Attached files

file filename
EX-32.2 - ShengdaTech, Inc.v196563_ex32-2.htm
EX-31.2 - ShengdaTech, Inc.v196563_ex31-2.htm
EX-31.1 - ShengdaTech, Inc.v196563_ex31-1.htm
EX-32.1 - ShengdaTech, Inc.v196563_ex32-1.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION 
Washington, D.C. 20549 

FORM 10-K
(Amendment No. 2)
 
 (Mark One)
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2009
 
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from __________ to __________
 
Commission file number: 01-31937 

SHENGDATECH, INC.
(Exact name of registrant as specified in its charter)
 
Nevada
 
26-2522031
(State or other jurisdiction
of incorporation or organization)
 
(I.R.S. Employer
Identification No.)

Unit 2003, East Tower, Zhong Rong Heng Rui International Plaza,
620 Zhang Yang Road, Pudong District, Shanghai 200122
People's Republic of China

(Address of Principal Executive Offices)

86-21-58359979 (Registrant’s Telephone Number, Including Area Code)

Not Applicable
(Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class:
 
Name of Each Exchange on Which Registered
Common Stock, par value $.00001
 
The NASDAQ Global Select Market
 
Securities registered pursuant to Section 12(g) of the Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o No þ  

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes o No þ
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨  No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer ¨
Accelerated filer x
Non-accelerated filer ¨
(Do not check if a smaller
reporting company)
Smaller reporting company ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act):
Yes ¨ No þ

 The aggregate market value of the 28,114,324 shares of voting and non-voting common equity stock held by non-affiliates of the registrant was $105,428,715 as of June 30, 2009, the last business day of the registrant’s most recently completed second fiscal quarter, based on the last sale price of the registrant’s common stock on such date of $3.75 per share, as reported by The NASDAQ Stock Market, Inc.

As of March 15, 2010, there were 54,202,036 shares of common stock of ShengdaTech, Inc. outstanding.
 
Explanatory Note
 
This amendment no. 2 to the Company's Annual Report on Form 10-K for the year ended December 31, 2009 is filed in response to comments in the letter dated August 11, 2010 received by the Company from the U.S. Securities and Exchange Commission.

 
 

 

SHENGDATECH, INC.
(A Nevada Corporation)

TABLE OF CONTENTS
 
     
Page
 
PART I
   
Item 1
Business
 
3
Item 1A
Risk Factors
 
12
Item 1B
Unresolved Staff Comments
 
29
Item 2
Properties
 
29
Item 3
Legal Proceedings
 
30
       
 
PART II
   
Item 5
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
30
Item 6
Selected Financial Data
 
32
Item 7
Management’s Discussion and Analysis of Financial Condition and Results of Operation
 
35
Item 7A
Quantitative and Qualitative Disclosures About Market Risk
 
48
Item 8
Financial Statements and Supplementary Data
 
49
Item 9
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
 
50
Item 9A
Controls and Procedures
 
50
Item 9B
Other Information
 
53
       
 
PART III
   
Item 10
Directors, Executive Officers and Corporate Governance
 
53
Item 11
Executive Compensation
 
57
Item 12
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
62
Item 13
Certain Relationships and Related Transactions, and Director Independence
 
62
Item 14
Principal Accounting Fees and Services
 
63
       
 
PART IV
   
Item 15
Exhibits and Financial Statement Schedules
 
63

 
-2-

 

PART I

Item 1. Business

Overview

We are a leading and fast growing Chinese manufacturer of specialty additives. Our nano precipitated calcium carbonate (“NPCC”) products are used as functional additives and fillers in a broad array of products due to their low cost and the overall improved chemical and physical attributes they provide to end products. As a market leader of high-grade NPCC products, we deploy advanced processing technology to convert limestone into high quality NPCC products, which are sold to our customers in the tire, polyvinyl chloride (“PVC”) building materials, polypropylene (“PP”) building materials, ink, paint, latex, adhesive, paper and polyethylene (“PE”) industries.

Prior to November 2008, we also manufactured, marketed and sold coal-based chemical products, namely, ammonium bicarbonate, liquid ammonia, methanol and melamine. We marketed and sold coal-based chemical products mainly as chemical fertilizers and raw materials for the production of organic and inorganic chemical products, including formaldehyde and pesticides.  On June 16, 2008, the Tai’an City Government, as part of China’s strengthening of environmental law enforcement reform, issued a notice directing Bangsheng Chemical Facility, our coal-based chemical facility in Tai’an City, to cease production due to the close proximity of our facility to residential and non-manufacturing business properties.  In accordance with the Tai’an City Government’s notice, we ceased production at our Bangsheng Chemical Facility on October 31, 2008. As a result, we recorded an impairment charge of approximately $3.9 million for Bangsheng Chemical Facility equipment in the fourth quarter of 2008. We do not believe there is additional impairment of assets in 2009. In December 2009, the Company decided to discontinue our operations at Bangsheng Chemical Facility and to sell all of its operating assets and inventory. Although we discontinued the Bangsheng coal-based chemical operations, the Company is currently seeking other strategic opportunities in the chemical business.

Our Reorganization and Corporation Structure

We were organized as a Nevada corporation on May 11, 2001 under the name Zeolite Exploration Company for the purpose of acquiring, exploring and developing mineral properties. We conducted no material operations from the date of our organization until March 2006. On March 31, 2006, we consummated a share exchange pursuant to a Securities Purchase Agreement and Plan of Reorganization with Faith Bloom Limited, a British Virgin Islands company, and its stockholders. As a result of the share exchange, we acquired all of the issued and outstanding capital stock of Faith Bloom in exchange for a total of 50,957,603 shares of our common stock. The share exchange is accounted for as a recapitalization of Zeolite and resulted in a change in our fiscal year end from July 31 to December 31. Faith Bloom Limited was deemed to be the accounting acquiring entity in the share exchange and, accordingly, the financial information included in this annual report reflects the operations of Faith Bloom, as if Faith Bloom had acquired us.

Faith Bloom was organized on November 15, 2005 for the purpose of acquiring from Eastern Nanomaterials Pte. Ltd., a Singapore corporation, all of the capital shares of Shandong Haize Nanomaterials Co., Ltd and Shandong Bangsheng Chemical Co., Ltd., which are Chinese corporations engaged in the manufacture, marketing and sales of a variety of NPCC products and coal-based chemicals for use in various applications. On December 31, 2005, Faith Bloom acquired all of the capital shares of Shandong Haize Nanomaterials Co., Ltd and Shandong Bangsheng Chemical Co., Ltd.

As a result of the transactions described above, Shandong Haize Nanomaterials Co., Ltd and Shandong Bangsheng Chemical Co., Ltd. are wholly-owned subsidiaries of Faith Bloom, and Faith Bloom is a wholly-owned subsidiary of Zeolite. On April 4, 2006, Faith Bloom formed a wholly-owned subsidiary in Shaanxi, China to run the  NPCC facility in Shaanxi Province. Effective January 3, 2007, Zeolite changed its name to ShengdaTech, Inc.  On July 1, 2008, Faith Bloom formed a wholly-owned subsidiary in Zibo, Shandong Province to operate our new NPCC facility in Zibo.
  
On December 11 2009, Faith Bloom completed its acquisition of Anhui Chaodong Nanomaterials Science and Technology Co., Ltd. (“Chaodong”), a company located in Anhui province, to operate our new Anhui facility.  The name of Anhui Chaodong Nanomaterials Science and Technology Co. Ltd. was changed to Anhui Yuanzhong Nanomaterials Co., Ltd. (“Anhui Yuanzhong”) in April 2010.

 
-3-

 

Our corporate structure is depicted in the following chart:
 

Market Opportunity
 
The NPCC Markets in china
 
NPCC refers to ultrafine nano precipitated calcium carbonate, a synthetic industrial material made from limestone, which has an average particle diameter of less than 100 nanometers or 0.1 micron. The nano particle is smaller than the wavelength of visible light and provides characteristics such as narrow distribution range of grain-size and improved decentrality, which make the compounds suitable for many applications. In the filler and additive industry, traditional fillers, including carbon blacks and precipitated calcium carbonate, have been used for years as a means to reduce material costs by replacing a portion of higher cost materials. The main functions of the traditional fillers are to occupy the space and act as cheap diluents of more expensive materials. Fillers play a major role in all types of polymers, such as thermoplastics, rubbers and thermosets. NPCC is an emerging product in the functional filler and additive industry with numerous possibilities of new applications, many of which are yet to be developed. As functional additives, NPCC offers additional benefits than traditional fillers. Due to its low cost and special chemical properties, NPCC has been widely used in the rubber, plastic, paint, ink, paper and adhesive manufacturing industries to improve product quality while maintaining or reducing costs. It can be used solely as an additive which contributes to the processing features of end products, or it can also be applied together with other fillers such as precipitated calcium carbonate, titanium oxide and silicon dioxide.
 
Compared to traditional fillers, NPCC offers a broad range of advantages when used as functional additives. These advantages include the following:
 
·
Enhanced performance of end products, including but not limited to improved durability, increased tensile strength, improved heat resistance and better stabilization; and

·
Reduced product cost through substitution of NPCC for more expensive materials.
 
While research into and manufacturing of NPCC in China began in the early 1980s, the NPCC industry only recently experienced strong growth, resulting from increased awareness of its ability to replace more expensive materials and its functionality to enhance the performance of various end products. In China, NPCC products are primarily used as functional additives in feedstock materials to the automobile, construction and consumer sectors. Typical feedstock materials that use NPCC include tires, PVC building materials, PP building materials, ink, paint, latex, adhesives, paper and PE plastic materials.  We believe that the development of the plastics, rubber, paper, construction coating and daily-use chemical industries in China will increase demand for NPCC. With the maturity of the NPCC technology and its expanded applications in China, we believe that domestically produced NPCC with superior quality and steady performance will gradually replace the market share of the imported products of foreign competitors.

 
-4-

 

NPCC products have been primarily used in the following industries:
 
Tire and Rubber
 
NPCC, when treated by a surface coating agent to improve compatibility, can fill the spatial structure in rubber and enhance the properties of certain rubber products, such as tires and latex. NPCC can be applied solely as an additive or used together with other fillers such as precipitated calcium carbonate, clay and carbon black to reduce expensive rubber content and to improve certain properties of the rubber products. NPCC is a rubber strengthening additive that can enhance the flexibility, break elongation, tear resistance, abrasion resistance and anti-aging performance of rubber and the use of NPCC provides a 10-20% overall improvement in performance measured by increased traction wave resistance, tear resistance, break elongation, tensile strength and aging resistance. In addition, NPCC can also partially substitute for certain more expensive materials such as carbon black and silicon dioxide, thus reducing the overall cost of manufacturing without negative impact on reinforcing and whitening features.
 
In 2009, China has exceeded the United States and became the world’s largest automobile consumption nation with annual sales of passenger cars of approximately 10.3 million units.  Therefore, we expect NPCC products to obtain a larger market share compared to traditional fillers in the rubber and tire fields.
 
Plastic Materials
 
Plastic materials, including PVC, PE and PP, are a significant end market for NPCC products. When modified with a surface coating agent, NPCC particles become compatible with organic substances which facilitate their use as a functional additive in plastic materials. Modified NPCC particles can be used in plastics such as PVC building materials to increase their tensile strength, flexibility, durability and heat resistance, to stabilize their dimensions and to improve color fastness and glossiness. In addition, NPCC can be used as a substitute for more expensive materials, such as silicon dioxide, which may considerably reduce the total cost of the end products.
 
Paper
 
We believe that China’s paper industry represents large untapped market opportunities for domestic NPCC manufacturers. NPCC can be used as a functional additive for newsprint paper, coating paper and specialty paper products. NPCC can improve the glossiness, whiteness, opacity and printability of paper products, while reducing the requirement for more expensive titanium dioxide or kaolin. China’s paper industry is currently migrating from acid sizing to alkaline sizing in terms of production process. We believe this migration increases the market opportunity for NPCC, which can only be applied in the alkaline sizing process.
 
Paints, Ink and Adhesives
 
NPCC products have a range of other applications in the construction and automotive industries, including surface coatings, water-based and oil-based paints, adhesives and sealants. NPCC has also been widely used as an additive in oil-based printing inks. When used as a substitute of certain more expensive materials such as titanium dioxide or kaolin, NPCC can reduce component cost as well as maintain or reinforce the features of the end products.

 
-5-

 

Our Business
 
NPCC Production
 
We commenced our NPCC operations in 2001 with the installation of our first NPCC production line, which had an annual production capacity of 10,000 metric tons, in Tai’an, Shandong Province. As of December 2009, we have increased our total annual NPCC production capacity to 250,000 metric tons. We believe that we are currently the largest Chinese manufacturer of NPCC products in terms of net sales for the year ended December 31, 2009.

In August 2009, we, through our wholly-owned subsidiary, Faith Bloom, entered into an equity transfer agreement with Anhui Chaodong Cement Co., Ltd., a company incorporated under the laws of the People’s Republic of China, pursuant to which Faith Bloom acquired the entire equity of Chaodong, a PRC company and wholly-owned subsidiary of Anhui Chaodong Cement Co., Ltd. Chaodong was an inactive manufacturer of NPCC, and its assets include mining rights to reserves of approximately 13.2 million metric tons of limestone and existing buildings and equipment. The acquisition was approved by the Chinese government in November 2009. Anhui Chaodong Cement Co., Ltd. and Chaodong were not affiliates of our Company or any of our directors or officers. On December 11, 2009, we completed our acquisition of Chaodong, which has an annual production capacity of 10,000 metric tons. The name of Chaodong was changed to Anhui Yuanzhong Nanomaterials Co., Ltd. in April 2010. Anhui Yuanzhong, which operates our Anhui facility, started production in May 2010 after we completed certain repairs and maintenances of the acquired facility and equipment and performed certain technological upgrades consistent with our Zibo, Shandong facility.
 
In August 2009, we, through Faith Bloom Limited, entered into a project investment agreement with the local government of Hanshan County, Anhui Province. Pursuant to this agreement, we agreed to invest an aggregate amount of RMB 1,200 million (approximately $175.7 million) in several phases by 2013, which includes an investment in a new NPCC project with an annual capacity of 200,000 metric tons of NPCC per year and the purchase of land-use rights for a total area of approximately 341,335 square meters (approximately 84.35 acres). The local government also agreed to grant to us exclusive mining rights to good quality limestone, and provide other utilities and services for manufacturing purposes. We plan to utilize third parties for mining or processing operations and do not plan to engage in any mining or processing operations. In addition to this agreement, we also agreed to purchase land-use rights for a total area of approximately 66,767 square meters (16.5 acres) from the local government of Hanshan County, Anhui Province for Anhui Yuanzhong. These agreements are investment plans and are not contractually binding until key elements of contract terms such as transaction prices and specific payment schedules are fully agreed upon, binding agreements are executed, and approval from the relevant government agencies are obtained.
 
The following table exhibits all of our facilities with their respective annual production capacities and production volume of NPCC for the last three years.
 
       
2007
   
2008
   
2009
 
Tai’an, Shandong facility
 
Production Capacity (metric tons)
as of December 31
   
30,000
     
30,000
     
30,000
 
   
Annual Output   (metric tons)
   
34,259
     
34,070
     
33,538
 
                             
Xianyang, Shaanxi facility
 
Production Capacity (metric tons)
as of December 31
   
100,000
     
160,000
     
160,000
 
   
Annual Output   (metric tons)
   
87,652
     
147,935
     
163,294
 
                             
Zibo, Shandong facility
 
Production Capacity (metric tons)
as of December 31
   
-
     
-
     
60,000
 
   
Annual Output   (metric tons)
   
-
     
-
     
13,350
 
                             
Total
 
Production Capacity (metric tons)
as of December 31 
   
130,000
     
190,000
     
250,000
 
   
Annual Output   (metric tons) 
   
121,911
     
182,004
     
210,181
 

 
-6-

 

We established a research and development center in Pudong, Shanghai, which is dedicated to the research and development of NPCC applications. Our research and development center has attracted NPCC researchers and scholars with advanced degrees in chemistry and materials science who primarily focus on improving the quality of our existing NPCC products and developing innovative NPCC products for new applications. As an example, we developed new NPCC products for use in the paper and PE industries and began receiving orders from paper manufacturers in 2007 and from PE customers in February 2008. In addition, we expect to begin selling our newly developed NPCC products to the asphalt and PVC plastic glove markets in the near future. Currently, our product is undergoing trials with a number of potential asphalt industry customers.
 
We currently sell our NPCC products in Shandong Province, the Yangtze River Delta and other parts of China through resident sales representatives. Internationally, in 2009, we targeted five countries for our product export: Singapore, Thailand, South Korea, Malaysia and India. International sales accounted for approximately 0.4%, 9.6%, and 7.1% of our total NPCC net sales in 2007, 2008, and 2009, respectively. In July 2009, we established a new international sales team at our headquarters in Shanghai, China. In January 2010, we strengthened our international sales and marketing efforts by appointing Mr. Gary Cao, who has over 12 years of experience as a sales and marketing director for leading chemical companies in China and the Asia Pacific region, as our new international marketing director. We believe international sales and marketing will make more contribution to our business as the worldwide economy recovers.
 
Revenue and Net Income from Continuing Operations
 
Our revenue and net income from continuing operations have increased steadily since 2006. In 2009, our revenue was $102.1 million and our net income from continuing operations was $23.6 million.
 
Our Products
 
Our key applications for our NPCC products and their respective end markets are as follows:

NPCC Applications 
  
Primary Use 
Rubber
 
Additive for tires
Plastic
 
Additive for PVC building materials and PE
Paint and ink
 
Additive for ink and water-based and oil-based paints
Latex
 
Additive for latex gloves
Adhesive
 
Additive for high-grade silicone adhesive and polysulfide sealant
Paper
 
Additive for coating paper

Our NPCC business focuses on the production of high-quality and low-cost NPCC products. Our NPCC business has strong positions in the tire and PVC building materials markets, and has expanded into the ink, paint, latex and adhesives markets. To further diversify our customer base, we plan to gain share in the paper and PE markets, which are currently relatively underserved by the NPCC industry.
 
We have established effective quality assurance systems for our NPCC products. Our Tai’an, Shandong facility has been ISO 9001-certified since 2003 and our NPCC products were awarded “Shandong Top Brand” at the end of 2006. Our Xianyang, Shaanxi facility has been ISO 9001-certificated since 2007.

Intellectual Property
 
We jointly own a patent with Tsinghua University for an advanced NPCC particle production technology based on membrane-dispersion techniques. This patent was granted by the State Intellectual Property Office of the PRC in November 2007 and will expire on September 9, 2025.
 
We also utilize a proprietary technique for NPCC chemical modification to tailor our NPCC particles to the end product.
 
We utilize a trademark for our NPCC products, which is licensed by our related party and registered with the Trademark Office of the State Administration for Industry and Commerce of China, relating to the Chinese words “盛科 (Shengke).” As agreed to by our related party, we have rights to use this trademark at no cost indefinitely.

 
-7-

 
 
Research and Development
 
As of December 31, 2009, we have 26 members in our research and development team. Among them, 13 hold Ph.D. degrees, 13 hold Masters degrees and most have worked in the NPCC research field for more than four years. Mr. Xiaochuan Zhu, our Director of Research and Development, with more than 10 years of experience, is leading our effort to develop and improve a proprietary technology for modifying NPCC products. This new technology can be used to modify the property of a specific NPCC product to fit a particular end product and, in addition, improve the quality of such end product. Recently, much progress has been made in the applications in paper, PE and asphalt products. With this new technology, tires, PVC building materials, paints, adhesives and paper of equal or better quality can be made at a lower cost. We are also developing NPCC products for other applications, including extensions of existed products and new products such as epoxy resin, cosmetics and asphalt.
 
Our research and development activities are a three-stage process. During the first stage, we apply surface coating agents to NPCC according to different pre-designed formulas for comparative studies. The modified NPCC is tested for mass, size, oil absorbance and other traits to determine if it displays the appropriate features. During the second stage, approximately two kilograms of NPCC product is produced with lab equipment using a formula selected at the first stage. The NPCC product produced is applied to an end product such as a tire, paint or ink. The end product is then tested for a set of properties and other parameters to determine if they meet expectations. If the formula is successful at the second stage, it will be further tested. During the third stage, several tons of the NPCC products are manufactured at a NPCC facility using the formula that passed the second test and is sent to potential customers for an industrial scale test. Our research and development staff is dispatched to such customers’ sites to assist with the test.
 
We focus on further developing and improving our core manufacturing technologies to expand our product lines and reduce overall costs. In 2009, we completed sample testing of our NPCC products with approximately 40 companies in various industries, such as PVC, rubber, adhesive, latex and coating. As of December 31, 2009, we had 59 potential customers at various stages of our sample testing process.
 
We had previously entered into joint development agreements with Tsinghua University and Qingdao University of Science and Technology to develop new NPCC technologies. Under the agreement with Qingdao University of Science and Technology, we have exclusive ownership to any technology developed. Under the agreement with Tsinghua University, we jointly own any technology developed and have an exclusive right to use such technology. Our joint development program with Tsinghua University has produced a membrane-dispersion patent which was granted by the Patent Office of the State Intellectual Property Office of China in November 2007.
 
In addition, we have adopted an advanced membrane-dispersion technology in the production process at our Xianyang, Shaanxi facility and our Zibo, Shandong facility with phase I capacity of 60,000 metric tons. This technology not only reduces production cost, but also enables us to have better control of the size and consistency of the nano-particles, which greatly improves our NPCC product quality. Our research and development center in Pudong, Shanghai, China is our base for training research and technical personnel and developing new technologies. We believe that this research and development center is sufficient to meet our current research and development needs and we are in a good position to attract qualified research personnel at a reasonable cost. Thus, we are currently conducting our research and development internally, and have terminated our research and development cooperation with Tsinghua University and Qingdao University of Science and Technology.
    
Sales and Marketing
 
Our sales team consists of 52 employees, 32 of which are devoted to domestic sales and 20 of which are devoted to international sales. To expand distribution channels and increase our market share, we will continue our efforts on building our international sales team. We also plan to regularly attend industry fairs and exhibitions to obtain the latest industry information. We have become a member of www.alibaba.com.cn, the largest business-to-business Internet portal in China.

 
-8-

 
 
Through our sales and marketing efforts, we have established our leadership in the NPCC industry in China, particularly for applications in the tire and PVC building materials markets. We have successfully entered the oil-based paint and paper industries. We are now actively marketing our NPCC products to major international companies in the adhesive industry and our products in the asphalt industry are under testing processes domestically. We plan to begin supplying our products to certain major international companies in the adhesive industry and to domestic asphalt manufacturers.
 
At present, our NPCC products are primarily sold and marketed directly by our sales and marketing staff. Our NPCC products are mainly sold in Shandong Province, Yangtze River Delta and other parts of China. We are actively expanding our NPCC marketing network into other parts of China and have resident sales representatives in multiple locations in China including Shanghai, Xi’an, and Dongying, Shandong Province. We have also successfully expanded into the international market for NPCC. We have sold our NPCC products to a number of Asian countries, including Singapore, Thailand, South Korea, Malaysia and India. Additionally, our international sales department is actively testing our products with customers in North America.

Raw Materials
 
In 2009, the cost of raw materials accounted for approximately 52.8% of our total production cost. Anthracite, modification agents and limestone are the major raw materials for producing NPCC products.
 
We have multiple suppliers for all of our major raw materials, except for modification agents. Soft coal and anthracite are in abundant supply in China with a large number of suppliers. We are currently considering increasing the number of our supplier partners for modification agents or potentially producing them internally.
 
Given the importance of certain key raw materials such as limestone to our business, we obtained mining rights over high quality limestone in Shaanxi and Anhui Provinces.  All of our limestone reserves, 11.6 million metric tons in Shaanxi Province and 13.2 million metric tons in Anhui Province, are proven reserves.  We are currently in negotiations with the government regarding the price and payment terms for our mining rights for our Zibo, Shandong facility. The Company plans to utilize third parties for mining and processing operations and does not plan to engage in any mining or processing operations. During 2009, 2008 and 2007, all of our limestone was purchased from external sources and amounted to 376,707 metric tons, 311,253 metric tons and 223,803 metric tons, respectively.
 
For production of NPCC, high quality limestone has both strict requirements in its chemical content and certain requirements in its physical properties.  With regards to chemical composition, high calcium carbonate content in the limestone is required, and at the same time, identified detrimental impurity must be at a low enough level.  Although high calcium carbonate content in limestone is prevalent in nature, most of it cannot be used to produce NPCC due to the levels of certain detrimental impurities. We measure the required chemical content in percentages. Generally, we consider the content percentage of various chemicals when measuring the quality standard, such as the percentages of CaCO3, Fe2O3, Al2O3, MgO, and other chemicals in the limestone.
 
In terms of the physical properties, we utilize two measures: the whiteness of the limestone (with over 90% of calcium) and that the limestone does not disintegrate when it is calcinated under high temperatures.  Our whiteness test requirement is a measurement of the chemical purity of calcium carbonate.The Company’s policies limit the purchase of limestone to limestone that fulfills the Company’s criteria described above.
 
Supplier Management System
 
Although most of our key raw materials are widely available in China, the price for certain raw materials such as coal has been fluctuating greatly in the past few years, which has affected our profit margin. We have adopted measures to reduce risks in raw material supply costs, including establishing long-term relationships with suppliers and diversifying supply sources.

 
-9-

 

Purchasing Procedures with View to Quality and Stability of Suppliers
 
Purchasing activities are conducted in accordance with our standard purchasing procedures. Potential suppliers are provided with our quality standards for the raw material and are invited to make initial offers, which are compared objectively according to relevant quality guidelines. After validating various suppliers’ services and capabilities for quality and stable supply, we select the qualified supplier with the lowest price. Our finance department has also established an oversight process by appointing individuals to conduct independent market research of key raw material prices periodically. We have implemented a standard procedure to insure that all purchasing requirements are strictly adhered to.
   
We generally use either cash payment or on credit for payment to suppliers of our raw materials.  Credit payments have terms of 30 to 90 days. We enter into contracts with all long-term suppliers of raw materials.  Regardless of payment terms, payments are not made until our purchasing procedures are completed.
   
Major Suppliers

The table below lists our major suppliers for the year ended December 31, 2009.

Major Suppliers for NPCC Business
Suppliers 
   
  
Amount 
Purchased in 
2009 
(USD 
 million)
  
  
% of Total 
Purchases 
in 
2009
  
Xintai Liantai Material Co., Ltd
 
Anthracite
   
4.46
     
8.42
%
Xianyang Chuangfa Trading Co., Ltd.
 
Anthracite and soft coal
   
8.63
     
16.30
%
Qingdao Siwei Chemical Co. Ltd.
 
Modification agent
   
6.93
     
13.09
%
Qianxian Tianhe Mining Industry LLC
 
Limestone and soft coal
   
5.38
     
10.16
%
   
Total
           
47.97
%
 
Our Major Customers
 
We sell our NPCC products to customers in the tire, PVC building materials, ink, paint, latex, adhesive, paper and PE industries. Our customers are mainly located in Shandong Province, the Yangtze River Delta and other parts of China. Most of our top NPCC customers are large-scale manufacturers of tires and PVC building materials.
   
For the year ended December 31, 2009, sales to our top five NPCC customers collectively accounted for 10.5% of total NPCC sales. For the same period, approximately 7.0% of our NPCC sales were contributed by overseas markets.
 
Major Customers of our NPCC Products
Name 
 
Industry 
  
Amount 
of 
Sale in 
2009 
(USD 
million)
  
  
Percentage of 
Total Sales
  
Triangle Tire Co., Ltd.
 
Tire
   
2.12
     
2.08
%
Zhaoyuan Liao Rubber Products Co., Ltd.
 
Tire
   
2.25
     
2.21
%
Qingdao Doublestar Tire Industrial Co., Ltd.
 
Tire
   
2.18
     
2.14
%
Zhenjiang Suhui Latex Production Co., Ltd.
 
Tire
   
1.83
     
1.78
%
Shengtai Group Co., Ltd.
 
Tire
   
1.75
     
1.70
%
Total
       
10.13
     
9.91
%
  
                   
Dalian Jinyuan Building Materials & Plastics Co., Ltd.
 
PVC
   
2.17
     
2.13
%
Shandong Ruifeng Chemical Co., Ltd.
 
PVC
   
2.00
     
1.96
%
Tangshan Jiaji Composite Pipe Corp. Ltd.
 
PVC
   
1.70
     
1.67
%
Cangzhou Cangjing Chemical Co., Ltd.
 
PVC
   
1.65
     
1.62
%
Total
       
7.52
     
7.38
%

 
-10-

 

Competition
 
We are subject to intense competition. Some of our competitors have greater financial resources, larger size, and better established market recognition in both domestic and international markets than us.
 
For our NPCC products, we compete based upon proprietary technologies, manufacturing capacity, product quality, production cost and ability to produce a diverse range of products. Our competitors include NPCC manufacturers both within China and around the world.
 
We also face competition from certain well-established foreign chemical companies, including Imperial Chemical Industries Limited (ICI), Solvay S.A., Minerals Technologies Inc., and Shiraishi Calcium Kaisha Ltd. For example, competition for our NPCC products in the paper and ink industries primarily comes from Japanese manufacturers such as Shiraishi Calcium Kaisha, which sells to Chinese automobile paint makers and Japanese ink makers in China.
 
Regulation
  
In China, waste gas and water discharges in our manufacturing processes are regulated and must meet certain standards under China’s environmental laws and regulations. The local branch of the Ministry of Environmental Protection of the People’s Republic of China samples and tests our gas and water discharge regularly. The specifications of these discharges must be consistent with the regulations for industrial waste water and gas and relevant laws and standards, including the Water Pollution Discharge Standard for the Synthetic Ammonia Industry issued by the Ministry of Environmental Protection of the People’s Republic of China. Our NPCC facilities are not required to obtain Production Safety Licenses.
 
Pursuant to the Environment Impact Assessment Law, which came into effect on September 1, 2003, the construction or expansion of our NPCC facilities is subject to environment impact assessment procedures conducted by local environmental protection authorities in China, including the acceptance of environment impact assessment reports of each project by the environmental protection authorities. As of December 31, 2009, we have a total annual production capacity of 250,000 tons of NPCC, and we have passed environment impact assessment for 190,000 metric tons of NPCC production capacity. The remaining capacity has not yet passed the assessment and is expected to pass the assessment by the end of September 2010. The local environmental regulatory department in Qian County, where our Xianyang, Shaanxi facility is located, has orally advised us that we may continue to produce NPCC during the process of passing the environmental impact assessment, and we therefore believe that the temporary non-compliance with the Environment Impact Assessment Law will not have and has not had in the past material effects on our capital expenditures, earnings, and competitive position. However, if the environmental regulatory department in Xianyang or at a higher level determines that we are not compliant with the Environment Impact Assessment Law, we may be subject to fines or other legal sanctions. Although we have not been punished by any environmental regulatory department as of December 31, 2010, we cannot assure you that the government will take the same position in future.

Employees
 
As of December 31, 2009, we employed 1,063 full-time employees. Of our total employees, 10.5% are management personnel, 3.6% are sales staff members and 2.4% are R&D staff members. We believe that we maintain a satisfactory working relationship with our employees, and we have not experienced any significant labor disputes or any difficulty in recruiting staff for our operations.
 
As required by applicable Chinese law, we have entered into employment contracts, which include confidentiality and non-compete provisions prohibiting employees from disclosing our trade secrets or using trade secrets for purposes other than benefiting us, with all employees.

 
-11-

 
 
Our employees in China participate in a state pension program organized by Chinese municipal and provincial governments. We are required to contribute to the program at the rate of 20% of the average monthly salary of our employees. In addition, we are required by Chinese law to cover employees in China with other types of social insurance. Our total contribution may amount to as much as 30% or more of the average employee monthly salary. We have purchased social insurance for all of our employees who voluntarily participate in the social insurance program. Social insurance expenses were approximately $347,287 and $567,741 for 2009 and 2008, respectively.
 
Pursuant to Chinese laws, our Chinese subsidiaries are required to establish housing accumulation funds for their employees and to contribute to the funds at a certain percentage of the monthly salary of each employee. Failure to comply with such obligation may subject our Chinese subsidiaries to fines not exceeding approximately $7,200 for each subsidiary. We have established housing accumulation funds for our qualified employees since December 2008.
 
Additional Information
 
Our Internet address is www.shengdatechinc.com. We make available, free of charge, through our Internet address our annual report on Form 10-K, 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 Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
 
Item 1A. Risk Factors

Cautionary Statement Regarding Future Results, Forward-Looking Information And Certain Important Factors
 
In this report we make, and from time to time we otherwise make, written and oral statements regarding our business and prospects, such as projections of future performance, statements of management’s plans and objectives, forecasts of market trends, and other matters that are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Statements containing the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimates,” “projects,” “believes,” “expects,” “anticipates,” “intends,” “target,” “goal,” “plans,” “objective,” “should” or similar expressions identify forward-looking statements, which may appear in documents, reports, filings with the Securities and Exchange Commission, news releases, written or oral presentations made by officers or other representatives made by us to analysts, stockholders, investors, news organizations and others, and discussions with management and other of our representatives. For such statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.
 
Our future results, including results related to forward-looking statements, involve a number of risks and uncertainties. No assurance can be given that the results reflected in any forward-looking statements will be achieved. Any forward-looking statement speaks only as of the date on which such statement is made. Our forward-looking statements are based upon assumptions that are sometimes based upon estimates, data, communications and other information from suppliers, government agencies and other sources that may be subject to revision. Except as required by law, we do not undertake any obligation to update or keep current either (i) any forward-looking statement to reflect events or circumstances arising after the date of such statement, or (ii) the important factors that could cause our future results to differ materially from historical results or trends, results anticipated or planned by us, or which are reflected from time to time in any forward-looking statement.

In addition to other matters identified or described by us from time to time in filings with the SEC, there are several important factors that could cause our future results to differ materially from historical results or trends, results anticipated or planned by us, or results that are reflected from time to time in any forward-looking statement, include the following:

 
-12-

 

 Risks Related To Our Business and Operations
 
Subsequent to the cease of production of our coal-based chemical production facility on October 31, 2008, we generate all of our net sales from our NPCC products and a reduction in net sales from our NPCC products would cause our net sales to decline and could materially harm our business. After we ceased production at our Bangsheng Chemical Facility on October 31, 2008 in compliance with the directive from the Tai’an City Government, we no longer generate net sales from the sale of coal-based chemical products and derive all of our net sales from the sale of our NPCC products. As of December 31, 2009, the Bangsheng coal-based chemical operations have been discontinued. For the year ended December 31, 2009, our sales of NPCC products were approximately $102.1 million, or 99.7% of our total net sales and the remaining 0.3% or $295,899 was generated from sales of coal inventory of Bangsheng Chemaical Facility. Going forward, continued market acceptance of our NPCC products will remain important to our success, and a reduction in revenue from the sale of our NPCC products will materially harm our business, financial condition and results of operations.
 
We may not be able to maintain our competitive advantage in NPCC technology. At present, we are the largest manufacturer of NPCC products in China in terms of production capacity. Our competitive edge depends heavily on the new technology employed in our NPCC manufacturing process. We adopted the ultra gravity precipitation technology in the manufacturing process in our Tai’an, Shandong facility.  In our Xianyang, Shaanxi facility and Zibo, Shandong facility, we deployed the membrane-dispersion technology co-developed and co-owned with Tsinghua University. We currently have the exclusive right to use this technology.  At this time, other than maintaining our own research and development center in Shanghai, we are not working in partnership with any universities or research institutions.  The growth of our business and development of new technology may require that we seek external collaborative partners for research and development.  We cannot assure you that we will be able to enter into agreements with collaborative partners on terms acceptable to us, if any at all.  In addition, if more advanced technology is developed for the manufacturing of NPCC by our competitors, we may lose our competitive advantage and our results of operations may be adversely affected.
 
Our failure to develop and introduce new NPCC products could reduce our sales or market share.  We rely on our research and development team develop and improve technologies for NPCC production.  Our research and development team developed a technology used to modify the property of a specific NPCC product to fit a particular end product and, in addition, improve the property of such end product.  However, research and development activities are inherently uncertain, and we might encounter practical difficulties in commercializing our research results.  A variety of competing NPCC products that our competitors may develop could prove to be more cost-effective and have better performance than our NPCC products.  Therefore, our research and development efforts may be rendered obsolete by the technological advances of our competitors.  Our failure to develop and introduce new NPCC products could render our products uncompetitive or obsolete, and result in a decline in our sales or market share.
 
Our NPCC products have limited applications. We may not be able to increase the range of applications of our NPCC products.  Presently, our existing NPCC products are used as functional additives for tire, PVC building materials, PP building materials, ink, paint, latex, adhesive, paper and PE products.  Our products, therefore, depend heavily on a limited number of industries.  Our growth potential may be limited if we cannot expand the markets for our existing NPCC products or develop new products for other industries.  Although we have increased our research and development efforts to expand the range of applications of our NPCC products, there is no assurance that we will succeed in our efforts.

We may not be able to continue to produce high-quality NPCC products, which may negatively impact our business.  We believe that the quality of our NPCC products is critical to our success.  We maintain quality control standard procedures and expect our employees to strictly comply with these procedures.  We also apply a distribution control system in NPCC production to ensure process control and stability.  Any quality problems with our products due to any reason such as the failure to implement our quality control and distribution control systems, delays in shipments, cancellations of orders or customer returns and complaints, could harm our reputation.  In addition, we purchase raw materials such as limestone and modification agents from third-party suppliers.  We may be unable to exercise the same degree of quality control over these third-party production facilities as we can over our own facilities.  Any quality problems associated with the raw materials produced by these third-party producers or suspension of the supply of high-quality raw materials may adversely affect our reputation and cause a decrease in sales of our products and a loss of market share.

 
-13-

 
 
Our NPCC business depends significantly on the tire industry. If the composition of tires changes and we fail to develop formulas that are applicable to a new composition, our NPCC business could be harmed. In 2009, our NPCC business derived approximately 34.3% of revenues from sales to tire manufacturers. If these customers cease or decrease their orders of NPCC products from us, our NPCC business could be adversely affected. In addition, our NPCC products can be used in tire production to obtain desired properties since the current tire composition allows for calcium carbonate as an additive. If the composition of tires changes in the future, our NPCC products may not be compatible with the change. As a result, our NPCC business could be adversely affected.

The United States government’s increase in tariffs on tires imported from China may harm the business of our customers, which would cause our revenue to decline and materially and adversely affect our business. China’s accession to the World Trade Organization (“WTO”) included transitional remedies to address import surges into other countries leading to market disruption. In the United States, the relevant safeguard provision was enacted as Section 421 of the Trade Act of 1974. Section 421 permits US domestic industries and workers injured by rapidly increasing imports from China to seek relief. Similar to other safeguard provisions, a Section 421 investigation is initiated by the filing of a petition with the United States International Trade Commission (“ITC”). On the basis of information developed in an investigation, the ITC determined, pursuant to section 421(b)(1) of the Trade Act of 1974, that certain passenger vehicle and light truck tires from China are being imported into the United States in such increased quantities or under such conditions as to cause or threaten to cause market disruption to the domestic producers of like or directly competitive products. On September 11, 2009, the United States government announced the decision to grant relief in the form of increasing the tariffs on such passenger vehicle and light truck tires from China for a three-year period by 35% in year one, 30% in year two, and 25% in year three. The increase in tariffs may harm the export business of our NPCC customers in the tire industry, which would decrease demand for our NPCC products, cause our revenue to decline and materially and adversely affect our business.

The Chinese government is tightening its environmental laws and strengthening its enforcement, which could adversely affect our business. With increased environmental awareness among Chinese citizens, the Chinese government is beginning to tighten environmental laws and regulations. The measures include adopting new laws and regulations such as Urban and Rural Planning Law and Regulation on National General Survey of Pollution Sources, and amending existing laws and regulations such as Law of the PRC on the Prevention and Control of Water Pollution. Some of these laws and regulations govern the level of fees payable to government entities providing environmental protection services and the prescribed standards relating to the discharge of solid or liquid wastes and gases. Recently, the Chinese government has stepped up its enforcement efforts due to the occurrence of several significant environmental disasters. If we fail to comply with the PRC environmental protection laws and regulations or if any new or revised environmental laws and regulations are promulgated, we may have to increase capital investments to build or upgrade environmental protection facilities or incur the risk of being subject to fines, and, in either scenario, our business, results of operations and prospects may be adversely affected.
 
Pursuant to the Environment Impact Assessment Law, which came into effect on September 1, 2003, the construction or expansion of our NPCC facilities is subject to environment impact assessment procedures by local environmental protection authorities in China, including the acceptance of environment impact assessment reports of each project by the environmental protection authorities. As of December 31, 2009, we have a total annual production capacity of 250,000 tons of NPCC, and we have passed environment impact assessment for 190,000 metric tons NPCC production capacity. The remaining capacity has not yet passed the assessment and is expected to pass the assessment by the end of September 2010. The local environmental regulatory department in Qian County, where our Xianyang, Shaanxi facility is located, has orally advised us that we may continue to produce NPCC during the process of passing the environmental impact assessment, and we therefore believe that the temporary non-compliance with the Environment Impact Assessment Law will not have and has not had in the past material effects on our capital expenditures, earnings, and competitive position. However, if the environmental regulatory department in Xianyang or at a higher level determines that we are not compliant with the Environment Impact Assessment Law, we may be subject to fines or other legal sanctions.

 
-14-

 

We, our suppliers and our customers are vulnerable to natural disasters which could severely disrupt the normal operation of our business and adversely affect our business, financial condition and operating results. We operate multiple facilities and source products from companies that operate facilities, which may be damaged or disrupted as a result of natural disasters such as earthquakes, floods, and heavy rains, technical disruptions such as electricity or other power source outage or other infrastructure breakdowns, computer outages and electronic viruses. Such events may lead to the disruption of information systems and telecommunication services for sustained periods. Such natural disasters also may make it difficult or impossible for our employees to reach our business locations. Damage or destruction that interrupts our provision of products could adversely affect our reputation, our relationships with clients, or cause us to incur substantial additional expenditure to repair or replace damaged equipment or facilities. We may also be liable to our customers for disruption in service resulting from such damage or destruction. Furthermore, the operations of our suppliers could be subject to natural disasters and other business disruptions, which could cause shortages and price increases in various materials essential for the manufacturing of our products or result in shortage of our products. If we are unable to procure an adequate supply of raw materials that are required to manufacture our products, our revenue and operating results would be adversely affected.

Our business, financial condition and operating results depend on our customers’ future success with their products, which may fail to achieve the results we and our customers expect. Currently, we supply the tire, PVC building materials, PP building materials, ink, paint, latex, adhesive, paper and PE industries with our NPCC products. The potential for growth and success of our NPCC business largely depends on our customers’ future success in their products. If our customers are not successful in developing their products, their demand for our NPCC products may decrease and our NPCC business may be adversely impacted as a result.

The sales cycle for our products is difficult to predict, which may make it difficult to plan our expenses and forecast our operating results and could have an adverse effect on our financial results and share price. If our sales cycle lengthens, our quarterly operating results may become less predictable and more volatile. Due to the relatively large size of some orders, a delayed sale could have a material adverse effect on our quarterly revenue and operating results. If our projected revenue does not meet our expectations, we are likely to experience a shortfall in our operating profit relative to our expectations. As a result, we believe that period-to-period comparisons of our historical results of operations are not necessarily meaningful and that you should not rely on them as an indication for future performance. It is also possible that our quarterly results of operations may be below the expectations of public market analysts and investors. If this occurs, the price of our common stock will likely decrease.

We may not be able to achieve and maintain an effective system of internal control over financial reporting, a failure of which may prevent us from accurately reporting our financial results or detecting and preventing fraud. We are subject to reporting obligations under the U.S. securities laws. We are required to prepare a management report on our internal control over financial reporting containing our management’s assessment of the effectiveness of our internal control over financial reporting. In addition, our independent registered public accounting firm must report on the effectiveness of our internal control over financial reporting. Our management may conclude that our internal control over our financial reporting is not effective. Moreover, even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm may conclude that our internal control over financial reporting is not effective. Our reporting obligations as a public company may place a significant strain on our management, operational and financial resources and systems for the foreseeable future.

In May 2008, our consolidated financial statements for the year ended December 31, 2007 were restated to correct an overstatement of advances paid to suppliers and an understatement of property and equipment. In January 2007, our consolidated financial statements were restated to correct an overstatement of revenues and selling expenses for the years ended December 31, 2003, 2004, and 2005. Also, our December 31, 2003 consolidated financial statements were restated to correct an overstatement of general and administrative expenses and an understatement of cost of sales and selling expenses. Our restatements of our prior consolidated financial statements may have exposed us to risks associated with litigation, regulatory proceedings and government enforcement actions. We are unable to predict what action, if any, the SEC or other regulatory bodies may pursue or what consequences such an action may have on us. We are also unable to predict the likelihood of or potential outcomes from litigation, other regulatory proceedings or government enforcement actions, if any, relating to the need to restate our historical consolidated financial statements. The resolution of these matters could be time-consuming and expensive, and further distract management from other business concerns and harm our business. Furthermore, if we were subject to adverse findings in litigation, regulatory proceedings or government enforcement actions, we could be required to pay damages or penalties or have other remedies imposed, which could harm our business and financial condition.

 
-15-

 

Although the restatements we have made did not result in material changes to our previously reported revenues and profits, our management determined that certain material weaknesses existed in our internal control over financial reporting as of December 31, 2008. Our management had continued to work on taking remedial measures and determined that our internal control over financial reporting was effective as of December 31, 2009. We, however, cannot assure you that our financial statements will not be restated in a way that causes material changes to our reported revenues and profits in the future.
 
We may not be able to successfully carry out our strategic acquisition and investment strategy. Our future success depends in part on our ability to make strategic acquisitions and investments and failure to do so could have a material adverse effect on our market penetration and revenue growth. We, therefore, intend to make strategic acquisitions and investments in the chemical business. We cannot assure you however that we will be able to successfully make such strategic acquisitions and investments that will prove to be effective for our business due to certain uncertainties such as delay in obtaining required governmental approvals for making such strategic acquisitions.

Strategic acquisitions and investments could subject us to a number of risks, including risks associated with shared proprietary information and loss of control of operations that are material to our business. Moreover, strategic acquisitions and investments may be difficult to finance and/or expensive to fund and may also be expensive to implement and subject us to the risk of non-performance by a counterparty, which may in turn lead to monetary losses that materially and adversely affect our business. Strategic acquisition and investment could also divert our management’s attention as well as other resources away from our core business. Finally, a full integration of the acquired companies into our business may also prove to be difficult, which may hinder or delay our planned growth.

The cost of our raw materials fluctuates significantly, which may adversely impact our profit margin and financial position. Raw materials that we use in the manufacture of our NPCC products include limestone, anthracite and modification agents, among which costs of anthracite represented 21.1% of the cost of goods sold of our NPCC business in 2009. The costs of modification agents and limestone represented 25.8% of the cost of goods sold of our NPCC business in 2009. The prices of these materials are subject to market forces beyond our control. In the last few years, coal prices have fluctuated substantially. The price for coal may continue to increase in the future due to the rapid development of the Chinese economy. If the price for coal and other raw materials increases in the future, our profit margin could decrease considerably.

We are dependent on our suppliers for key materials such as limestone and modification agents. If we cannot secure such raw materials from our suppliers, our business may be adversely affected. We purchase raw materials from suppliers. We may experience a shortage or interruption in the supply of our raw materials in the future and if any such shortage or interruption occurs, our production capabilities and results of operations could be materially adversely affected. At the present time, we purchase our supply of modification agents used in NPCC production exclusively from two suppliers. If these two suppliers are unwilling or unable to provide us with the modification agent we require in sufficient quantities and at acceptable prices, we would have to resort to our research and development center or alternative suppliers for modification agent supply. We cannot assure you that our research and development center would be able to make modification agents in a timely manner and in sufficient quantities or that alternative suppliers would be able to provide modification agents at commercially acceptable prices, on satisfactory terms, in a timely manner, or at all. Our inability to find or develop alternative sources could adversely affect our business operations.

We extend relatively long payment terms for accounts receivable for our NPCC business. If any of our customers fails to pay us, our business may be adversely affected as a result. As is customary in our industry in China, we extend relatively long payment terms to our customers of up to 90 days. As a result of the size of many of our orders, these extended terms may adversely affect our cash flow and our ability to fund our operations from operating cash flow. Also, if our customers place large orders for our products, requiring fast delivery, our inventory and working capital may be impacted. If our customers experience sales slowdowns or other issues, they may not pay us in a timely fashion, even on our extended terms. The failure of our customers to pay us in a timely manner would negatively affect our working capital, which could in turn adversely affect our cash flow, revenues and operating results in subsequent periods.

 
-16-

 

Expansion of our business may put added pressure on our management and operational infrastructure and we may not be able to meet increased demand for our NPCC products, adversely affecting our operating results. Our business plan is to significantly grow our operations to meet anticipated growth in demand for existing NPCC products. Growth in our business may place a significant strain on our personnel, management, financial systems and other resources. The evolution of our business also presents numerous risks and challenges, including:
 
·
the continued acceptance of our NPCC products by the tire, PVC building materials and other industries;

·
our ability to successfully and rapidly expand sales to potential customers in response to potentially increasing demand;

·
the cost associated with such growth, which is difficult to quantify, but could be significant;

·
rapid technological changes;

·
continued R&D efforts; and

·
the highly competitive nature of the NPCC industry.

If we are successful in achieving rapid market growth of our NPCC products, we will be required to deliver large volumes of quality products to customers on a timely basis at a reasonable cost to those customers. Meeting any such increased demand will require us to expand our manufacturing facilities, to increase our ability to purchase raw materials, to increase the size of our work force, to expand our quality control capabilities and to increase our production scale. Such demands would require more capital and working capital than we currently have available. We cannot assure you that our current and planned operations, personnel, systems, internal procedures and controls will be adequate to support our future growth.

Our business depends substantially on the continuing efforts of our executive officers, research personnel and other key personnel, and our business may be severely disrupted if we lose their services. We depend on key members of our management team, research personnel and other key personnel. We do not maintain key employee insurance. If one or more of our executive officers and other key personnel are unable or unwilling to continue in their present positions, we may not be able to replace them readily, if at all. Therefore, our business may be severely disrupted, and we may incur additional expenses to recruit and retain new officers. Each of our executive officers, key research personnel and marketing managers has either entered into a confidentiality and non-competition agreement with us or is subject to confidentiality and non-competition obligations under their employment agreements with us. However, if any disputes arise between our executive officers, key research personnel and marketing managers and us, we cannot assure you, in light of uncertainties associated with the PRC legal system, the extent to which any of these agreements could be enforced in China, where all of our executive officers reside and hold substantially all of their assets. See “—Risks Related to Doing Business in China—Our business is largely subject to the uncertain legal environment in China and your legal protection could be limited.”
 
We may not be able to obtain the consent of Tsinghua University for the use of the membrane-dispersion patent by any future subsidiaries. Pursuant to agreements with Tsinghua University, our Tai’an, Shandong, Zibo, Shandong and Xianyang, Shaanxi facilities have the right to use a membrane-dispersion patent jointly held by Tsinghua University and us, and any third-party use of the patent is prohibited without the prior consent of Tsinghua University. In the event that any future subsidiary, including our Anhui facility with 10,000 metric tons of capacity, desires to use the membrane-dispersion patent, we will be required to enter into additional fee arrangements with Tsinghua University. However, we cannot assure you that we will be able to enter into such arrangements with Tsinghua University allowing the use by such future subsidiaries of the membrane-dispersion patent under terms and conditions acceptable to us, if at all.

 
-17-

 

Our business depends on our ability to protect our intellectual property effectively. If any of our patents are not protected or any of our trade secrets are divulged, our business prospects may be harmed. The success of our business depends in substantial measure on the legal protection of the patent which we are licensed to use and co-own with Tsinghua University in China and other proprietary rights in technology we hold. We cannot assure you that our procedures adequately monitor the infringements of our intellectual property rights, and we cannot be certain that the steps we have taken will prevent unauthorized use of our intellectual property in China where it may be difficult to enforce the law to protect our proprietary rights as compared to the laws of the United States. The validity and breadth of claims in patents and trade secrets involve complex legal and factual issues and, therefore, the extent of their enforceability and protection is highly uncertain. Issued patents or patents based on pending patent applications or any future patent applications or trade secrets may not exclude competitors from the use of such intellectual property or may not provide a competitive advantage to us. In addition, patents that are licensed to us or that have been issued to us may not be held valid if subsequently challenged and others may claim rights in or ownership of such patents. Furthermore, we cannot assure you that our competitors have not developed, or will not develop similar products, will not duplicate our products, or will not design around any patents issued to or licensed by us.
 
We claim proprietary rights in various unpatented technologies, know-how, and trade secrets relating to products and manufacturing processes. We protect our proprietary rights in our products and operation through know-how and trade secrets, especially where we believe patent protection is not appropriate or obtainable. Trade secrets, however, are difficult to protect. While we use reasonable efforts to protect our trade secrets, such as nondisclosure agreements, our employees and research partners may unintentionally or willfully disclose our information to competitors. In addition, nondisclosure agreements may not be enforceable or provide meaningful protection for our trade secrets or other proprietary information in the event of unauthorized use or disclosure. For example, NPCC products are differently formulated for different applications. The formulas are maintained as trade secrets and are revealed only to a small number of technical and management personnel. In particular, our trade secrets provide us with a competitive edge in the tire industry, of which only a very few other NPCC manufacturers have successfully entered. If any of our trade secrets are divulged, we could lose our competitive edge in the tire and other industries. In addition, if our competitors independently develop information that is equivalent to our trade secrets, it will be more difficult for us to enforce our rights and our business could be harmed.

We may have difficulties in enforcing our intellectual property rights through litigation. Litigation may be necessary to enforce our intellectual property rights, protect our trade secrets or determine the validity and scope of proprietary rights of others. We cannot assure you that the outcome of such potential litigation will be in our favor. Such litigation may be costly and may divert management attention as well as our other resources away from our business. An adverse determination in any such litigation will impair our intellectual property rights and may harm our business, prospects and reputation. In addition, we have no insurance coverage against litigation costs and would have to bear all costs arising from such litigation to the extent we are unable to recover them from other parties. The occurrence of any of the foregoing could have a material adverse effect on our business, results of operations and financial conditions.
  
Our business benefits from certain PRC government incentives. Expiration of, or changes to, these incentives could have a material adverse effect on our results of operations. In accordance with the former PRC Income Tax Law for Enterprises with Foreign Investment and Foreign Enterprises and the related implementing rules, and as approved by the relevant tax authorities, some of our PRC subsidiaries were subject to an enterprise income tax rate of 15% and a local income tax rate of 1.5% for 2007. Under approvals issued by the tax authorities and the transitional arrangements under the EIT Law and its relevant regulations, Shandong Haize Nanomaterials Co., Ltd. and Shandong Bangsheng Chemical Co., Ltd. were exempted from income tax for 2005 and 2006, were taxed at a reduced rate of 16.5% for 2007, and were taxed at 12.5% for 2008 and 2009; and Shaanxi Haize Nanomaterials Co., Ltd. was exempted from income tax for 2006 and 2007, and is taxed at a reduced rate of 12.5% from 2008 to 2010. As these tax incentives expire, our PRC subsidiaries income tax rate will increase significantly, and any increase of our PRC subsidiaries’ income tax rate in the future could have a material adverse effect on our financial condition and results of operations.

 
-18-

 

The EIT Law provides a unified enterprise tax rate of 25% and unifies tax deduction standards are applied equally to both domestic-invested enterprises and foreign invested enterprises such as our PRC subsidiaries. The EIT Law and its relevant regulations provide a five-year transition period starting from January 1, 2008 for enterprises which were established prior to March 16, 2007. On December 26, 2007, the State Council issued the Notice of the State Council Concerning Implementation of Transitional Rules for Enterprise Income Tax Incentives, or Circular 39. Pursuant to Circular 39, foreign-invested enterprises established prior to March 16, 2007 and eligible for certain preferential tax treatments, such as our PRC subsidiaries, continue to enjoy the preferential tax treatments in the manner and during the periods as former laws and administrative regulations provided until such periods expire. The unified income tax rate of 25% will be applied to our PRC subsidiaries after the expiration of the above-mentioned periods of preferential tax treatments. While the EIT Law equalizes the tax rate for foreign-invested enterprises and domestic companies, preferential tax treatments continue to be given to companies in certain encouraged sectors and to those classified as high technology companies enjoying special support from the state. We cannot assure you that our PRC subsidiaries who enjoyed/is enjoying their respective tax holidays will continue to qualify for any preferential tax treatment after the transitional period provided by the EIT Law and its relevant regulations, which could result in a decrease in our profits. Any increase in our effective tax rate as a result of the above may adversely affect our operating results. 
 
We have limited business insurance coverage in China, which could harm our business. We are exposed to many risks, including equipment failures, natural disasters, industrial accidents, power outages, and other business interruptions. We do not have adequate property or casualty insurance covering all of our facilities, equipment, offices or inventory. Furthermore, if any of our products are faulty, then we may become subject to product liability claims or we may have to engage in a product recall. We do not carry business interruption insurance or product liability insurance and, as a result, we may be required to pay for financial and other losses, damages and liabilities, including those caused by natural disasters and other events beyond our control, out of our own funds, which could have a material adverse effect on our business, financial condition and results of operations.
 
We may require additional capital, which may not be available on commercially reasonable terms, or at all. Capital raised through the sale of equity securities may result in dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. Financing may be unavailable in amounts or on terms acceptable to us, or at all. Failure to obtain such additional capital could have an adverse impact on our business strategies and growth prospects.
 
If our executive officers, directors and principal stockholders choose to act together, they will be able to exert significant influence over us and our significant corporate decisions and may act in a manner that advances their best interests and not necessarily those of other stockholders. Our executive officers, directors, and beneficial owners of 5% or more of our outstanding common stock and their affiliates will beneficially own approximately 48.1% of our outstanding common stock. As a result, these persons, acting together, will have the ability to influence significantly the outcome of all matters requiring stockholder approval, including the election and removal of directors and any merger, consolidation, or sale of all or substantially all of our assets and they may act in a manner that advances their best interests and not necessarily those of other stockholders, including investors, by, among other things:

·
delaying, deferring or preventing a change in control of us;

·
entrenching our management and/or our board of directors;

·
impeding a merger, consolidation, takeover or other business combination involving us;

·
discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of us; or

·
causing us to enter into transactions or agreements that are not in the best interests of all stockholders.

We may incur substantial additional indebtedness in the future, which could adversely affect our financial condition and our ability to generate sufficient cash to satisfy our outstanding and future debt obligations. We may from time to time incur substantial additional indebtedness. If we or our subsidiaries incur additional debt, the risks that we face as a result of such indebtedness and leverage could intensify. The increase in the amount of our indebtedness could adversely affect our financial condition and our ability to generate sufficient cash. For example, it could:

·
increase our vulnerability to adverse general economic and industry conditions;

 
-19-

 
   
 
·
require us to dedicate a substantial portion of our cash flow from operations to servicing and repaying indebtedness, thereby reducing the availability of cash flow to fund working capital, capital expenditures, dividend payments and other general corporate purposes;

 
·
limit our flexibility in planning for or reacting to changes in the businesses and the industries in which we operate;

 
·
place us at a competitive disadvantage compared to our competitors which have less debt;

 
·
limit, along with the financial and other restrictive covenants of such indebtedness, our ability to borrow additional funds; and

 
·
increase the cost of additional financing.

Our ability to generate sufficient cash to satisfy our outstanding and future debt obligations will depend upon our future operating performance, which will be affected by prevailing economic conditions and financial, business and other factors, many of which are beyond our control. We may not generate sufficient cash flow to meet our anticipated operating expenses or to service our debt obligations as they become due.
  
Risks Related To Our Industry

Disruptions in the capital and credit markets related to the current national and worldwide financial crisis, which may continue indefinitely or intensify, could adversely affect our results of operations, cash flows and financial condition, or those of our customers and suppliers. The current disruptions in the capital and credit markets may continue indefinitely or intensify, and adversely impact our results of operations, cash flows and financial condition, or those of our customers and suppliers. Disruptions in the capital and credit markets as a result of uncertainty, changing or increased regulation, reduced alternatives or failures of significant financial institutions could adversely affect our ability to access capital needed to conduct or expand our businesses or conduct acquisitions or make other discretionary investments, as well as our ability to effectively hedge our currency or interest rate. Such disruptions may also adversely impact the capital needs of our customers and suppliers, which, in turn, could adversely affect our results of operations, cash flows and financial conditions.

China’s commitments to the World Trade Organization may intensify competition. In connection with its accession to the World Trade Organization, China made many commitments including opening its markets to foreign products, allowing foreign companies to conduct distribution businesses and reducing customs duties. As a result, foreign manufacturers may ship their NPCC products into or establish manufacturing facilities in China. Competition from foreign companies may reduce our selling prices, net sales and profit margins, adversely affecting our business.

Our failure to comply with ongoing governmental regulations could hurt our operations and reduce our market share. In China, the chemical industry is undergoing increasing regulations as environmental awareness increases in China and our manufacturing facilities are subject to various pollution control laws and regulations which include Environmental Protection Law of the PRC, the Law of the PRC on the Prevention and Control of Water Pollution, Implementation Rules of the Law of the PRC on the Prevention and Control of Water Pollution, the Law of the PRC on the Prevention and Control of Air Pollution, Safety Administration Regulations for Hazardous Chemicals, the Law of the PRC on the Prevention and Control of Solid Waste Pollution, and the Law of the PRC on the Prevention and Control of Noise Pollution. The trend is that the Chinese government toughens its regulations and penalties for violations of environmental regulations. New regulatory actions are constantly changing our industry. Although we believe we have complied with applicable government regulations in all material aspects, there is no assurance that we will be able to do so in the future.
 
If we cannot compete successfully for market share against other NPCC product companies, we may not achieve sufficient product revenues, and our business could suffer. The market for our products is characterized by intense competition and rapid technological advances. Our products compete with a multitude of products developed, manufactured and marketed by others and we expect competition from new market entrants in the future. We believe that the principal competitive factors in the markets for our products are manufacturing capacity, quality of products, price, research and development capability, and customer base.

 
-20-

 

Risks Related To Doing Business In China

Changes in China’s political or economic situation could harm our business and our operational results. Economic reforms adopted by the Chinese government have had a positive effect on the economic development of the country, but the government could change these economic reforms or any of the legal systems at any time. This could either benefit or damage our operations and profitability. Some changes that could have this effect are:

·
Level of government involvement in the economy;

·
Control of foreign exchange;

·
Methods of allocating resources;

·
Balance of payments position;

·
International trade restrictions; and

·
International conflict.

The Chinese economy differs from the economics of most countries belonging to the Organization for Economic Cooperation and Development, or OECD, in many ways. The economic reforms in China have been conducted under a tight control of the Chinese government. As a result of these differences, we may not develop in the same way or at the same rate as might be expected if the Chinese economy were similar to those of the OECD member countries.

Our business is largely subject to the uncertain legal environment in China and your legal protection could be limited. The Chinese legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which precedents set in earlier legal cases are not generally used. The overall effect of legislation enacted over the past 20 years has been to enhance the protections afforded to foreign invested enterprises in China. However, these laws, regulations and legal requirements are relatively recent and are evolving rapidly and their interpretation and enforcement involves uncertainties. 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. These uncertainties could limit the legal protections available to foreign investors, such as the right of foreign invested enterprises to hold licenses and permits such as requisite business licenses. In addition, all of our executive officers and our directors are residents of China, and substantially all the assets of these persons are located outside the U.S. As a result, it could be difficult for investors to effect service of process in the U.S., or to enforce a judgment obtained in the U.S. against us or any of these persons.
 
The Chinese government exerts substantial influence over the manner in which we conduct our business activities. China only recently has permitted provincial and local economic autonomy and private economic activities. The 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, import and export tariffs, environmental regulations, land use rights, property, work safety, labor protection, 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 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 hold in Chinese properties.

 
-21-

 

A slowdown or other adverse developments in the economy of the PRC may materially and adversely affect our customers, demand for our products and our business. All of our operations are conducted in the PRC. Although the economy of the PRC has grown significantly in recent years, we cannot assure you that such growth will continue. A slowdown in overall economic growth, an economic downturn or recession or other adverse economic developments in the PRC could materially reduce the demand for our products and materially and adversely affect our business.

Future inflation in China may inhibit our activity to conduct business in China. In recent years, the Chinese economy has experienced periods of rapid expansion and high rates of inflation. During 2007 and 2008, the rates of inflation in China were 4.8% and 5.9%, respectively. However, in 2009, the inflation rate in China was negative 0.8%. Expansion and inflation 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. Higher 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 end market for our products. In addition, due to the tightening of credit, we may have difficulties in securing funding from financial institutions in China, which could adversely affect our operations.

Restrictions on currency exchange may limit our ability to receive and use our revenues effectively. The majority of our revenues will be settled in Renminbi and U.S. Dollars, and any future restrictions on currency exchanges may limit our ability to use revenue generated in Renminbi to fund any future business activities outside China or to make dividend or other payments in U.S. dollars. Although the Chinese government introduced regulations in 1996 to allow greater convertibility of the Renminbi for current account transactions, significant restrictions still remain, including primarily the restriction that foreign-invested enterprises may only buy, sell or remit foreign currencies after providing valid commercial documents at those banks in China authorized to conduct foreign exchange business. In addition, conversion of Renminbi for capital account items, including direct investment and loans, is subject to governmental approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. We cannot be certain that the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the Renminbi.

The value of our securities will be affected by the foreign exchange rate between U.S. dollars and Renminbi. The value of our common stock will be affected by the foreign exchange rate between U.S. dollars and Renminbi, and between those currencies and other currencies in which our sales may be denominated. For example, to the extent that we need to convert U.S. dollars into Renminbi for our operational needs and should the Renminbi appreciate against the U.S. dollar at that time, our financial position, our business, and the price of our common stock may be harmed. If we decide to convert our Renminbi into U.S. dollars for the purpose of declaring dividends on our common stock or for other business purposes and the U.S. dollar appreciates against the Renminbi, the U.S. dollar equivalent of our earnings from our subsidiaries in China would be reduced.

We may not be able to distribute our assets upon liquidation. Our assets are predominately located inside China. Under the laws governing foreign investment enterprises in China, dividend distribution and liquidation are allowed but subject to certain procedures under the relevant laws and rules. Any dividend payment will be subject to the decision of the board of directors and subject to foreign exchange rules governing such repatriation. Any liquidation is subject to both the relevant government agency’s approval and supervision as well the foreign exchange control. This may generate additional risk for our investors in case of liquidation.

 
-22-

 

PRC regulations relating to the establishment of offshore special purpose companies by PRC domestic residents and registration requirements for employee stock ownership plans or share option plans may subject our PRC resident beneficial owners or the plan participants to personal liability, limit our ability to inject capital into our PRC subsidiaries, limit our subsidiaries’ ability to increase their registered capital or distribute profits to us, or may otherwise adversely affect us. State Administration for Foreign Exchange or SAFE issued a circular in October 2005 requiring PRC domestic residents to register with the local SAFE branch before establishing or controlling any company outside of China for the purpose of capital financing with assets or equities of PRC companies, referred to in the circular as an “offshore special purpose company.” PRC domestic residents who are stockholders of offshore special purpose companies and have completed round trip investments but did not make foreign exchange registrations for overseas investments before November 1, 2005 were retroactively required to register with the local SAFE branch before March 31, 2006. PRC resident stockholders are also required to amend their registrations with the local SAFE branch in certain circumstances. We are aware that our PRC domestic resident stockholders subject to the SAFE registration requirement have registered with the Shandong SAFE branch and amended their registration upon the share exchange between us and Faith Bloom Limited. We cannot provide any assurances that all of our stockholders who are PRC residents have made all required amendments and will make or obtain any applicable registrations or approvals required by these SAFE regulations. The failure or inability of our PRC resident stockholders to comply with the registration procedures set forth therein may subject us to fines and legal sanctions, restrict our cross-border investment activities, or limit our PRC subsidiaries’ ability to distribute dividends or limit our PRC subsidiaries’ ability to obtain foreign-exchange-dominated loans.

As it is uncertain how the SAFE regulations will be interpreted or implemented, we cannot predict how these regulations will affect our business operations or future strategy. For example, we may be subject to more stringent review and approval process with respect to our foreign exchange activities, such as remittance of dividends and foreign currency-denominated borrowings, which may adversely affect our results of operations and financial condition. In addition, if we decide to acquire a PRC domestic company, we cannot assure you that we or the owners of such company, as the case may be, will be able to obtain the necessary approvals or complete the necessary filings and registrations required by the SAFE regulations. This may restrict our ability to implement our acquisition strategy and could adversely affect our business and prospects.

In December 2006, the People’s Bank of China promulgated the Implementation Rules of the Administrative Measures for Individual Foreign Exchange, or the Individual Foreign Exchange Rules, setting forth the respective requirements for foreign exchange transactions by PRC individuals under either the current account or the capital account. In January 2007, SAFE issued implementing rules for the Individual Foreign Exchange Rules, which, among other things, specified approval requirements for certain capital account transactions such as a PRC individuals participation in the employee stock ownership plans or stock option plans of an overseas publicly-listed company. On March 28. 2007, SAFE promulgated the Application Procedure of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Holding Plan or Stock Option Plan of Overseas-Listed Company, or the Stock Option Rule. Under the Stock Option Rule, PRC individuals who are granted stock options by an overseas publicly-listed company are required, through a qualified PRC agent or a PRC subsidiary of such overseas publicly-listed company, to register with SAFE and complete certain other procedures. We and our PRC employees who might be granted stock options are subject to the Stock Option Rule. If we or our PRC optionees fail to comply with these regulations, we or our PRC optionees may be subject to fines and legal sanctions.

We may be treated as a resident enterprise for PRC tax purposes, under the Enterprise Income Tax Law and its implementing rules which became effective on January 1, 2008, and may subject to PRC income tax on our worldwide income and we may have to withhold PRC withholding tax for any dividends or interest we pay to our non-PRC corporate stockholders or noteholders. Under the Enterprise Income Tax Law of the People’s Republic of China, or the EIT Law, and its implementing rules, all domestic and foreign investment companies in China are subject to a uniform enterprise income tax at the rate of 25%. In addition, dividends from domestic companies to their foreign corporate stockholders are subject to withholding tax at a rate of 10%, if the foreign investors are considered non-resident enterprises without any establishment or place of operation within China or if the dividends payable have no connection with the establishment or place of the foreign investors within China, unless any such foreign investor’s jurisdiction of incorporation has a tax treaty with China that provides for a lower withholding tax rate. Moreover, under the EIT Law, enterprises established under the laws of non-PRC jurisdictions, but whose “de facto management body” is located in the PRC are treated as resident enterprises for PRC tax purposes. Under the implementing rules of the EIT Law, “de facto management body” is defined as a body that has material and overall management and control over the business, personnel, accounts and properties of an enterprise. Because all of our management is currently based in China, we may be considered as a PRC resident enterprise.

 
-23-

 

If the PRC tax authorities determine that we are a “resident enterprise” for PRC EIT Law purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to 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 non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the 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, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. The impact of the imposition of enterprise income tax will be mitigated to the extent we can obtain a foreign tax credit for such taxes against our U.S. income tax liability on such income. Finally, it is possible that the new “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends or interest we pay to our non-PRC corporate stockholders or noteholders and with respect to gains derived by our non-PRC corporate stockholders or noteholders from transferring our shares or our convertible notes.
 
Our subsidiaries in China are subject to restrictions on dividend payments and making other payments to us or any other affiliated company. We are primarily a holding company and do not conduct any business operations other than our holding of the equity interests in China. As a result, we rely on dividends, consulting and other fees paid to us by our subsidiaries in China. Our ability to pay dividends and meet our obligations is partially dependent upon receiving such payments from our subsidiaries in China. PRC regulations permit payment of dividends only out of accumulated profits as determined in accordance with Chinese accounting standards and regulations. Our subsidiaries in China are also required to set aside at least 10% of their after-tax profits, if any, each year according to Chinese accounting standards and regulations 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. Furthermore, our subsidiaries are required to allocate portions of their respective after-tax profits to their enterprise expansion funds and staff welfare and bonus funds at the discretion of their boards of directors or equivalent governing bodies.
 
Our PRC subsidiaries are obligated to withhold and pay PRC individual income tax in respect of the salaries and certain other income received by their employees who are subject to PRC individual income tax. If our PRC subsidiaries fail to withhold or pay such individual income tax in accordance with applicable PRC regulations, they may be subject to certain sanctions and other penalties, which could have a material adverse impact on its business. Under PRC individual income tax law, our PRC subsidiaries are obligated to withhold and pay individual income tax in respect of the salaries and certain other income received by their employees who are subject to PRC individual income tax. Our PRC subsidiaries may be subject to certain sanctions and other liabilities under the PRC tax rules and regulations in case of failure to withhold and pay individual income taxes for their employees in accordance with the applicable law and regulations. Sales commission is a component of the compensation paid to our sales personnel and we do not currently deduct or withhold individual income tax for this portion of the salary. Although we have not received any notice or penalty from PRC tax authorities, we cannot assure you that such notice or penalty will not occur in the future. We have subsequently established relevant tax withholding policies and we believe that such taxes will be effectively withheld in 2010.
 
Any future outbreak of severe acute respiratory syndrome or avian influenza in China, or similar adverse public health developments, may severely disrupt our business and operations. A renewed outbreak of severe acute respiratory syndrome, the Avian Flu or another widespread public health problem in China, where all of our manufacturing facilities are located and where all of our revenues are derived from, could have a negative effect on our operations. In addition, there have been confirmed human cases of avian influenza in PRC, Vietnam, Iraq, Thailand, Indonesia, Turkey, Cambodia and other countries which have proven fatal in some instances. If such an outbreak or any other similar epidemic were to spread in China, where our operations are located, it may adversely affect our business and operating results.

Such an outbreak could have an impact on our operations as a result of:

 
·
quarantines or closures of our manufacturing facilities, which would severely disrupt our operations,

 
·
the sickness or death of our key officers and employees, and

 
·
a general slowdown in the Chinese economy.

 
-24-

 

Risks Related To Our Common Stock

The trading prices of many companies that have business operations only in China have been volatile, which may result in large fluctuations in the price of our common stock and losses for investors. The stock market has experienced significant price and volume fluctuations that have particularly affected the trading prices of equity securities of many companies that have business operations exclusively in China. These fluctuations have often been unrelated or disproportionate to the operating performance of many of these companies. Any negative change in the public’s perception of these companies could decrease our stock price regardless of our operating results. The market price of our common stock has been and may continue to be volatile. We expect our stock price to be subject to fluctuations as a result of a variety of factors, including factors beyond our control. These factors include:

 
·
actual or anticipated variations in our quarterly operating results;

 
·
announcements of technological innovations or new products or services by us or our competitors;

 
·
announcements relating to strategic relationships or acquisitions;

 
·
additions or terminations of coverage of our common stock by securities analysts;

 
·
statements by securities analysts regarding us or our industry;

 
·
conditions or trends in the our industry; and

 
·
changes in the economic performance and/or market valuations of other NPCC and chemical companies.

The prices at which our common stock trades will affect our ability to raise capital, which may have an adverse affect on our ability to fund our operations.
 
The market price of our shares experienced, and may continue to experience, significant volatility. For the period from December 31, 2008 to December 31, 2009, the trading price of our shares on the NASDAQ Global Select Market and previously, on the Nasdaq Capital Market has ranged from a low of US$2.52 per share to a high of US$7.20 per share. Numerous factors, including many over which we have no control, may have a significant impact on the market price of our shares.
  
We do not intend to pay cash dividends in the near future. We have never declared or paid cash dividends on our capital stock and we do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain all available funds and any future earnings for use in the operation and expansion of our business. In addition, the terms of any future debt or credit facility may preclude us from paying any dividends. As a result, capital appreciation, if any, of our common stock will be your sole source of potential gain in your investment for the foreseeable future.

We may incur increased costs as a result of changes in laws and regulations relating to corporate governance matters. As a public reporting company, we are required to comply with the Sarbanes-Oxley Act of 2002 and the related rules and regulations adopted by the SEC and by The NASDAQ Global Select Market, including expanded disclosures and accelerated reporting requirements. Compliance with Section 404 of the Sarbanes-Oxley Act of 2002 and other requirements have increased our costs and require additional management resources. Additionally, these laws and regulations could make it more difficult or more costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers.
  
For the year ended December 31, 2009, net cash inflow from operating activities of continuing operations was US$28.0 million. If we are unable to service our indebtedness, we will be forced to adopt an alternative strategy that may include actions such as reducing or delaying capital expenditures, selling assets, restructuring or refinancing existing indebtedness or seeking equity capital. These strategies, if implemented, may not be instituted on satisfactory terms. Any of these constraints upon us could materially and adversely affect our ability to satisfy our obligations under our 6.0% convertible senior notes due 2018.

 
-25-

 

Future issuances of shares or equity-related securities may depress the trading price of our shares. Any issuance of equity securities could dilute the interests of our existing stockholders and could substantially decrease the trading price of our shares. We may issue equity securities in the future for a number of reasons, including to finance our operations and business strategy (including in connection with acquisitions, strategic collaborations or other transactions), to adjust our ratio of debt to equity and to satisfy our obligations upon the exercise of outstanding warrants or options or for other reasons.
 
Sales of a substantial number of shares or other equity-related securities in the public market could depress the market price of our shares, and impair our ability to raise capital through the sale of additional equity securities. We cannot predict the effect that future sales of our shares or other equity-related securities would have on the market price of our shares. In addition, the price of our shares could be affected by possible sales of our shares by investors who view our convertible notes as a more attractive means of obtaining equity participation in our company and by hedging or arbitrage trading activity by investors that we expect to develop involving our convertible note.
 
Our articles of incorporation contain anti-takeover provisions that could have a material adverse effect on the rights of holders of our shares. Our articles of incorporation contain provisions that could discourage, delay or prevent a merger, acquisition or other change of control of our company or changes in our board of directors that our stockholders might consider favorable, including transactions in which you might receive a premium for your shares. For example, our board of directors has the authority to create and issue, without prior stockholder approval, preferred stock that may have rights senior to those of our common stock and that, if issued, could operate as a “poison pill” to dilute the stock ownership of a potential hostile acquirer to prevent an acquisition that is not approved by our board of directors. These provisions also could limit the price that investors might be willing to pay in the future for our shares, thereby depressing the market price of our shares. Stockholders who wish to participate in these transactions may not have the opportunity to do so. In addition, we are subject to the provisions of Chapter 78 of the Nevada Revised Statutes, which may prohibit certain business combinations with stockholders owning 10% or more of our outstanding voting stock. Any delay or prevention of a change of control transaction or changes in our board of directors could cause the market price of our common stock to decline.

You may have difficulty enforcing judgments obtained against us. Substantially all of our assets are located outside of the United States. Substantially all of our current operations are conducted in the PRC. In addition, most of our directors and officers are nationals and residents of countries other than the United Slates. A substantial portion of the assets of these persons are located outside the United States. As a result, it may be difficult for you to effect service of process within the United States upon those persons. It may also be difficult for you to enforce in U.S. courts judgments obtained in U.S. courts based on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors, most of whom are not residents in the United Stales and the substantial majority of whose assets are located outside of the United States. In addition, there is uncertainty as to whether the courts of the PRC would recognize or enforce judgments of U.S. courts against us or such persons predicated upon the civil liability provisions of the securities laws of the United States or any state. In addition, it is uncertain whether such PRC courts would he competent to hear original actions brought in the PRC against us or such persons predicated upon the securities laws of the United States or any state.
 
Risks Related To Our 6.0% Convertible Senior Notes Due 2018

The notes are unsecured, are effectively subordinated to all of our existing and future secured indebtedness and are structurally subordinated to all liabilities of our subsidiaries, including trade payables. The notes are unsecured, are effectively subordinated to all of our existing and future secured indebtedness, to the extent of the assets securing such indebtedness, and are structurally subordinated to all liabilities of our subsidiaries, including trade payables. As of December 31, 2009, our subsidiaries had no short-term bank borrowings or long-term bank borrowings to which the notes would be structurally subordinated. All of our operations are conducted through our subsidiaries. None of our subsidiaries has guaranteed or otherwise become obligated with respect to the notes. Our right to receive assets from any of our subsidiaries upon its liquidation or reorganization, and the right of holders of the notes to participate in those assets, is structurally subordinated to claims of that subsidiary’s creditors, including trade creditors. Even if we were a creditor of any of our subsidiaries, our rights as a creditor would be subordinate to any security interest in the assets of that subsidiary and any indebtedness of that subsidiary senior to that held by us. Furthermore, none of our subsidiaries is under any obligation to make payments to us, and any payments to us would depend on the earnings or financial condition of our subsidiaries and various business considerations. Statutory, contractual or other restrictions may also limit our subsidiaries’ ability to pay dividends or make distributions, loans or advances to us. For these reasons, we may not have access to any assets or cash flows of our subsidiaries to make payments on the notes.

 
-26-

 

We have made only limited covenants in the indenture for the notes, and these limited covenants may not protect your investment. The indenture for the notes does not:

 
·
require us to maintain any financial ratios or specific levels of net worth, revenues, income, cash flows or liquidity and, accordingly, does not protect holders of the notes in the event that we experience significant adverse changes in our financial condition or results of operations;

 
·
restrict our subsidiaries’ ability to issue securities that would be senior to the shares of our subsidiaries held by us;

 
·
restrict our ability to repurchase our securities;

 
·
restrict our ability to pledge our assets or those of our subsidiaries

 
·
restrict our ability to make investments or to pay dividends or make other payments in respect of our shares, or other securities ranking junior to the notes; or

 
·
restrict our ability to incur indebtedness in an amount not exceeding $15 million.

Furthermore, the indenture for the notes contains only limited protections in the event of a change in control. We could engage in many types of transactions, such as acquisitions, refinancings or recapitalizations, which could substantially affect our capital structure and the value of the notes and our shares but may not constitute a “fundamental change” that permits holders to require us to repurchase their notes. For these reasons, the noteholder should not consider the covenants in the indenture or the repurchase features of the notes as a significant factor in evaluating whether to invest in the notes.

Because we have not registered the notes and the shares issuable upon conversion of the notes, the noteholders will have a limited ability to resell them. We have not registered the notes or the shares issuable upon conversion of the notes under the Securities Act or any state securities laws. Unless they are registered, noteholders may not offer or sell the notes or the shares issuable upon conversion of the notes except pursuant to exemptions from the registration and qualification requirements of federal and state securities law. Although we have agreed to file and make effective a registration statement under the Securities Act with respect to the notes and the shares issuable upon conversion of the notes, we have not done so and we may not be required to do so pursuant to the registration rights agreement if the notes or the shares issuable upon conversion of the notes become eligible for resale pursuant to Rule 144 promulgated under the Securities Act. In addition, the registration rights agreement we entered into with the initial purchasers will permit us to prohibit offers and sales of the notes pursuant to that registration statement for a period of up to an aggregate of 30 days (or, under certain circumstances, 60 days) in any 90 days period or an aggregate of 90 days in any 12-month period. Holders of the notes must also take certain actions, including completing and submitting a questionnaire, and undertake certain obligations, before we are required to register their notes or the shares issuable upon conversion of the notes. For these reasons, the noteholder may not be able to resell their notes or shares issuable upon conversion of the notes. In addition, holders who sell their notes under the registration statement we agree to file may have certain potential liability under the Securities Act.

 
-27-

 

The increase in the conversion rate applicable to notes that holders convert in connection with a make-whole change of control may not adequately compensate you for the lost option time value of your notes that result from that make-whole change of control. If a make-whole change of control occurs, we will under certain circumstances increase the conversion rate applicable to holders who convert their notes within a specified time frame. The amount of the increase in the conversion rate depends on the date when the make- whole change of control becomes effective and the applicable price described in the notes’ offering memorandum. Although the increase in the conversion rate is designed to compensate the noteholder for the lost option time value of their notes as a result of the make-whole change of control, the increase in the conversion rate is only an approximation of the lost value and may not adequately compensate the noteholder for the loss. In addition, the noteholder will not be entitled to an increased conversion rate if the applicable price is greater than US$150 per share or less than US$15 per share (in each case, subject to adjustment).

Our obligation to increase the conversion rate as described above also could be considered a penalty, in which case its enforceability would be subject to general principles of reasonableness of economic remedies.

We may be unable to raise the funds to pay interest on the notes, to purchase the notes on the purchase dates, upon a fundamental change or at maturity. The notes initially bear interest semi-annually at a rate of 6.0%, and we, in certain circumstances, are obligated to pay additional interest. On June 1, 2011 and June 1, 2013, holders may require us to purchase, for cash, all or a portion of their notes, at 100% of their principal amount, plus any accrued and unpaid interest to, but excluding, that date. If fundamental change occurs, holders of the notes may require us to repurchase, for cash, all or a portion of their notes. We are obligated to pay the principal amount of the notes outstanding at the maturity date. We may not have sufficient funds for any required repurchase of the notes or required payment of principal return or interest, and we may have to refinance our credit facilities in order to make payments under the notes. In addition, the terms of any borrowing agreements which we may enter into from time to time may require early repayment of borrowings under circumstances similar to those constituting a fundamental change. These agreements may also make our repurchase of notes an event of default under such agreements. If we fail to pay interest on the notes or repurchase the notes when required, we will be in default under the indenture governing the notes.

The conversion rate of the notes may not be adjusted for all dilutive events. The conversion rate of the notes is subject to adjustment upon the occurrence of certain events, including, but not limited to, the issuance of share dividends on our shares, the issuance of certain rights or warrants, subdivisions, combinations, distributions of share capital, indebtedness or assets, cash dividends and certain issuer tender or exchange offers.

Such conversion rate will not be adjusted, however, for other events, such as a third party tender or exchange offer or an issuance of shares for cash, any of which may adversely affect the trading price of the notes or our shares. In addition, an event that adversely affects the value of the notes may occur, and that event may not result in an adjustment to the conversion rate.

Certain significant restructuring transactions may not constitute a fundamental change, in which case we would not be obligated to offer to purchase the notes. The fundamental change provisions will only afford protection to holders of the notes upon the occurrence of certain transactions. Other transactions such as leveraged recapitalizations, refinancings, restructurings, or acquisitions initiated by us may not constitute a fundamental change. In the event of any such transaction, the holders would not have the right to require us to purchase the notes, even though each of these transactions could increase the amount of our indebtedness, or otherwise adversely affect our capital structure or any credit ratings, thereby adversely affecting the value of notes.

Because your right to require repurchase of the notes is limited, the market price of the notes may decline if we enter into a transaction that is not a fundamental change under the indenture relating to the notes. The term “fundamental change” is limited and may not include every event that might cause the market price of the notes to decline or result in a decrease in creditworthiness of the notes. The term “fundamental change” does not apply to certain transactions in which at least 90% of the consideration paid for our shares in a merger or similar transaction is securities traded on a United States national securities exchange. Our obligation to repurchase the notes upon a fundamental change may not preserve the value of the notes in the event of a highly leveraged transaction, reorganization, merger or similar transaction.

 
-28-

 

If you hold notes, you are not entitled to any rights with respect to our shares, but you are subject to all changes made with respect to our shares. If you hold notes, you are not entitled to any rights with respect to our shares (including, without limitation, voting rights and rights to receive any dividends or other distributions on our shares), but you are subject to all changes affecting the shares. You will only be entitled to rights on the shares if and when we deliver shares to you in exchange for your notes. For example, in the event that an amendment is proposed to our certificate of incorporation or articles of association requiring stockholders approval and the record date for determining the stockholders of record entitled to vote on the amendment occurs prior to delivery of the shares, you will not be entitled to vote on the amendment, although you will nevertheless be subject to any resulting changes in the powers, preferences or special rights that affect our shares.

If an active and liquid trading market for the notes does not develop, the market price of the notes may decline and the noteholders may be unable to sell the notes. The notes are a new issue of securities for which there is currently no public market, and no active trading market might ever develop. If the notes are traded after their initial issuance, they may trade at a discount from their initial offering price, depending on prevailing interest rates, the market for similar securities, the price and volatility in the price, of our shares, our performance and other factors. In addition, we do not know whether an active trading market will develop for the notes. To the extent that an active trading market does not develop, the liquidity and trading prices for the notes may be harmed.

We have no plans to list the notes on a securities exchange; however, the notes sold to qualified institutional buyers pursuant to Rule 144A will be eligible for The Portal Market at the time of issuance thereof. Any market-making activity, if initiated, may be discontinued at any time, for any reason or for no reason, without notice.

The liquidity of any market for the notes will depend upon the number of holders of the notes, our results of operations and financial condition, the market for similar securities, the interest of securities dealers in making a market in the notes and other factors. An active or liquid trading market for the notes may not develop, and you may be unable to resell your notes or may only be able to sell them at a substantial discount.

Provisions of the notes could discourage an acquisition of us by a third party. Certain provisions of the notes could make it more difficult or more expensive for a third party to acquire us. Upon the occurrence of certain transactions constituting a fundamental change, holders of the notes will have the right, at their option, to require us to repurchase all of their notes or any portion of the principal amount of such notes in integral multiples of US$1,000. We may also be required to issue additional shares upon conversion in the event of certain fundamental changes.
 
Item 1B. Unresolved Staff Comments

There are no unresolved comments from the SEC.

Item 2. Properties

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 period of 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 lease from our affiliate, Shandong Shengda Technology Co., Ltd., a total area of approximately 60,000 square meters of land with manufacturing facilities, employee quarters, warehouses and office buildings in Tai’an City, China. We also own approximately 315,783 square meters of land in Xianyang, Shaanxi Province, with manufacturing facilities, employee quarters, warehouses, kitchens and office buildings. These constitute the basis of our operations as a manufacturer of NPCC products. In addition, we have obtained land use rights of approximately 234,487 square meters of land in Zibo, Shandong Province, with manufacturing facilities, employee quarters, warehouses, kitchens and office buildings.  We are currently in negotiations with the government regarding the price and payment terms for our mining rights at our Zibo, Shandong facility.

On June 16, 2008, the Tai’an City Government, as part of China’s strengthening of environmental law enforcement reform, issued a notice directing the Company to cease the production of the current products of our Bangsheng Chemical Facility in Tai’an City due to the close proximity of the facility to residential and non-manufacturing business properties. In accordance with the Tai’an City Government’s relocation notice, we ceased production at our Bangsheng Chemical Facility on October 31, 2008. In December 2009, the Company committed to a plan to sell all of the Bangsheng Chemical Facility operating assets, primarily plant equipment and inventory, and discontinued the Bangsheng coal-based chemical operations.

 
-29-

 

In August 2006, Shandong Shengda Technology completed the construction of a NPCC manufacturing facility with approximately 251,285 square meters in Xianyang City, Shaanxi Province, China. The designed capacity for this facility is 60,000 metric tons of NPCC in the first phase. In July 2007, we completed an additional 40,000 tons of capacity in the second phase. We added an additional 60,000 metric tons of capacity in the second quarter of 2008.  In May 2010, the Company entered into an agreement to purchase three-year mining rights for approximately 11.6 million metric tons of limestone reserve with the Shaanxi provincial government for its Xianyang, Shaanxi facility.

In August 2009, we completed the first phase construction of our NPCC facility in Zibo, Shandong on approximately 234,487 square meters in the Zibo High-Tech Development Zone in Zibo, Shandong Province with an annual production capacity of 60,000 metric tons.

In August 2009, we, through our wholly-owned subsidiary Faith Bloom Limited, entered into an Equity Transfer Agreement with Anhui Chaodong Cement Co., Ltd., a company incorporated under the laws of the People’s Republic of China, pursuant to which Faith Bloom acquired the entire equity of Chaodong. Chaodong was an inactive manufacturer of nano precipitated calcium carbonate, and its assets include mining rights to reserves of 13.2 million tons of limestone and existing buildings and equipment.  All of our limestone reserves, 11.6 million metric tons in Shaanxi Province and 13.2 million metric tons in Anhui Province, are proven reserves.  The name of Chaodong was changed to Anhui Yuanzhong in April 2010. The acquisition was approved by the Chinese government in November 2009. Anhui Yuanzhong has an annual capacity of 10,000 metric tons. In connection with the acquisition of Anhui Yuanzhong, in August 2009, we, through Faith Bloom Limited entered into a Project Investment Contract with the local government of Hanshan County, Anhui Province, People’s Republic of China. Pursuant to this agreement, we anticipate investing RMB 1,200,000,000 (approximately $175.7 million) in several phases by 2013, which includes an investment in a new NPCC project that has the capacity to manufacture 200,000 tons of NPCC per year and the purchase of land-use rights for approximately 341,335 square meters (approximately 84.35 acres) of land. This agreement is currently under government review and is subject to governmental approval. In addition to the investment per this agreement, the Company also agreed to purchase the land-use rights for approximately 66,767 square meters (16.5 acres) of land from the local government for Anhui Yuanzhong, which is subject to the approval of the local government. Such approval will require administrative procedures including a public bidding to establish the transaction price. These agreements are investment plans and are not contractually binding until key elements of contract terms such as transaction prices and specific payment schedules are fully agreed upon and evidenced by execution of agreements.

The main equipment and machinery of our NPCC business includes ultra gravity reactors, membrane dispersion micro-mix reactors, carbonators, limestone kilns, slaking equipment, and packaging machines.

We believe that all our properties and equipment have been adequately maintained, are generally in good condition, and are suitable and adequate for our business. In addition, we believe that the newly completed facility and the expected additional land use rights will be sufficient for our expansion efforts.

Item 3. Legal Proceedings

There are no known pending legal proceedings to which we or our properties are subject.

PART II

Item 5. Market For Registrant’s Common Equity, Related Shareholder Matters, And Issuer Purchases Of Equity Securities

MARKET PRICE INFORMATION

Our common stock has been quoted on The NASDAQ Global Select Market under the symbol “SDTH” since January 31, 2008. This was after our common stock had been quoted on the NASDAQ Capital Market under the symbol “SDTH” since May 24, 2007. There was no public trading activity in our shares during the two fiscal years through March 31, 2006. From March 31, 2006 to May 24, 2007 there was some minimal trading activity in our shares. The following table provides the high and low sales prices for our common stock for years 2008 and 2009.

 
-30-

 
 
Year ending December 31, 2008 
 
High
   
Low
 
First Quarter
 
$
15.57
   
$
7.01
 
Second Quarter
 
$
10.60
   
$
7.43
 
Third Quarter
 
$
10.49
   
$
6.00
 
Fourth Quarter
 
$
7.15
   
$
2.67
 

Year ending December 31, 2009
 
High
   
Low
 
First Quarter
 
$
4.29
   
$
2.52
 
Second Quarter
 
$
4.78
   
$
3.05
 
Third Quarter
 
$
7.20
   
$
3.86
 
Fourth Quarter
 
$
7.19
   
$
5.31
 

Year ending December 31, 2010
 
High
   
Low
 
First Quarter (until March 12)
 
$
7.05
   
$
5.30
 

On March 12, 2010, the last reported sale price of our common stock on The NASDAQ Global Select Market was $6.87 per share.

Shareholders

As of March 12, 2010, we had 54,202,036 outstanding shares of common stock held by approximately 310 shareholders of record.

Recent Sales of Unregistered Securities

None.

Dividend Policy

To date, we have neither declared nor paid any cash dividends on shares of our common stock. We presently intend to retain earnings to finance the operation and expansion of our business and do not anticipate declaring cash dividends in the foreseeable future.
 
Repurchases of Equity Securities
 
No repurchases of our common stock were made in the fiscal year covered by this Form 10-K.

Stock Price Performance Graph

The following chart compares the cumulative total shareholder return on the Company’s shares of Common Stock with the cumulative total stockholder return of (i) the Nasdaq Stock Exchange Market Index and (ii) the Dow Jones US Specialty Chemical Index:

 
-31-

 


 The material in this chart is not soliciting material, is not deemed filed with the SEC and is not incorporated by reference in any filing of the Company under the Securities Act of 1933, as amended or the Exchange Act, whether made before or after the date of this Annual Report on Form 10-K and irrespective of any general incorporation language in such filing.

Item 6.   Selected Financial Data

You should read the following selected consolidated financial data in conjunction with “Management's Discussion and Analysis of Financial Condition and Results of Operations,” our consolidated financial statements and related notes, and the other financial information included in this report.

 
-32-

 

SHENGDATECH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

   
As of December 31,
 
   
2005
   
2006
   
2007
   
2008
   
2009
 
ASSETS
                             
Current assets:
                             
Cash
  $ 10,749,300     $ 34,684,142     $ 26,366,568     $ 114,287,073     $ 115,978,763  
Accounts receivable
    2,583,881       4,115,538       6,075,371       6,806,066       4,600,722  
Inventories
    253,104       909,493       1,074,820       2,310,995       2,018,283  
Due from related parties
    -       1,601       1,712       -       -  
Prepaid expenses and other receivables
    1,314,640       1,028,499       2,262,872       510,825       3,947,086  
Income tax refund receivable
    -       -       -       -       1,455,906  
Current assets of discontinued operations
    6,476,727       2,716,399       2,695,151       962,942       801,983  
Assets held for sale
    -       -       -       -       1,718,475  
Total current assets
    21,377,652       43,455,672       38,476,494       124,877,901       130,521,218  
                                         
Property, plant and equipment, net
    4,216,158       18,288,002       56,623,334       98,344,722       123,099,860  
Land use rights
    -       -       124,028       15,710,333       15,432,743  
Intangible assets
    -       -       -       -       280,329  
Debt issuance costs
    -       -       -       3,096,073       1,720,209  
Non-current assets of discontinued operations
    4,363,518       5,285,677       5,720,082       1,777,800       -  
Total assets
  $ 29,957,328     $ 67,029,351     $ 100,943,938     $ 243,806,829     $ 271,054,359  
                                         
LIABILITIES AND SHAREHOLDERS' EQUITY
                                       
Current liabilities:
                                       
Accounts payable
  $ 400,542     $ 1,211,485     $ 2,996,020     $ 4,493,551     $ 3,998,532  
Accrued expenses and other payables
    721,677       1,076,408       2,848,308       4,342,006       4,737,356  
Income taxes payable
    195,859       564,151       5,869       1,588,895       60,573  
Due to related parties
    193,150       2,852,885       633,638       1,737,404       1,572,427  
Payable for acquisition
    -       -       -       -       3,803,060  
Current liabilities of discontinued operations
    3,673,512       4,195,158       5,456,918       14,912       42,068  
Total current liabilities
    5,184,740       9,900,087       11,940,753       12,176,768       14,214,016  
                                         
Long-term convertible notes
    -       -       -       77,926,310       79,298,539  
Non-current income taxes payable
    -       -       -       974,131       1,598,237  
Note payable to related party
    -       -       -       -       601,631  
Net deferred income tax liabilities
    -       -       -       5,387,262       4,443,810  
Non-current liabilities of discontinued operations
    -       -       -       293,977       294,708  
Total liabilities
    5,184,740       9,900,087       11,940,753       96,758,448       100,450,941  
                                         
Total shareholders' equity
    24,772,588       57,129,264       89,003,185       147,048,381       170,603,418  
Total liabilities and shareholders' equity
  $ 29,957,328     $ 67,029,351     $ 100,943,938     $ 243,806,829     $ 271,054,359  
 
-33-

 

SHENGDATECH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

   
For the Years Ended December 31,
 
   
2005
   
2006
   
2007
   
2008
   
2009
 
                               
Net sales
  $ 14,613,733     $ 22,007,814     $ 46,721,673     $ 82,419,689     $ 102,121,804  
Cost of goods sold
    9,264,339       13,297,976       26,812,587       48,316,242       60,218,310  
Gross profit
    5,349,394       8,709,838       19,909,086       34,103,447       41,903,494  
                                         
Operating expenses:
                                       
Selling
    796,074       1,181,341       1,680,259       2,438,908       2,103,822  
General and administrative
    426,339       2,110,956       2,658,806       3,074,051       5,669,923  
Total operating expenses
    1,222,413       3,292,297       4,339,065       5,512,959       7,773,745  
Operating income
    4,126,981       5,417,541       15,570,021       28,590,488       34,129,749  
Other income (expense):
                                       
Interest income
    8,474       47,654       94,643       132,423       685,858  
Interest expense
    -       -       -       (7,456,418 )     (10,662,252 )
Gain on extinguishment of long-term convertible notes
    -       -       -       5,511,487       1,624,844  
Gain on bargain purchase
    -       -       -       -       619,466  
Other expense, net
    -       (72,690 )     (12,094 )     (51,604 )     (121,976 )
Other income (expense), net
    8,474       (25,036 )     82,549       (1,864,112 )     (7,854,060 )
Income from continuing operations before income taxes
    4,135,455       5,392,505       15,652,570       26,726,376       26,275,689  
Income tax expense
    -       -       450,347       3,705,669       2,721,532  
Income from continuing operations
    4,135,455       5,392,505       15,202,223       23,020,707       23,554,157  
Income (Loss) from discontinued operations, net of taxes
    11,827,016       12,134,143       11,828,122       13,007,595       (449,550 )
Net Income
  $ 15,962,471     $ 17,526,648     $ 27,030,345     $ 36,028,302     $ 23,104,607  
                                         
Basic Earnings per share:
                                       
Income from continuing operations
  $ 0.07     $ 0.11     $ 0.28     $ 0.42     $ 0.43  
Income (Loss) from discontinued operations
  $ 0.18     $ 0.23     $ 0.22     $ 0.24       (0.00 )
Net income per share
  $ 0.25     $ 0.34     $ 0.50     $ 0.66     $ 0.43  
Diluted Earnings per share:
                                       
Income from continuing operations
  $ 0.07     $ 0.11     $ 0.28     $ 0.39     $ 0.43  
Income (Loss) from discontinued operations
  $ 0.18     $ 0.23     $ 0.22     $ 0.21       (0.00 )
Net income per share
  $ 0.25     $ 0.34     $ 0.50     $ 0.60     $ 0.43  
Weighted average shares outstanding:
                                       
Basic
    64,455,210       51,900,641       54,107,408       54,202,036       54,202,036  
Diluted
    64,455,210       52,022,801       54,188,410       62,205,660       54,204,923  
 
 
-34-

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is designed to provide a reader of our financial statements with a narrative explanation from the perspective of our management on our business, financial condition, results of operations, and cash flows.
 
Overview

We are a leading and fast growing Chinese manufacturer of specialty additives. Our nano-precipitated calcium carbonate (“NPCC”) products are used as functional additives and fillers in a broad array of products due to their low cost and the overall improved chemical and physical attributes they provide to end products. As a market leader of high-grade NPCC products, we deploy advanced processing technology to convert limestone into high quality NPCC products, which are sold to our customers in the tire, PVC building materials, PP building materials, ink, paint, latex, adhesive, paper and PE industries.

Factors Affecting our Results of Operations

Our operating results are primarily affected by the following factors:

 
·
NPCC Industry Growth.  We believe the growth of the market for NPCC in China for the long term and the penetration of NPCC applications into different industries will be general determining factors in evaluating our financial condition and operating performance.

 
·
Research and Development. We believe our research and development capabilities have become an increasingly important driver of our growth. Our research and development team has developed a technology to modify the property of a specific NPCC product to fit a particular end product and, in addition, improve the property of such end product. We believe this technology is essential to the development and introduction of our new NPCC products, and we focus on our research and development capabilities in evaluating our operating performance.

 
-35-

 

 
·
Production Capacity and Production Volume.  We believe the rapid growth of the NPCC market in China and our ability to continuously penetrate new areas of NPCC applications are factors that determine our financial condition and operating performance. We believe that the ability to increase our production capacity will allow us to significantly increase revenues and profit.

 
·
Price of NPCC Products. We believe our ability to maintain a stable price structure with the quality of our products and our technical service capabilities are factors that determine our financial condition and operating performance.  We believe most of our customers in China use NPCC as an additive to enhance functionalities of their end products and to save costs, which are directly affected by the quality of NPCC used. Accordingly, we believe our reputation for quality and reliable technical support allows us to command relatively higher average selling prices and generate higher gross margins than our competitors who do not possess the same reputation.

 
·
Raw Material Supply and Prices.  We focused on the costs of raw material supplies in evaluating our financial condition and operating performance. The per unit costs of producing our products are subject to the supply and price volatility of coal and other raw materials. We expect that they will continue to be affected by factors such as fluctuations of world energy prices and general economic conditions such as inflation and transportation.

 
·
Competition.  While China’s NPCC market is expected to grow, we are subject to intense competition.  We face significant competition from NPCC manufacturers within China and well-established chemical companies from other countries.  We compete based upon proprietary technologies, manufacturing capacity, product quality, production costs and the ability to produce a diverse range of NPCC products.  Whether we compete successfully will determine our net sales, financial condition and operating performance.

Organization
 
ShengdaTech is incorporated in Nevada in the United States of America.  ShengdaTech’s wholly-owned subsidiaries, Chaodong, Shandong Haize Nanomaterials Co., Ltd. (“Shandong Haize Nano”), Bangsheng Chemical, Shaanxi Haize Nanomaterials Co., Ltd. (“Shaanxi Haize Nano”), and Zibo Jiaze Nanomaterials Ltd. (“Zibo Nano”) and collectively the “PRC operating subsidiaries” are established under the laws of the PRC.

On December 11, 2009, Faith Bloom, a wholly-owned subsidiary of ShengdaTech, acquired 100% of the equity interest of Chaodong.  Chaodong was an inactive manufacturer of NPCC products. The name of Chaodong was changed to Anhui Yuanzhong Nanomaterials Co., Ltd. in April 2010.

 
-36-

 

Our corporate structure is depicted in the following chart:
 

Net Sales
 
We derive our net sales from the sale of our NPCC products. 

The most significant factors that directly or indirectly affect our sales are as follows:

·
Manufacturing capacity of NPCC;

·
Breakthroughs of R&D and applications of NPCC;

·
Pricing of our NPCC products;

·
Competitive landscape;

·
Industry demand; and

·
Exchange rate

Manufacturing capacity of NPCC. We increased our annual manufacturing capacity of NPCC from 90,000 metric tons as of December 31, 2006 to 190,000 metric tons as of December 31, 2008 and further to 250,000 metric tons as of December 31, 2009. Our Phase I NPCC facility in Zibo started production in late August 2009. The facility reached 90% capacity utilization at the end of 2009 and 100% capacity in January 2010. Our Anhui facility started production in May 2010 after we completed certain repair and maintenance of the facility and equipment and performed certain technological upgrades consistent with our Tai’an, Shandong facility. Increasing capacity allows us to provide a stable supply of NPCC to our existing customers and attract new customers.
 
Breakthroughs of research and development and applications of NPCC. We jointly developed with Tsinghua University the membrane-dispersion technology for NPCC production, which was officially granted a patent in November 2007. With the membrane-dispersion patent, we intend to maintain our leading position in technology for the NPCC market in China through continuing efforts in developing new NPCC products for applications in different industries.

Pricing of our NPCC products. The pricing of our NPCC products generally is determined by manufacturing costs, overall market demand, competition, and, increasingly, costs associated with developing the technology. In addition, the pricing of some of our NPCC products depends on the amount of cost saving that a particular industry or customer can achieve. For example, with respect to tire and PVC building materials, the pricing of NPCC products is principally affected by the cost saving benefit our customers realize by replacing some of the relatively expensive carbon black and silicon dioxide with less expensive NPCC. With respect to paper, the pricing of NPCC is principally affected by comparable imported products.

 
-37-

 

Competitive landscape. The competition in the Chinese NPCC market is stratified. In low-end applications, where several options are available, including precipitated calcium carbonate (PCC) and other fillers, suppliers are experiencing price pressure from their counterparts and from end users. However, in more complex applications, where NPCC use has proven to lower manufacturing costs and improve quality, end users will accept higher-priced and technologically advanced products, especially producers of tires, adhesives, high-end oil and inks, and auto coating industries. We target potential end users of high-end NPCC products. Our exclusive, patent-protected membrane-dispersion technology differentiates us from other competitive offerings and enables us to penetrate the market.
 
Industry demand. Our business and sales of product growth depends on industry demand for NPCC. The downstream industries we supply are the tire, polyvinyl chloride (PVC) building materials, ink, paint, latex, adhesive, paper and polyethylene (PE) industries. Given the diverse application of our NPCC products and the development of our R&D pipeline for new end markets, we believe that our business is well positioned for continued growth.

Section 421 of the Trade Act of 1974. China’s accession to the World Trade Organization (“WTO”) included transitional remedies to address import surges into other countries leading to market disruption. In the United States, the relevant safeguard provision was enacted as Section 421 of the Trade Act of 1974.  Section 421 permits U.S. domestic industries and workers injured by rapidly increasing imports from China to seek relief. Similar to other safeguard provisions, a Section 421 investigation is initiated by the filing of a petition with the United States International Trade Commission (“ITC”). On the basis of information developed in such investigation, the ITC determined, pursuant to Section 421(b)(1) of the Trade Act of 1974, that certain passenger vehicle and light truck tires from the PRC are being imported into the United States in such increased quantities or under such conditions as to cause or threaten to cause market disruption to the domestic producers of like or directly competitive products. On September 11, 2009, the United States government announced the decision to grant relief in the form of increasing the tariffs on such passenger vehicle and light truck tires for a three-year period by 35% in year one, 30% in year two, and 25% in year three. The increase in tariffs may harm the export business of our NPCC customers in the tire industry, which would decrease demand for our NPCC products, cause our revenue to decline and materially and adversely affect our business.

Exchange rate. Our sales of products have been affected by the foreign exchange rate between USD and RMB because the functional currency of our operating subsidiaries in the PRC is Renminbi while our financial statements have been expressed in USD, the functional currency of ShengdaTech, Inc. The accompanying consolidated statements of income have been translated using the average exchange rates prevailing during each of the periods presented.

Cost of Goods Sold
 
Cost of goods sold consists primarily of  raw materials, packaging, utility and supply costs consumed in the manufacturing process, manufacturing labor, depreciation expenses and direct overhead expenses necessary to manufacture finished goods as well as warehousing and distribution costs such as inbound freight charges, shipping and handling costs, purchasing and receiving costs, and inspection costs.
 
The most significant factors that directly or indirectly affect our cost of goods sold are as follows:

 
·
Processing technologies for NPCC;
 
 
·
Transporting, supply, and price of limestone;
 
 
·
Supply and price of limestone;
 
 
·
Availability and price of anthracite and soft coal;
 
 
·
Supply and price of electricity; and

 
-38-

 

 
·
Exchange rate.

Processing technologies for NPCC. The advancement of NPCC processing technologies is crucial in order to deliver value to our clients. In conjunction with Tsinghua University, we successfully completed the development of a more advanced membrane-dispersion technology, which was officially granted a patent in November 2007. We and Tsinghua University each have a 50% ownership share of the technology. We have the exclusive right to use the technology under a license agreement with Tsinghua University for the life of the patent. The membrane-dispersion technology enables us to produce NPCC in a more efficient and cost effective manner.

Transporting, supply, and price of limestone. Limestone is an important raw material for NPCC. Our average unit price for limestone have fluctuated from $6.53 per metric ton in 2008 to $6.90 per metric ton in 2009. Our Shaanxi Facility is close to a high-quality limestone quarry, which enables us to minimize transportation cost of limestone. We maintain a strong relationship with our mining contractor which conducts extracting activities for us. In addition, on June 19, 2008, we entered into an investment agreement with the Management Committee of Zibo High-Tech Industrial Development Zone (the “Management Committee”). The Management Committee has agreed to continue to sell to us sources of good quality limestone. As of December 31, 2009, the transfer of mining rights to our Company is still under review of the Management Committee. In addition, the acquisition of Anhui Yuanzhong on December 11, 2009 included approximately two years of limestone mining rights. We are applying for the extension of mining rights with the PRC government. If the application is approved, another thirty years of mining rights will be granted. In addition, we have entered into a Project Investment Agreement with the government of Hanshan County, Anhui Province, which also includes the exclusive mining rights of good quality limestone. We believe that our access to these limestone sources will be sufficient to satisfy our limestone requirements and expansion needs for the foreseeable future.

Availability and price of anthracite and soft coal. Anthracite and soft coal are used in the production of our NPCC products as key raw material and fuel, respectively. Anthracite and soft coal represented approximately 37.6% of our total cost of goods sold in 2009.  We have long-term relationships with our coal suppliers. We have also developed a network of alternative suppliers for backup purposes. Average anthracite prices has fluctuated in recent periods, increasing from approximately $145 per metric ton for 2008 to approximately $151 per metric ton for 2009.

Supply and price of electricity. Electricity from the grid is the primary power source for the production of NPCC, and it is currently supplied by the local government. The price of electricity for the NPCC industry remained fairly consistent at $0.08/kwh for 2008 and 2009.
 
Exchange rate. Our cost of products sold has been affected by the foreign exchange rate between USD and RMB because the functional currency of our operating subsidiaries in the PRC is the RMB while our financial statements are expressed in USD, which is the functional currency of ShengdaTech, Inc. The accompanying consolidated statements of income have been translated using the average exchange rates prevailing during each of the periods presented.
 
Gross Profit
 
Our gross profit has been, and will be, affected by many factors, including (a) the demand for our products, (b) the average selling price of our products, which in turn depends in part on the mix of products sold, (c) new product introductions, (d) the volume and costs of manufacturing of our products, (e) competitive activities, (f) expanded international operations and (g) entry into new industry applications.

 
-39-

 

Operating Expenses
 
Operating expenses consist of selling and general and administrative expenses.

Selling, general and administrative expenses consist primarily of personnel costs, including salaries, bonuses, commission and employee benefits, office facility and equipment costs, amortization of land use rights,  research and development costs, and other support costs including utilities, insurance, and professional fees.
 
Critical Accounting Policies and Estimates

 
The selection of critical accounting policies, the judgments and other uncertainties affecting application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors to be considered when reviewing our financial statements. Our significant accounting policies are set forth in detail in Note 2 to our consolidated financial statements included elsewhere in this annual report. We believe the following critical accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements

 
Revenue Recognition - We recognize revenues from the sale of products when they are realized and earned. We consider revenue realized or realizable and earned when (1) it has persuasive evidence of an arrangement, (2) delivery has occurred, (3) the sales price is fixed or determinable, and (4) collectability is reasonably assured. Revenues are not recognized until products have been shipped to the client (except for our exported products, for which title transfers at the customer’s port), risk of loss has transferred to the client and client acceptance has been obtained, client acceptance provisions have lapsed, or we have objective evidence that the criteria specified in client acceptance provisions have been satisfied.  We sell all products to end users and recognize revenues, net of sales rebates and taxes, when the products are shipped. We have no post-delivery obligations on our products sold.
 
Valuation of Long-lived Assets - The carrying values of our long-lived assets are reviewed for impairment annually or whenever events or changes in circumstances indicate that they may not be recoverable. When such an event occurs, we project the undiscounted cash flows to be generated from the use of the asset and its eventual disposition over the remaining life of the asset. If projections were to indicate that the carrying value of the long-lived asset will not be recovered, the carrying value of the long-lived asset is reduced by the estimated excess of the carrying value over the estimated fair value. Assets held for sale for discontinued operations are recognized at the lesser of carrying value or fair value less costs to sell.  
 
Long-term convertible notes - On January 1, 2009, as required by US GAAP, we changed how we account for our long-term convertible notes (the “Notes”) The change significantly impacts the accounting for our convertible notes by requiring us to account separately for the liability and equity components of the Notes because, upon conversion at any time before June 1, 2011, the make-whole interest payment may be settled in cash. The liability component is measured so the effective interest expense associated with the convertible notes reflects our borrowing rate at the date of issuance for similar debt instruments without the conversion feature. The difference between the cash proceeds associated with the convertible notes and this estimated fair value is recorded as a debt discount and amortized to interest expense through June 1, 2011, the earliest date the holders of the Notes can demand payment. Determining the fair value of the liability component requires the use of accounting estimates and assumptions. These estimates and assumptions are judgmental in nature and could have a significant impact on the determination of the liability component and, in effect, the associated interest expense. According to the guidance, the carrying amount of the liability component is determined by measuring the fair value of a similar liability that does not have an associated equity component. If no similar liabilities exist, estimates of fair value are primarily determined using assumptions that market participants would use in pricing the liability component, including market interest rates, credit standing, yield curves, and volatilities.

Business combination - The application of the purchase accounting requires certain estimates and assumptions especially concerning the determination of the fair values of the acquired intangible assets and property, plant and equipment as well as the liabilities assumed at the date of the acquisition. Moreover, the useful lives of the acquired intangible assets, property, plant and equipment have to be determined. Measurement of fair value and useful lives are based to a large extent on anticipated cash flows. If actual cash flows vary from those used in calculating fair values, this may significantly affect our future results of operations. Factors that may affect the assumptions regarding future cash flows include: long-term sales forecasts and anticipation of selling price erosion due to excessive capacities and competition. For significant acquisitions, the purchase price allocation is carried out with assistance from independent third-party valuation specialists. The valuations are based on information available at the acquisition date.
 
 
-40-

 

Results of operations

Continuing Operation —Comparison for the Years ended December 31, 2008 and 2009

Sales of Products

  
  
For the Years Ended December 31,
  
  
  
2008
  
  
2009
  
  
Change
  
  
  
Amount ($)
  
  
% of Total
Revenue
  
  
Amount ($)
  
  
% of
Total
Revenue
  
  
Amount ($)
  
  
%
  
Net sales-NPCC
   
82,419,689
     
100.0
     
102,121,804
     
100.0
     
19,702,115
     
23.9
 
 
For the year ended December 31, 2009, net sales increased by $19,702,115 or 23.9% compared to the year ended December 31, 2008. The increase was mainly due to an increase in sales volume of 32,684 metric tons driven by an increased market demand during the year ended December 31, 2009, resulted in a $15,745,065 increase in sales. In addition, the average selling price for the year ended December 31, 2009 was approximately $482 per metric ton, an increase of $22 per metric ton from an average selling price of $460 per metric ton for the year ended December 31, 2008, which resulted in a $3,957,050 increase in sales. The increase in our average selling price was due primarily to our pricing strategy and the change in our product mix based on market demands.
 
We expect our average selling price to fluctuate narrowly within a small range. We believe the quality of our products and our strong technical service capability will allow us to maintain a stable price structure. For the year ended December 31, 2009, our sales for plastic, adhesive and latex applications increased by $15,972,617, $3,523,549, and $873,377, respectively, compared to the year ended December 31, 2008. Our sales for rubber, paper, paint and ink applications for the year ended December 31, 2009 remained stable compared to the year ended December 31, 2008.
 
Cost of Goods Sold and Gross Profit

  
  
For the Years Ended December 31,
  
  
  
2008
  
  
2009
  
  
Change
  
  
  
Amount ($)
  
  
% of Total
Revenue
  
  
Amount ($)
  
  
% of Total
Revenue
  
  
Amount ($)
  
  
(%)
  
Cost of Goods Sold-NPCC
   
48,316,242
     
58.6
     
60,218,310
     
59.0
     
11,902,068
     
24.6
 
                                       
Gross Profit-NPCC
 
34,103,447
   
41.4
   
41,903,494
   
41.0
   
7,800,047
     
22.9
 
 
The cost of goods sold increased by $11,902,068 or 24.6% for the year ended December 31, 2009 compared to the year ended December 31, 2008. The increase in cost of goods sold comprised an increase in raw material cost of $6,239,578, an increase in utilities of $4,050,260 and an increase in other production expenses of $1,612,230.  Raw materials for our products are mainly limestone, anthracite, and supplemental chemicals. During 2009, our raw materials costs per metric ton increased by 5.2% or $7 compared to 2008. We expect the cost for raw materials to fluctuate with commodity price of anthracite. Price of anthracite correlates with general changes in energy price. During 2009, utilities costs and other productions expenses per metric ton increased 5.6% or $7 compared to 2008 due to price increase in electricity and initial production start-up costs at our Zibo, Shandong Facility for the first several months after the August 2009 production launch.

The gross margin decreased slightly by 0.4%, from 41.4% for the year ended December 31, 2008 to 41.0% for the year ended December 31, 2009. An increase in sales volume and the average selling price in the current period were offset by an increase in raw material costs, utilities and production expenses. The initial production start-up costs at our Zibo, Shandong Facility for the first several months after the August 2009 production launch had a negative impact of $1,006,410 on our gross margin for the year ended December 31, 2009.

 
-41-

 

Operating Expenses

  
For the Years Ended December 31,
 
  
2008
 
2009
 
Change
 
  
Amount ($)
 
% of Total
Revenue
 
Amount ($)
 
% of Total
Revenue
 
Amount ($)
 
(%)
 
Operating Expenses
                       
Selling expenses
   
2,438,908
     
3.0
     
2,103,822
     
2.0
     
(335,086
)
   
(13.7
)
General and administrative expenses
   
3,074,051
     
3.7
     
5,669,923
     
5. 6
     
2,595,872
     
84.4
 
Total Operating expenses
   
5,512,959
     
6.7
     
7,773,745
     
7.6
     
2,260,786
     
41.0
 

Selling expenses decreased by $335,086, or 13.7%, for the year ended December 31, 2009 compared to the prior year. This decrease was mainly due to a decrease of approximately $572,126 that resulted from a change in our NPCC staff commission policy to lower commission rates from 3.0% to 1.6% effective January 1, 2009, which was partially offset by an increase of $237,040 in office expenses, salary and welfare expenses.

General and administrative expenses increased by $2,595,872 or 84.4% for the year ended December 31, 2009 compared to the year ended December 31, 2008. The increase was mainly due to an increase in our professional services costs of $1,223,579 associated with accounting and auditing and other professional expenses, an increase in our payroll costs associated with executive compensation of $656,005, an increase in research and development expenses of $214,510, an additional amortization charge for land use rights and related property tax expenses for our new Zibo, Shandong facility of $212,636 and $141,724, respectively, and an increase of $147,418 in other miscellaneous expenses.
 
Operating Income and Income from Continuing Operations before Income Taxes

  
 
For the Years Ended December 31,
 
  
 
2008
   
2009
   
Change
 
  
 
Amount ($)
   
% of
Total
Revenue
   
Amount ($)
   
% of
Total
Revenue
   
Amount ($)
   
(%)
 
Operating Income
   
28,590,488
     
34.7
     
34,129,749
     
33.4
     
5,539,261
     
19.4
 
Interest income
   
132,423
     
0.2
     
685,858
     
0.7
     
553,435
     
417.9
 
Gain on extinguishment of long-term convertible notes
   
5,511,487
     
6.7
     
1,624,844
     
1.6
     
(3,886,643
)
   
(70.5
)
Other expenses
   
(51,604
)
   
(0.1
)
   
(121,976
)
   
(0.1
)
   
(70,372
)
   
136.4
 
Gain on bargain purchase
   
-
     
-
     
619,466
     
0.6
     
619,466
     
-
 
Interest expense
   
(7,456,418
)
   
(9.0
)
   
(10,662,252
)
   
(10.4
)
   
(3,205,834
)
   
(43.0
)
Income from Continuing operations before income taxes
   
26,726,376
     
32.4
     
26,275,689
     
25.7
     
(450,687
)
   
(1.7
)
Income tax expense
   
3,705,669
     
4.5
     
2,721,532
     
2.7
     
(984,137
)
   
(26.6
)
 
Operating income increased by $5,539,261 or 19.4% for the year ended December 31, 2009, compared to the year ended December 31, 2008.

Interest income for the year ended December 31, 2009 increased by $553,435 compared to the year ended December 31, 2008, which was mainly due to an increased average cash balance as a result of the proceeds from the issuance of convertible notes in May 2008.
 
 
-42-

 

Interest expense, related primarily to our convertible notes, was $10,635,500 for the year ended December 31, 2009.  Interest expense included $5,447,649 contractual coupon interest on convertible notes, $1,217,755 amortization of debt issuance costs, and $5,690,927 amortization of debt discount. Interest expense was reduced by $1,720,831 interest cost capitalized during the year ended December 31, 2009. Our long-term convertible notes balance is accreted through the amortization of our debt discount to interest expense. Interest expense is calculated each period on the debt balance during the year using the effective interest method.
 
During the first quarter of 2009, we recorded a gain on extinguishment of debt of $1,624,844 due to the repurchase of the convertible notes with an aggregate principal amount of $5,223,000 from certain investors for cash of $2,535,745 plus accrued interest of $72,144 through privately negotiated transactions.  The difference of $1,062,411 was allocated to debt issuance cost and the discount on the convertible notes in an amount of $158,109 and $904,302 respectively.  We did not repurchase any additional convertible notes during the remaining year of 2009. The Company is not actively seeking to repurchase additional convertible notes and has no plan for early termination of the convertible notes. 

On December 11, 2009, we completed our acquisition of Anhui Yuanzhong and recognized a gain on bargain purchase of $619,466. The company was able to acquire Anhui Yuanzhong  with a bargain purchase price due to the fact that  the seller planned to focus on its core business of manufacturing cement and that the seller has experienced difficulty in selling the business in the market as all equipment used by the business was specifically built to fit ultra gravity technology systems. We are one of the very few potential buyers that have the technology, human resources, research and development expertise, and sales and marketing capabilities to operate the business. Prior to recording a gain, the Company reassessed whether all acquired assets and all liabilities assumed have been identified and performed re-measurements to verify that the consideration paid and assets acquired have been properly valued and recorded based on information available to the Company.
 
Our effective income tax rate decreased from 13.9% for the year ended December 31, 2008 to 10.3% for the year ended December 31, 2009 due primarily to the effect of the PRC income tax holiday, which amounted to $3,673,625 and $4,385,137, respectively.

Discontinued Operations—Comparison for the Years ended December 31, 2008 and 2009

In December 2009, the Company decided to discontinue operations at our Bangsheng Chemical Facility and to sell all of its fixed assets and inventory. The facility ceased production at the end of October 2008. Our Bangsheng Chemical Facility operation was a component of our consolidated entity, and as such requires discontinued operations reporting treatment.
 
A summary of the operating results of discontinued operations for the years ended December 31, 2009 and 2008 is as follows:

  
 
For the Years Ended December 31,
 
  
 
2008
   
2009
   
Change
 
  
 
Amount ($)
   
% of Total
Revenue
   
Amount ($)
   
% of Total
Revenue
   
Amount ($)
   
(%)
 
Net Sales
   
67,007,450
     
100.0
     
295,899
     
100.0
     
(66,711,551
)
   
(99.6
)
Gross profit
   
21,020,951
     
31.4
     
-
     
-
     
(21,020,951
)
   
(100.0
)
Impairment of property, plant and equipment
   
3,931,253
     
5.9
     
-
     
-
     
(3,931,253
)
   
(100.0
)
Income /(Loss) from discontinued operations before income taxes
   
15,758,189
     
23.5
     
(449,550
)
   
(151.9
)
   
(16,207,739
)
   
(102.9
)
Income tax expense
   
2,750,594
     
4.1
     
-
     
-
     
(2,750,594
)
   
(100.0
)

The net sales of $295,899 for the year ended December 31, 2009 were generated from sale of Bangsheng Chemical Facility’s residual coal inventory after it ceased operations at the end of October 2008. Our Bangsheng Chemical Facility conducted ordinary course of business between January 1, 2008 and October 31, 2008 and its operating results during that period were included in our financial statement for the year ended December 31, 2008.

 
-43-

 

Due to the cessation of production at our Bangsheng Chemical Facility, the carrying amount of the plant equipment was reduced to the fair value based on the estimated selling price in the used equipment market. This resulted in an impairment loss of fixed asset of $3,931,253 for the year ended December 31, 2008. We re-assessed our Bangsheng Chemical Facility equipment in 2009 based on the estimated selling price in the used equipment market and determined that no further impairment of loss is required for the year ended December 31, 2009.

We did not have income tax expense for the discontinued operations for the year ended December 31, 2009 due to our loss position during the year. The effective income tax rate for 2008 was approximately 17.4%.
 
Continuing Operation—Comparison for the Years ended December 31, 2007 and 2008

Sales of Products

  
  
For the Years Ended December 31,
  
  
  
2007
  
  
2008
  
  
Change
  
  
  
Amount ($)
  
  
% of
Total
Revenue