U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

FORM 10-Q

 

(Mark One)

☒    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2016

 

☐   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: 333-124837

 

Keyuan Petrochemicals, Inc.

(Exact name of registrant as specified in its charter)

 

Nevada		45-0538522
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

 

Qingshi Industrial Park

Ningbo Economic & Technological Development Zone

Ningbo, Zhejiang Province

P.R. China 315803

(Address of principal executive office)

 

(86) 574-8623-2955

 (Issuer's telephone number)

 

 

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 ☐  No ☒

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Sec. 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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “larger accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer	☐	Accelerated Filer	☐
Non-accelerated filer	☐	Smaller reporting company	☒

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934) Yes ☐  No ☒

 

As of November 3, 2016, the Registrant has 63,132,726 shares of common stock outstanding.

 

 

 

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION
Item 1.	Financial Statements.	1
	Condensed Consolidated Balance Sheets	1
	Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)	2
	Condensed Consolidated Statements of Cash Flows	3
	Notes to Condensed Consolidated Financial Statements	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	27
Item 4.	Controls and Procedures.	27
PART II – OTHER INFORMATION		28
Item 1.	Legal Proceedings.	28
Item 1A.	Risk Factors.	28
Item 2.	Unregistered Sales of Equity Securities And Use Of Proceeds.	29
Item 3.	Defaults Upon Senior Securities.	29
Item 4.	Mine Safety Disclosures.	29
Item 5.	Other Information.	29
Item 6.	Exhibits.	29

 

 

INTRODUCTORY NOTE

 

Except as otherwise indicated by the context, references in this quarterly report on Form 10-Q (this “Form 10-Q”) to “Keyuan”, “we”, “us” or “our” are references to the combined business of Keyuan Petrochemicals, Inc. and its consolidated subsidiaries.  References to the “Company” are references to Keyuan Petrochemicals, Inc., a Nevada corporation; references to “Sinotech Group” are references to our wholly-owned subsidiary, Sinotech Group Limited, a British Virgin Islands company, previously known as Keyuan International Group Limited; references to “Keyuan HK” are references to our wholly-owned Hong Kong subsidiary, Keyuan Group Limited; references to “Ningbo Keyuan” are references to our wholly-owned subsidiary, Ningbo Keyuan Plastics Co., Ltd., a Chinese company; references to “Ningbo Keyuan Petrochemicals” are references to our wholly-owned subsidiary, Ningbo Keyuan Petrochemicals Co., Ltd., a Chinese company; references to “Keyuan Synthetic Rubbers” are references to our wholly-owned subsidiary, Ningbo Keyuan Synthetic Rubbers Co., Ltd., a Chinese company; references to “Guangxi Keyuan” are references to our partially-owned subsidiary, Guangxi Keyuan New Materials Co., Ltd. (we own 67.1% as if Hengyun Energy has already made full payment under the Investment Cooperation Agreement as described herein below), a Chinese company; and references to “Zhongkexuneng” are references to our wholly-owned subsidiary, Zhejiang Zhongkexuneng Trading Co., Ltd, a Chinese company. A structure chart is found in Item 2. References to “China” or “PRC” are references to the People’s Republic of China.  References to “RMB” are to Renminbi, the legal currency of China, and all references to “$” and dollar are to the U.S. dollar, the legal currency of the United States of America.

 

Special Note Regarding Forward-Looking Statements

 

This report contains forward-looking statements and information that are based on the beliefs of our management as well as assumptions made by and information currently available to us.  Such statements should not be unduly relied upon.  Forward-looking statements include statements about our expectations, beliefs, plans, objectives, intentions, assumptions and other statements that are not historical facts or that are not present facts or conditions. Forward-looking statements and information can generally be identified by the use of forward-looking terminology or words, such as “anticipate,” “approximately,” “believe,” “continue,” “estimate,” “expect,” “forecast,” “intend,” “may,” “ongoing,” “pending,” “perceive,” “plan,” “potential,” “predict,” “project,” “seek,” “should,” “views” or similar words or phrases or variations thereon, or the negatives of those words or phrases, or statements that events, conditions or results “can,” “will,” “may,” “must,” “would,” “could” or “should” occur or be achieved and similar expressions in connection with any discussion, expectation or projection of future operating or financial performance, costs, regulations, events or trends. The absence of these words does not necessarily mean that a statement is not forward-looking.

 

Forward-looking statements and information are based on management’s current expectations and assumptions, which are inherently subject to uncertainties, risks and changes in circumstances that are difficult to predict. These statements reflect our current view concerning future events and are subject to risks, uncertainties and assumptions.  There are important factors that could cause actual results to vary materially from those described in this report as anticipated, estimated or expected, including, but not limited to, those factors and conditions described under “Item 1A. Risk Factors” in our annual report on Form 10-K for the fiscal years ended December 31, 2015 and 2014 (the “Form 10-K”) as well as general conditions in the economy, petrochemicals industry and capital markets, Securities and Exchange Commission (the “SEC”) regulations that affect trading in the securities of “penny stocks,” and other risks and uncertainties.  Except as required by law, we assume no obligation to update any forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, even if new information becomes available in the future.  Depending on the market for our stock and other conditional tests, a specific safe harbor under the Private Securities Litigation Reform Act of 1995 may be available.  Notwithstanding the above, Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), expressly state that the safe harbor for forward-looking statements does not apply to companies that issue penny stock.  Because we may from time to time be considered to be an issuer of penny stock, the safe harbor for forward-looking statements may not apply to us at certain times.

 

 

PART I – FINANCIAL INFORMATION

  

KEYUAN PETROCHEMICALS, INC. AND SUBSIDIAIRES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except share data)

 

		Note				June 30, 2016				December 31, 2015
						(Unaudited)
ASSETS
Current assets:
Cash						$	10,034			$	4,764
Pledged bank deposits							239,010				282,968
Notes receivable							1,393				735
Accounts receivable							29,588				23,398
Inventories			3				40,844				55,730
Prepayments to suppliers, net							148,492				80,077
Consumption tax recoverable			4				62,605				44,377
Amounts due from related parties			15				60				92
Amounts due from non-controlling shareholder							32,383				19,376
Other current assets			5				20,018				19,049
Total current assets							584,427				530,566
Property, plant and equipment, net							274,070				273,146
Intangible assets, net							963				1,021
Land use rights							22,902				23,757
Value added tax recoverable							794				1,205
Total assets						$	883,156			$	829,695
LIABILITIES AND DEFICIT
Current Liabilities:
Short-term borrowings			6			$	317,503			$	360,720
Notes payable			7				341,894				334,139
Accounts payable							69,029				52,820
Amounts due to related parties			15				4,937				5,330
Amounts due to non-controlling interest							17,953				-
Advances from customers							54,840				15,563
Accrued expenses and other payables			8				48,196				42,654
Income tax payable							5,391				1,596
Long term debt due within one year							15,080				-
Dividends payable							2,382				2,382
Total current liabilities							877,205				815,204
Long term debts							-				15,400
Total liabilities							877,205				830,604
Stockholders’ deficit:
Common stock:
Par value: $0.001; Authorized: 100,000,000 shares Issued 57,646,160; outstanding: 57,221,050 as at June 30, 2016 and December 31, 2015							58				58
Consideration receivable							(9,417	)			(9,417	)
Additional paid-in capital							70,917				70,917
Statutory reserve							6,114				6,109
Accumulated other comprehensive income							1,797				7,098
Accumulated deficit							(88,755	)			(101,594	)
Treasury stock, at cost, 425,110 shares at June 30, 2016 and December 31, 2015, respectively							(449	)			(449	)
Total stockholders’ deficit							(19,735	)			(27,278	)
Non-controlling interests							25,686				26,369
Total equity (deficit)							5,951				(909	)
Total liabilities and equity (deficit)						$	883,156			$	829,695

 

See accompanying notes to the condensed consolidated financial statements.

 

 

KEYUAN PETROCHEMICALS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

(Amounts in thousands, except share and per share data)

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2016				2015				2016				2015
Sales		$	99,003			$	106,122			$	185,342			$	164,404
Cost of sales			78,115				86,144				152,199				164,987
Gross profit (loss)			20,888				19,978				33,143				(583	)
Selling expenses			769				176				1,658				410
General and administration expenses			2,614				5,725				6,644				10,367
Total operating expenses			3,383				5,901				8,302				10,777
Income (loss) from operations			17,505				14,077				24,841				(11,360	)
Other income (expense):
Interest income			860				3,652				2,835				6,977
Interest expense			(4,198	)			(11,843	)			(10,598	)			(20,191	)
Foreign exchange gain (loss), net			2,581				4,165				1,247				(5,243	)
Other expense, net			(52	)			(544	)			(204	)			(8,601	)
Total other expense, net			(809	)			(4,570	)			(6,720	)			(27,058	)
Income (loss) before income taxes			16,696				9,507				18,121				(38,418	)
Income tax expense			4,468				69				5,464				1
Net income (loss)			12,228				9,438				12,657				(38,419	)
Net loss attributable to non-controlling interests			(80	)			-				(187	)			-
Net income (loss) attributable to Keyuan Petrochemicals Inc. common stockholders		$	12,308			$	9,438			$	12,844			$	(38,419	)
Net income (loss) attributable to Keyuan Petrochemicals Inc. stockholders		$	12,228			$	9,438			$	12,657			$	(38,419	)
Other comprehensive (loss) income:
Foreign currency translation adjustment			(5,056	)			479				(5,301	)			-
Comprehensive income (loss)		$	7,172			$	9,917			$	7,356			$	(38,419	)
Comprehensive loss attributable to non-controlling interest			(80	)			-				(187	)			-
Comprehensive income (loss) attributable to Keyuan Petrochemicals Inc. common stockholders			7,252				9,917				7,543				(38,419	)
Earnings (loss) per share:
Attributable to common stock:
-Basic		$	0.22			$	0.17			$	0.22			$	(0.67	)
-Diluted		$	0.22			$	0.17			$	0.22			$	(0.67	)
Weighted average number of shares of common stock used in calculation:
-Basic			57,221,050				57,221,050				57,221,050				57,221,050
-Diluted			57,221,050				57,221,050				57,221,050				57,221,050

 

See accompanying notes to the condensed consolidated financial statements.

 

 

KEYUAN PETROCHEMICALS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(Amounts in thousands, except share data)

 

		Six Months Ended June 30,
		2016				2015
Cash flows from operating activities:
Net income (loss)		$	12,657			$	(38,419	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation			7,578				7,679
Amortization			71				74
Bad debt expense			31				6,043
Land use rights amortization			368				390
Deferred income tax expense			-				13,096
Changes in operating assets and liabilities:
Notes receivable			(684	)			(1,262	)
Accounts receivable			(6,789	)			(26,031	)
Inventories			13,946				7,917
Prepayments to suppliers			(72,798	)			(45,231	)
Consumption tax refund receivable			(19,449	)			(19,862	)
Other current assets			2,913				85,740
Due from related parties			(2,340	)			(18,455	)
Accounts payable			19,676				19,020
Advances from customers			40,280				990
Income taxes payable			3,888				1,145
Accrued expenses and other payables			(28	)			(11,836	)
Other liabilities – related parties			15,123				9,134
Pledged deposit for operating activities			29,847				(68,523	)
Net cash provided by (used in) operating activities			44,290				(78,391	)
Cash flows from investing activities:
Purchase of property, plant and equipment			(14,275	)			(2,271	)
Net cash used in investing activities			(14,275	)			(2,271	)
Cash flow from financing activities:
Pledged bank deposits used for borrowings			27,385				36,047
Proceeds from short-term bank borrowings			203,484				397,717
Repayment of short-term bank borrowings			(239,778	)			(476,912	)
Proceeds from bank notes			285,405				344,004
Repayments of bank notes			(270,485	)			(216,764	)
Proceeds from long term debt			-				16,318
Net cash provided by financing activities			6,011				100,410
Effect of foreign currency exchange rate changes on cash			(30,756	)			(14,526	)
Net increase in cash			5,270				5,222
Cash at beginning of period			4,764				870
Cash at end of period		$	10,034			$	6,092
Supplemental disclosure of cash flow information:
Income tax paid		$	2,208			$	124
Interest paid, net of capitalized interest		$	10,086			$	14,660
Non cash investing and financing activities:
Amount not yet paid for purchase of property, plant and equipment (net of VAT)		$	1,774			$	(3,018	)

 

See accompanying notes to the condensed consolidated financial statements.

 

 

1	ORGANIZATION AND NATURE OF BUSINESS, RECENT EVENTS, AND GOING CONCERN AND MANAGEMENT’S PLANS

 

(a) Organization and Nature of business

 

Keyuan Petrochemicals, Inc. (the “Company”) was incorporated in the State of Texas on May 4, 2004 in the former name of Silver Pearl Enterprises, Inc. The Company, through its wholly-owned subsidiary, Sinotech Group Limited (“Sinotech Group”) and its indirect subsidiaries, Keyuan Group Limited (“Keyuan HK”), Ningbo Keyuan Plastics Co., Ltd. (“Ningbo Keyuan”), Ningbo Keyuan Petrochemicals Co., Ltd. (“Ningbo Keyuan Petrochemicals”), Ningbo Keyuan Synthetic Rubbers Co., Ltd. (“Keyuan Synthetic Rubbers”), Zhejiang Zhongkexuneng Trading Co. (“Zhongkexuneng”) and Guangxi Keyuan New Materials Co., Ltd. (“Guangxi Keyuan”) (collectively referred herein below as “the Group”) are engaged in the manufacture and sale of petrochemical and rubber products in the People’s Republic of China (“PRC”).

 

(b) Financial condition, liquidity, and capital resources

 

Due to the Company’s continuous efforts in realignment of product profiles and the fact that the petrochemical industry in China has been stabilized since 2015, the Company reported a net income of approximately $12.7 million and a net loss of approximately $60.5 million for the six months ended June 30, 2016 and the year ended December 31, 2015, respectively. In addition, cash flows provided by operations were approximately $44.3 million for the six months ended June 30, 2016 and cash flows used in operations were approximately $112.5 million for the year ended December 31, 2015, respectively. At June 30, 2016 and December 31, 2015, the Company had a working capital deficit of approximately $292.8 million and $284.6 million, respectively.

 

Consequently, there is substantial doubt about the company’s ability to continue as a going concern.

 

The Company continues to finance and support its operations primarily through short-term bank borrowings. Short-term bank borrowings and notes payable amounted to approximately $659 and $695 million at June 30, 2016 and December 31, 2015, respectively. In addition, the Company continues to benefit from favorable PRC tax policies related to consumption tax. As of June 30, 2016, the Company had consumption tax refund receivables of approximately $62.6 million, and as of October 31, 2016, approximately $59.6 million was refunded to the Group.

 

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

 

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

 

2	BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) and include the consolidated financial statements of the Company and its subsidiaries. All intercompany balances and transactions are eliminated in consolidation. The consolidated financial statements have been prepared in accordance with U.S. GAAP applicable to interim financial information and the requirements of Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. These interim financial statements should be read in conjunction with the audited consolidated financial statements for the years ended December 31, 2015 and 2014, as not all disclosures required by generally accepted accounting principles for annual financial statements are presented. The interim financial statements follow the same accounting policies and methods of computation as the audited consolidated financial statements for the years ended December 31, 2015 and 2014. Interim results are not necessarily indicative of results for a full year. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the financial position and the results of operations and cash flows for the interim periods have been included.

 

 

3	INVENTORIES

 

Inventories consist of the following:

 

		June 30,				December 31,
		2016				2015
		($’000)				($’000)
		(Unaudited)
Raw materials		$	10,090			$	34,116
Finished goods			26,884				18,003
Work-in-process			3,870				3,611
Total		$	40,844			$	55,730

 

4	CONSUMPTION TAX REFUND RECEIVABLE

 

The PRC government enacted a regulation pursuant to which domestically purchased heavy oil to be used for producing ethylene and aromatics products was exempted from consumption tax. In addition, the consumption tax paid for imported heavy oil is to be refunded if it is used for producing ethylene and aromatics products. Because all the Group’s purchased heavy oils are, or are to be, used for producing ethylene and aromatics products, the Group recognizes a consumption tax recoverable when a consumption tax for heavy oils has been paid and the relevant heavy oils have been used for producing ethylene and aromatics products. At June 30, 2016 and December 31, 2015, the Group recorded an estimated consumption tax refund receivables amounting to approximately $62.6 million and $44.4 million, respectively. As of October 31, 2016, approximately $59.6 million was refunded to the Group.

 

5	OTHER CURRENT ASSETS

 

Other current assets consist of the following:

 

		June 30,				December 31,
		2016				2015
		($’000)				($’000)
		(Unaudited)
VAT recoverable		$	11,118			$	10,397
Deposits paid to suppliers			2,195				3,907
Other			6,705				4,745
		$	20,018			$	19,049

 

Management estimates the deductible input value added tax (“VAT”) using vendor contracts, engineering and other estimates, as well as historical experience.

 

Customs deposits for imported inventories represent amounts paid to the local customs office in connection with the import of raw materials inventories. Upon approval by the customs authorities, these amounts become refundable by the local tax authority and are reclassified as consumption tax refund receivable (Note 4).

 

 

6	SHORT-TERM BORROWINGS AND LONG-TERM DEBT

 

As of June 30, 2016 and December 31, 2015, short-term borrowings outstanding carried a weighted average interest rate of 4.6% and 5.3% for loans in RMB, respectively; and a weighted average interest rate of 2.5% and 2.4% for loans in USD, respectively, and had maturity terms ranging from July 2016 to June 2017 and interest rates ranging from 1.8% to 5.7% and 1.9% to 6.9%, respectively.

  

Short-term borrowings consist of the following:

 

		June 30,								December 31,
		2016								2015
		SHORT-TERM  BORROWINGS				PLEDGED BANK DEPOSITS				SHORT-TERM  BORROWINGS				PLEDGED BANK DEPOSITS
		($’000)				($’000)				($’000)				($’000)
		(Unaudited)
China Construction Bank		$	178,366			$	104,550			$	181,799			$	104,500
Shanghai Pudong Development Bank			2,036				-				5,929				-
Agricultural Bank of China			6,786				-				23,100				-
Pingan Bank			-				-				2,800				2,867
Bank of Communication			11,725				-				10,934				-
Bank of China			95,609				-				122,168				19,450
China Merchant Bank			7,540				-				7,700				283
Ningbo Commerce Bank			3,000				3,090				3,000				3090
China Minsheng Bank			12,441				-				3,290				-
Total		$	317,503			$	107,640			$	360,720			$	130,190

 

The only long term debt of the Group is a loan to Ningbo Keyuan from Zhouji (Group) Co., Ltd (“Zhouji Group”) made on April 9, 2015 in the initial amount of RMB 100 million (approximately $15.4 million). The debt matures on the second anniversary of being made and carries an interest of 7.0%, which is approximately 40% higher than average interest rate of long-term bank loans made at that time of similar tenor. The long-term loan is secured by 15% of Mr. Chunfeng Tao’s ownership of Ningbo Keyuan. Upon the maturity of the loan, Zhouji Group has an option to elect a payment of the principal and the accrued interest or the transfer of 15% of Mr. Tao’s ownership of Ningbo Keyuan.

 

7	NOTES PAYABLE

 

Notes payable represent bills issued by an accepting bank in favor of the Group’s suppliers. The Group’s suppliers receive payments from such accepting bank directly upon maturity of the bills, and the Group is obliged to repay the face value of the bills to such accepting bank. Bills that are not remitted directly by the Group to its suppliers may be sold by the Group to other accepting banks for cash prior to their maturity. Discounts paid are recorded as a component of interest expense. Notes payable with financing nature amounted $248 million and $312 million as of June 30, 2016 and December 31, 2015, respectively.

 

8	ACCRUED EXPENSES AND OTHER PAYABLES

 

Accrued expenses and other payables consist of the following:

 

		June 30,				December 31,
		2016				2015
		($’000)				($’000)
		(Unaudited)
Purchase of property, plant and equipment		$	14,041			$	12,555
Accrued payroll and welfare			653				677
Liquidated damages			2,493				2,493
Deposit from customers			2,499				2,499
Loan from unrelated parties			1,508				1,540
Other tax payable			2,302				2,765
Accrued interest expense			7,826				7,476
Accrued expense according to ongoing lawsuit			14,788				10,200
Other accruals and payables			2,086				2,449
		$	48,196			$	42,654

 

9	COMMITMENTS AND CONTINGENCIES

 

(a) Operating commitments

 

As of June 30, 2016, the Group had outstanding Letters of Credit of approximately $33 million.

 

 

(b) Capital commitments

 

As of June 30, 2016, the Group had contractual capital commitments of approximately $14 million for purchases of equipment. The capital commitments relate primarily to manufacturing equipment enhancements.

 

(c) Litigation

 

On October 28, 2014, Dragon State Limited (“Dragon State”), an investor in a private placement that the Company closed in September 2010, filed a complaint against, among others, Keyuan Petrochemicals, Inc. and Mr. Chunfeng Tao, seeking rescission of the securities purchase agreement in the private placement and the return of $20 million, and in the alternative, seeking monetary damages to be determined at a trial but not less than $20 million (the “Complaint”). Pursuant to the September 2010 private placement, Dragon State had purchased from the Company for an aggregate price of $20 million, 5,333,340 shares of Series B preferred stock, 800,001 series C warrants to purchase 800,001 common shares, at a price of $4.50 per share (subject to adjustments), and 800,001 series D warrants to purchase 800,001 common shares at a price of $5.25 per share (subject to adjustments).

 

On July 11, 2016, the Company entered into a share purchase and settlement agreement (the “Settlement Agreement”) among Dragon State, Delight Reward Limited (“Delight Reward”), Keyuan HK, Ningbo Keyuan Petrochemicals, Ningbo Keyuan, and Keyuan Synthetic Rubbers (the Company, Keyuan HK, Ningbo Keyuan Petrochemicals, Ningbo Keyuan and Keyuan Synthetic Rubbers are collectively referred as the “Keyuan Group”), Mr. Chunfeng Tao, and Prax Capital Equity Management Co., Ltd., an affiliated party to Dragon State. Pursuant to the Settlement Agreement, Dragon State agreed to transfer the securities purchased in the September 2010 Private Placement to Delight Reward for a consideration of RMB 12,000,000 or approximately $1,800,000. In addition, Delight Reward and Keyuan Group agreed to pay, and Dragon State agreed to accept, a settlement of RMB 6,000,000 or approximately $900,000 to waive all claims and liabilities that Dragon State or its affiliated companies or individuals had brought or would bring against Delight Reward, Keyuan Group, Mr. Tao and their affiliates including the Complaint. These amounts were paid on July 15, 2016. On July 19, 2016, the United States District Court Southern District of New York entered an order granting final approval of the settlement. The Complaint was dismissed.

 

On August 4, 2016, Delight Reward entered into a side agreement with the Company (the “Side Agreement”). Under the Side Agreement, Delight Reward agreed not to claim that the warrants transferred pursuant to the Settlement Agreement were exercisable, and agreed pay to the Company for each convertible share underlying the Series B preferred stock transferred pursuant to the Settlement Agreement, the highest sale price of the Company’s Common Stock per share as reported on the OTC Pink during a period commencing on the date of the Settlement Agreement and ending on August 4, 2016, which was $0.005 per share of Common Stock. The aggregate purchase price for the shares of Common Stock underlying the series B preferred stock was therefore $27,465.01. On August 8, 2016, these funds were paid in cash on hand by Delight Reward. On August 10, 2016, the shares of Series B preferred stock were converted into 5,493,001 shares of Common Stock pursuant to the terms of the certificate of designations of series B preferred stock and the Side Agreement.

 

10	INCOME TAXES

 

The provision for income taxes is recorded at the end of each interim period based on the Group’s best estimate of its effective income tax rate expected to be applicable for the full fiscal year. The Group’s effective tax rate for the six months ended June 30, 2016 is approximately 30%. The increased effective rate for the six months ended June 30, 2016 compared to year 2015 is primarily due to losses in non-PRC jurisdictions, the benefit of which is not expected to be realized. The Group paid income taxes of approximately $1.5 million and $2.2 million, respectively during the three months and six months ended June 30, 2016.

 

 

11	EARNINGS (LOSS) PER SHARE

 

The following table sets forth the computation of basic and diluted net earnings (loss) per share:

 

		Three months ended June 30								Six months ended June 30
		2016				2015				2016				2015
		($’000)				($’000)				($’000)				($’000)
		(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)
Basic earnings (loss) per share:
Net income (loss)		$	12,228			$	9,438			$	12,657			$	(38,419	)
Net loss attributable to non-controlling interests			(80	)			-				(187	)			-
Net income (loss) attributable to Keyuan
Petrochemicals Inc. common stockholders		$	12,308			$	9,438			$	12,844			$	(38,419	)
Weighted average common share
(Denominator for basic and diluted income (loss) per share)			57,221,050				57,221,050				57,221,050				57,221,050
Basic net earnings (loss) per share:		$	0.22			$	0.17			$	0.22			$	(0.67	)
Diluted net earnings (loss) per share:		$	0.22			$	0.17			$	0.22			$	(0.67	)

 

Diluted earnings (loss) per share is calculated by dividing net income (loss) attributable to the Company’s stockholders as adjusted for the effect of dilutive common stock equivalents, if any, by the weighted average number of common stock and dilutive common stock equivalents outstanding during the year. Common stock equivalents consist of the common stock issuable upon the exercise of outstanding stock options and stock purchase warrants (using the treasury stock method). Potential dilutive securities are not included in the calculation of dilutive earnings (loss) per share if the effect is anti-dilutive. No warrants and options were included in diluted earnings (loss) per share for the three and six months ended June 30, 2016 and 2015, respectively, as their effect was anti-dilutive.

 

12	STOCK REPURCHASE PROGRAM

 

On September 22, 2014, the Board of Directors authorized the termination of a repurchase program that was commenced on December 31, 2012 to repurchase of up to $2 million of its common stock at a price of up to $1.50 per share. The Company purchased 425,110 shares of common stock through the stock repurchase program.

 

Shares of common stock repurchased by the Company are recorded at cost as treasury stock and result in a reduction of equity in the consolidated balance sheets. Treasury shares may be reissued as part of the Company’s stock-based compensation programs. There were no reissuances during the three and six months ended June 30, 2016 and 2015.

 

13	FAIR VALUE MEASUREMENTS

 

The Company did not have any assets or liabilities that were measured at fair value on a recurring basis as of June 30, 2016 and December 31, 2015, respectively.

 

The fair values of cash, pledged bank deposits, notes receivable, accounts receivable, short-term bank borrowing, notes payable, accounts payable and long term debt due within one year approximate their respective carrying amounts due to their short-term nature. The fair value of pledged bank deposits and short-term bank borrowings approximate their carrying amount because of their varying interest rates and/or their short maturities.

 

 

14	SIGNIFICANT CONCENTRATIONS AND RISKS

 

As of June 30, 2016 and December 31, 2015, the Group held cash and pledged bank deposits in financial institutions of approximately $249 million and $288 million, respectively. These were primarily held in major financial institutions located in mainland China and the Hong Kong Special Administrative Region, which management believes have high credit quality.

 

During the three and six months ended June 30, 2016 and the three and six months ended June 30, 2015, no sales to individual customer exceeded 10% of the Group’s total net revenue. As of June 30, 2016, three customers accounted for 37%, 21% and 18% of accounts receivables.

 

The Group currently buys a majority of its heavy oil and styrene, important components of its products, from three suppliers. Management believes that other suppliers could be found to provide similar products on comparable terms if it were to become necessary. A change in suppliers, however, could cause a delay in manufacturing and a possible loss of sales, which would affect operating results adversely.

 

During the three and six months ended June 30, 2016, three suppliers to the Group each accounted for more than 10% of total group purchase. These three suppliers accounted for approximately 27%, 27% and 20% of the total purchase for three months ended June 30, 2016 and 19%, 13% and 12% of total purchase for the six months ended June 30, 2016, respectively. During the three months ended June 30, 2015, the three individual suppliers from whom the Group purchased more than 10% of its total purchases, accounted for approximately 17%, 14% and 11% of the total purchase. During the six months ended June 30, 2015, the Group has three individual suppliers exceeded 10% of the Group’s total purchases, accounted for approximately 23%, 20% and 10% of the total purchase. As at June 30, 2016, two customers accounted for 76%, 16% of total accounts payable.

 

The Group commenced trading of heavy oil in April 2013 as an agent on behalf of a Hong-Kong based customer. For the three months ended June 30, 2016 and 2015, and for the six months ended June 30, 2016, there were no trading of heavy oil. For the six months ended June 30, 2015, the trading of heavy oil consists of purchases of approximately $3.0 million and sales of approximately $3.0 million, resulting in no profit or loss.

 

The Group’s operations are carried out in the PRC. Accordingly, the Group’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC, as well as by the general state of the PRC’s economy. The business may be influenced by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittances abroad, and rates and methods of taxation, among other things.

 

 

15	RELATED PARTY TRANSACTIONS AND RELATIONSHIPS AND TRANSACTIONS WITH CERTAIN OTHER PARTIES

 

(A) Related Party Transactions

 

The Company considers all transactions with the following parties to be related party transactions.

 

Name of parties		Relationship
Mr. Chunfeng Tao (“Mr. Tao”)		Majority stockholder
Mr. Jicun Wang (“Mr. Wang”)		Principal stockholder
Mr. Peijun Chen (“Mr. Chen”)		Principal stockholder
Ms. Sumei Chen		Member of the Company’s Board of Supervisors and spouse of Mr. Wang
Ms. Yushui Huang (“Ms. Huang”)		Vice President of Administration, Ningbo Keyuan
Ms. Feng Chen		Acting Chief Executive Officer, Chief Financial Officer and Vice President of Administration of Keyuan Petrochemicals Inc. since April 8, 2016
Ningbo Pacific Ocean Shipping Co., Ltd (“Ningbo Pacific”)		100% ownership by Mr. Wang
Ningbo Hengfa Metal Product Co., Ltd (“Ningbo Hengfa”, former name “Ningbo Tenglong”)		100% ownership by Mr. Chen
Ningbo Xinhe Logistic Co., Ltd (“Ningbo Xinhe”)		10% ownership by Ms. Huang

 

Related party transactions and amounts outstanding with the related parties as of June 30, 2016 and December 31, 2015 and for the three and six months ended June 30, 2016 and 2015, are summarized as follows:

 

		Three months ended June 30,								Six months ended June 30,
		2016				2015				2016				2015
		($’000)				($’000)				($’000)				($’000)
		(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)
Purchase of transportation services (a)		$	-			$	297			$	862			$	455

 

		June 30, 2016				December 31, 2015
		($’000)				($’000)
		(Unaudited)
Amounts due from related parties (d)		$	40			$	92
Amounts due to related parties (c)		$	4,930			$	4,592
Account payable to related parties (c)		$	7			$	739
Account receivable from related parties (d)		$	20			$	-

 

 

(a) The Group purchased transportation services of approximately nil and $0.3 million from Ningbo Xinhe during the three months ended June 30, 2016 and 2015, respectively. The Group purchased transportation services of $0.9 million and $0.5 million from Ningbo Xinhe during the six months ended June 30, 2016 and 2015, respectively.

 

(b) Guarantees for Bank Loans

 

Guarantee provided by Mr. Tao amounted $135.7 million and $138.6 million as of June 30, 2016 and December 31, 2015.

 

Bank loans guarantee provided by Mr. Tao amounted $96.8 million and $95.9 million as of June 30, 2016 and December 31, 2015.

 

(c) Amounts due to related parties consist of the following.

 

		June 30, 2016				December 31, 2015
		($’000)				($’000)
		(Unaudited)
Mr. Tao			4,592				4,592
Ningbo Xinhe			338				-

 

Amounts payable to related party consist of the following:

		June 30, 2016				December 31, 2015
		($’000)				($’000)
		(Unaudited)
Ningbo Xinhe			7				739

 

(d) Amount due from related parties consist of the following.

 

		June 30, 2016				December 31, 2015
		($’000)				($’000)
		(Unaudited)
Mr. Dingan Zhang		$	-			$	38
Ms. Yushui Huang			-				8
Mr. Tao			40				46
Total		$	40			$	92

 

Amounts receivable from related party consist of the following:

 

		June 30, 2016				December 31, 2015
		($’000)				($’000)
		(Unaudited)
Ningbo Xinhe			20				-

 

 

(B) Relationships and transactions with certain other parties

 

The Group has the following relationships and transactions with certain other parties:

 

Name of parties		Relationship
Ningbo Litong Petrochemical Co., Ltd (“Ningbo Litong”)		Former 12.75% nominee shareholder of Ningbo Keyuan
Huaning International Trading Co., Ltd (“Huaning”)		The director of Huaning is the shareholder and director of Ningbo Xinghe, one of the Group’s related parties
Mercuria energy trading Pte Ltd (“Mercuria”)		Major supplier
Ningbo Anqi Petrochemical Co., Ltd		A related party until September 2011 when control transferred
Ningbo Lide Investment Co., Ltd. (“Ningbo Lide”, f/k/a Ningbo Kewei)		A related party until September 2011 when control transferred
Ningbo Kunde Petrochemical Co, Ltd. (“Ningbo Kunde”)		A related party until September 2011 when control transferred

 

Transactions and amounts outstanding with these parties for the three and six months ended June 30, 2016 and 2015 and as of June 30, 2016 and December 31, 2015 are summarized as follows:

 

		Three months ended June 30								Six months ended June 30
		2016				2015				2016				2015
		($’000)				($’000)				($’000)				($’000)
		(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)
Sales of products (e)		$	-			$	6,606			$	-			$	8,542
Purchase of raw materials (f)		$	-			$	65,416			$	55,489			$	94,573

 

		June 30, 2016				December 31, 2015
		($’000)				($’000)
		(Unaudited)
Guarantee for bank borrowings (g)		$	214,139			$	310,276
Amounts due from these parties (h)		$	2,195			$	3,907
Advance payments to these parties(i)		$	74,796			$	4,552
Advance received from these parties (j)		$	33,119			$	4
Accounts payables (l)		$	38,063			$	41,269
Notes payable (m)		$	131,750			$	140,715
Notes receivable (n)		$	-			$	514

 

(e)The Group sold finished products of approximately nil and $2.6 million to Ningbo Litong during the three months ended June 30, 2016 and 2015, respectively. The Group sold finished products of approximately nil and $4.0 million to Ningbo Lide during the three months ended June 30, 2016 and 2015, respectively. The Group sold finished products of approximately nil and $4.1 million to Ningbo Litong, during the six months ended June 30, 2016 and 2015, respectively. The Group sold finished products of approximately nil and $4.4 million to Ningbo Lide during the six months ended June 30, 2016 and 2015, respectively.

 

 

(f) Purchase of raw materials

 

		Purchase of raw materials during the three months ended June 30,								Purchase of raw materials during the six months ended June 30,
		2016				2015				2016				2015
		($’000)				($’000)				($’000)				($’000)
		(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)
Ningbo Litong		$	-			$	27,094			$	21,429			$	36,768
Ningbo Lide			-				29,789				28,618				29,807
Huaning			-				3				-				2,852
Mercuria			-				8,529				5,442				25,146
Total		$	-			$	65,415			$	55,489			$	94,573

 

(g) Guarantees for Bank Loans

 

		Guarantee provided as of
		June 30, 2016				December 31, 2015
		($’000)				($’000)
		(Unaudited)
Ningbo Litong		$	40,717			$	102,379
Ningbo Lide			173,422				207,897
Total		$	214,139			$	310,276

 

		Bank loans Guaranteed as of
		June 30, 2016				December 31, 2015
		($’000)				($’000)
		(Unaudited)
Ningbo Litong		$	19,265			$	18,634
Ningbo Lide			98,813				101,783
Total		$	118,078			$	120,417

 

(h) At June 30, 2016 and December 31, 2015, the amounts due from these parties consist of amounts due from Huaning of $1.2 million and $3.9 million, respectively, and amounts due from Mercuria of $1.0 million and nil, respectively.

 

(i) At June 30, 2016 and December 31, 2015, advances payments to these parties consist of payments to Ningbo Litong of $53.2 million and nil, respectively, and Ningbo Lide of $21.6 million and $4.6 million, respectively. 

 

(j) At June 30, 2016 and December 31, 2015, advances received from these parties consist of amounts received from Ningbo Litong of $33.1 million and nil, respectively, and amounts received from Huaning of $4,000 and $4,000, respectively. 

 

(k) At June 30, 2016 and December 31, 2015 accounts payables to these parties consist of payables to Ningbo Litong of nil and $1.4 million, respectively, and payables to Mecuria of $38.1 million and $39.9 million, respectively.

 

 

(l) At June 30, 2016 and December 31, 2015 notes payable to these parties consist of notes payable to Ningbo Litong of $75.5 million and $68.6 million, respectively, and notes payables to Ningbo Lide of $56.3 million and $72.2 million, respectively.

 

(n) At June 30, 2016 and December 31, 2015 notes receivables from these parties consist of notes receivable from Ningbo Litong of nil and $0.5 million, respectively, and notes receivables from Ningbo Lide of nil and $0.02 million, respectively.

 

(C) Relationships and transactions with the entity that has non-controlling interests in Company’s subsidiaries: 

 

The Group has the following relationships and transactions with non-controlling interest shareholder:

 

Name of party		Relationship
Ningbo Hengyun Energy Technology Co, Ltd (Ningbo Hengyun)		Non-controlling interest shareholder of Guangxi Keyuan since 2015

 

The transactions and amounts outstanding with this party as of June 30, 2016 and December 31, 2015 and for the three and six months ended June 30, 2016 and 2015 are summarized as follows:

 

		Three months ended June 30								Six months ended June 30
		2016				2015				2016				2015
		($’000)				($’000)				($’000)				($’000)
		(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)
Sales of products		$	-			$	1,111			$	268			$	1,668
Purchase of raw materials		$	-			$	34,901			$	42,115			$	57,690

 

		As at June 30, 2016				As at December 31, 2015
		($’000)				($’000)
		(Unaudited)
Advance received from non-controlling interest shareholder		$	17,953			$	-
Advance payments to non-controlling interest shareholder		$	32,069			$	2,222
Accounts receivables		$	314			$	17,153
Notes receivables		$	87,092			$	90,601

 

16	Consolidated Segment Data

 

Segment information is based on how management reviews the business, makes investing and resource allocation decisions and assesses operating performance. The segment data presented reflects management’s segment structure. The Company reports financial and operating information in the following two segments:

 

(a) Petrochemicals Segment: Manufacturing and sales of mixed light aromatics, mixed heavy aromatics, fine propylene, propane, butane, liquefied petroleum gas (LPG), methyltert butyl ether, styrene, etc.

 

 

(b) Rubber Segment: Manufacturing and sales of various rubber products.

 

Segment information for the three and six months ended June 30, 2016 and 2015 is as follows:

 

		Three Months Ended June 30
		2016												2015
		Petrochemical				Rubber				Total				Petrochemical				Rubber				Total
		($'000)				($'000)				($'000)				($'000)				($'000)				($'000)
		(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)
Sales		$	75,654			$	23,349			$	99,003			$	90,922			$	15,200			$	106,122
Income (loss) from operations		$	22,109			$	(4,604	)		$	17,505			$	14,530			$	(453	)		$	14,077

 

		Six months Ended June 30
		2016												2015
		Petrochemical				Rubber				Total				Petrochemical				Rubber				Total
		($'000)				($'000)				($'000)				($'000)				($'000)				($'000)
		(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)				(Unaudited)
Sales		$	140,613			$	44,729			$	185,342			$	135,229			$	29,175			$	164,404
Income (loss) from operations		$	32,543			$	(7,702	)		$	24,841			$	(13,420	)		$	2,060			$	(11,360	)

  

		As of June 30, 2016												As of December 31, 2015
		Petrochemical				Rubber				Total				Petrochemical				Rubber				Total
		($'000)				($'000)				($'000)				($'000)				($'000)				($'000)
		(Unaudited)				(Unaudited)				(Unaudited)
Total assets		$	772,252			$	110,904			$	883,156			$	724,008			$	105,687			$	829,695

  

17	SUBSEQUENT EVENTS

 

On July 11, 2016, the Company and certain affiliates of the Company entered into the Settlement Agreement with Dragon State and others described in Note 9(c) above, pursuant to which Dragon State agreed to transfer the securities of the Company it owned to Delight Reward and waive all claims and liabilities that Dragon State or its affiliated companies or individuals had brought or would bring against the Company, Delight Reward and certain affiliates of the Company for an aggregate consideration of RMB 18 million or approximately $2.7 million.

 

On August 4, 2016, the Company entered into the Side Agreement with Delight Reward described in Note 9(c) above in connection with the execution of the Settlement Agreement and the payment subsequently made thereunder by the Company to Dragon State.

 

For more details of the Settlement Agreement and the Side Agreement, please refer to Note 9(c) above.

 

 

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

The following discussion and analysis of our financial condition and result of operations should be read in conjunction with our unaudited consolidated financial statements and the notes to those financial statements appearing elsewhere in this Form 10-Q. This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those described in the "Risk Factors" section of the Form 10-K for the fiscal years ended December 31, 2015 and 2014, and the other reports we file with the Securities and Exchange Commission. Our actual results may differ materially from those contained in any forward-looking statements.

 

General Overview

 

Nature of Business

 

We are engaged in the manufacture and sale of petrochemical products and rubber in the PRC through our PRC operating subsidiaries, Ningbo Keyuan, Ningbo Keyuan Petrochemicals, Keyuan Synthetic Rubbers, Guangxi Keyuan and Zhongkexuneng. Our operations include:

 

	(1)	A production facility with an annual petrochemical production capacity of 720,000 metric tons (“MT”) of a variety of petrochemical products;
	(2)	A Styrene-Butadiene-Styrene (“SBS”) production facility with a designed annual production capacity of 70,000 MT;
	(3)	A Styrene-Ethylene-Butylene-Styrene (“SEBS”) production facility with a designed annual production capacity of 10,000 MT;
	(4)	Facilities for the storage and loading of raw materials and finished petrochemical and rubber goods; and
	(5)	Manufacturing technologies that can support our manufacturing process with relatively low raw material costs and high utilization and yields.

 

In January 2012, we signed a cooperation agreement with Fangchenggang City to build a new petrochemicals production facility in Guangxi Keyuan New Materials Industrial Park, Guangxi Province (the “Guangxi Project”). The estimated cost for the Guangxi Project is approximately $300 million. According to the cooperation agreement, the local government of Fangchenggang City agreed to grant to us land use rights for the facility.

 

On August 9, 2013, the Guangxi Project was approved by the local government of Fangchengang City. We were granted a land use right for 40 years for approximately 4,668,437 square feet of land, effective in 2014. In August 2013, we commenced engineering and facility construction. The preliminary investigation for foundation piling was completed in late October 2013. We completed the land leveling and finished the installation of water pipes, electricity wires and basic pipelines at the end of 2014. We completed the technical design of the facility and the equipment at the end of 2015. We are currently arranging the tendering on the construction of the facility and major equipment. We expect to finish construction of the facility and installation of main equipment and pipelines by the end of 2017 and commence production by the end of 2018.

 

We believe that the Guangxi Project once it goes into operation, will improve our competitive positions by extending and expanding our supply chain and manufacturing base. The facility is expected to have an annual production capacity of 50,000 MT of Acrylonitrile Butadiene Styrene (“ABS”). We plan to fund the construction and operation of the Guangxi Project through outside financing. If such financing is not available on terms acceptable to us, the project will be delayed until appropriate financing is available. As a result, the timelines for the Guangxi Project described above are subject to adjustment pending the status of outside financing.

 

 

Organization

 

Keyuan Petrochemicals, Inc. (formerly known as “Silver Pearl Enterprises, Inc.”) was incorporated in the State of Texas on May 4, 2004 and redomiciled to Nevada on February 28, 2007.

 

On April 22, 2010, we entered into a share exchange agreement (the “Exchange Agreement”) with Sinotech Group, Delight Reward Limited (“Delight Reward”), a British Virgin Islands company and sole stockholder of Sinotech Group, and Denise D. Smith, our former principal stockholder. Pursuant to the terms of the Exchange Agreement, Delight Reward transferred to us all of its shares of Sinotech Group in exchange for 47,658 shares of our Series M convertible preferred stock (the “Share Exchange”). On an “as converted” basis, the Series M convertible preferred stock represented approximately 95% of our outstanding common stock immediately after the Share Exchange. The Series M convertible preferred stock voted with the common stock on an “as converted basis” and was converted into 47,658,000 shares of our common stock on December 28, 2010.

 

As a result of the Share Exchange, Sinotech Group became a wholly-owned subsidiary of us and Delight Reward became our controlling stockholder. The Share Exchange was accounted for as a reverse acquisition and recapitalization whereby Sinotech Group was deemed to be the accounting acquirer (and the legal acquiree).

 

On May 12, 2010, we formed a corporation under the laws of the State of Nevada called Keyuan Petrochemicals, Inc. as our wholly-owned subsidiary (the “Merger Subsidiary”). Effective as of May 17, 2010, the Merger Subsidiary was merged with and into us. As a result of the merger, our name was changed to “Keyuan Petrochemicals, Inc.” Prior to the merger, the Merger Subsidiary had no liabilities and nominal assets and, as a result of the merger, the separate existence of the merger subsidiary ceased. We are the surviving corporation in the merger except for the name change, and there was no change in our directors, officers, capital structure or business.

 

On August 8, 2010, we established a wholly owned subsidiary in China, Ningbo Keyuan Petrochemicals, through our subsidiary Keyuan HK. Ningbo Keyuan Petrochemicals was initially set up to engage in the sales and marketing for products produced by Ningbo Keyuan and, later, by Keyuan Synthetic Rubbers. However, in fact, Ningbo Keyuan and Keyuan Synthetic Rubbers have been selling their products directly and Ningbo Keyuan Petrochemicals has mostly assisted each subsidiary in training and recruiting sale persons as well as organizing marketing events.

 

On April 4, 2012, a wholly-owned, indirect subsidiary, Guangxi Keyuan, was formed for the purpose of developing the Guangxi Project.

 

On June 15, 2012, Keyuan Synthetic Rubbers was established as a wholly-owned PRC subsidiary of Ningbo Keyuan to engage in the production and sales of SBS and SEBS.

 

On May 13, 2014, Zhongkexuneng was incorporated by Sinotech Group owning 75% of Zhongkexuneng and Ningbo Keyuan owning the remaining 25% of Zhongkexuneng. Zhongkexuneng is located in Zhejiang province, China. Zhongkexuneng was formed for the purpose of trading petrochemical products.

 

On September 16, 2015, Ningbo Keyuan and Sinotech Group entered into an investment cooperation agreement with Ningbo Hengyun Energy Technology Co., Ltd (“Hengyun Energy”) (the “Investment Cooperation Agreement”), pursuant to which Sinotech Group agreed to transfer 32.88% of its equity interest in Guangxi Keyuan to Hengyun Energy subject to a payment of consideration of RMB 198,284,300 by Hengyun Energy (approximately $30.5 million) to be made by December 31, 2016. As the date of this report, Hengyun Energy has paid RMB 138,284,300 (approximately $21.7 million).

 

 

The current shareholding structure of the Company is illustrated in the following diagram. The diagram is presented as if Hengyun Energy has already made full payment under the Investment Cooperation Agreement:

 

 

Our Facility and Equipment

 

Facilities

 

During the six months ended June 30, 2016, we have invested a total of approximately $9.8 million in the construction and improvement of our production facility. Our current production facility encompasses approximately 7.2 million square feet, which includes 2.5 million square feet facility in Zhejiang Province and 4.7 million square feet facility in Guangxi Province.

 

Facilities for Petrochemical Products

 

Product		Amount of Production Lines				Location of Facility		2015 Designed Annual Manufacturing  Capacity (MT)				2015 Actual Annual Production (MT)				Utilization Rate
BTX Aromatics			1			Ningbo, Zhejiang			300,000				235,347				78	%
Propylene			1			Ningbo, Zhejiang			50,000				21,713				43	%
Styrene			1			Ningbo, Zhejiang			80,000				65,695				82	%
LPG			1			Ningbo, Zhejiang			100,000				61,366				61	%
MTBE and other chemicals			1			Ningbo, Zhejiang			190,000				118,293				62	%
Total			5			N/A			720,000				502,414				N/A

 

Facilities for Rubber Products

 

Product		Amount of Production Lines				Location of Facility		2015 Designed Annual Manufacturing  Capacity (MT)				2015 Actual Annual Production (MT)				Utilization Rate
SBS			2			Ningbo, Zhejiang			70,000				29,828				43	%
SEBS			1			Ningbo, Zhejiang			10,000				2,355				24	%
Total			3			N/A			80,000				32,183				N/A

 

We have a total of 134,000 MT of storage capacity, consisting of 84,000 MT of storage capacity for raw materials and 50,000 MT for finished products. As a part of our expansion plan, we intend to add additional 16,000 MT of new storage capacity which is now under construction and expected to be completed in the fourth quarter of 2016.

 

We own an on-site ocean shipping dock with 50,000 MT of shipping capacity and a 10-truck loading capacity next to our production facility in Ningbo, China. Approximately 90% of our feedstock and finished products use this shipping dock. We are currently upgrading the classification of our own dock so that we can unload foreign cargo vessels under the 50,000 MT cargo capacity to our dock directly. We expect that the upgrade will be completed by the end of 2017 and we will be able to unload certain cargoes directly rather paying a third party to do so.

 

Our Guangxi Project is located in Fangchengang city, an important port for Guangxi province, and other than Beihai, the only major Chinese port on the Tonkin Gulf. The storage and logistics costs are generally lower in Fanchengang city compared to other ports in China.

 

Equipment 

 

Our major processing equipment includes the following:

 

●

Heavy oil catalytic pyrolysis processing equipment: risers/generators/precipitators, fuel gas boilers, fractionating tower, absorbing, re-absorbing, and desorbing towers, heat exchangers, pumps, and a stabilizing tower;

 

 

●

Gas fractionation processing equipment: de-propanizing tower, refining propylene tower, de-ethanizination tower, heat exchangers, and pumps;

 

●

Ethylbenzene processing equipment: alkylation reactor, anti-alkylation reactor, dehydrogenation reactor, propylene absorbing tower, de-ethylene tower, ethylbenzene recovering tower, heating furnace for benzene, heating furnace for gas, steam overheating furnace, tail gas compressor, and washing tower; and

 

●

Liquefied petroleum gas (LPG) and sulfur recovery processing equipment: LPG desulfurization extraction tower, dry gas desulfurization tower, regenerating tower, and LPG de-mecaptan extraction tower.

 

Our Products

 

We manufacture and supply a variety of petrochemical and rubber products, including petrochemical products such as Benzene Toluene-Xylene Aromatics (“BTX Aromatics”), propylene, styrene, liquid petroleum gas (“LPG”), Methyl Tertiary Butyl Ether (“MTBE”) and rubber products such as SBS and SEBS, each of which is described below, and other products.

 

Petrochemical Products:

 

●

BTX Aromatics: consisting of benzene, toluene, xylene and other chemical components for further processing into plastics, gasoline and solvents materials widely used in paint, ink, construction coating and pesticide.

 

●

Propylene: a chemical intermediate as one of the building blocks for an array of chemical and plastic products that are commonly used to produce polypropylene, acrylonitrile, oxo alcohols, propylene oxide, cumene, isopropyl alcohol, acrylic acid and other chemicals for paints, household detergents, automotive brake fluids, indoor/outdoor carpeting, textile, insulating materials, auto parts and electrical appliances.

 

●

Styrene: a precursor to polystyrene and several copolymers widely used for packaging materials, construction materials, electronic parts, home appliances, household goods, home furnishings, toys, sporting goods and others.

 

●

LPG: a mixture of hydrocarbon gases used as fuel in heating appliances and vehicles. It is also a replacement for chlorofluorocarbons as an aerosol propellant and a refrigerant, which we believe reduces damage to the ozone layer.

 

●

MTBE & Other Chemicals: MTBE, oil slurry, sulphur and others are used for a variety of applications including fuel components, refrigeration systems, fertilizers, insecticides and fungicides.

 

Rubber Products:

 

●

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

 

●

SEBS: Styrene-Ethylene-Butylene-Styrene, a product similar to SBS but we believe with a more durable product feature.

 

In addition, we will start producing ABS once we complete the construction of the facility in Guangxi and the trail production.

 

 

Production Capacity and Expansion

 

Our annual designed manufacturing capacity is 720,000 MT in the aggregate of these products. Our designed capacity for SBS production facility is to 70,000 MT annually and for SEBS production facility is to 10,000 MT annually. Additionally, we have a total of 134,000 MT of storage capacity, consisting of 84,000 MT of storage capacity for raw materials and 50,000 MT for finished products. We also own a dock in Ningbo, China which can directly unload foreign cargo vessels under the 50,000 MT cargo capacity to our dock.

 

All of our facilities, except for the SBS and SEBS facility, have been operating since 2009. Therefore, those older facilities generally provide us with a stable output. While we are continuously working on existing equipment upgrades to increase production, we realize that optimizing the utilization rates for our current facilities is currently not sufficient to meet increasing customer demands. More specifically, increasing market demand for tire and auto parts has resulted in increasing market demand for styrene and ABS; and higher requirements related to environmental protection imposed by the PRC government have led to greater demand for transformer oil and catalytic cracking oil.

 

Based on these market trends, we completed the construction of an oil catalytic cracking processing facility by the end of 2014. It is used as an extension of our catalytic pyrolysis processing equipment. This facility can reduce production costs and the market risk in the purchase of raw materials, and improve the stability and efficiency of project production of heavy oil to 200,000 MT of heavy oil per year.

 

We are currently focused on the following improvements to our infrastructure to expand our manufacturing capacity:

 

	●	Constructing an ABS production facility in Guangxi Province. We completed the technical design of the facility and the equipment at the end of 2015. We are currently arranging the tendering on the construction of the facility and major equipment. We expect to finish construction of the facility and installation of main equipment and pipelines by the end of 2017 and commence production by the end of 2018 with an annual production capacity of 50,000 MT of ABS;
	●	Upgrading our facility for styrene to increase annual design capacity of ethylene-styrene from 80,000 MT to 200,000 MT, of which 120,000 MT can be used for producing synthetic materials and 80,000 MT can be sold to downstream petrochemical companies;
	●	Constructing a transformer oil facility using hydrogen from the ethylene-styrene facility so that we can complete a double hydrogenation process on original products (such as BTX Aromatic) for refining transformer oil and producing high value transformer oil with a design capability of 100,000 MT per year. Construction of the main facility column was completed at the end of October 2013. We are currently performing the assembly and installation and expect to start production by the end of March 2017; and
	●	Adding additional 16,000 MT of new storage capacity which is under construction. We expect to complete the construction at the end of 2016 and start operation in early 2017.

 

The total estimated cost of our expansion plan is approximately $372.5 million, including $300 million for Guangxi Project, $30 million for the transformer oil facility, $40 million for the increased annual design capacity of ethylene-styrene, and $2.5 million for additional storage capacity. Upon completion of our expansion described above, our total production capacity is expected to reach 1,270,000 MT per year comprised of our current petrochemical production of 720,000 MT, SBS of 70,000 MT, SEBS of 10,000 MT, additional styrene of 120,000 MT, catalytic cracking oil of 200,000 MT, ABS of 50,000 MT, and transformer oil of 100,000 MT.

 

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

 

Expansion Project		Expected Completion Date
Ethylene-Styrene Facility		End of Q1, 2017
Transformer Oil Facility		End of Q1, 2017
ABS Production Facility		End of Q4, 2017(1)
New storage capacity of 16,000 MT		End of Q4, 2016

 

(1)	The construction of the ABS facility and installation of main equipment and pipelines is expected to be completed by the end of 2017 and production is expected to be started by the end of 2018.

 

 

Manufacturing and Sales

 

Our total production of finished products was 352,032 MT for the six months ended June 30, 2016, and we generated $185.3 million in revenue based on the sale of 400,334 MT of petrochemical and rubber products. Our total production of finished products was 209,705 MT for the six months ended June 30, 2015 and we generated $164.4 million in revenue based on the sale of 193,042 MT of petrochemical and rubber products.

 

The increase in total production of finished products and revenues during the first half year of 2016 was mainly due to a 85-day production suspension during the first half year of 2015 while there was no production suspension during the first half year of 2016.

 

During the first half year of 2015, operation of Ningbo Keyuan and Keyuan Synthetic Rubbers was suspended for 85 days in connection with continuing depressed oil price in international markets occurring in June 2014 which materially negatively impacted us and our downstream distributors. As a result, we did not have enough capital to satisfy the unsustainable cash demand to maintain operations. We resumed operations in April 2015 when we observed the recovery and stabilization of oil market. During the suspension, we conducted routine maintenance of our facility, which is required every two years and requires a temporary suspension of production. There was no production suspension during the six months ended June 30, 2016. As a result, our total production of finished products for the six months ended June 30, 2016 was increased by 142,327 MT compared to the comparative period in 2015 and revenue for the six months ended June 30, 2016 was increased by approximately $20.9 million compared to the comparative period in 2015.

 

Going Concern and Management’s Plans

 

Due to our continuous efforts in realignment of product profiles and the fact that the petrochemical industry in China has been stabilized since 2015, we reported a net income of approximately $12.7 million and a net loss of approximately $60.5 million for the six months ended June 30, 2016 and the year ended December 31, 2015, respectively. In addition, cash flows provided by operations were approximately $44.3 million for the six months ended June 30, 2016 and cash flows used in operations were approximately $112.5 million for the year ended December 31, 2015, respectively. Nevertheless, at June 30, 2016 and December 31, 2015, we had a working capital deficit of approximately $292.8 million and $284.6 million, respectively.

 

Consequently, there is substantial doubt about our ability to continue as a going concern.

 

We continue to finance and support our operations primarily through short-term bank borrowings. Short-term bank borrowings and notes payable amounted to approximately $659 and $695 million at June 30, 2016 and December 31, 2015, respectively. In addition, we continue to benefit from favorable PRC tax policies related to consumption tax. As of June 30, 2016, we had consumption tax refund receivables of approximately $62.6 million, and as of October 31, 2016, approximately $59.6 million was refunded to us.

 

We are exploring sources of additional financing, including short-term financing from our vendors and other parties and equity financing. In addition, we are closely monitoring its cash balances, cash needs and expense levels. In addition, we are currently contemplating our options to reduce our costs, including one option to "go dark." If we decide to undertake this, and if it is successful, we expect that our legal, accounting and certain other expenses that we currently incur as a result of being a public company may be reduced.

 

Our ability to continue as a going concern is dependent upon management’s ability to implement our expansion plan - particularly Guangxi project - to increase our production capacity, obtain additional capital and generate net income and positive cash flows from operations. There can be no assurance that these plans will be sufficient or that additional financing will be available in amounts or terms acceptable to us, if at all. 

  

 

Results of Operations

 

The following table sets forth information from our statements of operations and comprehensive income (loss) for the three and six months ended June 30, 2016 and 2015.

 

Comparison of the three and six months ended June 30, 2016 and 2015 (in thousands)

 

		For the three months								Year to Year Comparison								For the six months								Year to Year Comparison
		Ended June 30,								Increase				Percentage				Ended June 30,								Increase				Percentage
		2016				2015				/(Decrease)				change				2016				2015				/ (Decrease)				change
		(unaudited)				(unaudited)												(unaudited)				(unaudited)
Sales		$	99,003				106,122				(7,119	)			(6.7	)%			185,342				164,404				20,938				12.7	%
Cost of sales			78,115				86,144				(8,029	)			(9.3	)%			152,199				164,987				(12,788	)			(7.8	)%
Gross profit (loss)			20,888				19,978				910				4.6	%			33,143				(583	)			33,726				5784.9	%
Operating expenses
Selling expenses			769				176				593				336.9	%			1,658				410				1,248				304.4	%
General and administrative expenses			2,614				5,725				(3,111	)			(54.3	)%			6,644				10,367				(3,723	)			(35.9	)%
Total operating expenses			3,383				5,901				(2,518	)			(42.7	)%			8,302				10,777				(2,475	)			(23.0	)%
Income (loss) from operations			17,505				14,077				3,428				24.4	%			24,841				(11,360	)			36,201				318.7	%
Other income (expenses):
Interest income:			860				3,652				(2,792	)			(76.5	)%			2,835				6,977				(4,142	)			(59.4	)%
Interest expense			(4,198	)			(11,843	)			7,645				64.6	%			(10,598	)			(20,191	)			9,593				47.5	%
Foreign exchange gain (loss), net			2,581				4,165				(1,584	)			(38.0	)%			1,247				(5,243	)			6,490				123.8	%
Other expense, net			(52	)			(544	)			492				90.4	%			(204	)			(8,601	)			8,397				97.6	%
Total other expenses, net			(809	)			(4,570	)			3,761				82.3	%			(6,720	)			(27,058	)			20,338				75.2	%
Income (loss) before income taxes			16,696				9,507				7,189				75.6	%			18,121				(38,418	)			56,539				147.2	%
Income tax expense			4,468				69				4,399				6375.4	%			5,464				1				5,463				546300	%
Net Income (Loss)			12,228				9,438				2,790				29.6	%			12,657				(38,419	)			51,076				132.9	%
Other comprehensive (loss) income
Foreign currency translation adjustment			(5,056	)			479				(5,535	)			1155.5	%			(5,301	)			-				(5,301	)			-	%
Comprehensive income (loss)		$	7,172			$	9,917			$	(2,745	)			27.7	%		$	7,356			$	(38,419	)		$	45,775				119.1	%

 

 

Sales: Our sales for the three months ended June 30, 2016 were approximately $99.0 million compared to $106.1 million for the three months ended June 30, 2015, a decrease of $7.1 million, or 6.7%. The decrease was mainly due to the average unit sale price decreased by about $75/MT (RMB500/MT) compared to the same period in 2015 as the result of the management’s strategy to attract customers by lower sale price, which partially offset by the 10-day production suspension in the second quarter of 2015.

 

Sales for the six months ended June 30, 2016 were approximately $185.3 million compared to $164.4 million for the six months ended June 30, 2015, an increase of $20.9 million, or 12.7%. We incurred an 85-day production interruption responding to less market demands in the first and second quarter of 2015. There was no production interruption during the same period in 2016.

 

Cost of Sales: Our overall cost of sales was approximately $78.1 million for the three months ended June 30, 2016, or 78.9% of sales, compared to approximately $86.1 million, or 81.1% of sales for the three months ended June 30, 2015. Our cost of sales is primarily composed of the costs of direct raw materials (mainly heavy oil, benzene, butadiene and carbinol), labor, depreciation and amortization of manufacturing equipment and facilities, and other overhead. The decrease in the cost of sales for the three months ended June 30, 2016 compared to same period in 2015 was mainly due to the decrease in the sales during the three months ended June 30, 2016.

 

Our overall cost of sales was approximately $152.2 million for the six months ended June 30, 2016, or 82.1% of sales, compared to approximately $165.0 million, or 100.4% of sales for the six months ended June 30, 2015. The decrease in the cost of sales for the six months ended June 30, 2016 compared to the same period in 2015 was mainly due to the decrease in average purchase price of raw materials due to the stabilization of international crude oil market in the first half year of 2016 comparing to same period in 2015.

 

Energy required for production of our products consists of water, electricity and steam, the costs of which are attributed to cost of sales rather than operating expense. The supply prices of these energy sources in China have historically been very stable as a result of PRC government policy. Accordingly, the potential impact of changing energy costs to our production is minimal. The following are the costs for water, electricity and stream for the three and six months ended June 30, 2016 and 2015 (amounts in thousands):

 

		For the Three Months Ended June 30,								For the Six Months Ended June 30,
		2016 (Unaudited)				2015 (Unaudited)				2016 (Unaudited)				2015 (Unaudited)
Water			447				209				834				386
Electricity			2,902				3,048				6,089				5,508
Steam			1,699				1,179				3,120				2,444

 

Total energy cost was approximately $5.0 million for the three months ended June 30, 2016, which constitutes approximately 5.1% of sales. Total energy cost was approximately $4.4 million for the three months ended June 30, 2015, which constitutes approximately 4.2% of sales.

 

Total energy cost was approximately $10.0 million for the six months ended June 30, 2016, which constitutes approximately 5.4% of sales. Total energy cost was approximately $8.3 million for the six months ended June 30, 2015, which constitutes approximately 5.0% of sales.

 

Gross Profit (loss): Gross profit for the three months ended June 30, 2016 was approximately $20.9 million compared to a gross profit of $20.0 million for the three months ended June 30, 2015, representing an increase of approximately $0.9 million, or 4.6%, which we believe was not significant.

 

 

Gross profit for the six months ended June 30, 2016 was approximately $33.1 million compared to a gross loss of $0.6 million for the comparative period in 2015, representing an increase of $33.7 million, or 5,784.9%. Our total gross margin increased from negative 0.4% for the six months ended June 30, 2015 to 17.9% for the six months ended June 30, 2016.  The main reason for the increase is that we had a 85-day production suspension during the first six months in 2015 and the sale prices of our products were negatively impacted by the depressed international crude market during the six months ended June 30, 2015.

 

Operating Expenses:  Our operating expenses include selling expenses, and general and administrative expenses. Operating expenses were approximately $3.4 million or 3.4% of sales for the three months ended June 30, 2016 compared to $5.9 million or 5.6% of sales for the comparative period in 2015, a decrease of $2.5 million or 42.7%. The decrease was mainly because we incurred only $19,000 bad debt expense during the three months ended June 30, 2016 while we had accrued bad debt expense of approximately $3.5 million during the three months ended June 30, 2015, offset by an increase of $0.2 million in consulting expenses during the three months ended June 30, 2016.

 

Operating expenses were approximately $8.3 million or 4.5% of sales for the six months ended June 30, 2016 compared to $10.8 million or 6.6% of sales for the comparative period in 2015, a decrease of $2.5 million or 23.0%. The decrease was mainly because we incurred only $31,000 bad debt expense during the six months ended June 30, 2016 while we had the accrued bad debt expense of approximately $6.0 million during the same period in 2015, offset by an increase of $0.5 million in consulting expenses during the six months ended June 30, 2016.

 

Interest Income/Expense: For the three months ended June 30, 2016, interest income and interest expense were approximately $0.9 million and $4.2 million, respectively, compared to interest income and interest expense of approximately $3.7 million and $11.8 million, respectively, for the same period in 2015. The decrease in interest income was mainly due to decreased deposits as collateral for bank loans and the decrease in interest expense was mainly due to decreased borrowings during the three months ended June 30, 2016.

 

For the six months ended June 30, 2016, interest income and interest expense were approximately $2.8 million and $10.6 million, respectively, compared to interest income and interest expense of approximately $7.0 million and $20.2 million, respectively, for the same period in 2015. The decrease in interest income was mainly due to the decreased deposits as collateral for bank loans and the decrease in interest expense was mainly due to decreased borrowings during the six months ended June 30, 2016.

 

Net Income/(Loss): Net income was approximately $12.2 million for the three months ended June 30, 2016 compared to net income of approximately $9.4 million for the same period in 2015, representing an increase of $2.8 million or 29.6%. This increase was mainly due to a combination of increased gross profit, decreased operating expenses and decreased interest expense for the three months ended June 30, 2016 compared to the same period in 2015.

 

Net income was approximately $12.7 million for the six months ended June 30, 2016 compared to a net loss of approximately $38.4 million for the same period in 2015, representing an increase of $51.1 million or 132.9%. This increase was primarily due to the increase in gross profit and the decrease of interest expense during the six months ended June 30, 2016 compared to the same period in 2015.

 

Foreign Currency Translation Adjustment: Our reporting currency is the U.S. dollar. Our local currency, RMB, is our functional currency. Results of operations and cash flow are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by the People’s Bank of China at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of shareholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.

 

Currency translation adjustments resulting from this process are included in accumulated other comprehensive loss and amounted to $5.1 million and $5.3 million for the three and six months ended June 30, 2016, respectively. The balance sheet amounts at June 30, 2016 and December 31, 2015, with the exception of equity, were translated at RMB 6.6312 and RMB 6.1275 to 1.00 U.S. dollar, respectively. The equity accounts were translated at their historical rates. The average translation rates applied to income statement accounts for the three months ended June 30, 2016 and 2015 were RMB 6.5285 and RMB 6.1200, respectively, and the six months ended June 30, 2016 and 2015 were RMB 6.5282 and RMB 6.1284, respectively, to 1.00 U.S. dollar.

  

 

Liquidity and Capital Resources

 

The following table sets forth a summary of our cash flows for the periods indicated:

 

		For The Six Months Ended June 30,
		2016 (Unaudited)				2015 (Unaudited)
Net cash provided by (used in) operating activities			44,290				(78,391	)
Net cash used in investing activities			(14,275	)			(2,271	)
Net cash provided by financing activities			6,011				100,410

 

Net cash provided by operating activities was approximately $44.3 million for the six months ended June 30, 2016 compared to net cash used in operating activities of approximately $78.4 million for the same period in 2015, representing an increase of $122.7 million or 156%. The reason for the change is primarily due to a combination of increased net income, increased accounts payable and increased advances from customers during the six months ended June 30, 2016 compared to the comparative period in 2015.

 

Net cash used in investing activities was approximately $14.3 million and $2.3 million for the six months ended June 30, 2016 and 2015, respectively. The increase in net cash used in investing activities is primarily due to our increased investments of $9.8 million in the construction of our infrastructures and facilities in accordance with our expansion plan. 

 

Net cash provided by financing activities amounted to approximately $6.0 million for the six months ended June 30, 2016 compared with approximately $100.4 million for the same period in 2015. For the six months ended June 30, 2016, net cash provided by financing activities was primarily through bank borrowings. The decrease resulted primarily from decreases in bank borrowing during the six months ended June 30, 2016 compared to the same period in 2015.

 

There is substantial doubt about the Group’s ability to continue as a going concern. The Group continued to finance and support its operations primarily through short-term bank borrowings. Short-term bank borrowings and notes payable amounted to approximately $659 and $695 million at June 30, 2016 and December 31, 2015, respectively. In addition, the Group continued to benefit from favorable PRC tax policies related to consumption tax. As of June 30, 2016, the Group had consumption tax refund receivables of approximately $62.6 million, and as of October 31, 2016, approximately $59.6 million was refunded to us.

 

The Group is exploring sources of additional financing, including short-term financing from its vendors and other parties and equity financing. In addition, the Group closely monitored its cash balances, cash needs and expense levels.

 

Consumption Tax Refund

 

The PRC government enacted a regulation pursuant to which domestically purchased heavy oil to be used for producing ethylene and aromatics products was exempted from consumption tax. In addition, the consumption tax paid for imported heavy oil is to be refunded if it is used for producing ethylene and aromatics products. Given all the Group’s purchased heavy oils are, or are to be, used for producing ethylene and aromatics products, the Group recognizes a consumption tax recoverable when a consumption tax for heavy oils has been paid and the relevant heavy oils have been used for production of ethylene and aromatics products. At June 30, 2016 and December 31, 2015, the Group recorded an estimated consumption tax recoverable amounting to approximately $62.6 million and $44.4 million, respectively. As of October 31, 2016, approximately $59.6 million was refunded to the Group.

  

Bank Loans

 

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

 

We have entered into short-term loan agreements with our primary lenders such as Bank of China, China Construction Bank and Agricultural Bank of China. As of June 30, 2016, we had an aggregate outstanding principal of approximately $317.5 million in bank loans under the loan agreements, with maturity dates from July 2016 to June 2017 and interest rates from 1.8% to 5.7% per annum. The loan agreements were mainly guaranteed by third parties and individual persons or secured by a lien on our property and equipment. Historically, all debts due have been paid back by us in a timely manner. All short-term bank loans are revolving loans, and the lenders generally agree to extend the loans upon maturity if we request. As the date of this Form 10-Q, we have timely repaid or renewed all short-term bank loans. As such, we expect that outstanding bank loans will be extended if not paid back upon maturity. Depending on our capital needs, we evaluate whether to apply for additional long-term bank loans. We currently have sufficient lines of credit with our primary lenders for both short-term and long-term borrowings for our operations. However, we estimate the total cost of the expansion will be $372.5 million. We plan to fund the expansion through debt financing, cash from operations, and potential equity financing. However, we may not be able to obtain additional financing at acceptable terms, or at all, and, as a result, our ability to increase our production capacity and to expand our business could be adversely affected.

 

  

Related Party Transactions

 

During the three months ended June 30, 2016, Mr. Chunfeng Tao, the Chairman of our Board of Directors and controlling shareholder, provided personal guarantees to our bank loans in a total amount of $5 million. In addition, as of June 30, 2016, Mr. Tao provided personal guarantees in a total amount of $135.7 million.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Not applicable to smaller reporting companies.

 

ITEM 4. CONTROLS AND PROCEDURES.

 

(a)      Disclosure Controls and Procedures

 

Disclosure controls are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this Form 10-Q, is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. We performed an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer has concluded that, as of June 30, 2016, our disclosure controls and procedures were not effective to ensure that information required to be disclosed in reports filed under the Exchange Act is recorded, processed, summarized and reported properly within the time periods specified by the SEC, and did not provide reasonable assurance that information required to be disclosed by us in such reports would be accumulated and communicated to our management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

  

(b)            Changes in Internal Control over Financial Reporting

In connection with the preparation of our financial statements for the fiscal year ended December 31, 2015 and 2014, the management determined that our internal control environment is not properly designed due to the existence of certain material weaknesses and that it did not operate effectively to ensure that our financial statements (and related financial statement disclosures) were prepared in accordance with US generally accepted accounting principles. We have established a number of remediation measures, which we believe will remediate the material weaknesses identified, if such measures are effectively implemented and maintained, however, we cannot assure when or if we will be able to successfully implement these remedial measures. For more information regarding our controls and procedures, please refer to Item 9A. Controls and Procedures in the Form 10-K.

 

There were no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter covered by this report that has materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

PART II - OTHER INFORMATION

 

ITEM 1.   LEGAL PROCEEDINGS.

 

We may from time to time become a party to various legal or administrative proceedings arising in the ordinary course of our business.

 

In 2014, Jiujiang Jianan Petrochemicals Engineering Co., Ltd. (“Jiujiang Jianan”) filed a suit against Ningbo Keyuan in the Beilun District People’s Court. Jiujiang Jianan and Ningbo Keyuan are parties to certain service contract pursuant to which Jiujiang Jianan performed maintenance to Ningbo Keyuan’s production equipment. Jiujiang Jianan claimed it had provided additional services and thus was entitled to additional service fee from Ningbo Keyuan. On July 27, 2016, the Beilun District People’s Court issued a judgment that Ningbo Keyuan should pay construction fee of RMB 9.0 million (approximately $1.4 million) plus an interest of RMB 0.8 million (approximately $0.1 million) to Jiujiang Jianan. Ningbo Keyuan appealed to the Ningbo City Intermediate People’s Court on August 8, 2016. The case is currently under the review by the Ningbo Intermediate People’s Court.

 

In May 2015, Taihua Plastic (Ningbo) Co., Ltd (“Taihua”) filed a complaint against Ningbo Keyuan and Zhongkexuneng in the Ningbo Intermediate People’s Court. Pursuant to a sale agreement between Taihua and Zhongkexuneng, Taihua made a payment of approximately RMB 29.7 million (approximately $4.8 million) to Zhongkexuneng for styrene. Taihua claimed damages in the amount of RMB 29.7 million, along with interest of RMB 0.8 million (approximately $0.1 million) and deductible value added tax of RMB 4.7 million (approximately US$0.7 million). On June 24, 2016, the Ningbo Intermediate People’s Court ruled that Zhongkexuneng should return the payment of RMB 29.7 million (approximately $4.8 million) to Taihua, plus the interest; and Ningbo Keyuan should be jointly liable to such payment as a shareholder of Taihua. Ningbo Keyuan appealed to the Zhejiang Higher People’s Court on July 11, 2016 claiming of its limited liability as a shareholder of a corporation. The case is currently under the trial.

 

On March 25, 2016, the Sixth Chemical Engineering Construction Co., Ltd (the “Sixth”) brought a suit against Ningbo Keyuan in the Beilun District People’s Court. The Sixth was a contractor who was supposed to build one of Ningbo Keyuan facilities. Completion of the construction was delayed for several months by the Sixth resulting in our loss of approximately RMB 30.4 million (approximately $4.7 million). The Sixth claimed that Ningo Keyuan owed a remaining contractual payment of RMB 24.8 million (approximately $3.8 million) plus the penalties of breach of the contract. In July 2016, Ningbo Keyuan filed a counter claim alleging that the Sixth had breached the contract by delaying the completion of the construction and requesting a total compensation of RMB 30.4 million (approximately $4.7 million) from the Sixth. A hearing is to be scheduled by the Beilun District People’s Court.

 

In July 2016, Mr. Zongdong Hu filed a labor dispute in Beilun District Ningbo City Labor Arbitration Department claiming a compensation of RMB 0.5 million (approximately $0.08 million). Mr. Hu was a former vice general engineer at Ningbo Keyuan. Ningbo Keyuan decided not to grant Mr. Hu certain amount of cash reward based on the evaluation of his performance in accordance with his employment agreement. Mr. Hu disagrees with our decision. The arbitration is currently pending.

 

Other than as set forth herein, we are currently not a party to any material legal or administrative proceedings and are not aware of any pending or threatened legal or administrative proceedings against us.

 

ITEM 1A. RISK FACTORS.

 

Not applicable to smaller reporting companies.

  

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

 

(a)           As reported in our current report on Form 8-K filed on August 8, 2016, we entered into a side agreement with Delight Reward on August 4, 2016, pursuant to which, Delight Reward agreed to pay us for each convertible share of Common Stock underlying 5,333,340 Series B preferred shares $0.005 per share of Common Stock, for an aggregate purchase price of $27,465.01. We intend to use the proceeds as general capital for the Company.

 

(b)          Not Applicable.

 

(c)          None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

(a)           Not Applicable.

 

(b)           Not Applicable.

 

ITEM 4.  MINE SAFETY DISCLOSURES.

 

Not applicable.

 

ITEM 5. OTHER INFORMATION.

 

(a)           Not applicable.

 

(b)           Not applicable.

 

ITEM 6.  EXHIBITS.

 

(a)          The following exhibits are filed as part of this report.

 

31.1 *		Certification of Chief Executive Officer and Chief Financial Officer required by Rule 13a-14/15d-14(a) under the Exchange Act
32.1 *		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS *		XBRL Instance Document
101.SCH*		XBRL Taxonomy Extension Schema Document
101.CAL*		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*		XBRL Taxonomy Extension Label Linkbase Document
101.PRE*		XBRL Taxonomy Extension Presentation Linkbase Document

 

* Filed herewith.  

 

 

SIGNATURES

 

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Date:  November 7, 2016	Keyuan Petrochemicals, Inc.
	By:	/s/ Feng Chen
		Feng Chen
		Chief Executive Officer,  Chief Financial Officer and Vice President of Accounting

 

 

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