Corporate History
Asia Carbon Industries, Inc. (the "Company" or “we”) was incorporated in the State of Maryland on June 23, 2008. Through the steps described below, we became the indirect holding company for Taiyuan Hongxing Carbon Black, Ltd. ("Hongxing"), a manufacturer of carbon black products in the People's Republic of China ("PRC"), on December 29, 2009.
On November 10, 2008, we formed Jinzheng Liteweisi Carbon (Taiyuan) Co., Ltd. (“Liteweisi”) as our wholly-owned subsidiary and a "wholly foreign-owned enterprise" in the PRC.
The laws of the PRC place restrictions on round trip investments, which are defined under PRC law as an acquisition of a PRC entity by an offshore special purpose vehicle owned by one or more PRC residents. To comply with these restrictions, on December 29, 2009, we, through Liteweisi, entered into Entrusted Management, Exclusive Option, Exclusive Purchase, Pledge of Equity and Shareholders’ Voting Proxy Agreements (collectively, the “Entrusted Agreements”) with Hongxing and shareholders of Hongxing, Guoyun Yao and Chunde Meng (the “Hongxing Shareholders”). Asia Carbon issued 36,239,394 restricted shares of its common stock to Karen Prudente, nominee and trustee for the Hongxing Shareholders, for Hongxing and the Hongxing Shareholders entering into the Entrusted Agreements. Karen Prudente’s role with respect to the restricted shares held by the Hongxing Shareholders is to manage the trust of the Hongxing Shareholders. These restricted shares issued to Karen Prudente were issued in reliance upon the exemptions set forth in Section 4(2) of the Securities Act of 1933, as amended, on the basis that they were issued under circumstances not involving a public offering. As a result of the aforementioned transaction, the Hongxing Shareholders obtained control of the Company. Subsequently, on April 17, 2012, the Hongxing Shareholders exercised options to purchase 32,615,455 shares as conditions for the exercise met.
Generally, we provide Hongxing with technology consulting and management services pursuant to the Entrusted Agreements, the material terms are as follows:
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Entrusted Management Agreement –
pursuant to this agreement entered into by and among the Hongxing Shareholders, Hongxing, and Liteweisi, the Hongxing Shareholders and Hongxing entrust the management of Hongxing to Liteweisi until (a) the winding up of Hongxing, (b) the termination date of the agreement as determined by the parties, or (c) the date on which Liteweisi acquires Hongxing. During the term, Liteweisi is fully and exclusively responsible for the management of Hongxing. In consideration of such services, the Hongxing Shareholders and Hongxing will pay a fee to Liteweisi as set forth in the agreement.
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Exclusive Option Agreement –
pursuant to this agreement entered into by and among Liteweisi, the Hongxing Shareholders, and Hongxing, the Hongxing Shareholders grant Liteweisi an irrevocable exclusive purchase option to purchase all or part of the shares of Hongxing, currently owned by any of the Hongxing Shareholders. Further, Hongxing grants Liteweisi an irrevocable exclusive purchase option to purchase all or part of the assets and business of Hongxing. Liteweisi and the Hongxing Shareholders will enter into relevant agreements regarding the price of acquisition based on the circumstances of the exercise of the option, and the consideration shall be refunded to Liteweisi or Hongxing at no consideration in an appropriate manner decided by Liteweisi. Upon the exercise of the option, Liteweisi will be subject to non-competition restrictions as set forth in the agreement.
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Exclusive Purchase Agreement
– pursuant to this agreement entered into by and among Liteweisi and Hongxing, Hongxing grants to Liteweisi the sole and exclusive right of purchasing all the products produced and manufactured by Hongxing at a price which is equal to the total cost of the products subject to adjustments by the parties’ mutual written agreement.
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Pledge of Equity Agreement
–pursuant to this agreement entered into by and among the Hongxing Shareholders (as Pledgors), and Liteweisi (as Pledgee), the equity interest of the Hongxing Shareholders is pledged to guarantee all of the rights and interest Liteweisi is entitled to under the Entrusted Management Agreement, the Exclusive Option Agreement, and the Shareholders’ Voting Proxy Agreement. The Hongxing Shareholders pledge, by way of a first priority pledge, all of its rights, title and interest in (i) 100% of the equity interest in Hongxing, (ii) 100% of the registered capital of Hongxing, (iii) all investment certificates and other documents in respect of the registered capital of Hongxing, (iv) all money, dividends, interest and benefits at any time arising in respect of all the equity interest and registered capital of Hongxing, and (v) all voting rights and all other rights and benefits attaching to or accruing to the equity interest of the registered capital of Hongxing to Liteweisi.
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Shareholders’ Voting Proxy Agreement
– pursuant to this agreement entered into by and among the Hongxing Shareholders and Liteweisi, the Hongxing Shareholders irrevocably appoint the persons designated by Liteweisi with the exclusive right to exercise, on their behalf, all of their voting rights of Hongxing. The persons designated by Liteweisi shall be the full board of directors of Liteweisi.
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When we sell our equity or borrow funds we expect the proceeds will be forwarded to Hongxing and accounted for as a loan to Hongxing and eliminated during consolidation. We may also use the proceeds to repurchase our capital stock or for our corporate overhead expenses. If we borrow funds we expect to be the primary obligor on any debt. For example, in April 2010 we raised $1,368,464, and in May 2010, we raised $1,667,984 in two private placements from certain non-affiliated accredited investors in a private placement of our common stock. Net proceeds after our expenses were provided to Hongxing through Liteweisi.
The Entrusted Agreements empowered Asia Carbon, through Liteweisi, the ability to substantially influence Hongxing’s daily operations and financial affairs, appoint its senior executives and approve all matters requiring shareholders’ approval. As a result of these Entrusted Agreements, which obligates Asia Carbon to absorb a majority of the risk of loss from Hongxing’s activities and enable Asia Carbon to receive a majority of its expected residual returns, Asia Carbon, through its wholly-owned subsidiaries, accounts for Hongxing as its Variable Interest Entity (“VIE”) under ASC 810-10. Accordingly, Asia Carbon consolidates Hongxing’s operating results, assets and liabilities.
By causing our subsidiary Liteweisi to enter into the Entrusted Agreements, we obtained substantially the same result as a direct share exchange, which is to permit us to consolidate the financial results of Hongxing as our VIE.
The following diagram sets forth the corporate structure of the Company as of December 31, 2012:
Neither Asia Carbon nor Liteweisi has any operations or plans to have any operations in the future other than acting as a holding and management company for Hongxing and raising capital for its operations. However, we reserve the right to change our operating plans regarding Asia Carbon and Liteweisi.
History of Hongxing
Hongxing, the primary entity through which we operate our business, was formed on December 4, 2003 as a limited liability company under the laws of the PRC, under the approval of Shanxi Development and Reform Commission. In December 2009, Hongxing and Liteweisi, a wholly-owned subsidiary of Asia Carbon, entered into a number of contractual agreements by which Liteweisi was entrusted to manage and operate Hongxing. These contractual agreements, described in further detail above, also provide for the consolidation of the financial statements of Asia Carbon, Liteweisi, and Hongxing.
Business of Hongxing
We are a holding company that, through our wholly-owned subsidiary Liteweisi and our variable interest entity ("VIE") Hongxing, manufactures in the PRC a series of high quality carbon black products under the brand name “Great Double Star.”
According to Company research, we are one of the top ten carbon black producers in Shanxi Province in China and have relationships with a high-profile customer base. Revenue for 2012 was $45.9 million, a decrease of $3.2 million, or 7%, compared to revenue in 2011. In 2011, we reported revenues of $49.1 million, a 65% increase over 2010, and $7.3 million in net income, a 123% increase compared to 2010.
Carbon black is a deep black powder with a number of applications. Derived from the controlled combustion of coal tar or residual oil feedstock, carbon black’s desirable chemical properties make it a critical raw material for many industries. It is widely used within the rubber industry as reinforcing filler; the paint and coating industry use carbon black as coloring agent and it is used in batteries as a conductive agent. Carbon black is used predominately by the automotive tire industry, where it can improve rubber’s strength, wear resistance, and life span, and thus lower the overall cost of tire products.
Hongxing manufactures carbon black through wet method production. In 2010, the Company directed resources to converting one of its existing lines into a wet method production line to produce better quality, lower cost, and more environmentally friendly carbon black. The wet line commenced full operation in the fourth quarter of 2010.
In June 2012, Hongxing began construction on a 3000 KW power plant, which was completed and commenced its testing in January 2013. Utilizing residual exhaust gas generated from Hongxing’s carbon black manufacturing process, the plant’s 3000 KW capacity is expected to satisfy Hongxing’s electricity needs for current production lines.
In September 2012 Hongxing decided to renovate and convert its three dry production lines to specialty carbon black production lines. Specialty carbon black has a broader range of use as compared to the more traditional products including use as a pigmenting agent, UV stabilizer or conductive agent in a variety of products, such as plastics, toners and printing ink and coating, battery and electrical parts. The management believes the specialty carbon black to be produced at the new facilities will potentially generate more revenues as a result of the higher sales prices. The conversion commenced in October 2012. As the three dry production lines ceased operations during the conversion period, Hongxing’s fourth quarter of 2012 and annual operations results were negatively affected. The project has been and will be funded by cash from operations. Management expects the project to be completed at the end of June 2013. The total estimated cost is approximately $4 million.
Industry Overview
While growth in worldwide demand may slow down, it is anticipated that China’s domestic demand will continue to bolster a healthy rubber market.
China is the world’s second largest producer of carbon black. According to the latest available report, a 2008 report by Dong Fang Securities, a national and comprehensive securities company in China that provides services like security underwriting, brokerage, investment consulting, and financial advising, the rubber industry accounts for 89.5% of worldwide carbon black consumption, 67.5% of which is used for tire manufacturing and 9.5% is for other rubber car parts (such as fan belts, bumpers, etc.). Other rubber industries account for 12.5%. The remaining 10.5% is used in other non-rubber industries like ink, coating, plastic, etc.
It is management’s belief based on industry experience that modern carbon black products are an adaption of early "lamp blacks," first produced in China over 3,500 years ago, when printers used the soot generated from burning oil in lamps to make ink. The technology did not change much until advances in the twentieth century facilitated cost-effective mass production. Today, carbon black is primarily produced from "sour" gas (natural gas that contains hydrogen sulfide or sulfur) and coal tar (one of the by-products formed when coal is carbonized to make coke or gasified to make coal gas).
It is our belief based on industry experience that the “dry” granulation method was traditionally used to produce carbon black. While this method is efficient, it has drawbacks. In its initial form, carbon black is a fluffy, black powder, which is difficult to handle and easily released into the atmosphere where it can be breathed in by workers. Without proper ventilation and worker protection, this can be a health hazard. Carbon black dust can also get into small, even closed spaces, such as electrical boxes, making it difficult to keep the work area clean.
It is also our belief based on industry experience that carbon black supplies were initially produced largely in the United States ("US"), predominately in oil producing areas such as Texas. However, as environmental and employee health concerns grew, production in the US decreased substantially. The shortfall was made up for in countries like China, where regulations are less stringent and labor is more accessible and less expensive. Today, these countries account for the majority of global production.
Over time, efforts to improve the overall manufacturing process resulted in the development of a “wet” granulation production method. This wet process virtually eliminates the carbon dust and provides additional benefits. Wet manufacturing lowers the cost of producing carbon black, leaves a smaller environmental footprint, and yields a final product that is denser and more durable. As a result, longer lasting end products are produced. The Company is converting all its existing lines from dry granulation to the wet production method.
Carbon Black Industry in China
According to China’s Carbon Black Association, the only national organization in the carbon black industry in China whose mandate is to assist the government to supervise the industry, conduct industry research and statistics, and to publish such research findings, and whose data are widely used and regarded as authoritative, of which Hongxing is a member, indicated that in 2007, the aggregate net revenue for its 39 members was $485 million, a 55.87% increase as compared to 2006. Sales volume for 2007 was 1.78 million tons, an increase of 31.17% compared to 2006. As a whole, China’s carbon black production capacity continues to grow; in 2008, the total output of carbon black in China reached 2.43 million tons, a 5.65% increase of 2.3 million tons from the total output in 2007. In 2009, the total output of carbon black reached 2.83 million tons. The total output of carbon black was approximately 3.76 million tons, 3.85 million tons and 3.25 million tons, in 2012, 2011 and 2010, respectively.
There are several factors affecting China’s carbon black market. The following is an overview of the key issues.
The total output of carbon black is in surplus, but the availability of high-quality and wet-granulation carbon black varieties for radial tire production is still insufficient to meet demand. In China, tire manufacturing accounts for more than 80% of total carbon black consumption. According to the China Association of Automobile Manufacturers, a self-regulatory and non-for-profit organization for auto manufacturers, spare part manufacturers and related industries approved by the Ministry of Civil Affairs of China, auto sales were 19.27 million, 18.50 million, 18.00 million and 13.64 million in 2012, 2011, 2010 and 2009, respectively, making China the largest auto market in the world. In the next few years, it is also expected that more and more global tire manufacturers will shift their production base to China.
To accelerate the industrial restructuring, and prevent redundant low-level construction and environmental pollution, the PRC strengthened its regulation over the carbon black industry in June 2002, issuing "The Directory of the Elimination of Outdated Production Capacity, Processes and Products." According to the Directory, any dry granulation device with annual production capacity of less than or equal to 10,000 tons of carbon black was to be eliminated. This decree resulted in more than 70 small-scale carbon black manufacturing companies withdrawing from the market due to outdated technology. As the market of carbon black intensifies, small-scale and poor performing enterprises will be eliminated. The China market favors large enterprises with great production capacity and modern technology.
It is management’s belief based on industry experience that China’s Eleventh Five-year Plan (2006-2010) with respect to the carbon black industry targets the development and production of high-quality and high-grade varieties for radial tires, especially for "green" high performance tires and tires with low rolling-resistance. As demand for conventional carbon black varieties for basic tires and other downstream sectors decreases, the Five-Year Plan encourages the carbon black sector to make greater effort in technical innovation and product development to satisfy the demand in the tire market.
While benefiting companies such as Hongxing, with the capability and resources to heed these government initiatives, such directives also serve as barriers to entry for new firms who must secure construction and environmental permits; many new projects have been rejected due to deviation from environmental protection standards. In recent years, China’s carbon black companies have made great strides to achieve energy conservation and emission reduction.
Properties of Carbon Black
The main three properties of carbon black are:
Particle Size
The diameter of spherical particles is the fundamental property which largely affects blackness and dispersibility when carbon black is mixed with resins or other vehicles. In general, the smaller the particle size is, the higher the blackness of carbon black becomes. Dispersion, however, becomes difficult due to an increase in coagulation force.
Structure
Like particle size, the size of the structure also affects the blackness and dispersibility of carbon black. Generally, the increase of structure size improves dispersibility but lowers blackness. Carbon black with a larger structure in particular shows an excellent conductive property.
Surface Chemistry
Various functional groups exist on carbon black’s surface. The affinity of carbon black with inks or paint varnishes changes depending on the type and amount of the functional groups.
Carbon black, with a large amount of hydroxyl group given with oxidation treatment, has a greatly enhanced affinity to print inks or varnishes, showing an excellent dispersibility.
Production of Carbon Black
Carbon black is produced with the thermal decomposition method or the partial combustion method using hydrocarbons such as oil or natural gas as raw material.
The characteristics of carbon black vary depending on manufacturing process, and therefore carbon black is classified by manufacturing process. Carbon black produced with the furnace or “dry” process, which was traditionally used, is called “furnace black,” distinguishing it from carbon black, which is manufactured with other processes.
The Company’s three production lines use the dry granulation method to produce carbon black. This method forms carbon black by blowing petroleum oil or coal oil as raw material (feedstock oil) into high-temperature gases to combust them partially. This method is suitable for mass production due to its high yield, and allows wide control over its properties such as particle size or structure. This is currently the most common method used for manufacturing carbon black for various applications from rubber reinforcement to coloring.
While this is efficient, a significant amount of carbon dust is generated. It is this dust which causes health and environmental concerns. The “wet” granulation lines that Hongxing completed on October 26, 2010, provide a number of significant benefits, including gas comprehensive utilization, lowering black carbon production cost, reducing environmental pollution, increasing black carbon product quality, and increased varieties of black carbon. The wet line has an annual capacity of 25,000 tons of carbon black. The Company is in the process of converting the rest three dry production lines to wet specialty carbon black production lines.
Products
The Company currently manufactures two “hard” and one “soft” carbon black products, called N220, N330 and N660, respectively. N220 hard carbon black, which has good strength and elongation properties, is mainly used in the manufacturing of automobile tires. The N330 hard carbon black has a lower production cost and is mainly used in manufacturing sides of automobile tires. The Company’s “soft” product N660, is a soft carbon black which has the flexibility necessary for the production of automobile tire inner tubes and hoses.
The demand for hard carbon black is significantly higher than the demand for the soft carbon black.
At the end of 2012, the market price of dry N220 hard carbon black was $919 per ton, of wet N220 hard carbon black was $933 per ton, of N330 hard carbon black was $864 per ton, and of N660 soft carbon black was $809 per ton. At the end of 2011, the market price of dry N220 hard carbon black was $1,008 per ton, of wet N220 hard carbon black was $1,090 per ton, of N330 hard carbon black was $952 per ton, and of N660 soft carbon black was $934 per ton. In terms of profitability, wet N220 is the most profitable product (the cost of producing wet N220 is the lowest among the three products). Producing a ton of wet N220 carbon black requires roughly 1.7 –1.8 tons of coal tar, and the profit margin is about 30%; producing a ton of wet N660 soft carbon black requires roughly 1.7 – 1.8 tons of coal tar, and the profit margin is about 18%; while producing a ton of dry N220 or N330 hard carbon black requires about 1.9 tons of coal tar, and the profit margin is only 6% -11%.
Manufacturing
The dry production of carbon black includes five processes: the supply of raw materials process, carbon black formation process, separation of carbon black process, dry granulation, and packaging process, as illustrated in the following diagram. The Company no longer has such production process since September 2012.
The wet production of carbon black is more complex in terms of technology and procedures, as illustrated in the following diagram.
Uses for Carbon Black
Practically all rubber products which require good tensile and abrasion wear properties use carbon black, thus they are black in color. Where physical properties are important but colors other than black are desired, such as white tennis shoes, precipitated or fused silica is typically substituted. The most common use of carbon black has been as a reinforcing agent in tires. Today, because of its unique properties, the uses of carbon black have expanded to include pigmentation, ultraviolet (UV) stabilization and conductive agents in a variety of everyday and specialty high performance products, including:
Tires and Industrial Rubber Products
Carbon black is added to rubber as both a filler and as a strengthening or reinforcing agent. For various types of tires, it is used in inner liners, carcasses, sidewalls and treads utilizing different types based on specific performance requirements. Carbon black is also used in many molded and extruded industrial rubber products, such as belts, hoses, gaskets, chassis bumpers, and multiple types of pads, boots, wiper blades, fascia, conveyor wheels, and grommets. A typical car tire contains approximately 3.63 kg of carbon black.
Coloring Agent for Ink and Paints
Carbon black has higher tinting strength compared to iron black or organic pigments, and is widely used for newspaper inks, printing inks, India inks, and paints. Carbon black is also used as black pigment for inkjet ink or toners. Carbon blacks enhance formulations and deliver broad flexibility in meeting specific color requirements.
Resin and Film Coloring Agents
Carbon black has high tinting strength and is thermally stable, and therefore it is widely used for general coloring for resins and films. Carbon black is also excellent for absorbing ultraviolet light, providing both a superb resistance against ultraviolet rays and a coloring effect when just a small amount is mixed with resins. Carbon black based resins are used in automobile bumpers, wire coverings and steel pipe linings which require weather resistance in particular.
Electric Conductive Agent
Carbon black particles have a graphite-like crystalline structure, providing excellent electric conductivity. Therefore, carbon black is widely used as conductive filler, mixed in plastics, elastomers, paints, adhesives, films, and pastes. For example, fuel caps and fuel-introducing pipes for automobiles are required to provide electric conductivity for preventing static and carbon black is an excellent antistatic agent.
Electrostatic Discharge (ESD) Compounds
Carbon blacks can be designed to transform electrical characteristics from insulating to conductive in products such as electronics packaging, safety applications, and automotive parts.
Plastics
Carbon blacks are widely used for conductive packaging, films, fibers, moldings, pipes and semi-conductive cable compounds in products such as refuse sacks, industrial bags, photographic containers, agriculture mulch film, stretch wrap, and thermoplastic molding applications for automotive, electrical/electronics, household appliances and blow-molded containers.
High Performance Coatings:
Carbon blacks provide pigmentation, conductivity, and UV protection for a number of coating applications including automotive (primer basecoats and clearcoats), marine, aerospace, decorative, wood, and industrial coatings.
Raw Materials and Equipment
The principal raw material used in our manufacture of carbon black is the residual heavy oils derived from distillation of coal tars. Raw material costs generally are influenced by the availability of various types of carbon black feedstock and natural gas, and related transportation costs.
Shanxi Province, where Hongxing’s facilities are located, is rich in coal tar resources, giving the Company an ample supply of raw materials. Even under serious competition for coal tar supply, Hongxing’s management believes that it would be able to stabilize its supply chain. Additionally, as Hongxing expands its operations, it anticipates that it will garner greater purchasing power, which in turn will bring the company greater leverage in pricing.
We have entered into long term contracts with a number of suppliers. Such long term contracts in our industry are typically for one year term due to the fluctuating prices of raw materials. We believe these contracts help us maintain regular production capacity even when supply experiences a shortage. During the year, the contracts guarantee the supply of specified amount of raw materials from the supplier, but the exact purchase price is determined by market conditions at the time purchase occurs. We keep good relationships with our suppliers, and we believe they grant us priority in purchase of raw materials at a competitive price. Because the price of raw materials fluctuates in accordance with supply and demand, the price of our end products will reflect the price fluctuation of the raw materials.
Production equipment includes the following: burning furnace, reaction furnace, heat collecting furnace, air heater, dyer, industrial blender, air blower, industrial vacuum, oil pre heater, pressuring air generator, oil pump, water pump, air filter, lifter, storage container, packaging machine, DCS controller etc. Production equipment is manufactured according to our specifications in accordance with national safety standards.
Suppliers
For the last two fiscal years, Hongxing’s top suppliers from whom the Company purchased more than 10% of its total purchase were as follows:
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Name
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Percentage of Purchases (%)
2012
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Percentage of Purchases (%)
2011
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Taiyuan Coal Gasification Co.,Ltd
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Taiyuan Gengyang Industries Co., Ltd
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Taiyuan Dongsheng Coking & Gas Co.,Ltd
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Shanxi Shenlong Energy Coking Co., Ltd
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Shanxi Xishan Coal Gasification Co., Ltd
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Shanxi Tianxing Coal Gasification Co., Ltd
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Shanxi Donghui Coal Chemical Co., Ltd
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Shanxi Changyuan Coking Co., Ltd
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Xiaoyi Jinhui Cold & Coking Co.,Ltd
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Shanxi Yinyan Energy Development Co., Ltd.
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Customers
The following table illustrates the percentage of sales to each of our major customers in the last two fiscal years.
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Company Name
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Percentage of 2012
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Percentage of 2011
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1
Xuzhou Xulun Rubber Co., Ltd.
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2
Shifeng Juxing Tire Co., Ltd.
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3
Shandong Luhe Group Co., Ltd.
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Sales and Marketing
Because carbon black is essentially a commodity and there are relatively few large end users, the industry is relationship and price-driven rather than directed by marketing efforts. To that end, Hongxing’s sales team focuses on spending time with existing and potential customers. Hongxing has assigned an exclusive sales person for each major market, and each of its target customers is visited frequently. Currently, the majority of sales occur in Shandong, Jiangsu and Guangdong Provinces.
Hongxing’s target market is large rubber companies and tire producers, and the Company’s management believes it has strong relationships with existing customers. With its effective, dedicated sales network, high quality product, reasonable price and strong after-sale service, management believes that as many as 90% of Chinese tire manufacturers are familiar with its products.
Currently our production falls short of market demand. In spite of this, we seek to expand our business presence and distribution channels in China. We have established an office in Qingdao, Shandong province, with plans to expand our business into areas where major tire manufacturers are located.
We plan to promote our products and increase our brand awareness through our relationships with several trade companies in Qingdao, Shangdong Province, where enterprises situated within the area enjoy the preferential policies such as tax rebates for exports and tax-free trading within the bonded area. Meanwhile, we will continue to cultivate good relations with additional rubber and plastic companies.
Growth Strategy
We have a multi-prong growth strategy, with the objective of establishing the Company as a leading manufacturer and marketer in China’s growing carbon black sector, with a particular emphasis in the tire and automotive industries.
To execute this strategy, we intend to implement the following plan:
Complete conversion of existing production facilities.
The primary component of this strategy is the addition of wet processing capabilities, which will provide the Company and its customers with several benefits, as discussed below. The capacity of the first completed wet line is approximately 25,000 tons per year. In September 2012, the Company decided to renovate and convert its three dry production lines to specialty carbon black production lines with a total production capability of 18,000 tons per year. The project is to be completed at the end of June 2013. The total estimated cost is approximately $4 million, funded by the Company’s cash from operations.
Low-carbon and clean production.
To pave the way to low-carbon and clean production, we seek to use natural gas to enhance its production process for energy conservation and emission reduction. The project was completed. We are using natural gas as fuel in wet production line, which will increase the quality of our products. Secondly, we are planning to build a power plant to recycle the exhaust gas produced in the manufacturing process to generate electricity needed in the production.
Development of superior end product.
Wet carbon black products are more stable than dry carbon black products in quality and performance. In the next five years, we believe our clients will require their carbon black to be denser and of higher quality to satisfy these three properties: lower rolling resistance, higher wet skid resistance, and stronger wear resistance. This denser, higher quality carbon black can only be produced through wet processing means.
Improved Margins.
The wet granulation method will improve the gross profit margin also. While the raw materials expense is the same, the wet process will consume less raw materials and yield higher quality end product, enabling the Company to charge a premium for wet process carbon black.
Expansion of the distribution network
. Management believes the domestic market represents a substantial opportunity, particularly as China’s rural economy is modernized. The nation’s growing “middle class” continues to increase demand for automobiles. To this end, we will continue to add to our dedicated sales force within existing markets, in addition to expanding into new geographic areas.
Expansion of production capacity.
We will continue to expand our current production capacity in the future. We intend to add new wet granulation production lines. We have the option of building a new wet line with 40,000 tons of capacity per year, or acquiring a target company with wet production capacity. We will continue to evaluate alternatives to add production capacity to our carbon black operation by analyzing the cost benefits of acquisition versus build out.
Investment in recyclable energy.
In conjunction with the addition of these new production lines, subject to the availability of financing, the Company intends to construct a thermal power plant within its facility campus that would use the exhaust gas generated from the manufacturing of the carbon black to generate electricity. There are no specific plans for construction of a thermal plant at this time.
Continue to Develop and Market New Products.
As China continues the shift from an agricultural market to a “controlled” capitalist environment, the demand for other carbon black related products, such as toner, high performance paints, electric materials, etc. is expected to expand as well. Management will be opportunistic in its approach to new product development. Line extensions are expected to come as a result of thorough internal research and development, customer requests, and acquisitions. In conjunction with the expansion of production capacity, we plan to continue to target and cater to the needs of both our new and existing customers.
Quality Control
Carbon black dust spreads easily in the air through virtually any air current or movement. Additionally, because carbon black is a pigment, it can stain exposed surfaces. We remain concerned with the effects of our operations on our employees and the environment, and to that end, management has instituted specific procedures that minimize the production of dust and optimize working conditions. These specific procedures entail strengthening the Company’s previous measures and standards, including upgrading the granulator, installing the dust-absorption to equipment by section and classification, and upgrading previously manual operations to a numerically controlled automatic packing system.
It is management’s belief based on industry experience that generally, there are no negative clinical health effects to the manufacture of carbon black. However, our facilities are subject to regular inspection to ensure they comply with health, safety and environmental regulations. This includes regular maintenance of equipment, training of employees with regard to handling of carbon black, and regular review of emergency response to conditions associated with the use of carbon black.
Hongxing’s advanced technology and scientific means of detection have met the PRC’s environmental protection and safety requirements. Our carbon black products have been verified by the ISO9000 quality system certification, and were identified by the Industrial Technology Research Institute. Our products are fully in compliance with national standards. To meet the environmental protection and safety standards, we are monitored by the local Environmental Protection Monitoring Station. These inspections are carried out in three aspects: (i) air surveillance, using a TH0150C large air sampler and TG328B analysis libra, and measuring against the national air pollutant emission standard, (ii) noise surveillance, using a HS6288D noise analysis instrument and measuring against the national industrial enterprise factory boundary noise emission standard and (iii) water surveillance, using a series of analysis instruments such as TG328B analysis Libra and measuring against the national standard for general wastewater discharge.
We were awarded the “Orange Company Prize” by Shanxi Environment Protection Administration in 2008. The Orange Company Prize is awarded by the provincial environmental government to indicate our environment protection standards meet the required standards. The Bureau of Environmental Protection of Taiyuan classifies the local companies into five categories by different environment protection level being achieved. Among them, the green and blue awards are the top two levels, which usually go to the agricultural business, while red and black levels mean that the company has failed to meet environmental protection standards. The Orange award means the Company met all the required standards, such as us.
Competition
We are in a very competitive and concentrated market. We have an annual capacity of 61,000 tons in the year of 2011. Our annual capacity temporarily reduced to 43,000 tons in the year of 2012 due to the conversion construction taken place on our three dry production lines during that year.
Our competitive advantages are as below:
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We are close to the areas where our raw material, coal tar oil is produced. As a result, we could have stable raw material suppliers with lower transportation cost.
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We are growing with our customers together.
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Our flat management structure lowered management cost.
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As a result of the foregoing, we have a higher net profit rate compared to the top manufacturers in China.
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Since new participants have to undergo a long period of production before they are capable of satisfying large quantity orders, management believes our primary competition lies in current market participants. Currently carbon black manufacturers are expanding their facilities through the use of new technologies and acquisition, new participants will find it very difficult to gain market share. The entry requirements for entering the industry have become tougher.
One of the largest barriers to entry is developing solid long-term clients. We believe we already have long-term relationships with several of our important customers, like Xuzhou Xulun Rubber Co., Ltd, Shifeng Juxing Tire Co., Ltd and Shandong Luhe Group Co., Ltd.
Intellectual Property
Our trademark “Great Double Star” was registered with the State Administration for Industry and Commerce, Trademark Office, and is valid from February 14, 2008 to February 13, 2018. It is registered for use with Commodity (Type 1), namely industrial carbon black, chemical rubber enhancer, industrial chemicals, activated carbon, accelerants, fixative, gas purifying agent, rubber preservatives, and chemicals for industrial usage.
Government Regulation
Environmental Regulation
Hongxing’s operation and facilities are subject to environmental laws and regulations stipulated by the national and the local environment protection bureaus in China. Relevant laws and regulations include provisions governing construction of production lines, air emissions, water discharges and the management and disposal of hazardous substances and wastes, more particularly, the laws on environment protection, water and air pollution, air pollutant emission standards, general wastewater discharge standards and industrial enterprise factory boundary noise emission standards.
On November 15, 2004, Hongxing obtained a construction commencement approval for its construction of one production line with production capacity of 12,000 tons of carbon black per year from the Taiyuan Municipal Environmental Protection Bureau. Failure to obtain the necessary environmental approvals for construction of our production lines and pollution emission permits may subject us to fines and, in some cases, may even result in the mandated cessation of production. However, Hongxing is not aware of any investigations, prosecutions, disputes, claims or other proceedings in respect of environmental protection, nor has it been subject to any action made by any environmental administration authorities of the PRC.
Regarding the cost of compliance, our annual investment in environmental protection equipment totals 7.9 million RMB ($1.26 million). That includes 5.4 million RMB ($0.86 million) on bag-filtering deduster, 1.6 million RMB ($0.25 million) on wastewater treatment equipment, and 900,000 RMB ($140,000) for the change of filtering bag and related materials.
Hongxing maintains controls at its production facilities to facilitate compliance with environmental rules and regulations. Hongxing is not aware of any investigations, prosecutions, disputes, claims or other proceedings in respect of environmental protection, nor has it been subject to any action made by any environmental administration authorities of the PRC. To management's knowledge, Hongxing’s operation meets or exceeds the existing requirements of the PRC.
Employees
As of February 15, 2013, Hongxing had 202 full time employees.
Hongxing maintains good relations with its employees. All of its employees belong to the Labor Union committee of Taiyuan Hongxing Carbon Black Co., Ltd., it is a self-operated organization but governed by the General Labor Union of Xigu Village, Qingxu County.
Hongxing is required to contribute a portion of its employees' total salaries to the Chinese government's social insurance funds, including medical insurance and unemployment insurance and to purchase job injuries insurance for employees, in accordance with relevant regulations. The government's social insurance funds account for 10% of employees' total salaries, while job injuries insurance premiums are about RMB 50 ($8) per person per year. Hongxing expects the amount of its contribution to the government's social insurance funds and the cost related to job injuries insurance to increase in the future as it expands its workforce and operations.
Executive Offices
Our executive office in China for Hongxing is located at Qingxu County, Taiyuan, Shanxi Province, Tel: 86-351-5966868, and Fax: 86-351-5966308. Our company website address is: www.asiacarbonindustries.com.
Risk of Loss and Product Liability Insurance
The Company doesn’t have any product liability insurance for its products.