ShengdaTech Q2 2009 Earnings Call Transcript

ShengdaTech (SDTH)

Q2 2009 Earnings Call

August 11, 2009 9:00 am ET

Executives

Crocker Coulson - Investor Relations, CCG

Xiangzhi Chen - Chief Executive Officer

Andrew Chen - Chief Financial Officer

Anhui Guo - Chief Operating Officer

Jenny Yang - Translator, CCG

Analysts

Greg Garned - Singular Research

John May - Roth Capital

Ping Luo - Global Hunter Securities

Paul Keung - Oppenheimer

Tom Belgret - Voltel Investment

Mike Bambenburg - Private Investor

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the ShengdaTech second quarter earnings conference call. (Operator instructions) I would now like to turn this presentation over to Mr. Crocker Coulson for any opening remarks. You may proceed, sir.

Crocker Coulson

Thank you. Good morning, ladies and gentlemen. Good evening to those of you joining us from China. I am Crocker Coulson with CCG Investor Relations, the company’s investor relations firm. We’d like to welcome all of you to ShengdaTech's second quarter 2009 conference call. With us today, joining us from China are Mr. Xiangzhi Chen, ShengdaTech's Chairman and CEO; Mr. Andrew Chen, the company's Chief Financial Officer; and Ms. Anhui Guo, Chief Operating Officer. Also from China and providing translation will be Jenny Yang of CCG.

Also joining us is Jenny Yang of CCG, who will provide translation for your questions and answers.

I'd like to remind our listeners that in this call management's prepared remarks contain forward-looking statements, which are subject to risks and uncertainties, and management may make some additional forward-looking statements in response to your questions. Therefore, the company claims the protection of the Safe Harbor for forward-looking statements that’s contained in the Private Securities Litigation Reform Act of 1995.

Actual results may differ from those discussed today due to various risks, including but not limited to such factors as unanticipated changes in product demand, especially in the tire and PVC industries, the ability to attract new customers, ability to prepare for growth, planned manufacturing capacity expansion, ability to increase our products’ applications, and other information detailed from time-to-time in our filings with the SEC.

Accordingly, although ShengdaTech believes that the expectations reflected in these forward-looking statements are reasonable, there can be no assurance that such expectations will prove to be correct. In addition, any projections as to our future performance represent management's estimates as of today, August 11, 2009, and ShengdaTech assumes no obligation to update these projections in the future as market conditions change.

For those of you unable to listen to the entire call at this time, we are going to make a recording available via webcast for 90 days and you can find that on ShengdaTech's corporate website.

I am now going to turn the call over to ShengdaTech's Chairman and CEO, Mr. Chen, for some brief opening remarks.

Xiangzhi Chen (Translation)

Thank you, Crocker and thanks to all of you for joining us this morning on our conference call to discuss our results for the second quarter 2009. This was an important quarter for ShengdaTech as we realized record NPCC revenue and successfully expanded our market presence by adding new customers and strengthening our existing customer base. The construction of our new NPCC production line and facilities in Zibo has been conducted according to our plan. The facility is set to begin production by the end of this month.

Crocker Coulson will discuss some additional remarks on our operations on my behalf. I will be on the phone and participate in the question-and-answer session along with Mr. Andrew Chen and Ms. Guo. We believe you will be pleased with our record second quarter results and I sincerely thank you for your continued interest in ShengdaTech.

Crocker Coulson

Thank you, Mr. Chen and thanks, Andrew. We are very pleased to announce in the second quarter of 2009 ShengdaTech's NPCC business achieved strong year-over-year revenue growth, driven by increased market demand, aggressive capacity expansion, and our growing customer base.

Our NPCC revenue for the second quarter was a record $26 million, up 36.2% from $19.1 million in Q2 of 2008. Sales volume rose more than 27% from the first quarter of 2009 as the Chinese economy showed signs of recovery and our end product markets experienced significant improvement. Average selling prices were down slightly from the first quarter of 2009 but rose 12% year over year.

Combined with our efficient cost control measures offsetting the increase in raw material prices, we reported record NPCC gross margin of 43.8% for the second quarter of 2009. During the quarter, we added three new domestic customers, including two polyethylene manufacturers and one tire manufacturer. Due to the influence of worldwide economic conditions, we are experiencing a definite and understandable softening in the international markets but we view this as a somewhat temporary situation and we will aggressively continue our sales and marketing efforts in introducing our powerful value proposition to many identified potential customers overseas.

To help focus on that effort, we plan to hire additional professional staff skilled in the area of advanced chemical products which will expand our coverage to sell NPCC applications internationally and leave us well-positioned to increase our penetration as economic conditions trend upward.

Currently our total prospect list consists of 39 prospective customers, including 34 domestic customers, of which 27 are now in the testing phase, and five international customers, of which three are in the testing phase.

We continued to diversify our product mix during the second quarter of 2009 as sales to our newer end markets showed some very positive growth. For example, NPCC use in polyethylenes, which is one of our higher margin products, showed phenomenal growth, accounting for 15% of our total revenues, up from less than 1% a year ago. Tires and PVC remain our largest end markets, accounting for slightly over 65% of NPCC revenues, down from 71% a year ago.

NPCC sales for the tire industry increased 20% year-over-year and 30% sequentially. China’s automobile manufacturers began rebuilding inventory at the end of the first quarter and well into the second quarter. According to the China Association for automobile manufacturers, auto sales increased 17.7% to reach over 6 million vehicles during the first half of 2009 and reached record highs during the second quarter of 2009.

The Chinese Government’s RMB4 trillion, or $586 billion stimulus plan includes lower sales tax for low emission cars, allowances for farmers to upgrade their vehicles, funds to support Chinese automakers to upgrade their technology and develop new alternative energy engines. This combined activity indicates further increased demand and future development of the Chinese auto industry.

In addition, higher export VAT rebates, strong demand for heavy trucks, and other favorable government policies, should encourage steady growth in this segment. The tire industry is one of our largest end markets and we supply three of China’s top 10 tire manufacturers.

Another major end market for our NPCC products is the plastics industry, which rose 10% in 2008 despite the global economic slowdown. Our NPCC products in this end market are primarily used in PVC window profiles. NPCC sales for PCV increased 11% year-over-year and were flat sequentially. We believe the Chinese Government’s economic stimulus plan will create demand from several major infrastructure projects that will continue to drive growth in the plastics industry.

Our rapid revenue growth, expanding customer base and global market presence are a direct result of our ability to constantly develop customized high quality products that meet our customers’ technical specifications.

During the second quarter of 2009, we continue to research new NPCC applications, including rubber, adhesives, epoxy resin, modifier, and other high-end NPCC applications. We are excited to share with you some significant progress in the development of NPCC applications for asphalt, including a new asphalt modifier. After making significant advances in our asphalt application during Q2, we received our first purchase order from a domestic customer. We will begin small scale trial production at our new Zibo facility later this month. While the initial order is for testing purposes only, we do expect follow-on orders to accelerate as the customer recognizes the benefits of NPCC in this end product. If it’s accepted, our early estimates indicate that the savings for an asphalt producer could be as much as $27 per metric ton. With millions of miles of asphalt laid every year in China, we are very excited and yet cautiously optimistic about the opportunity and the obvious potential this market holds.

We also recently hired Mr. [Xia Tuan Chu] to further strengthen our research process and enhance manufacturing efficiency. Mr. Chu has over 10 years of experience in research of functional macro-molecule materials in global management. Together with Mr. [Ju De Shu], an industry veteran with over 30 years of experience, they will successfully lead ShengdaTech's wide range of R&D initiatives and new product development projects.

During the second quarter, we also made good progress in the construction of phase one of our expansion at our new facility in Zibo, which will add 60,000 metric tons of capacity. Construction and equipment installation at the Zibo facility are on schedule and we will begin shipments in the next few weeks. With the help of the Zibo government, we are in the process of securing mining rights for a limestone mine with 100 million metric tons of high quality limestone. If the transaction is not completed before we commence production, we plan to purchase limestone from local suppliers at a cost per metric ton that would be about the same as the limestone being purchased for our [Xianche] facility.

After the completion of Zibo’s construction, our total annual production capacity will reach 250,000 metric tons. By the end of 2009, our NPCC production capacity is expected to achieve an 80% utilization run-rate.

In addition, Zibo’s proximity to many customers and prospect locations and it is about 120 miles from the Port of [Xingdou], which will facilitate international shipments.

The total of design annual production capacity through Zibo is 240,000 metric tons, which will be built out in several phases. We continue to monitor market demand and general economic conditions to identify the most opportune time to begin the next phase of expansion at Zibo.

Our growth strategy in 2009 primarily focuses on ramping up the capacity utilization and developing our new NPCC products at the Zibo facility, increasing market penetration of our existing end markets, and expanding our product offering through application development. We are also actively pursuing NPCC and high-tech chemical acquisitions, targeting NPCC candidates that have the potential for capacity expansion that will provide us access to new markets that own or have access to high quality limestone reserves.

We plan to utilize our industry experience to transform these smaller NPCC targets in the larger technologically advanced NPCC manufacturers. We are in active discussions with potential targets and we hope to be able to announce further details in the very near future.

In other company activity, we’ve completed the relocation of our global headquarters to Shanghai. We’re confident that our move to the new headquarters will position ShengdaTech to capitalize on both domestic and global growth opportunities.

With that, I would now like to turn the call over to Andrew Chen, the company’s CFO, who will discuss the financial results and business outlook in more detail. Andrew.

Andrew Chen

Thank you, Crocker and welcome, everybody. Before I get into our financial results, I would like to encourage all of you to read our 10-Q filed with the United States Securities and Exchange Commission in our quarterly press release published yesterday for more detailed financial disclosures.

In addition, we will also be discussing non-GAAP financial measure, EBITDA, which stands for earnings before interest, taxes, depreciation, and amortization. We present this financial measure as a supplement to our GAAP results because we believe it provides useful information in analyzing and benchmarking the performance of our operations and assists investors in analyzing our year-over-year financial performance. We presented a reconciliation of EBITDA to net income in our press release issued yesterday.

First, let me go to our quarterly results. Our total revenue for the second quarter of 2009 declined, due to the ceased production at our Bangsheng Chemical Facility on October 31, 2008, to $26.3 million, down 34% from $39.8 million in the second quarter of 2008. The ceased production resulted from a mandatory directive from the Tai'an city government due to rezoning of the facility's location into a residential and non-manufacturing area.

Revenue from our NPCC segment increased 36.2% to $26.0 million in the second quarter of 2009 from $19.1 million in the second quarter of 2008. Total volume of NPCC sold during the second quarter of 2009 was 54,383 metric tons, up 21.5% from 44,744 metric tons in the second quarter of 2008 and up 26.6% from 42,969 metric tons in the first quarter of 2009.

NPCC for use in tires and PVC accounted for 39.6% and 26.0% of our NPCC sales for the quarter, respectively. NPCC used in PE accounted for 15.0% of NPCC revenue, up from only 0.5% of total NPCC sales in the second quarter 2008. Sales from the NPCC products for use in adhesives and latex were 10% of total NPCC revenue during the second quarter. NPCC used in ink, paper, paint, and automobile underbody coatings combined to generate 9.3% of NPCC revenue.

Our gross profit for the second quarter of 2009, all of which was derived from NPCC products, was $11.4 million, down 22.3% compared with the gross profit of $14.6 million from the same period of 2008, which has improved gross profit from chemical operations. Gross profit for the NPCC segment rose 46.3% on a year-over-year basis. NPCC gross margin was 43.8% in the second quarter, up 3.1 percentage points from the NPCC segment's gross margin in the same quarter last year. Total gross margin was 43.3%, up 6.5 percentage points from 36.8% during the second quarter of 2008.

Selling expenses for the second quarter of 2009, all of which were attributable to NPCC products, were $0.5 million, or 2% of revenues, down 17.9% from $0.6 million, or 1.6% of revenue, for the same period last year. The decline in selling expenses was the result of lowered commission rates and the reclassification of export freight and related NPCC miscellaneous expenses to cost of goods sold, partially offset by higher salary and benefits expenses due to expansion of our NPCC business.

General and administrative expenses were $1.5 million, or 5.7% of revenue, up from $1.2 million or 2.9% of revenue for the same period of last year. The increase was mainly due to increased research and development expenditures, higher professional expenses, increase in managerial compensation, and amortization of land use rights related to the company's growing NPCC operations. These increases were partially offset by the elimination of certain expenses associated with the chemical business as a result of cessation of production at our Bangsheng Chemical Facility.

Operating income for the second quarter of 2009, all of which was derived from the NPCC segment, was $9.4 million, down 27.2% from $12.8 million in the same period a year ago. Operating margin improved to 35.5%, compared to 32.2% in the second quarter of 2008.

Interest expense, related primarily to our convertible bonds sold in May and June 2008 was $2.4 million for the three months ended June 30, 2009, up from $1.1 million a year ago. Interest expense included $1.4 million of contractual coupon interest on the convertible notes, $1.4 million of amortization of debt discounts, and $0.3 million of amortization of debt issuance costs due to the application of APB 14-1. The total interest expense was reduced by $0.7 million interest cost capitalized during the three-month period ended June 30, 2009.

EBITDA for the second quarter of 2009 was $10.4 million, down 24.7% from $13.8 million in the second quarter of 2008.

Net income in the second quarter of 2009, all of which was derived from the NPCC segment, was $6.5 million, down 33.5% from net income in the same period last year. Diluted earnings per share for the second quarter of 2009 was $0.12, compared with diluted earnings per share of $0.18 in the second quarter of 2008. Our diluted weighted average shares outstanding during the quarter were 66,954,996 shares, up 13.9% from 58,809,297 shares in the same quarter last year, due primarily to the outstanding duration of the convertible notes with dilutive effects.

Next, let’s move on to the balance sheet. As of June 30, 2009, ShengdaTech had $111 million in cash and $112.2 million in working capital. As of June 30, 2009, shareholders' equity reached $159.1 million, up 8.2% from shareholder's equities of $147 million as of December 31, 2008. For the first six months of 2009, our net cash flow generated from operating activities was $14.9 million.

Our NPCC business has demonstrated strong growth in the first half of the year and generated strong operating cash flow. We have a healthy cash balance t o support our capital requirements, including our new NPCC facility in Zibo, additional working capital requirements continued R&D endeavors, new marketing initiatives, and other cash requirements for potential acquisition opportunities. As of June 30, 2009, total capital expenditures for the Zibo facility was approximately $43.1 million. We expect to spend approximately $15.9 million to complete the phase one construction and ramp up production at the Zibo facility in 2009.

Currently the total capital expenditure for Zibo phase one are estimated to be $59 million instead of the $56 million announced previously due to appreciation of Chinese currency. Phase one costs are excluding the costs of long-term mining rights which are still in the process of being negotiated.

Now I want to go over our outlook. Also, we are proportionally running ahead of our 2009 annual guidance. Based on our corporate policy, we do not provide interim updates to our annual guidance. However, we are confident we will meet or exceed the annual guidance provided at the beginning of the year. With the revival of the economic conditions in China and increasing penetration of our products, we are optimistic about our prospects in the second half of 2009. Assuming market conditions remain the same in China, we expect the average selling price of our products and our overall gross margin to be relatively stable at or above the 40% level. Demand to be consistent with our forecast and look to Zibo to increase our tonnage output.

Crocker will now provide some remarks before -- provide final remarks before opening up the call for Q&A.

Crocker Coulson

Thanks, Andrew. On behalf of Mr. Chen, I would like to close by briefly commenting on the long-term growth outlook for the NPCC industry. The worldwide NPCC industry is in its initial phase of growth with limited manufacturers capable of supply high technology products.

Penetration rates among end users in our target industries is low and the technological expertise continues to remain an important aspect of our industry. ShengdaTech is a leader in the field of advanced NPCC production technology and is China’s largest NPCC manufacturer. Our management team’s long-term vision has enabled us to grow our production capacity very rapidly and therefore expand our geographic presence both domestically and internationally. We continue to add new capacity to meet growing demand and are actively pursuing acquisitions in the Chinese NPCC market and in the high-tech chemical market to capitalize on the available growth opportunities.

I would like to add that the company has announced in a proxy statement that we will hold our annual shareholders’ meeting in New York City on September 16th and we would certainly encourage anyone in the area to attend and visit with management at that time. If it’s not possible you’ll be able to dial in and listen to the meeting through a live conference call with access to webcasts which will be made available on the company’s website. Please watch for details to be released soon.

With that, we are now going to open up for questions. Any call for questions that you may have for any member of ShengdaTech's management team. We are going to take one question from every participant and then hope to return back to in case you have follow-up questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) You have your first question from the line of Greg [Garned] from Singular Research.

Greg Garned - Singular Research

Thank you and good morning. First of all, congratulations on a great quarter -- a question I have just about the outlook for ramp-up of the new Zibo facility. I just want to make sure I understand this correctly -- it says in the release, and I believe it was mentioned in the comments, that the additional 60,000 metric tons brings total capacity up to 250 but the expectations for the end of the year was that the total 250 was going to be at 80% or is this the new 60,000 that’s added on, is that going to be operating at 80%? This is what I am trying to clarify because if it’s the 250 operating at 80%, that means about only an additional 10,000 metric tons for the rest of the year, whereas if it’s the additional 60,000 operating at 80%, that’s quite a bit more.

Andrew Chen

Zibo, it is supposed to start production at the end of -- scheduled to start production at the end of August and we will start the shipment to customers at the beginning of September and gradually the production will be ramping up toward the very end of the year, it is going to be reaching an annualized capacity of 60,000 tons. However, during the remaining months of 2009, it is going to be producing an additional about 12,000 tons of products. So if you -- so when we say 80% utilization, we are referring to the 250,000 tons times 80%. That’s going to give you a total production of the company for 2009 so if you deduct 190,000 tons produced by [Xianshe] and also the [Tian] facility, you are going to actually get results about 12,000 tons will be produced at the Zibo facility this year.

Greg Garned - Singular Research

Okay. Can I ask one more question or --

Crocker Coulson

Yeah, sure, we’ll take one follow-up.

Greg Garned - Singular Research

Just the tax rate was quite low here, just about 10.5%. How should I look at the tax rate for the rest of the year?

Andrew Chen

It is expected to be between 12% to 15% for the rest of the year.

Greg Garned - Singular Research

Between 14 and 15?

Andrew Chen

Between 12% to 15%.

Greg Garned - Singular Research

Okay. Thank you very much.

Crocker Coulson

Greg, we’ll be happy to come back to you later.

Greg Garned - Singular Research

Okay.

Operator

Your next question comes from the line of John [May] from Roth Capital.

John May - Roth Capital

Congratulations on a very strong quarter. I have a question on your NPCC acquisition -- you mentioned that we would have 250,000 tons capacity at Zibo phase one and the Zibo facility, you have 240,000 tons total capacity. Given this is such a big capacity and also the limestone reserve, why would you consider a further acquisition in the NPCC field?

Andrew Chen

The consideration that we take to make our acquisition decisions usually depends on two things. If we identify a potential NPCC acquisition target, this target is located in a geographical area with access to markets and customers which we want to penetrate, then it becomes an attractive target for us to get.

Some of these potential targets might have access to high grade limestone mines, which are very valuable resources to secure for future developments. And also some of these acquisition targets might be very close to a transportation port, very easy for either exports or shipping to end customers.

So the consideration is not entirely on okay, you already have so much capacity yet also we also need to consider to lock down some of the potential markets, for example, like the [Yanzo] Delta River, [Yanzo] River Delta areas has a huge potential for our business growth and yet we don’t have any facility over there. That would be a great place for us to secure an NPCC target to acquire and potentially this target can be something that’s small in scale; however, has very large -- has access to a very large reserve of resources and also very vast markets. You can go in there and take over, improve the technology, upgrade the facility, expand the capacity and then make it into an upgraded model, NPCC facility and then you can use their existing, the customer base and sales channels to improve the penetration in the geographical area.

John May - Roth Capital

Okay. Thank you.

Operator

(Operator Instructions) Our next question comes from Ping Luo from Global Hunter Securities.

Ping Luo - Global Hunter Securities

Thank you. My question is regarding your new product development. I understand that in this quarter, tire and NPCC used for tire and PVC accounts for close to 70% of the revenue. Are there any other new developments, new products under development? Any products likely to become the next driver for your growth?

Anhui Guo (Translation)

Basically, aside from the asphalt, the [inaudible] within NPCC research that the company is currently undertaking, the company also tried to upgrade the current products -- the automobile under-body coating on the ink and also other products related to the PVC rubber, so it’s basically to upgrade a program that they have right now and trying to get into the industries that are related to those materials.

Does this answer your question?

Ping Luo - Global Hunter Securities

Any one of them has been really -- is still under the development stage or already, this product you mentioned, already in commercial production?

Anhui Guo (Translation)

Basically for example the asphalt, during the second quarter the company has actually achieved a huge progress and for other products, some of them are like under research and development, some are still under the testing process, so it really depends on the products.

Andrew Chen

And we actually have received a small size order for our asphalt NPCC and after that, we are expecting follow-on orders.

Ping Luo - Global Hunter Securities

Okay. Thank you very much.

Operator

Your next question comes from the line of Greg Garned from Singular Research.

Greg Garned - Singular Research

Thank you for taking me back again. On these new, the prospect list, 39 prospects and the number that are in test, can you give us a sense for what products they are testing and how long these tests typically last?

Anhui Guo (Translation)

Basically it’s concentrated in three major areas, including the tire industry, the PVC industry, and the adhesives industry.

Greg Garned - Singular Research

What was that last one? I didn’t hear that.

Anhui Guo (Translation)

Adhesives.

Greg Garned - Singular Research

I’m sorry -- I guess I’m not understanding that.

Crocker Coulson

Adhesives.

Greg Garned - Singular Research

Adhesives, okay -- and how long do these typically last then? Are these a couple of months or are they a year or --

Anhui Guo (Translation)

Basically the timeline on the testing process for those potential customers to become a regular customer takes about six to nine months but it really depends on the needs of each individual customers because they have different requirements on their characteristics of their products.

Greg Garned - Singular Research

Okay.

Andrew Chen

Typically the cycle is six to nine months.

Greg Garned - Singular Research

And if these had been -- if some of these had been testing for some time, then they may turn into new customers in 2009? It just seems as if with this number of customers or potential customers testing at the projections of only using 12% or 20% of the new -- of the new production at Zibo is sort of low, that you most likely are going to exceed that.

Andrew Chen

Even if some of these -- historically we have a 55% of conversion rate, meaning that 55% of a typical customer that under testing would eventually become our true customers, statistically. However, typically when they started to become our customers in terms of placing purchasing orders, usually the initial order is very small in scale. Okay, so it kind of -- it’s a type of process try to build into trust. They try your product and if it successfully produced the effects that the testing phase that it was going to produce and then gradually that they feel that it is in their benefit to expand the adoption of their products and then the cooperation is kind of gradually expanded. And it just takes a pretty long cycle to get the cooperation into a very large scale sales activity, so we try to be conservative and we will not try to account for so many of these new orders from new customers from the revenue perspective because the -- at the beginning phase, it’s supposed to be pretty small in size.

Greg Garned - Singular Research

Okay. Thank you. And just one last item on the new high quality limestone that you are trying to secure, the 100 million metric tons, how much NPCC would that manufacture? How many metric tons?

Andrew Chen

Well typically the raw material requirements for every one ton of NPCC product, it requires 1.8 times the limestone raw material.

Greg Garned - Singular Research

Okay, so that would certainly be quite a long-term supply, yes.

Andrew Chen

Absolutely.

Greg Garned - Singular Research

Okay, good. Thank you very much.

Operator

Our next question comes from Paul Keung at Oppenheimer.

Paul Keung - Oppenheimer

Good morning, everybody and congratulations on your 2Q results. My question is how has the looser credit conditions in China helped your business in 2Q and what impact do we expect to see in the second half of the year?

Jenny Yang

Sorry, Paul -- can you repeat your question?

Paul Keung - Oppenheimer

My question is the looser credit conditions in China in the first half, what is the impact to your 2Q results?

Andrew Chen

Well, I don’t think we have so much to do with the credit markets at this time because as you can see from our balance sheet, we have plenty of cash and actually we also have very solid cash flow from operating activities. Our [inaudible] cycle now stands about -- around 25 days, so the company itself has very strong cash generating capabilities and then we also have a large amount of cash sitting on a balance sheet which came from our operating, the proceeds from the convertible notes we issued in 2008.

So the -- yes, it’s very good for the credit policy of China to loosen up in the first half of this year. That actually creates a very good operating environment for our end customers which is going to promote their business and operations and in turn it’s going to turn into great demand for our products. So I think in that regard, the overall credit policy implemented by the Chinese Government has been benefiting this company indirectly.

Paul Keung - Oppenheimer

My next question is you operated at full capacity in 2Q and what’s your backlog and how much demand do you have waiting to be fulfilled by your new facility in Zibo?

Anhui Guo (Translation)

Basically the backlog order really depends on the potential, those potential customers that the company has so basically the testing process, as Andrew said before, the success of having a customer, a new customer is about 55%. So basically that’s the backlog order that the company has for the new production [inaudible]. For the orders, it is really the customer that have been buying the NPCC product for the company, their regular base.

Paul Keung - Oppenheimer

Okay, thanks -- can I ask one more question?

Crocker Coulson

Sure, go ahead.

Paul Keung - Oppenheimer

Okay. What is your outlook for raw material cost in 3Q?

Jenny Yang

What’s your outlook?

Crocker Coulson

Yes, for raw materials costs.

Anhui Guo (Translation)

Basically the two major raw materials for the company for NPCC is the limestone and the [inaudible]. The price of the [inaudible] has actually slightly decreased in comparison to the first quarter, and this will continue to be similar during the third quarter.

Andrew Chen

I would like to provide some supplemental information. As you can see from the press, recently that due to discouraging of the [entrocite] prices in the first quarter and also in other type of [inaudible], prices have been jumping up in Q1, we have seen people start to import a lot of [coals] from overseas. They are kind of coming in and has a dampening effect on the [coal] prices, that’s why Ms. Guo says that we are seeing a slight decline of coal prices in Q2 and we are expecting a stable coal price into Q3 and Q4.

Coal, the entrocite is actually very important. It’s the lion’s share of our raw material costs. It accounts for about 37% of our cost of goods sold and limestone is only a fraction of that [inaudible] about -- between 4% to 5%. So the bulk of coal is very important and we are sensitive to that and importantly, we are seeing a stabilizing coal prices. However, at the same time, even if we have -- even if in the future if there’s a jump in prices, we are confident with our quality of the product and reputation in the market, we should be able to adjust our selling prices accordingly to ensure that our gross margins remain stable as I indicated, about 14%.

Paul Keung - Oppenheimer

Okay. Thank you for your answers.

Operator

You have a follow-up question from the line of Ping Luo from Global Hunter Securities.

Ping Luo - Global Hunter Securities

Thank you for taking my other question. My question is regarding your capacity. I assume that you are running full capacity at this moment, or even exceed that capacity. And even with this -- another 60,000 ton capacity online and at the end of this year, end of this month, I assume some time next year, earlier next year you are going to reach 100% utilization of that total, 250,000 ton capacity as well. So my question is that in your Zibo facility, you have additional potential capacity there. I don’t know whether you have any plan to further expand in that facility.

And also I just heard that you -- you just mentioned that it looks like you’re acquiring, if you can confirm that, acquiring a company with the limestone mining license. If that’s the case, does that company have NPCC capacity and production capacity? I think basically my question is regarding basically your revenue growth. If you do not continue to expand your production capacity, your revenue basically will be constrained by your capacity. So basically that’s my question.

Andrew Chen

Well, let me answer the question -- let me first clarify the concept of the -- what’s going to be capacity for this year. Actually, for any case, the production generated from Zibo this year is only about 12,000 tons because we are ramping up the production gradually. So the full capacity, which is 60,000 tons, will become available at the very end of this year. So when you look into 2010, you are going to have a fresh at least 50,000 tons of capacity that is going to be producing in full capacity next year, which will becoming a revenue generating power for 2010. And then also in addition that due to our technology and a very good technology maintenance and very good management, all the existing capacity of 190,000 metric tons, on top of that we have about 10% of extra capacity that you can drive from the existing capacity, meaning that maybe another close to 20,000 tons of additional capacity if there is really a very strong demand for our products.

To answer your question on the need to expand Zibo further, I have to say that the phase one of Zibo actually is called for 80,000 tons of capacity but we are only building 60,000. So the building and the construction is designed to hold equipment for 80,000 and we are going to be installing the 60,000 first. And then this company historically has been very conservative, we plan our cash very carefully. We do not want to [inaudible] the [capitals] to early to waste the resources. So if we are convinced that there is very strong market demand out there, we will certainly consider to add that 20,000 tons of additional capacity on top of the 60,000 in Zibo.

And in terms of phase two, phase three, I think we need further understanding of the markets before committing of any additional [packaging].

When it comes to acquisitions, this is actually a short-cut for you to secure some of the very good potential markets and at the same time, you get an infrastructure of the facility. The technology that the existing target has may not be great, they may have been losing money because of poor management, because of a poor coordination with their technology and markets. However, this is what we are good at. We have been very successful in combining our very strong technology capabilities with the demand of the markets, so that’s the reason we are going out there to acquire. We can take over these facilities, upgrade the technology, upgrade the facility and then realign the sales channels of this potential target and quickly get access to this market. And on top of the existing facility, it is much easier to build additional capacity should we see additional market demand.

So the board of directors and the management does have very solid plans to continue to grow the company’s capacity in light of the very careful research on market demands. We do not want to go out there and build without planning, without understanding, without research. However, when we can substantiate these demands, I think we are always ready to do so.

Ping Luo - Global Hunter Securities

Thank you very much, Andrew. That’s very helpful. That’s all my questions. Thank you.

Operator

Our next question comes from Tom [Belgret] from [Voltel] Investment.

Tom Belgret - Voltel Investment

Following up on that question, just remind me -- how big the Zibo facility can get, what the potential size of it is, and timeline if you were to decide to add, not including the additional 20,000 that you’ve already got approval for?

Andrew Chen

The total potential capacity of the Zibo facility is going to be 240,000 metric tons and phase one called for 80,000, right? As I have described just now. The other is actually separate from the phase two and phase three. It is still premature to share with investors regarding the timing of building up of these two phases of facilities in Zibo because I indicated that the -- we want -- at this time we want to focus on making sure phase one is a very successful one. We are producing high quality product, we will sell everything we make, and we are satisfying our customers and we are producing a high margin type of NPCC product that is going to be driving the profits of this company. And then after a very successful phase one, then we can further establish our reputation in the market.

In turn, it is going to generate additional market demand and it will becoming a very good basis for us to consider if we are going to be building phase two and phase three. However, I do see that that’s going to be something that will be happening in the next few years and if everything turns out very well.

And at the same time, I think we also want to focus on at this moment the [inaudible], the limestone mines which is the very reason we have built that Zibo facility. The facility is extremely close to the mine and then we have devoted a lot of resources of the company to secure that resources and we believe that it’s going to be extremely important for the long-term health of this company.

Tom Belgret - Voltel Investment

Thank you. May I follow-up really quickly?

Crocker Coulson

Sure.

Tom Belgret - Voltel Investment

Okay. I think I was not clear -- I wasn’t asking how soon the company was going to do it because I am pretty clear of the process but once they did decide, the company, you guys decide to increase capacity and go to phase two, how quickly can that be brought in? Not when do you plan on doing it but what is the governmental process -- is it a six to nine months, 12 to 15 month process to be able to -- from the time you say okay, we need to add another 80,000 to the time it --

Jenny Yang

Okay.

Tom Belgret - Voltel Investment

-- production?

Andrew Chen

Typically it takes 10 to 11 months to build a factory and install all the equipment. It takes a long time to order all the equipment used and also to install the equipment, it takes about 5 to 6 months to order and install. And then plus you also need to build a new factory building so in total, it takes about 10 to 11 months to get the factory ready for production.

Tom Belgret - Voltel Investment

Does that include the government approval to do that?

Andrew Chen

Well, I think all approvals have been obtained when we set up this facility. Yes, all 240,000 metric tons of capacity, potential capacity have been approved. When we build up the -- potentially build up the phase two that it doesn’t require another round of approval process.

Tom Belgret - Voltel Investment

Okay. Thank you very much.

Operator

Our next question comes from the line of Mike [Bambenburg], a private investor.

Mike Bambenburg - Private Investor

Have you people given any consideration to penetrating the textile industry in China, which is very huge? Meaning that they use a lot of polyethylene and synthetic products and dyes, which are incorporated into homes, carpeting, upholstery in automobiles, as well as carpeting and upholstery and very aspects like that?

Anhui Guo (Translation)

Basically the NPCC has a lot of different applications but in terms of textile, the company has not started any research in this industry.

Mike Bambenburg - Private Investor

Do they plan to in the future?

Anhui Guo (Translation)

No, the company does not have any plans.

Mike Bambenburg - Private Investor

Last question I have, from my understanding you disassembled your chemical line to move it over to the other facility which fell apart. What became of that and is there any possibility of erecting that up on one of your current sites to get it ramped up again?

Andrew Chen

We do not have such plans at the moment.

Crocker Coulson

Operator, we’ll take one more question and then we’re going to conclude the call.

Operator

I show that you do not have anymore questions at this time, sir, so I will turn it back to you for any concluding remarks.

Crocker Coulson

Okay, great. Well, thank you, Operator. On behalf of the entire ShengdaTech management team, we want to thank all of you for your interest and your participation in this call. We always welcome anyone who wants to come and visit us in China and we are also happy to take any follow-up questions that you have after the call. So again, we want to thank you for your interest and this now concludes ShengdaTech's second quarter 2009 earnings conference call. Thank you very much.

Operator

Ladies and gentlemen, this concludes the presentation. Thank you for your participation in today’s conference. You may now disconnect. Have a great day.

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