management performs periodic evaluations of the relative credit standings of those financial institutions, and believes that they have high credit ratings.
(e) Pledged bank deposits
Pledged bank deposits represent amounts held by financial institutions, which are not available for the Group’s use, as security for issuances of bills payable to the Group’s suppliers, or as security for short-term bank borrowings. Upon maturity of the bills, which generally occurs within three to six months after the issuance of the bills, or upon the repayment of short-term bank borrowings, the deposits are released by the financial institutions and become available for use by the Group. Pledged bank deposits related to the purchase of inventories are reported within cash flows from operating activities and pledged bank deposits related to short-term bank borrowings are reported within cash flows from financing activities in the consolidated statements of cash flows.
(f) Inventories
Inventory is 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.
(g) Accounts receivable
With the approval of the Company’s general manager, the Company occasionally extends unsecured credit to its long-term customers with a good credit rating. An allowance for doubtful accounts is established and recorded based on management’s assessment of its analysis of trade receivables, customers’ credit-worthiness, past collection history, and charges in customers’ payment records. The Company writes-off accounts receivable when accounts are deemed uncollectible. At December 31, 2012 and 2011, the Group considers all of its accounts receivable to be collectible and no provision for doubtful accounts has been made in the consolidated financial statements.
(h) 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
Plant, machinery and equipment
5 to 15 years
Vehicles
5 years
Office equipment and furniture
3 to 10 years
2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
(i) Long-Lived Assets
In accordance with Financial Accounting Standard Board (“FASB”) Accounting Standard Codification (“ASC”) Topic 360-10, 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 undiscounted cash flows. If the total of the expected future undiscounted 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. No impairment is believed to exist at December 31, 2012.
(j) Land use rights
Land use rights represent the exclusive right to occupy and use a piece of land in the PRC for a specified contractual term. Land use rights are recorded at cost and amortized on a straight-line basis over the terms of the land use rights of 15 to 50 years.
(k) Bills receivable and bills payable
The Group utilizes banker’s acceptances in the form of bills receivable and bills payable.
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.
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 counterparty fails to honor its liability to the accepting bank. At December 31, 2012 and 2011, discounted bills receivable subject to reimbursement amounted to approximately $4.0 and $1.6 million, respectively. Historically, the Group has not suffered any losses under these reimbursement agreements.
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.
(l) Revenue recognition
The Group derives its revenue primarily from the sale of petrochemical products. In accordance with the provisions of the Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 104, codified in FASB ASC Topic 480, revenue should not be recognized until 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 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 as of December 31, 2012 and 2011.
(m) 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.
(n) Employee benefit plans
Pursuant to relevant PRC regulations, Ningbo Keyuan, Ningbo Keyuan Petrochemicals, Ningbo Keyuan Synthetic Rubbers and Guangxi Keyuan are required to make contributions to various defined contribution plans organized by municipal and provincial PRC governments. The contributions are made for each PRC employee at rates ranging from 18.6% to 26.1% on a standard salary base as determined by the local social security bureau.
Contributions to the defined contribution plans are charged to the consolidated statements of comprehensive loss when the related service is provided. For the years ended December 31, 2012 and 2011, contributions to the defined contribution plans were approximately $0.5 million and $0.4 million, respectively.
The Group has no other obligation for the payment of employee benefits associated with these plans beyond the contributions described above.
(o) 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 carry forwards. 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.
2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 comprehensive loss.
(p) Fair value measurements
The Group utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. The Group determines fair value based on assumptions that market participants would use in pricing an asset or liability in the principal or most advantageous market. When considering market participant assumptions in fair value measurements, the following fair value hierarchy distinguishes between observable and unobservable inputs, which are categorized in one of the following levels:
●
Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Group has the ability to access at the measurement date.
●
Level 2 inputs are inputs other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
●
Level 3 inputs are unobservable inputs for the asset or liability used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.
The level in the fair value hierarchy within which a fair value measurement in its entirety falls is based on the lowest level input that is significant to the fair value measurement in its entirety.
(q) Earnings (loss) per share
Basic earnings (loss) per share is computed by dividing net income (loss) attributable to the Company’s common stockholders by the weighted average number of common stock outstanding during the year.
Diluted earnings (loss) per share is calculated by dividing net income (loss) attributable to the Company’s stockholders as adjusted for the effect of dilutive common stock equivalents, if any, by the weighted average number of common stock and dilutive common stock equivalents outstanding during the year. Common stock equivalents consist of the common stock issuable upon the conversion of the Group’s Series B convertible preferred stock (using the if-converted method) and common stock issuable upon the exercise of outstanding stock options and stock purchase warrants (using the treasury stock method). Potential dilutive securities are not included in the calculation of dilutive earnings (loss) per share if the effect is anti-dilutive. A total of 7,190,766 and 7,886,586 warrants and options were excluded from diluted earnings per share for the years ended December 31, 2012, and 2011, respectively, as their effect was anti-dilutive.
(r) Segment reporting
The Group’s chief operating decision maker has been identified as its Chief Executive Officer (CEO).
The Group has two operating segments; the manufacture and sale of petrochemical products (petrochemical segment) and the manufacture and sale of rubber products (rubber segment), established in 2012. Substantially all of the Company’s operations and customers are located in the PRC. Consequently, no geographic information is presented.
2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(s) 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.
(t) Recent accounting pronouncements
In July 2012, the FASB issued ASU 2012-02-Intangibles-Goodwill and Other (Topic 350), effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if a public entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. The adoption of this guidance is not expected to have a material impact on the Group’s consolidated financial statements.
In October 2012, the FASB issued ASU 2012-06-Business Combinations (Topic 805), for public and nonpublic entities, effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. Early adoption is permitted. The amendments should be applied prospectively to any new indemnification assets acquired after the date of adoption and to indemnification assets existing as of the date of adoption arising from a government-assisted acquisition of a financial institution. The adoption of this guidance is not expected to have a material impact on the Group’s consolidated financial statements.
3 INVENTORIES
Inventories consist of the following:
4 ADVANCES FROM CUSTOMERS
The Group generally requires a prepayment of 100% of the sales contract price from its customers shortly before products are delivered. Such prepayment is recorded as “advances from customers” in the Group’s consolidated balance sheet, until the products are delivered and the customer takes ownership and assumes the risk of loss. With the approval of the Company’s general manager, the Company occasionally extends credit to its long-term customers with a good credit rating. As of December 31, 2012, the balance of accounts receivable was approximately $14.2 million (approximately $2.2 million at December 31, 2011), all of which was collected in January 2013.
5 PREPAYMENTS TO SUPPLIERS
As of December 31, 2012 and 2011, prepayments to suppliers are made in connection with the purchase of raw materials. Prepayments to suppliers are reclassified to inventories or expense when the Group applies the prepayments to related purchases of materials after the related invoices are received.
6 CONSUMPTION TAX REFUND RECEIVABLE
The PRC government enacted a regulation that provides that domestically purchased heavy oil to be used for producing ethylene and aromatics products would be exempted from a consumption tax. In addition, the consumption tax paid for imported heavy oil would be refunded if it was used for producing ethylene and aromatics products. Given all the Group’s purchased heavy oils are, or are to be, used for the production of ethylene and aromatics products, the Group recognizes a consumption tax refund receivable when the consumption tax has been paid and the relevant heavy oils have been used for production. At December 31, 2012 and 2011, the Group recorded an estimated consumption tax refund amounting to approximately $51.3 million and $55.8 million, respectively.
On August 15, 2012, the Group received a consumption tax refund of approximately $95.1 million and in December 2012 an additional $7.2 million was received. Consumption tax claims of approximately $51.3 million are in process and are expected to be approved and refunded by the end of June 2013.
7 OTHER CURRRENT ASSETS
Other current assets consist of the following:
Management estimates the deductible input VAT using vendor contracts, engineering and other estimates, as well as historical experience. Approximately $2.2 million and $2.9 million is included in non-current assets as of December 31, 2012 and 2011, respectively.
Customs deposits for imported inventories represent amounts paid to the local customs office in connection with the import of raw materials inventories. Upon approval by the customs authorities, these amounts become refundable by the local tax authority and are reclassified as VAT recoverable or consumption tax refund receivable (Note 6).
8 PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
Depreciation expense on property, plant and equipment is allocated to the following items:
For the years ended December 31, 2012 and 2011, interest capitalized amounted to approximately $0.8 million and $1.2 million, respectively.
9 INTANGIBLE ASSETS
Intangible assets consist of the following:
Licensing agreements consist of technology utilization rights for petrochemical production. For each of the years ended December 31, 2012 and 2011, amortization expense for intangible assets amounted to approximately $0.1 million. Amortization expense for each of the next five years is estimated to be approximately $0.1 million.
10 LAND USE RIGHTS
Land use rights consist of the following:
For each of the years ended December 31, 2012 and 2011, amortization expense related to land use rights was approximately $0.4 million.
11 SHORT-TERM BANK BORROWINGS
Short-term bank borrowings consist of the following:
Short−term bank borrowings outstanding as of December 31, 2012 carry a weighted average interest rate of 6.21% (2011: 5.45%) for bank loans in RMB; and a weighted average interest rate of 3.97% (2011: 3.78%) for bank loans in USD, and have maturity terms ranging from one to twelve months and interest rates ranging from 1.27% to 7.93% (2011: 2.97% to 7.93%).
Approximately $46.3 million included in short term bank borrowings at December 31, 2012 is payable to Shanghai Pudong Development Bank, and is secured by a one-year fixed term deposit with a carrying amount of $48.4 million. In addition, $46 million payable to Bank of China is secured by Ningbo Keyuan’s one-year fixed term deposit and pledged deposits with a carrying amount of $21.7 million as of December 31, 2012; $8.3 million payable to China Construction Bank is secured by Ningbo Keyuan's one-year fixed term deposit with a carrying amount of $24.5 million as of December 31, 2012; $4.4 million payable to Agricultural Bank of China is secured by Ningbo Keyuan's one-year fixed term deposit with a carrying amount of $8.1 million as of December 31,2012; $6.5 million payable to China Merchant Bank is secured by Ningbo Keyuan's one-year fixed deposit with a carrying amount of $6.7 million as of December 31, 2012; and $4.4 million payable to Bank of Shanghai is secured by Ningbo Keyuan's one-year fixed deposit with a carrying amount of $4.9 million as of December 31,2012. Among the rest of the Group's short-term borrowings, $105.5 million is guaranteed by related party and third-party entities and individuals, and $73.4 million that is secured by the Group’s land, buildings and equipment with a carrying amount of $125 million as of December 31, 2012.
12 LONG-TERM BANK BORROWINGS
At December 31, 2011, long term bank borrowing of approximately $15.7 million consisted of amounts payable to China Construction Bank with interest of 7.29% to 7.74% per annum and which was guaranteed by related party entities and Mr Tao (Note 23). All amounts were repaid in full in 2012.
13 ACCRUED EXPENSES AND OTHER PAYABLES
Accrued expenses and other payables consist of:
14 SERIES B CONVERTIBLE PREFFERED STOCK AND RELATED FINANCING AGREEMENTS
The significant terms of the Series B convertible preferred stock are as follows:
Conversion:
At any time on or after the issuance date, at the election of the holders, each share of the Series B convertible preferred stock may be converted into shares of the Company’s common stock, at a conversion $3.75 per share, subject to certain ownership limitations.
The conversion price is subject to certain anti-dilutive adjustments, including adjustments for stock splits, dividends and distributions, and reorganization, merger or consolidation. In addition, the conversion price may be adjusted down.
The Series B convertible preferred stock shall be automatically converted into common stock (for the same conversion price as described above) upon the third year anniversary of the issuance date of the Series B convertible preferred stock on September 28, 2013. In the event the Company shall issue or sell any additional shares of common stock at a price per share less than the then-applicable conversion price or without consideration, then the conversion price upon each such issuance shall be reduced to that price (the “Round Down Provision”).
Management evaluated the terms and conditions of the embedded conversion features and determined that there was no beneficial conversion features for the Series B convertible preferred stocks because the effective conversion price is equal to or higher than the fair value at the date of issuance.
Redemption:
As a result of the Round Down Provision, and in accordance with ASR 268 “Presentation in Financial Statement of Redeemable Preferred Stock”, the Series B convertible preferred stock has been classified as temporary equity as the Company does not control the events necessary to issue the maximum number of shares that could be required should the redemption feature be triggered. In the event the Company has insufficient authorized registered shares of common stock to effect a conversion request from the Series B investors, the Company, at its sole discretion, may elect to satisfy such conversion request by either redeeming the preferred stock at its liquidation preference of $3.75 per share, or by issuing restricted shares of the Company’s common stock.
The Series B convertible preferred stock is redeemable at the option of their holders simultaneously with the occurrence of the following events:
(i) Merger or consolidation where the holders of the Company’s outstanding voting securities prior to such merger or consolidation do not own over 50% of the outstanding voting securities of the merged or consolidated entity immediately after such merger or consolidation; or (ii) the sale of all or substantially all of the Company’s properties or assets (collectively, an “Organic Change”).
Management considers the occurrence of the Organic Change is solely within the control of the Company.
Voting Rights:
The Series B convertible preferred stock has no voting rights with the common stock or other equity securities of the Company other than certain class voting rights, as outlined in the related agreement.
Fixed dividends are accrued and cumulative for one year from the date of the initial issuance of the Series B convertible preferred stock, and are payable on a quarterly basis. Annual dividends are determined as 6% of $3.75 for each share of the Series B convertible preferred stock. Total dividends for the Series B convertible preferred stockholders for the years ended December 31, 2012 and 2011 were nil and approximately $1.2 million, respectively.
Registration rights agreement
In connection with the Series B private placement, the Company entered into a registration rights agreement with the Series B investors in connection with various warrants issued in connection with the Series B convertible preferred stock, If the Company does not comply with the registration rights agreement, the Company will be required to pay cash liquidated damages to each Series B Investor, at the rate of 1% of the applicable subscription amount for each 30 day period in which the Company is not in compliance; provided, that such liquidated damages will be capped at 10% of the subscription amount of each investor and will not apply to any registrable securities that may be sold pursuant to Rule 144 under the Securities Act if all of the conditions in Rule 144(i)(2) are satisfied at the time of the proposed sale, or are subject to an SEC comment with respect to Rule 415 promulgated under the Securities Act. Pursuant to the registration rights agreements, liquidated damages are also payable in the event that the registration statement is not maintained continuously effective for approximately 180 days, or if trading of the Company’s common stock is suspended or if the Company’s common stock is delisted from the principal exchange on which it is traded (NASDAQ) for more than three days.
On April 1, 2011, trading of the Company’s common stock was suspended and on October 7, 2011 was delisted by NASDAQ. Management determined that the registration statements were no longer effective commencing on April 7, 2011 and registrable securities in connection with the Series B private placement were not able to be sold pursuant to Rule 144 under the Securities Act until November 1, 2011. Accordingly, in the year ended December 31, 2011, an estimated contingent liability for approximately $2.5 million was accrued with a corresponding charge to earnings, as per the guidance in ASC 825-20, “Registration Payment Arrangements”.
Escrow shares agreement
In connection with the Series B Private Placement, the Company entered into escrow share agreements with the representatives of the Series B Investors, Delight Reward (the majority owner of the Company), and Anslow&Jaclin, LLP (the “Escrow Agent) (the “Escrow Agreements”), pursuant to which 3,400,000 shares of the Company’s common stock (the “Escrow Shares”) held by Delight Reward were delivered to the Escrow Agent. The Escrow Shares were to be released back to Delight Reward upon the Company’s achievement of no less than 95% of a net income target, as defined, of $33 million for the year ended December 31, 2010 (the “Performance Threshold”). The Performance Threshold was achieved and the 3,400,000 shares are expected to be released in 2013.
15 COMMON STOCK AND CAPITAL CONTRIBUTION
On January 17, 2011, the Company’s Board of Directors approved the distribution of an annual cash dividend of $0.36 per share for 2010 to be paid quarterly to its common stockholders at the assigned dates of record. The first quarter dividend of $0.09 per share was declared to be paid to stockholders of record as of March 1, 2011, with the actual distribution occurring on April 15, 2011. Certain stockholders of the Company announced the waiver of their rights to receive such cash dividends. In addition, Dragon State International Limited, the primary Series B convertible stockholder agreed to waive its rights to receive cash dividends for 2010 should it choose to convert its preferred stock before the record date. The estimated dividends to be distributed and the dividends waived were approximately $3.5 million and $17.2 million respectively. Approximately $0.9 million has been distributed to the common stockholders as dividends. Beginning October 2011, the Company's Board of Directors suspended the payment of quarterly cash dividends on the Company’s common stock while it pursued strategic alternatives including, but not limited to, taking the Company private, a merger or other transaction.
During the year ended December 31, 2011, 66,670 shares of the Series B convertible preferred stock were converted into 66,670 shares of the Company’s common stock. In addition, 1,150 Series A warrants and 500 Series B warrants were exercised, and the Company issued 1,150 shares and 500 shares of the Company’s common stock, receiving proceeds of $4,863 and $2,468, respectively.
16 COMMON STOCK PURCHASE WARRANTS
The Company was issued the following warrants to purchase the Company’s common stock:
Each of the above warrants entitles the holder to purchase shares of the Company’s common stock at any time after their respective issuance dates and shall expire after three years from their respective issuance dates. The Series A and Series B Warrants are callable at $0.01 per share, at the Company’s election, if the volume weighted average price (“VWAP”) of the Company’s common stock equals or exceeds $9.00 and $10.50 for 15 consecutive trading days, with the average daily trading volume of no less than 75,000 shares. The Series C and Series D Warrants and the placement agent warrants are not callable.
The Series A, Series B, Series C and Series D Warrants and the placement agent warrants are classified within the Company’s stockholders’ equity since they are solely indexed to the Company’s common stock.
17 SHARE-BASED PAYMENTS
(a) Employee stock option grants
The Board of Directors has approved the Company’s 2010 Equity Incentive Plan (the “Plan”). The maximum numbers of shares of common stock of the Company issuable pursuant to the Plan is 6,000,000 shares. The Plan shall be administered by the Board; provided however, that the Board may delegate such administration to a Plan Committee (the “Committee”).
Subject to the provisions of the Plan, the Board and/or the Committee shall have authority to determine the type or types of awards to be granted to each participant under the Plan. The exercise price of options to purchase shares of the Company’s common stock granted under the Plan shall be determined by the Board or the Committee, provided, however that the exercise price of any incentive stock option shall not be less than 100% of the fair market value of a share on the date of grant. The term of each option shall be fixed by the Board or the Committee, provided that no incentive stock option shall have a term greater than 10 years
On January 1, 2011, the following stock options were outstanding:
(i) 3,000,000 stock options to certain senior management employees with a contractual term of 5 years. The exercise price of these stock options is $4.20 per share and the grant-date fair value of these stock options amounted to approximately $3.3 million. A total of 2,810,000 stock options vest over three years as follows: 30% shall vest and become exercisable one year after grant date, 40% shall vest and become exercisable two years after grant date, and 30% shall vest and become exercisable three years after grant date. For the remaining 190,000 stock options: 40% shall vest and become exercisable one year after grant date and 60% shall vest and become exercisable two years after grant date.
(ii) 80,000 stock options to two independent directors with contractual terms of 5 years. The exercise price of these stock options is $4.20 per share and the grant-date fair value of these stock options amounted to approximately $0.1 million. A total of 40,000 options shall vest and become exercisable one year after the grant date and the remaining 40,000 options shall vest and become exercisable two years after the grant date, provided that the independent directors are re-elected for successive one year terms one year after the stock options issuance date.
(iii) 700,000 stock options to employees with a contractual term of 5 years. The exercise price of these stock options was $4.50 per share and the grant-date fair value of these stock options amounted to approximately $1.3 million. These stock options vest over three years as follows: 30% shall vest and become exercisable one year after the grant date, 40% shall vest and become exercisable two years after the grant date and 30% shall vest and become exercisable three years after the grant date. 600,000 of these stock options were cancelled. As compensation for such cancellation, the Company committed to pay these employees incremental cash payments during the period through August 2013. The fair value of the committed cash payment at the date of commitment was approximately $0.4 million and no incremental compensation cost resulted from the cancellation of these stock options. Included in accrued expenses and other payables is approximately $0.3 million and $0.2 million representing the liability related to the committed cash payment as of December 31, 2012 and 2011, respectively.
There were no share options granted during the years ended December 31, 2012 and 2011. A summary of the share options activity during the year ended December 31, 2012 is as follows:
The following table presents information relating to non-vested stock options as of December 31, 2012
The total fair value of stock options that vested during the year ended December 31, 2012 was approximately $1.5 million.
As of December 31, 2012, unrecognized compensation costs related to employee stock options was approximately $0.7 million. These costs are expected to be recognized on a straight-line basis, over the remaining weighted average service period of 0.44 years.
(b) Non-employee stock option grants
A summary of stock options granted to non-employees as of December 31, 2012 is as follows:
18 STATUTORY RESERVES
Ningbo Keyuan, Ningbo Keyuan Petrochemicals, Ningbo Keyuan Synthetic Rubbers and Guangxi Keyuan are required to allocate at least 10% of their after tax profits as determined under generally accepted accounting principles in the PRC to a statutory surplus reserve until the reserve balances reach 50% of their respective registered capitals. As of December 31, 2012 and 2011, Ningbo Keyuan, Ningbo Keyuan Petrochemicals, Ningbo Keyuan Synthetic Rubbers and Guangxi Keyuan had made appropriations to this statutory reserve of approximately $4.1 million and $3.7 million, respectively.
19 COMMITMENTS AND CONTINGENCIES
(a) Operating commitments
The Group leases storage facilities and dormitories under operating lease agreements with terms ranging from monthly to 2 years. Future minimum lease payments under non-cancellable operating lease agreements with terms of more than one year were $6,856 at December 31, 2012, all due in 2013.
(b) Capital commitments
As of December 31, 2012, the Group had contractual capital commitments of approximately $1.3 million for purchases of equipment. The capital commitments relate primarily to manufacturing equipment updates.
(c) Litigation
The Group at times is involved in various legal actions arising in the ordinary course of business. Management does not currently believe that there are any pending legal actions where the outcome of such legal actions would have a material adverse effect on the Group’sconsolidated financial statements.
On November 15, 2011, the Company and several of its officers were named in a securities class action, alleging violation of federal securities laws by issuing materially false and misleading statements and omitting material facts with regard to disclosure of related party transactions and effectiveness of internal controls in past public filings. The case is currently at the discovery stage and management believes that there is no basis to the suit and intends to contest the case vigorously.
(d) Contingencies
In connection with the shipping of finished products, inaccurate product information was previously provided to the PRC Port authority. In addition, through March 31, 2011, Ningbo Keyuan failed to withhold income tax of approximately $50,000 from payments to certain external service providers and employees. In consultation with PRC legal counsel, management has evaluated the contingencies associated with the provision of inaccurate information and expects that the penalty, if any, will not be significant and will not have a material impact on the consolidated financial statements.
In addition, the Group had outstanding Letter’s of Credit as of December 31, 2012 of approximately $70 million.
20 INCOME TAXES
The Company and its subsidiaries file separate income tax returns.
The United States of America
The Company is incorporated in the State of Nevada in the U.S., and is subject to U.S. federal corporate income tax at progressive rates ranging from 15% to 35%. The state of Nevada does not impose any state corporate income tax.
British Virgin Islands
Keyuan International is incorporated in the British Virgin Islands (“BVI”). Under the current laws of the BVI, Keyuan International is not subject to tax on income or capital gains. In addition, upon payments of dividends by Keyuan International, no BVI withholding tax is imposed.
Hong Kong
Keyuan HK is incorporated in Hong Kong. Keyuan HK did not earn any income that was derived in Hong Kong for the years ended December 31, 2012 and 2011 and therefore was not subject to Hong Kong Profits Tax. The payments of dividends by Hong Kong companies are not subject to any Hong Kong withholding tax.
PRC
Ningbo Keyuan, Ningbo Keyuan Petrochemicals, Ningbo Keyuan Synthetic Rubbers and Guanxi Keyuan are all incorporated in the PRC and the applicable PRC statutory income tax rate for these companies is 25%.
Components of loss before income tax expense (benefit) consist of the following jurisdictions:
The Group’s income tax expense (benefit) in the consolidated statements of comprehensive loss consists of the following:
Reconciliation between income tax expense and the amounts computed by applying the PRC statutory income tax rate of 25% to income (loss) before income taxes is as follows:
The PRC income tax rate has been used because the majority of the Group’s consolidated income (loss) before income taxes arises in the PRC.
The tax effects of the temporary differences that give rise to significant portions of deferred income tax assets are presented below:
Deferred tax assets arising from net operating loss carryforwards (“NOL’S”) from the Group’s operations outside of the PRC were approximately $6.4 and $4.8 million at December 31, 2012 and 2011, respectively. Management has determined that it is more likely than not that they will not generate sufficient taxable income in those jurisdictions to realize the deferred tax asset. Accordingly, a valuation allowance for the full amount was provided. At December 31, 2012, NOL’S and their expiration dates arose in the following jurisdictions:
According to the prevailing PRC income tax law and its relevant regulations, non-PRC-resident enterprises are levied withholding tax at 10%, unless reduced by tax treaties or similar arrangements, on dividends from their PRC-resident investees for earnings accumulated beginning on January 1, 2008, and undistributed earnings generated prior to January 1, 2008 are exempt from such withholding tax. Further, the Group’s distributions from its PRC subsidiaries are subject to U.S. federal income tax at 34%, less any applicable qualified foreign tax credits. Due to the Group’s policy of reinvesting permanently its earnings in its PRC business, the Group has not provided for deferred income tax liabilities for U.S. federal income tax purposes on its PRC subsidiaries’ undistributed earnings of $37.7 million and $31 million as of December 31, 2012 and 2011, respectively.
For each of the years ended December 31, 2012 and 2011, the Group did not have unrecognized tax benefits, and therefore no interest or penalties related to unrecognized tax benefits were accrued. Management does not expect that the amount of unrecognized tax benefits will change significantly within the next twelve months.
The Group mainly files income tax returns in the United States and the PRC. The Company is subject to U.S. federal income tax examination by tax authorities for tax years beginning in 2009. According to the PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational errors made by the taxpayer or the withholding agent. The statute of limitations is extended to five years under special circumstances where the underpayment of taxes is more than RMB100,000 ($15,000). In the case of transfer pricing issues, the statute of limitation is ten years. There is no statute of limitation in the case of tax evasion. The PRC tax returns for the Company’s PRC subsidiaries are open to examination by the PRC state and local tax authorities for the tax years beginning in 2008.
21 FAIR VALUE MEASUREMENTS
The Company did not have any assets and liabilities that are measured at fair value on a recurring basis as of December 31, 2012 and 2011.
The fair values of cash, pledged bank deposits, bills receivable, accounts receivable, short-term bank borrowings, bills payable, and accounts payable approximate their respective carrying amounts due to their short-term nature. Amounts due to related parties are not practicable to estimate due to the related party nature of the underlying transactions.
22 SIGNIFICANT CONCENTRATIONS AND RISKS
At December 31, 2012 and 2011, the Group held cash and pledged bank deposits in financial institutions of approximately $225 million and $164 million, respectively. They were primarily held in major financial institutions located in mainland China and the Hong Kong Special Administrative Region, which management believes have high credit ratings.
Sales to major customers, which individually exceeded 10% of the Group’s total annual net revenue, are as follows:
The Group currently buys a majority of its heavy oil, an important component of its products, from three suppliers. Although there are a limited number of suppliers of the particular heavy oil used in production, management believes that other suppliers could provide similar heavy oil on comparable terms. A change in suppliers, however, could cause a delay in manufacturing and a possible loss of sales, which would affect operating results adversely. Purchases (net of VAT) from the largest three suppliers for the years ended December 31, 2012 and 2011 were approximately $549 million and $377 million, respectively. These purchases represented 78% and 83%, respectively of all of the Group’s purchases for the years ended December 31, 2012 and 2011. The Company’s largest supplier accounted for approximately $473 million and $305 million, or 68% and 67% of total purchases for the years ended December 2012 and 2011, respectively. In addition, the supplier provided short-term financing to the Company of approximately $29 million during 2012, of which $20 million was included in accounts payable at December 31, 2012 and was repaid in January 21, 2013. Interest paid for this financing amounted to approximately $0.43 million. In addition, on December 27, 2012, the supplier provided a non-interest bearing advance of approximately $10 million to the Company, that was repaid in full on January 8, 2013.
The Group’s operations are carried out in the PRC. Accordingly, the Group’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC, as well as by the general state of the PRC’s economy. The business may be influenced by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittances abroad, and rates and methods of taxation, among other things.
23 RELATED PARTY TRANSACTIONS AND RELATIONSHIPS AND TRANSACTIONS WITH CERTAIN OTHER PARTIES
(A) Related Party Transactions
The Company considers all transactions with the following parties to be related party transactions.
Related party transactions and amounts outstanding with the related parties as of and for the years ended December 31, 2012 and 2011, are summarized as follows. Transactions with Ningbo Kunde and Ningbo Kewei are through the date the related party relationship ceased at which time transactions with these parties are included in details of transactions with certain other parties (Note 23(b))
(a)
The Group sold finished products of approximately $92.7 million to Ningbo Kunde during the year ended December 31, 2011. Sales to Zhenhai Jinchi for the year ended December 31, 2012 and 2011 were nil and less than $0.1 million, respectively.
(b)
The Group purchased raw materials of approximately $7.2 million from Ningbo Kunde during the year ended December 31, 2011.
(c)
The Group purchased transportation services of approximately $2.8 million and $3.0 million from Ningbo Xinhe during each of the years ended December 31, 2012 and 2011, and amounts owed to Ningbo Xinhe as of December 31, 2012 and 2011 in respect of these purchase transactions was approximately $0.5 million and $0.6 million, respectively.
(d)
Guarantees for Bank Loans
Beginning in 2011, loan guarantee fees of 0.3% of the loan principal guaranteed are to be paid quarterly. In the year ended December 31, 2012, loan guarantee fees were approximately $0.1 million and $0.3 million for Ningbo Hengfa and Ningbo Pacific, respectively. In 2011, loan guarantee fees were approximately $0.3 million, $0.6 million and $0.4 million for Ningbo Hengfa, Ningbo Pacific and Ningbo Kewei, respectively.
(e)
Short-term financing transactions with related parties
(i) Transactions during the year are translated at average exchange rates.
(ii) Balances at year end are translated at the balance sheet exchange rate.
(f)
Amounts due from related parties consist of amounts due from Mr. Tao for advances made for business expenses. These amounts are unsecured, interest free and due on demand.
(g)
At December 31, 2012 and 2011, amounts due to related parties consist of balances due to Ningbo Xinhe for services.
(B) Relationships and transactions with certain other parties
The Group has the following relationships and transactions with certain other parties:
Transactions and amounts outstanding with these parties for the years ended December 31, 2012 and 2011 are summarized as follows:
(h)
The Group sold finished products of approximately $45.4 million and $7.4 million to Ningbo Litong for the years ended December 31, 2012 and 2011, respectively. The Group sold finished products of approximately $98.2 million and $22.2 million to Ningbo Kunde for the years ended December 31, 2012 and 2011, respectively. The Group sold finished products of approximately $3.1 million to Ningbo Kewei for the year ended December 31, 2012, respectively.
(i)
The Group purchased raw materials of approximately $26.0 million and $11.6 from Ningbo Litong and Kunde, respectively, during the year ended December 31, 2012. During the year ended December 31, 2011, the Group purchased raw materials of approximately $20.3 million from Ningbo Litong. Amounts payable to Litong were nil and approximately $ 2.7 million as of December 31, 2012 and 2011, respectively. The Group purchased raw materials of approximately $3.7 million from Ningbo Kewei during the year ended December 31, 2012.
(j)
Guarantees for Bank Loans
Beginning in January 2011, loan guarantee fees of approximately 0.3% of the loan principal guaranteed after January 2011 are to be paid quarterly. Guarantee fees paid to Litong and Kewei were approximately $0.7 million each for the year ended December 31, 2012. Guarantee fees paid to Litong and Kewei were approximately $1.0 million and $0.2 million for the year ended December 31, 2011.
(k)
Short-term financing transactions
Historically the Group and these parties have provided each other with short-term financing, typically in the form of cash, bills receivable and bills payable.
Short-term financing with these parties is as follows:
(i) Transactions during the year are translated at average exchange rates.
(ii) Balances at year end are translated at the balance sheet exchange rate.
(l)
Amounts due to certain other parties were nil at December 31, 2012 and $2.7 million due to Litong at December 31, 2011.
(m)
At December 31, 2012, amounts due from certain other parties consist of amounts due from Litong, Kunde and Kewei of $15.3 million, $3.7 million, and $9 million, respectively.
(n)
Advances from certain other parties for sales is nil at December 31, 2012 and $0.1 million from Kunde at December 31, 2011.
24 Consolidated Segment Data
Segment information is consistent with how management reviews the business, makes investing and resource allocation decisions and assesses operating performance. The segment data presented reflects this segment structure. The Company reports financial and operating information in the following two segments:
(a) Petrochemicals Segment: Manufacturing and sale of mixed light aromatics, mixed heavy aromatics, fine propylene, propane, butane, liquefied petroleum gas (LPG), methyl tert-butyl ether, styrene, etc.
(b) Rubber Segment: Manufacturing and sale of various rubber products.
Prior to 2012, the Company had one operating segment, the Petrochemicals Segment. The segment information in the following tables reflects the establishment of the Rubber Segment in 2012.
25 Keyuan Petrochemicals, Inc. (Parent Company)
Relevant PRC statutory laws and regulation permit payments of dividends by the Company’s subsidiaries in the PRC only out of their retained earnings, if any, as determined in accordance with the PRC accounting standards and regulations.
Under the Law of the PRC on Enterprises with Wholly Owned Foreign Investment, the Company’s subsidiaries in the PRC are required to allocate at least 10% of their after tax profits, after making good their accumulated losses as reported in their PRC statutory financial statements, to the general reserve fund and have the right to discontinue allocations to the general reserve fund if the balance of such reserve has reached 50% of their registered capital. These statutory reserves are not available for distribution to the shareholders (except in liquidation) and may not be transferred in the form of loans, advances, or cash dividends.
As of December 31, 2012, approximately $4.1 million (2011:$3.7 million) was appropriated from retained earnings and set aside for the statutory reserve by the Company’s subsidiaries in the PRC.
As a result of these PRC laws and regulations, the Company’s subsidiaries in the PRC are restricted in their ability to transfer a portion of their net assets, either in the form of dividends, loans or advances, and consisting of paid-in capital and statutory reserves amounting to approximately $60.1 million as of December 31, 2012 (2011: $57.1 million).
The following presents condensed unconsolidated financial information of the Parent Company only:
Condensed Balance Sheets:
Consolidated Statements Of operations:
Condensed Statements of Cash Flows:
26 SUBSEQUENT EVENTS
On September 17, 2012, the Board of Directors authorized the repurchase of $2 million of the Company’s common stock for up to $1.50 per share. On December 31, 2012, the Company engaged TriPoint Global Equities LLC (“TriPoint Global”) as its agent to design and execute the stock repurchase program. Through March 31, 2013, the Company has purchased 117,554 shares of common stock for approximately $0.134 million through the stock repurchase program. On April 17, 2013, the stock repurchase program was suspended.
On April 22, 2013, Series A warrants and Series B warrants to purchase 661,562 and 661,562 shares of common stock, respectively, expired.
On May 18, 2013, Series A warrants and Series B warrants to purchase 87,142, and 87,142 shares of common stock, respectively, expired.
ITEM 9
ITEM 9
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
1.
During the preparation of our Annual Report on Form 10-K for the year ending December 31, 2010, our independent registered accounting firm, KPMG, raised certain issues, primarily relating to unexplained issues regarding certain cash transactions and recorded sales. On March 31, 2011, our Audit Committee elected to commence an Investigation of the issues raised and engaged the services of an Investigation Team. On May 24, 2011, KPMG resigned as the Company’s auditors while the Investigation was being carried out and before the results of such Investigation had been formulated or concluded. From January 17, 2011 when KPMG was engaged, through KPMG's resignation on May 24, 2011, there were no disagreements between the Company and KPMG on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements, if not resolved to the satisfaction of KPMG would have caused KPMG to make reference to the subject matter of the disagreements in connection with its reports.
2.
Effective July 5, 2011, we engaged GHP Horwath, P.C. (“GHP Horwath”) as our new independent registered public accounting firm. The decision to engage GHP Horwath was approved by the Company’s Audit Committee of the Board of Directors.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures
Our management maintains disclosure controls and procedures designed to provide reasonable assurance that material information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that the information is accumulated and communicated to our management, including our Chief Executive Officer and Acting Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. We performed an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Acting Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, our Chief Executive Officer and our Acting Chief Financial Officer have concluded that our disclosure controls and procedures were ineffective in ensuring that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission, and were ineffective in providing reasonable assurance that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
We do not expect that our disclosure controls and procedures will prevent all errors and all instances of fraud. Disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Further, the design of disclosure controls and procedures must reflect the fact that there are resource constraints, and the benefits must be considered relative to their costs. Because of the inherent limitations in all disclosure controls and procedures, no evaluation of disclosure controls and procedures can provide absolute assurance that we have detected all our control deficiencies and instances of fraud, if any. The design of disclosure controls and procedures also is based partly on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
(b) Changes in internal control over financial reporting
In connection with the preparation of our Form 10-K for the period ended December 31, 2010, our former auditors, KPMG, raised certain issues, which were primarily related to issues regarding certain cash transactions and recorded sales. As a result, our Audit Committee elected to commence an independent investigation and engaged the services of independent counsel, Pillsbury Winthrop Shaw Pittman LLP, which in turn engaged the services of Deloitte Financial Advisory Services LLP, as independent forensic accountants, and King & Wood, as Audit Committee counsel in PRC. As a result of the investigation, the Audit Committee identified a number of issues that may have a material impact on our internal controls and procedures over financial reporting.
As a result of the findings of the Audit Committee and its review of our controls and procedures, management concluded that the Company had material weaknesses. A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected.
In connection with the preparation of our financial statements for the fiscal year ended December 31, 2012, management has determined that our internal control environment is still not properly designed and did not operate effectively to ensure that the Company’s financial statements (and related financial statement disclosures) were prepared in accordance with US generally accepted accounting principles (US GAAP). As a result we continue to have material weaknesses in our controls and procedures.
Some specific weaknesses in our control environment included:
1) Lack of sufficient knowledge of U.S. GAAP reporting by our existing accounting staff;
2) Lack of sufficient accounting staff which results in a lack of segregation of duties necessary for an efficient internal control system;
3) Lack of a sufficient number of personnel appropriately qualified to perform control monitoring activities;
4) Lack of internal control consciousness and awareness by individuals responsible for certain key control activities, including lack of sufficient documentation of our existing financial processes, risk assessment and internal controls;
5) Inadequate training and training programs; and
6) Lack of necessary senior management oversight and monitoring of the accounting functions of the organization, and because the Company completed a reverse merger in April 2010, senior management lacks the background, skills and experience to meet the reporting requirements of a US listed company.
Although we have previously taken steps to remediate these material weaknesses, such as restructuring of our accounting department and streamlining its roles; terminating our former Vice President of Accounting/PRC CFO, Mr. Xue, and hiring a new Vice President of Accounting/PRC CFO, Mr. Zhang; hiring a bilingual director, Mr. Yuxin Xiang to facilitate Board oversight and augment our current independent directors; and cessation of the use of off balance sheet accounts; in the past fiscal year, we have experienced a large amount of turnover in our accounting department and our current staff is relatively new and inexperienced, and thus unfamiliar with the Company, as well as U.S. GAAP reporting. In order to meet the rigorous demands of being a U.S. listed company and remediate the weaknesses that have been identified, we believe that will need to implement the following additional measures:
a) Implement regular training programs with regard to internal controls, compliance requirements and corporate governance;
b) Identify outside directors with greater U.S. public company experience and increase board oversight;
c) Hire additional accounting personal, including but not limited to an experienced controller;
d) Hire a permanent CFO with the appropriate skills and experience, and background in US GAAP and SEC reporting;
e) Implement policies and procedures to provide for the rigorous monitoring and oversight of the control environment, including the CEO’s role therein; monitoring of the organizational structure, implement a robust internal audit program;
f) Further review the responsibilities of senior management including evaluation of the duties and responsibilities of our CEO;
g) Implement procedures for the identification, documentation, Board approval and appropriate disclosure of potential related party transactions;
h) Implement policies and procedures to ensure that all non-routine transactions are identified in a timely manner, such that all such transactions are approved by the Board and that systems and processes are developed to accumulate appropriate documentation supporting the transactions and to accumulate all information required for disclosure in our financial statements;
i) Develop policies to ensure that all identified contingencies are evaluated completely and in a timely manner; to provide for a continuous and robust risk assessment process, including evaluation of legal and regulatory considerations related to business activities;
j) Implement policies and procedures related to construction-in-process, including formalized budget monitoring, timely and accelerated receipt of invoices from vendors to reduce both the risks inherent in the estimation of deductible input VAT and the risks associated with the estimation of accounts payable, approval of contract change orders and updating of contract schedules for contract cancellations, and more robust documentation of goods and services received;
k) Implement policies and procedures to ensure that consolidated financial statements are properly recorded and reviewed by accounting personnel in accordance with US GAAP;
If we are able to successfully undertake the remediation measures outlined above, and if such measures are effectively implemented and maintained, we believe that we will be able to remediate the material weaknesses discussed above. However, due to the limited cash flow we are currently experiencing and the current lack of experience in public company governance by key personnel, we cannot assure when or if we will be able to successfully implement these remedial measures.
Except as described above, there have been no changes in our internal controls over financial reporting that occurred during the fiscal year to which this Annual Report on Form 10-K relates that have materially affected, or are reasonably likely to materially affect our internal controls over financial reporting.
Item 9b.
Item 9b. Other Information.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table and text set forth the names and ages of all directors and executive officers as of December 31, 2011. The Board of Directors is comprised of only one class. All of the directors will serve until the next annual meeting of shareholders and until their successors are elected and qualified, or until their earlier death, retirement, resignation or removal. There are no family relationships among our directors and executive officers. Also provided herein are brief descriptions of the business experience of each director, executive officer and advisor during the past five years and an indication of directorships held by each director in other companies subject to the reporting requirements under the Federal securities laws.
As of the closing of the Share Exchange on April 22, 2010, Ms. Smith resigned as Chairman of the Board, Chief Executive Officer, Chief Financial Officer, President and Secretary, effective immediately. Our Board of Directors appointed Mr. Tao to serve as President, Chief Executive Officer, and Chief Financial Officer effective immediately at the closing of the Share Exchange.
Prior to the consummation of the Share Exchange, our Board of Directors was comprised of one director, Ms. Smith. Effective at the closing of the Share Exchange, Ms. Smith resigned from her position as Chairman and tendered her resignation as a member of our Board; prior to resigning as Chairman, Ms. Smith appointed Mr. Chunfeng Tao to serve as Chairman of our Board. This change in our Board was effective on May 10, 2010, which was 10 days after we mailed a schedule 14(f) to our shareholders regarding same.
Set forth below is information regarding our current directors and executive officers:
Mr. Chunfeng Tao, Chairman, President and Chief Executive Officer. Mr. Tao has been a member of our Board of Directors and the CEO of the Company since April 22, 2010. Mr. Tao has over 20 years’ extensive experience in the petrochemical industry. Between 2008 to 2010, he served as President of Ningbo Plastics. Between 2005 and 2008, he served as President of Ningbo Hebang Chemical Co., a company with annual revenue of RMB 10 billion which he managed and built to an annual production capacity of 250,000 MT for aromatic and heavy oil cracking products. Between 2002 and 2005, Mr. Tao served as Executive Vice President of Ningbo Daxie Liwan Petrochemicals Co., a company with annual revenue of RMB 6 billion. Under his management, the company’s annual production was increased to 500,000 MT of high grade asphalt. Between 1989 and 2002, Mr. Tao served in various senior management and technical positions at Sinopec Zhenhai Refining & Chemical Co., the largest base for crude oil processing and sour crude oil processing in China, and won over 30 technological innovations, management awards and distinction during his service period.
Mr. Fan Zhang, Vice President of Accounting & Acting Chief Financial Officer. On August 20, 2011, Mr. Fan Zhang was appointed as Vice President of Accounting by the Board of the Directors to replace Mr. Weifeng Xue, effective as of August 20, 2011. Before joining Keyuan, Mr. Zhang was a Finance Director in Ningbo LG Yongxing Chemical Co., Ltd., a Sino-Korean joint venture between Ningbo Yongxing Chemical Investment Co. Ltd., and LG Chemical Co. Ltd., the largest chemical company in Korea. Ningbo LG Yongxing Chemical Co. Ltd is the largest ABS producer in China. Mr. Zhang has more than twelve years experience in financial reporting and controls, tax planning, fund management, ERP operation system management, internal audit and property insurance planning. Mr. Zhang holds a Bachelor degree in Economics from Hangzhou Electronic Technical University.
Mr.Yuxin Xiang, Director. Mr. Yuxin Xiang has been a member of our Board of Directors since September 6, 2012. Mr. Xiang serves as the President of CNX Consulting Inc. which provides financial reporting, asset management and capital transactions services to North American companies, as well as a director and Audit Committee member of five companies listed on the Toronto Stock Exchange (TSX) and TSX Venture Exchange (TSXV). Prior to joining CNX Consulting, Mr. Xiang served as the Chief Financial Officer of IND DairyTech Limited and GobiMin Inc, both listed on TSXV. Mr. Xiang also worked in corporate finance management for several TSX listed companies, including COM DEV International Ltd., ATS Automation Tooling Systems Inc. and CFM Corporation. He holds a Bachelor of Arts Degree from Huazhong University of Science & Technology in China, and a Masters of Business Administration from York University in Canada. Mr. Xiang is a Certified Management Accountant (Ontario) and a Certified Public Accountant (Delaware).
Mr. Dish Shen, Director. Mr. Shen has been a member of our Board of Directors since July 1, 2010. Mr. Shen is a senior petrochemical engineer with nearly 40 years of oil refining and petrochemical industry expertise and management experience and has served in a variety of progressive leadership roles in planning and economic development in Zhejiang Province, focusing primarily on development of the petrochemical industry, and serves today as a member of the People's Committee of Zhejiang Province. Since 2005, he has been serving as a senior counsel for Zhejiang Provincial Association Of Engineering Consultants, the institute providing consulting and administration service. He graduated from Beijing Petroleum Institute with a major in oil refining systems.
Mr. Xin Yue, Director . Mr. Yue has been a member of our Board of Directors since July 1, 2010. Mr. Yue currently is co-founder and chief executive officer of Cmark Capital Co., Ltd from 2005. Previously he also co-founded Golden Spider Co., Ltd., and New Shengtong Technology Co., Ltd. Mr. Yue serves as an advisor to Tianyin Pharmaceutical Co., Inc. and Jpak Group Inc. and president at a Shanghai subsidiary of Jiubai Group Co., Ltd. He received his Bachelor of Science in Economics and Management at Capital Economic and Trade University and his MBA in Finance from Baruch College at The City University of New York.
Significant Employees
The following are employees who are not executive officers, but who are expected to make significant contributions to our business:
Dr. Jingtao Ma, Executive Vice President. Dr. Ma joined the Company in 2007 and he has over 20 years’ experience in corporate management, research & development, sales & marketing, and business development. Dr. Ma is responsible for the sales & marketing and raw material procurement of the Company. Between 1992 and 2007, he served in management and technical positions at Sinopec Zhenhai Refining & Chemical Co. in various functions including manufacturing and operations, and chemical and technical analysis. Dr. Ma received his Master of Science and studies for Doctorate in Physical Chemistry from Lanzhou Chemistry & Physics Research Institute of CSA.
Mr. Shifa Wang, Vice President & Chief Engineer. With 30 years’ management experience in petrochemical technology and manufacturing, and specialty in oil refining and catalytic cracking, Mr. Wang has been responsible for technology, and research and development of the Company since 2009. In December , 2012, Mr. Wang was appointed as the new General Manager of Ningbo Keyuan replacing Dr. Ma, responsible for daily operation and management and efficiency improvement of Ningbo Keyuan. Between 2007 and 2009, Mr. Wang served as General Manager at Guangdong Yingchang Heavy Road Asphalt Co., Ltd, responsible for managing and overseeing the overall business operations of the company. Between 1981 and 2002, he served as the Chief Engineer at Sinopec Anqing Refinery Co., Ltd., responsible for technology development and research and development. Between 2003 and 2006, he was the Head of Operations for Phase II production line expansion, including construction of 500,000 MT heavy oil catalytic cracking facility, 150,000 MT gas fractionation facility, 10,000 MT sulphur recovery facility and 30,000 MT polypropylene facility, at Guangdong Tianyi Group Co., Ltd. Mr. Wang received his Bachelor of Science from Chemical Engineering Department of China Petroleum University and Master of Art in Enterprise Management from Qinghua University.
Mingliang Liu, Vice President of Manufacturing. Mr. Liu has been responsible for overseeing the manufacturing by the Company since 2009. Mr. Liu has over 30 years of experience in petrochemical manufacturing and production management and specializes in oil refining, heavy oil cracking and crude oil processing. Between 1975 and 2009, he served in various supervisory and managerial positions at Sinopec Zhenhai Refining & Chemical Co. Mr. Liu majored in Economics & Management at Zhejiang CCP Institute.
Corporate Governance
Corporate governance is the system that allocates duties and authority among a company’s stockholders, Board of Directors and management. The stockholders elect the Board of Directors and vote on extraordinary matters; the Board of Directors is a company’s governing body, responsible for hiring, overseeing, and evaluating management, particularly the chief executive officer; and management runs a company’s day-to-day operations. Our Board of Directors currently consists of five seats.
Board Leadership Structure.
The Board of Directors maintains a structure with the Chief Executive Officer of the Company holding the position as Chairman of the Board of Directors.
The Board of Directors utilizes a leadership structure that has the Chief Executive Officer (who is the Corporation’s principal executive officer and a director) who also acts in the capacity as Board Chairman, without a designated independent lead director. This structure creates efficiency in the preparation of the meeting agendas and related Board materials as the Company’s Chief Executive Officer works more directly with those preparing the necessary Board materials and is more connected to the overall daily operations of the Company. Agendas are also prepared with the permitted input of the full Board of Directors allowing for any concerns or risks of any individual director to be discussed as deemed appropriate. Given the Company’s relatively small size (both in terms of number of employees and in scope of operational activities directly conducted by the Company), its corporate strategy and its focus on research and development, this structure is deemed to be appropriate and allows for efficient oversight. However, in order to improve corporate governance, the Board has authorized the establishment of a sub-committee composed of the independent directors, the Company’s SOX 404 compliance consultant and a U.S. securities counsel to the Company to examine the responsibilities and duties of the Chief Executive Officer and Chairman of the Board, and further evaluate this structure.
Compliance with Section 16(a) of the Exchange Act
Section 16(a) of the Exchange Act requires our officers, directors and persons who own more than 10% of any class of our securities registered under Section 12(g) of the Exchange Act to file reports of ownership and changes in ownership with the SEC. Officers, directors and greater than 10% stockholders are required by SEC regulation to furnish us with copies of all Section 16(a) forms they file.
Based on our review of copies of such reports, we believe that there was compliance with all filing requirements of Section 16(a) applicable to our officers, directors and 10% stockholders during fiscal 2010.
Code of ethics
The Company has always encouraged its employees, including officers and directors to conduct business in an honest and ethical manner. Additionally, it has always been our policy to comply with all applicable laws and provide accurate and timely disclosure.
We have always encouraged our employees, including officers and directors to conduct business in an honest and ethical manner. Additionally, it has always been our policy to comply with all applicable laws and provide accurate and timely disclosure. Due to our lack of operations and small employee base prior to the Share Exchange, we did not maintain a formal written code of ethics. However, as a result of the Share Exchange, we decided to adopt formal written codes of ethics for our executive officers, our directors and our employees.
Our codes of ethics are designed to deter wrongdoing and promote honest and ethical conduct and compliance with applicable laws and regulations. These codes also incorporate our expectations of our executives that enable us to provide accurate and timely disclosure in our filings with the Securities and Exchange Commission and other public communications. Our codes of ethics are attached as exhibits to the Current Report on Form 8-K that we filed with the SEC on July 7, 2010 and are available on our website, http://ir.stockpr.com/keyuanpetrochemicals/governance-documents. Any future changes or amendments to our code of ethics, and any waiver of our codes of ethics will also be posted on our website when applicable.
Board Independence and Committees
Since our stock start started trading on Nasdaq in September 2010, we were required to comply with the director independence requirements of the Nasdaq rules. Since that time, , in determining whether our directors are independent, we have complied and plan to continue to comply with the Nasdaq rules although our common stock is currently trading on Pink Sheets. The Board of Directors will also consult with counsel to ensure that the Boards of Director’s determinations are consistent with those rules and all relevant securities and other laws and regulations regarding the independence of directors, including those adopted under the Sarbanes-Oxley Act of 2002 with respect to the independence of Audit Committee members. The Nasdaq listing standards define an “independent director” generally as a person, other than an officer of a company, who does not have a relationship with the company that would interfere with the director’s exercise of independent judgment. Our two directors, Mr. Shen and Mr. Xiang are “independent” as that term is defined by Nasdaq Rule 4200(a)(15). We are planning to add additional one or two bilingual Chinese-speaking independent directors to facilitate the Board oversight and augment the efforts of the current independent directors.
Audit Committee and Financial Expert
Our Audit Committee consists of Mr. Yuxin Xiang and Mr. Dishen Shen, each of whom is independent. The Audit Committee assists the Board of Directors oversight of (i) the integrity of the our financial statements, (ii) our compliance with legal and regulatory requirements, (iii) the independent auditor’s qualifications and independence, and (iv) the performance of our internal audit function and independent auditor, and prepares the report that the Securities and Exchange Commission requires to be included in our annual proxy statement. The Audit Committee operates under a written charter. Mr. Xiang is the Chairman of our Audit Committee.
The Board of Directors determined that Mr. Xiang possesses accounting or related financial management experience that qualifies him as financially sophisticated within the meaning of Rule 4350(d)(2)(A) of the Nasdaq Marketplace Rules and that he is an “audit committee financial expert” as defined by the rules and regulations of the SEC.
Compensation Committee
The Compensation Committee is responsible for overseeing and, as appropriate, making recommendations to the Board of Directors regarding the annual salaries and other compensation of our executive officers and general employees and other policies, and for providing assistance and recommendations with respect to our compensation policies and practices. Each of Mr. Yuxin Xiang and Mr. Dishen Shen are members of the Compensation Committee. The Compensation Committee operates under a written charter. Mr. Xiang is the Chairman of Compensation Committee.
Nominating Committee and Corporate Governance Committee
The purpose of the Nominating and Corporate Governance Committee is to assist the Board of Directors in identifying qualified individuals to become members of our Board of Directors, in determining the composition of the Board of Directors and in monitoring the process to assess Board effectiveness. Each of Mr. Yuxin Xiang and Mr. Dishen Shen are members of the Nominating and Corporate Governance Committee. The Nominating and Corporate Governance Committee operates under a written charter.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Executive Compensation
Summary Compensation Table of Named Executive Officers
The following table sets forth all cash compensation paid by us, as well as certain other compensation paid or accrued, in 2012, 2011 and 2010 to each of the following named executive officers. The total amount was $133,755 in 2012, $361,519 in 2011, $462,138 in 2010 respectively.
(1)
Although they are not executive officers, based on upon the compensation received, Mr. Ma and Mr. Xue qualify as named executive officers for purposes of this table. Mr. Xue no longer has any further responsibility or authority with regard to the accounting or finance of the Company since August 20, 2011. Mr. Xue remained available to assist the Company with the transition for a period of up to two months.
(2)
On October 12, 2011, Ms. Li resigned her position as Chief Financial Officer of the Company. Ms. Li was a consultant retained by the Company until December 12, 2011.
(3)
Mr. Zhang was appointed as Acting Chief Financial Officer after Ms. Li resigned her position as the CFO of the Company in October 2011.
Pension Benefits
We do not sponsor any qualified or non-qualified defined benefit plans.
Nonqualified Deferred Compensation
We do not maintain any non-qualified defined contribution or deferred compensation plans.
Retirement/Resignation Plans
We do not have any plans or arrangements in place regarding the payment to any of our executive officers following such person’s retirement, resignation, constructive termination or change in control transaction.
Employment Agreements
We have entered into employment agreements with each of the PRC subsidiary’s employees, officers and directors.
On May 1, 2007, Ningbo Keyuan entered into a non-fixed term employment agreement with Mr. Chunfeng Tao, pursuant to which, Ningbo Keyuan hired Mr. Tao as its general manager effective May 1, 2007. The compensation in connection with this employment shall be commensurate with Mr. Tao’s duties and responsibility as the general manager and is subject to mutual agreement between Mr. Tao and Ningbo Keyuan. On May 10, 2007, Keyaun Plastics entered into a similar employment agreement with Dr. Jingtao Ma to hire Dr. Ma as its vice executive general manager, effective May 10, 2007. On the same day, Keyuan Plastics entered into a similar employment agreement with Mr. Weifeng Xue to hire Mr. Xue as its vice general manager. On February 2, 2009, Keyaun Plastics entered into another similar agreement with Mr. Mingliang Liu to hire him as vice general manager. On October 21, 2009, Mr. Shifa Wang was hired by Ningbo Keyuan as a vice technical general manager and chief engineer and a similar employment agreement was signed between Ningbo Keyuan and Mr. Wang.
On May 1, 2007, Ningbo Keyuan also entered into a confidentiality and non-compete agreement with Mr. Tao, pursuant to which, Mr. Tao agreed, among other things, (i) that he will keep in confidence all Ningbo Keyuan confidential information obtained in connection with such employment; (ii) that Ningbo Keyuan has the sole ownership right to all Ningbo Keyuan intellectual properties, either developed by Mr. Tao individually or collectively with other parties during his employment term or within one (1) year following the termination of his employment; and (iii) that within two (2) years following the termination of his employment, he will not, directly or indirectly, engage in any business or other activities related to Ningbo Keyuan confidential information that he obtained during his last five (5) years of employment (or such less term) with Ningbo Keyuan. On May 10, 2007, similar confidentiality and non-compete agreements were entered into between Ningbo Keyuan and Mr. Jingtao Ma and also between Ningbo Keyuan and Mr. Weifeng Xue. In addition, using the same form of the agreement, Ningbo Keyuan entered into confidentiality and non-compete agreements with Mr. Mingliang Liu and Mr. Shifa Wang respectively on February 2, 2009 and October 21, 2009.
On May 7, 2010, we entered into a one-year employment agreement with Aichun Li, our Chief Financial Officer. The agreement was effective as of May 7, 2010, at a base salary of $150,000 subject to adjustment by the Board, plus the right, at the Board’s discretion, to participate in all management bonuses and incentive plans, and the right to participate in all employee benefit plans, to the extent maintained by the Company. The employment agreement also contained standard provisions concerning confidentiality, non-competition and non-solicitation. On October 12, 2011, Ms. Aichun Li resigned her position as our Chief Financial Officer.
On May 23, 2011, Ningbo Keyuan Plastics entered into an open-term employment agreement with Mr. Fan Zhang as its PRC Chief Financial Officer. The agreement was effective as of May 23, 2011. On August 20, 2011, Mr. Fan Zhang was appointed as Vice President of Accounting by the Board of Directors to replace Mr. Weifeng Xue, and Mr. Zhang assumed the responsibilities of our Acting Chief Financial Officer after Ms. Li’s resignation as our Chief Financial Officer.
Compensation of Directors
Our directors are reimbursed for expenses incurred by them in connection with attending Board of Directors’ meetings.. The following table sets forth all cash compensation paid by us, as well as certain other compensation paid or accrued, in 2012, to each of the following named directors.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The following table sets forth certain information regarding beneficial ownership of our Common Stock as of April 10, 2012 by (i) each person (or group of affiliated persons) who is known by us to own more than five percent (5%) of the outstanding shares of our Common Stock, (ii) each director, executive officer and director nominee, and (iii) all of our directors, executive officers and director nominees as a group. As of April 13, 2013, we had 57,646,160 shares of Common Stock issued and outstanding, and 5,333,340 shares of Series B Preferred Stock issued and outstanding.
Beneficial ownership is determined in accordance with SEC rules and generally includes voting or investment power with respect to securities. For purposes of this table, a person or group of persons is deemed to have “beneficial ownership” of any shares of common stock that such person has the right to acquire within 60 days of April 13, 2013. For purposes of computing the percentage of outstanding shares of our common stock held by each person or group of persons named above, any shares that such person or persons has the right to acquire within 60 days of April 13, 2013 is deemed to be outstanding for such person, but is not deemed to be outstanding for the purpose of computing the percentage ownership of any other person. The inclusion herein of any shares listed as beneficially owned does not constitute an admission of beneficial ownership.
Notwithstanding the foregoing, because the Series M Preferred Stock votes on as converted basis with the Common Stock, we have included the owners of such stock in this table. Accordingly, we calculate beneficial ownership for purposes of this table as follows:
A + B
X + B
Where:
A = individual’s current holders of common stock
B = number of shares of common stock individual may own within 60 days
X= number of common stock currently outstanding, including the shares of common stock underlying the Series M Preferred Stock since such class votes on as converted basis with the common.
Unless otherwise noted, the principal address of each of the stockholders, directors and officers listed below is Qingshi Industrial Park, Ningbo Economic & Technological Development Zone, Ningbo, Zhejiang Province, P. R. China 31580.
(1) Delight Reward Limited is owned by Apex Smart Limited (68.864%), , Chance Brilliant Holdings Limited (20.5694%), Harvest Point Limited (5.3896%) and Strategic Synergy Limited (5.1755%). Mr. Chunfeng Tao is the controlling person of Apex Smart Limited. Mr. Peijun Chen is the controlling person of Chance Brilliant Holdings Limited .Ms. Muxin Duan is the controlling person of Harvest Point Limited. Mr. Brian Pak Lun Mok is the controlling person of Strategic Synergy Limited (subject to the Slow Walk Agreement described in the discussion below).
(2) In connection with the Share Exchange, Delight Reward received 47,658 shares of Series M Preferred Stock that converted into 47,658,000 shares of Common Stock on December 28, 2010. On October 23, 2012, Delight Reward repurchased 105 shares of Delight Reward shares from Happyvale Limited in a consideration of 100,000 shares of Common Stock of the Company, resulting its holding of 47,558,000 shares of common stock of the Company.
(3) Pursuant to a share transfer agreement, Mr. Chunfeng Tao, our Chairman, Chief Executive Officer and President exercised his Slow Walk Options after certain performance targets were met, to purchase from Mr. Brian Pak-Lun Mok, 100% of Apex Smart Limited’s equity, which entitled Mr. Tao to own 45.6132% of the equity of Delight Reward Limited. Accordingly, upon exercise of such option, which is currently being processed, Mr. Tao will indirectly (through his 45.6132% ownership of Delight Reward Limited) owned and controled 21,738,338 shares of our Common Stock. On March 25, 2013, Best Castle Investments Limited transferred 11,626 shares of Delight Reward Limited to Apex Smart Limited, increasing Apex Smart Limited’s ownership of Delight Reward Limited from 45.6132% to 68.864%. Delight Reward Limited holds 47,558,000 shares of common stock of Keyuan Petrochemicals, Inc.. As a result of this transfer, Mr. Chunfeng Tao, through his 100% ownership of Apex Smart Limited, owns and controls 32,750,341 shares of our common stock.
(4) In connection with the September 2010 Private Placement, Dragon State International Limited owns 5,333,340 shares of Series B Preferred Stock. However, pursuant to the relative rights and preferences of the Series B preferred stock, the numbers of common stock to be issued upon conversion of the Series B preferred stock cannot exceed 9.99% of the then issued and outstanding shares of common stock outstanding at such time. Given as of January 12, 2010, there are 57,577,840 shares of common stock outstanding giving effect that 47,658 of Series M preferred stock has converted into 47,658,000 shares of common stock.
(5) On November 4, 2010, the Company exercised its mandatory conversion rights under the terms of the Series A Preferred Stock to convert all of outstanding shares of its Series A 6% Cumulative Convertible Preferred Stock into a total of 6,132,032 shares of Common Stock, $0.001 par value per share. As a result, following the conversion, all 6,132,032 shares of Series A Preferred Stock that had been outstanding will be cancelled and will be automatically converted, without any delivery of conversion notice required on the part of the holders of Series A Preferred Stock. As of the date hereof, the Company has 9,919,840 shares of Common Stock outstanding. Dividends on the Series A Preferred Stock accrued through November 3, 2010 and amounted to approximately $143,000 and will be paid to the holders of Series A Preferred Stock on the regularly scheduled payment date of January 31, 2011. As a result of foregoing, as of November 4, 2010, the Company will no longer incur the Series A Dividend that was payable quarterly, at the rate of 6% per annum for each outstanding share, payable in cash or common stock dividends, as applicable.
(6) On December 28, 2010, Keyuan Petrochemicals, Inc (the “Company”) exercised its mandatory conversion rights under the terms of the Series M Preferred Stock to convert all of outstanding shares of its Series M Preferred Stock into a total of 47,658,000 shares of Common Stock, $0.001 par value per share. As a result, following the conversion, all 47,658 shares of Series M preferred stock that had been outstanding will be cancelled and will be automatically converted, without any delivery of conversion notice required on the part of the holders of Series M Preferred Stock. As of the date hereof, the Company has 57,646,160 shares of Common Stock outstanding.
(7) Pursuant to a share transfer agreement, Mr. Peichun Chen exercised his Slow Walk Options, after certain performance targets were met, to purchase from Mr. Lo Kan Kwan, 100% of Chance Brilliant Holdings Limited’s equity, which entitled Mr. Wang to own 20.5694% of the equity of Delight Reward Limited. Accordingly, upon exercise of such option, Mr. Wang indirectly (through his 20.5694% ownership of Delight Reward Limited) owns and controls 9,802,965 shares of our Common Stock.
Changes in Control
Lock Up Agreements
Pursuant to the lock up agreement the Company entered into in April-May Private Placement, all of the shares of common stock to be owned by Delight Reward will be restricted from public or private sale for a period of six (6) months following October 19, 2010 (the effective date of the registration statement registering the registrable shares issued in the April-May Private 2010 Placement ); following such six (6) month period, Delight Reward shall be allowed to sell up to 1/12 of its holdings each month for the next twelve months. Notwithstanding the foregoing, Delight Reward shall be permitted to engage in a transfer in a private sale of the lock-up shares, provided that such transferee agrees in writing to be bound by and subject to the terms of the lock-up agreement.
Pursuant to the lock up agreement the Company entered into in September Private Placement, all of the shares of common stock to be owned by Mr. Chunfeng Tao, Mr. Jicun Wang, Mr. Peijun Chen and Mr. Xin Yue will be restricted from public or private sale until January 19, 2011 ( the effective date of the registration statement registering all registrable shares in September Private Placement); during the twenty four (24) months immediately following January 19, 2011, such shareholders shall not transfer more than twenty percent (20%) of the their lock-up shares in the aggregate, provided, that they may transfer not more than 0.83333% of the lock-up shares during each calendar month in such 24 month period. Notwithstanding the foregoing, such shareholders are permitted to engage in a transfer in a private sale of their lock-up shares, provided that such transferee agrees in writing to be bound by and subject to the terms of the lock-up agreement. .
Share Escrow Agreement
We also entered into an escrow agreement with the Investors of the April-May 2010 Private Placement and the September 2010 Private Placement, pursuant to which we placed 5,000 shares of Series M Preferred Stock in an escrow account. The 5,000 shares of Series M Preferred Stock automatically converted into 5,000,000 shares of Common Stock (the “Escrow Shares”) after we amended our Articles of Incorporation to increase our authorized Common Stock to one hundred million (100,000,000) shares on December 28, 2010.
If we achieved less than 95% of the 2010 performance threshold ( net income equal to or greater than $33.0 million), then the Escrow Shares for such year were delivered to the Investors in the amount of 500,000 shares of Common Stock for each full percentage point by which such threshold was not achieved up to a maximum of 5,000,000 shares of Common Stock.
Slow Walk Agreements
The controlling persons of each of the five shareholders entities of Delight Reward Limited have entered into certain Slow Walk Agreements whereby the controlling persons have each agreed to transfer their shareholdings to another beneficiary, subject to certain performance targets being met. The performance targets are: at least $39 million of gross revenue for the three months commencing from July 2010 to September 2010; at least $40 million of gross revenue for the three months commencing from October 2010 to December 2010; and, at least $41 million of gross revenue for the three months commencing from January 2011 to March 2011.
Pursuant to these agreements, (i) Mr. Brian Pak-Lun Mok, the sole shareholder of Apex Smart Limited, granted to Mr. Tao an option to acquire the 50,000 ordinary shares of Apex Smart Limited if the performance targets are met; (ii) Mr. O. Wing Po, the sole shareholder of Best Castle Investments Limited, granted to Mr. Jicun Wang an option to acquire the 50,000 ordinary shares of Best Castle Investments Limited if the performance targets are met; (iii) Mr. Lo Kan Kwan, the sole shareholder of Chance Brilliant Holdings Limited, Mr. Peijun Chen an option to acquire the 50,000 ordinary shares of Chance Brilliant Holdings Limited if the performance targets are met; (iv) Mr. Brian Pak-Lun Mok, the sole shareholder of Harvest Point Limited, granted to Mr. Xin Yue an option to acquire the 50,000 ordinary shares of Harvest Point Limited if the performance targets are met; and, (v) Mr. Brian Pak-Lun Mok, the sole shareholder of Strategic Synergy Limited, granted to Mr. Yue an option to acquire the 50,000 ordinary shares of Strategic Synergy Limited if the performance targets are met. Pursuant to each of these agreements, the option to acquire theses shares shall vest at a rate of one-third (1/3) for each performance target that is met ( the “Slow Walk Options”).
On November 5, 2010, one-third of the Slow Walk Options were exercised after the first performance target was met.
On April 29, 2011, Harvest Point Limited transferred 1,028 shares of Delight Reward Limited’s stock to Strategic Synergy Limited, changing their ownership of Delight Reward Limited’s stock to 3.334% and 7.232% respectively. On the same day, Mr. Brian Pak-Lun Mok and Mr. Xin Yue transferred 33,333 shares and 16,667 shares of Harvest Point Limited, respectively, to Ms. Muxia Duan thus transferring 100% of the ownership of Harvest Point Limited to Ms. Muxia Duan.
After the relative performance targets were met, Mr. Chen and Mr. Wang exercised their remaining two-thirds of the Slow Walk Options on February 15, 2012 and Mr. Tao exercised his remaining two-thirds of the Slow Walk Options on March 30, 2012. As the date of hereof, Mr. Yue has not yet exercised his remaining two-thirds of the Slow Walk Options.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
We have not entered into any transaction during the last two fiscal years with any director, executive officer, director nominee, 5% or more shareholder, nor have we entered into transaction with any member of the immediate families of the foregoing person (including spouse, parents, children, siblings, and in-laws) or is any such transaction proposed, except as follows:
(A) Related Party Transactions
The Company considers all transactions with the following parties to be related party transactions.
Related party transactions and amounts outstanding with the related parties as of and for the years ended December 31, 2012 and 2011, are summarized as follows; Transactions with Ningbo Kunde and Ningbo Kewei are through the date the related party relationship ceased at which time transactions with these parties are included in details of transactions with certain other parties (Note (b))
(a)
The Group sold finished products of approximately $92.7 million to Ningbo Kunde during the year ended December 31, 2011. Sales to Zhenhai Jinchi for the year ended December 31, 2012 and 2011 were nil and less than $0.1 million, respectively.
(b)
The Group purchased raw materials of approximately $7.2 million from Ningbo Kunde during the year ended December 31, 2011.
(c)
The Group purchased transportation services of approximately $2.8 million and $3.0 million from Ningbo Xinhe during each of the years ended December 31, 2012 and 2011, and amounts owed to Ningbo Xinhe as of December 31, 2012 and 2011 in respect of these purchase transactions was approximately $0.5 million and $0.6 million, respectively.
(d)
Guarantees for Bank Loans
Beginning in 2011, Loan guarantee fees of 0.3% of the loan principal guaranteed are to be paid quarterly. In the year ended December 31, 2012, loan guarantee fees were approximately $0.1 million and $0.3 million for Ningbo Hengfa and Ningbo Pacific, respectively. In 2011, loan guarantee fees were approximately $0.3 million, $0.6 million and $0.4 million for Ningbo Hengfa, Ningbo Pacific and Ningbo Kewei, respectively.
(e)
Short-term financing transactions with related parties
(i) Transactions during the year are translated at average exchange rates.
(ii) Balances at year end are translated at the balance sheet exchange rate.
(f)
Amounts due from related parties consist of amounts due from Mr. Tao for advances made for business expenses. These amounts are unsecured, interest free and due on demand.
(g)
At December 31,2012 and 2011, amounts due to related parties consist of balances due to Ningbo Xinhe for services.
(B) Relationships and transactions with certain other parties
The group has the following relationships and transactions with certain other parties:
Transactions and amounts outstanding with these parties for the years ended December 31, 2012 and 2011 are summarized as follows:
(h)
The Group sold finished products of approximately $46.6 million and $7.4 million to Ningbo Litong for the years ended December 31, 2012 and 2011, respectively. The Group sold finished products of approximately $98.4 million and $22.2 million to Ningbo Kunde for the year ended December 31, 2012 and 2011.The Group sold finished products for approximately $3.1 million to Ningbo Kewei for the year ended December 31, 2012, respectively.
(i)
The Group purchased raw materials of approximately $26.0 million and $11.6 from Ningbo Litong and Kunde during the year ended December 31, 2012. During the year ended December 31, 2011, the Group purchased raw materials of approximately $20.3 million from Ningbo Litong. Amounts payable to Litong were nil and approximately $ 2.7 million as of December 31, 2012 and 2011, respectively. The Group purchased raw materials of approximately $3.7 million from Ningbo Kewei during the year ended December 31, 2012.
(j)
Guarantees for Bank Loans
Beginning in January 2011, loan guarantee fees of approximately 0.3% of the loan principal guaranteed after January 2011 are to be paid quarterly. Guarantee fees paid to Litong and Kewei (as a certain other party) were approximately $0.7 million for the year ended December 31, 2012. Guarantee fees paid to Litong and Kewei were approximately $1.0 million and $0.2 million for the year ended December 31,2011, respectively.
(k)
Short-term financing transactions
Historically the Group and these parties have provided each other with short-term financing, typically in the form of cash, bills receivable and bills payable.
Short-term financing with these parties is as follows:
(i) Transactions during the year are translated at average exchange rates.
(ii) Balances at year end are translated at the balance sheet exchange rate.
(l)
Amounts due to certain other parties were nil at December 31, 2012 and $2.7 million due to Litong at December 31, 2011.
(m)
At December 31, 2012 ,amounts due from certain other parties consist of amounts due from Litong, Kunde and Kewei of $15.3 million, $3.7 million, and $9 million, respectively.
(n)
Advances from certain other parties for sales is nil at December 31, 2012 and advance $0.1 million from Kunde at December 31, 2011.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Aggregate fees for professional services rendered to the Company by GHP Horwath for the years ended December 31, 2012 and 2011 were as follows:
Audit Fees. The aggregate fees billed for the years ended December 31, 2012 and 2011 were for the audits of our financial statements and reviews of our interim financial statements included in our annual and quarterly reports.
Audit Related Fees. The aggregate fees billed for the years ended December 31, 2012 and 2011 were for the audit or review of our financial statements that are not reported under Audit Fees.
Tax Fees. The aggregate fees billed for the years ended December 31, 2012 and 2011 were for professional services related to tax compliance, tax advice and tax planning.
All Other Fees. The aggregate fees billed for the years ended December 31, 2012 and 2011 were for services other than the services described above.
(5) AUDIT COMMITTEE POLICIES AND PROCEDURES
The policy of our Audit Committee is to pre-approve all audit and permissible non-audit services to be performed by the Company’s independent auditors during the fiscal year. Under these procedures, the Audit Committee pre-approves both the type of services to be provided by our auditor and the estimated fees related to these services.
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934 this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Chunfeng Tao
Chairman, President, Chief Executive Officer and Director
June 4, 2013
Chunfeng Tao
/s/Fan Zhang
Vice President of Accounting/ Acting Chief Financial Officer
June 4, 2013
Fan Zhang
/s/Yuxin Xiang
Director, Audit Committee Chairman and Compensation Committee Chairman
June 4, 2013
Yuxin Xiang
/s/ Dishen Shen
Director
June 4, 2013
Dishen Shen
/s/Xin Yue
Director
June 4, 2013
Xin Yue