Shengdatech Inc. Q1 2008 Earnings Call Transcript

Shengdatech Inc. (SDTH)

Q1 2008 Earnings Call

May 7, 2008 9:00 am ET

Executives

Xiangzhi Chen - Chairman and CEO

Anhui Guo - CFO

Linda Ni - CCG, Market Intelligence Officer

Crocker Coulson - CCG Elite, IR

Analysts

Robert Sussman - Bentley Capital

James Allen - James Allen Investment

Andrew Braswell - iNano Capital

Alex Harbin - Toll Cross Securities

David Dulley - Merriman Curhan Ford

Chris Pauli - The Crown Advisors

Wayne Brown - Altium Securities

Presentation

Operator

Welcome to the Shengdatech first quarter Earnings Call. My name is Tolisha and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions)

I would now like to turn the call over to your host for today, Mr. Crocker Coulson, please proceed sir.

Crocker Coulson

Thank you very much. Good morning, ladies and gentlemen, and good evening to those of you joining us from China. I am Crocker Coulson, from CCG Elite, the company's investor relations firm. I would like to welcome all of you to Shengdatech's first quarter 2008 conference call.

With us today are Mr. Xiangzhi Chen, Shengdatech’s CEO and Chairman, Ms. Anhui Guo, the company's Chief Financial Officer, also will be joining us from China. Also joining us is CCG Elite's Linda Ni who will provide translation for your questions and answers at the end of this call.

I would 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 additional forward-looking statements in response to your questions. Therefore, the company claims the protection of the Safe Harbor for forward-looking statements that is 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; pricing and demand trends for the company's chemical products; the ability to attract new customers; the ability to increase our product to applications; and other information detailed from time to time in the company's filings and future filings with the US SEC.

Accordingly, although the company believes that the expectations reflected in these forward-looking statements are reasonable, we can provide no assurance that these expectations will ultimately prove to be correct. In addition, any projections as to the company's future financial performance represent management's estimates as of today, May 7, 2008. ShengdaTech assumes no obligation to update these projections in the future as market conditions change.

For those of you who are 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 will be able to find that on Shengdatech’s corporate website.

I am now going to provide the managements discussions section on behalf of Shengdatech’s Chairman and CEO, Mr. Chen.

Xiangzhi Chen

(Translated)

Welcome everybody and thank you for joining for joining Shengdatech’s first quarter 2008 conference call. We are very pleased to report our first quarter 2008 results that produced strong year-over-year growth in both our top and bottom lines. This growth reflects ShangdaTech's ability to continue to expand our business in domestic and international markets, to successfully develop new end applications for NPCC and to maintain strict control over operations. We are also very proud of the recent upgrade of our common stock to the NASDAQ global select market from the NASDAQ capital market.

Revenue for the first quarter of 2008 increased to $28.6 million, up 28.7% from the first quarter of 2007. Revenues were relatively flat, compared to the fourth quarter of 2007, due to the snowstorm which somewhat affected production at our Shaanxi factory and also the traditional one-week closure due to the Chinese New Year holiday.

Revenue generate from our NPCC segment increased 49.6%, to $13.4 million, representing 47% of total revenues. Our chemical segment revenue increased 14.6% year-over-year to $15.1 million, and accounted for the remaining 53% of revenues.

Gross profit was $10 million, with gross margin up 35.2%, up 3.8 percentage points from a year ago. Gross margin was favorably impacted by the increase to contributions from our NPCC segment along the strong pricing for our chemical products. Net income was $7.4 million, up 37.1% year-over-year and fully diluted earnings per share were $0.14, up from $0.10 in the same period last year.

Our strong financial results demonstrate the continuing robust demand for out NPCC products and our success in operating our expanded NPCC factories at full capacity.

In addition, at the end of March 2008, we completed construction of three new stainless steel NPCC lines, each of which has 20,000 metric tons of annualized production capacity. We built these new lines using stainless steel equipment instead of carbon steel, because stainless steel required one-third less maintenance time and has an expected life of 30 years, compared to 10 years for the carbon steel equipment.

Just as importantly, the stainless steel lines will allow us to employ our patent protected membrane-dispersion technique co-developed with Tsinghua University, which resulted in improved product purity and higher quality NPCC end product. This in turn yield better end product performance and is a key competitive advantage in winning international accounts.

Our new lines became production and shipments of products in early April and we expect them to reach full capacity by August of this year. Our total NPCC capacity is 190,000 metric tons, more than double our NPCC capacity a year ago, and making us clearly the leader in this category in China.

While we anticipate 60% to 70% of our recently added capacity will be utilized by existing customers, we are constantly seeking to win new customers. We are very pleased to report significant progress in this area. Domestically, we added 11 new customers, during the first quarter of 2008, including two PVC manufacturers, three tire manufacturers, two latex manufactures and four adhesive manufactures.

Building upon our success in winning our first two international customers last year, we added three new international customers in the first quarter of 2008. These customers are located in Vietnam, Malaysia and Thailand, and have purchased NPCC for use in PVC, polyethylene, and latex respectively.

We are also working closely with over 10 potential overseas customers for NPCC application in polyethylene and adhesives in these markets, as well as in Singapore. Further penetration of international markets is an important part of our stated strategy and our current focus is on Southeast Asia, Asia, North America and Europe.

Our current expectation is that international customers will grow to an annualized run rate of approximately 15% of NPCC revenues by the end of 2008, up from just 1% in 2007.

To that end we have more than doubled our international sales force, adding five English speaking and experienced sales professionals with extensive international trade experience. We have plans to expand our global sales coverage by adding another seven international sales professional in 2008 based on our forecasted market potential.

We believe we are still in the very early stages of penetrating the enormous market opportunity for high-quality NPCC, used as a functional filler, in a variety of high-end applications. This is why one of the most important elements of our growth strategy is to leverage our world class R&D capabilities to develop new applications for this product.

In January, we introduced NPCC for use in surface coating of high-grade color inkjet printer. This NPCC product was co-developed with Jinan Anne Paper Company, a subsidiary of Xiamen Anne Paper Company. The use of NPCC in color inkjet paper increases the paper's whiteness, brightness, opacity, smoothness, rate of ink absorption and also bolsters the paper's tensile strength.

In February, we introduced a new NPCC product for use in polyethylene or PE and have already won two new customers, including an international customer, which is the largest plastic manufacturer in Singapore. PE is a highly attractive versatile plastic, frequently used in consumer products such as plastic bags, shrink wrap for plastic drink bottles, food packaging and drink containers.

The use of NPCC in PE products significantly improves the quality of the end products and reduces the amount of polyethylene needed, thereby reducing the overall cost of raw materials. This PE scenario is a typical example of the execution of our compelling value proposition, which we effectively demonstrate in every application we sell.

More recently, we made a significant breakthrough in developing a new NPCC product for use in asphalt. Our research team began this project in the fourth quarter of 2007 in collaboration with Tongji University, one of China's leading research institutions. As a functional filler in asphalt pavement, NPCC helps prevent water damage and ultraviolet oxidation, which are two of the primary causes of highway damage.

Consequently, when our exclusive NPCC formulation is added to the asphalt mix, it serves to decrease the frequency of costly road repairs. NPCC can also lower production cost for asphalt manufacturers as it reduces the amount of raw materials needed to produce their finished products.

We are particularly excited about this new NPCC application for a good reason. According to industry reports, the asphalt market in China tops 12.3 million metric tons in 2005. Domestic demand is expected to outpace global demand, rising 6% annually through 2010 to over 16 million metric tons, as the industry benefits from the robust growth in infrastructure construction in China.

We are working with some potential asphalt manufacturers to develop customized formulas and expect to finalize customer acceptance within the next month or two.

Another NPCC application in development is for use in epoxy resin. Epoxy-based materials are polymers, often using coatings, adhesives and composite materials such as those using carbon fiber and fiberglass reinforcements.

Industry reports state, as of 2006, the epoxy industry amounted to more than 5 billion in North America and about 15 billion worldwide. The Chinese market has been growing rapidly as estimated to be more than 30% of the total worldwide market. We are also developing NPCC applications for automobile undercoating paints and paper manufacturing, including the use of NPCC in coating for a variety of paper grades, and as an additive, used in paper manufacturing.

Given the number of new applications that we are developing, creating strong demand in the domestic and international markets, we are actively exploring potential sites in Eastern China for our next phase of NPCC expansion, which will add an additional annual capacity of 120,000 metric tons. Construction on the first phase of 60,000 metric tons is expected to begin in August of 2008, with production beginning in either July or August of 2009.

The sites we are evaluating provide access to high-quality limestone quarries, are close to our growing customers base and also close to a port that makes it convenient to ship products to international customers.

Now, I would like to briefly discuss our chemical business. During the first quarter, we experienced strong growth in our coal-based chemical business due to increasing demand for fertilizer products in China. Revenue from ammonia bicarbonate, a key raw material used in producing nitrogenous fertilizers, saw the largest increase due to stronger market demand and an increase in market prices.

As part of our growth strategy, we aggressively continue to evaluate acquisition opportunities that would be complementary to our chemical business. The acquisition targets we are considering are companies with inefficient operations that can benefit from our expertise and superior production capabilities to quickly return to profitability.

We are confident in our ability to successfully execute in this area, given our strong track record of improving our existing chemical businesses operations and its profit contribution. We will provide updates as further developments are made.

Now, I would like to discuss Shengdatech’s financial results in more detail on behalf of the company's CFO, Ms. Guo.

Anhui Guo

(Translated)

Turing to our financial results. Our revenues for the first quarter of 2008 increased to $28.6 million, up 28.7% from $22.2 million in the same quarter of 2007. This very strong increase is attributed to increased NPCC production capacity and our ability to develop product applications that add measurable value to our customers.

NPCC now accounts for 47% of revenues, with 53% coming from the chemical segment, compared to 40.5% and 59.5% respectively a year ago. On a sequential basis, revenues were slightly down from the fourth quarter of 2007. This was because our first quarter of 2008 had 10 fewer shipping days as a result of the closure of the NPCC factories in Xiangyang City in Shaanxi Province due to snowstorm and one-week closure for the Chinese New Year's holiday.

The lower number of shipping days was partially offset by stronger growth in the chemical products in the first quarter of 2008 due to strong demand for chemical products in China.

Revenue from NPCC products increased 49.6% to $13.4 million in the first quarter of 2008, up from $9 million a year ago. The increase in year-over-year revenue was due to the 40,000 metric tons of added NPCC capacity in July of 2007, which is now operating at full capacity during the first quarter of 2008. Total volume of NPCC sold during the first quarter of 2008 was 33,716 metric tons, up from 10,465 metric tons or 45% from 23,251 metric tons a year ago.

NPCC for use in tires and PVC represented the majority of our NPCC sales at 43.7% and 36.1% of total NPCC revenues respectively. NPCC for use in latex increased 5.5% sequentially, representing 10.6% of total NPCC revenues.

Sales of our new NPCC application, paper manufacturing, experienced the strongest sequential growth, contributing 4.8% of total NPCC revenues, while other new NPCC applications for printing ink, paint and polyethylene generated 4.8% of NPCC revenues.

Our revenue from the chemical products increased 14.6% to $15.1 million in the first quarter of 2008, from $13.2 million a year ago. Sales of ammonium bicarbonate representing 36.1% of the chemical segments revenues increased 47.8% sequentially.

While demand for fertilizers in winter, from December to next February, is abnormally not as strong as the other seasons, we did experience stronger market demand and an increase in market prices during this quarter. Liquid ammonia and methanol represented 33.4% and 15.5% of chemical sales respectively. And melamine contributed the remaining 14.9% of chemical segment revenue during the quarter.

Our gross profit in the first quarter of 2008 was $10.1 million, up 44.3% from $7.0 million a year ago. Gross margin for the quarter was 35.2% compared to 31.4% for the same period in 2007. The chemical segment benefited from strong pricing for ammonia bicarbonate and liquid ammonia, resulting in gross margin of 30.1%, up 5.2 percentage points from 24.9% in the same period of 2007.

Gross margin for the NPCC segment was 41.1% in the first quarter, relatively unchanged from 41% in the same quarter last year. Sequentially, gross margin for the NPCC segment decreased slightly from 42.6% in the fourth quarter of 2007, due to a combination of increased depreciation expenses, higher limestone prices, and fewer manufacturing days during the first quarter of 2008.

Selling expenses in the first quarter of 2008 were $400,000 or 1.5% of revenue, down from $500,000 or 2.2% of revenue a year ago. G&A expenses were $700,000 or 2.6% of revenue compared to $500,000 or 2.1% of revenue a year ago. The increase in G&A expense was mainly a tribute to higher professional and legal expenses, cost related to NASDAQ upgrades, and higher research and development expenses.

Operating income in the first quarter of 2008 was $8.9 million, up 47.8% from $6 million in the same period a year ago. Our operating margin was 31.1% compared to 27.1% a year ago.

Provision for income tax in the first quarter of 2008 was $1.5 million, up from $700,000 in the first quarter of 2007. The significant increase was due to the end of the first two-year phase of the income tax holiday at our Xiangyang factory, which began paying at a rate of 16.5% of taxable income beginning in 2008, and will continue at that reduced rate through 2010. For our facilities in Shandong, we began to pay a tax rate of 16.5% in 2007 and that continue through 2009.

Net income in the first quarter of 2008 was $7.4 million, up 37.1% from $5.4 million in the same period a year ago.

Fully diluted earnings per share for the first quarter of 2008 were $0.14 compared to $0.10 in the same period last year.

And now I will turn to the balance sheet. As of March 31, 2008, we had $18.4 million in cash and cash equivalents, 13 million in working capital and 800,000 in long-term payables. Net cash provided by operating activities for this period was $15.3 million. Shareholders equity stood at $100.3 million, up from $89 million at yearend 2007.

As reported subsequent to the quarter end, we determine the needs to restate our 2007 balance sheet and cash flow results for the year ended December 31, 2007, to correct a $17.2 million misclassification of advances paid to suppliers, which should have been treated as construction-in-progress within property and equipment. This reclassification has effect of decreasing current assets and increasing in fixed assets by $17.2 million and also increases cash flow from operations by the same amount.

Now, I will provide some final remarks, before we open up the call to your questions. I would like to conclude by saying that our success this quarter was the result of Shengdatech’s proven ability to execute our business model by pioneering the use of NPCC as a functional filler in our ever broadening range of end market applications. We are able to accomplish this due to our patent protected membrane dispersion technology and world class R&D.

These allow us to produce higher quality, more stable NPCC products, which we use to develop new higher end market applications for NPCC. In order to create and capture the growing demand for NPCC, we introduced several new applications for NPCC products and we were successful in expanding our presence in both domestic and international markets.

Subsequent to the quarter-end, we brought on another 60,000 metric tons of annual production capacity online and we are now in the final planning stages for our next capacity expansion build.

Given the strong market demand for our chemical products, we believe there are additional highly attractive opportunities in the chemical segment as we continue to evaluate potential acquisition targets to enhance our existing operations and profitability. With that we would like to close by thanking our shareholder for your strong support and we will now open up the call to any questions you have, for Mr. Chen or Ms. Guo.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from the line of Robert Sussman with Bentley Capital. Please proceed.

Robert Sussman - Bentley Capital

Hi, I have got two questions. As I recall, on the fourth quarter conference call you indicated that the next expansion for 2009 would be 60,000 metric tons and I believe that you have changed it to a 120,000 metric tons. Could you explain the reason for that if I am correct?

And my second question is could you discuss the potential in terms of metric tons of the asphalt market for ShengdaTech for the next few years?

Crocker Coulson

Robert thank you very much for your question. Maybe I'll clarify the first part and then I'll have Linda translate the whole thing and Mr. Chen can take the second part of your question. So in the last call we did talk about a 60,000 metric ton expansion somewhere in Eastern China, but we now have clarified that it will be -- the 60,000 ton will be the first phase of a 120,000 ton plan. So we are still on track for the starting to build on the 60,000 tone by the end of the summer and bringing on within 12 months after that, but that's the first phase of a 120,000 tone expansion.

So, with that Linda maybe you can translate the question and answer and get some clarification on the asphalt issue.

Anhui Guo

(Translated)

Okay. Anhui Guo, the CFO, she wants to add a little bit more to what Crocker said. So, basically, the capacity of the facility for the NPCC production is actually the full operating capacity should be 200,000 to 300,000 metric tons. And by July 2009, Ms. Guo is confident that we can reach full capacity for the 60,000 tons. And Crocker is correct. The rest of 60,000 tons will start production after the first phase.

Linda Ni

Let me go ahead and ask for the question and turn to the next question regarding the asphalt. (Foreign Language)

Anhui Guo

(Translated)

Okay. So as far as asphalt, so currently they are working with their existing customers, and also they are in the research and development stage of the asphalt product. And the market for asphalt, as Ms. Guo said, is huge. And because it is for basically the surface of pavements and the roads, so the market is tremendous for asphalt. And they are working on getting the patent for it.

Robert Sussman - Bentley Capital

So, as we said, the estimated market size in terms of asphalt production in China is supposed to grow to 16 million metric tons by 2010. Maybe you can ask Ms. Guo if they have any reasonable estimate as to what percentage of asphalt production could be replaced by NPCC.

Linda Ni

Okay. (Foreign Language)

Anhui Guo

(Translated)

So, Ms. Guo has said the percentage for NPCC is about 4% to 5% of that 16 million metric tons.

Crocker Coulson

So, Robert, does that give you enough to work with?

Robert Sussman - Bentley Capital

Yes. Crocker, I'm not sure that I understand on the first part of my question about the expansion.

Linda Ni

Robert said, I am not sure of the first question. So, maybe I can further explain what Ms. Guo had said. Ms. Guo said that they plan to purchase 800 to 1,000 more land for our next phase of NPCC production is done in Eastern China with enough space for expansion of 220,000 metric tons.

This land, 220,000 metric tons in Eastern China, is divided into two parts. And the first 60,000 metric tons is planned to be put into production in July 2009. With our market conditions and our RD& efforts, we may evaluate a suitable construction time for the next 60,000 metric tons. And Ms. Guo is saying we are very confident on the NPCC market potential and our strategy.

Crocker Coulson

Okay. Does that answer your question now, Robert?

Robert Sussman - Bentley Capital

Yes, okay. Thank you.

Linda Ni

Thank you.

Operator

And our next question comes from the line of [James Allen with James Allen Investment]. Please proceed.

Crocker Coulson

Good morning.

James Allen - James Allen Investment

Good evening to you. I have a question. Are you people considering using NPCC in the textile industry, and textile meaning obviously is carpets, which could be automotive as well as business and home or upholstery, clothing, that type of thing?

Crocker Coulson

Okay. Linda will translate the question.

Linda Ni

(Foreign Language)

Anhui Guo

(Translated)

Okay. So, actually, it's definitely possible to use NPCC in the textile industry for clothing, et cetera. However, they have not really spent on any research or development into how to use NPCC in the textile industry. But this is definitely a possibility.

James Allen - James Allen Investment

Well Ms. Guo and Mr. Chen and we hear that that obviously the textile industry uses a lot of products that are, how should we say like many -- what sort of I am looking, for were they manufactured artificial products that are made out of, like plastics and chemicals and I think it would be added to that as well. Another thing I want to ask you how much inroads have you made into the automotive and aerospace paints with the…

Linda Ni

Automotive and aerospace paints, okay.

James Allen - James Allen Investment

Yes.

Anhui Guo

(Translated)

Okay. So, definitely they have considered for the automotive paint, they definitely have looked at that and but for the aerospace there is something that we have not looked at and but definitely a possibility in the future for our research and development team to come up with a product for that industry.

Crocker Coulson

So thank you, I think we will take our next question.

James Allen - James Allen Investment

I am not done yet Crocker, okay. Is that okay with you. All right, another thing tell me Guo was the demand on the textile was synthetic, okay.

Linda Ni

Synthetic.

James Allen - James Allen Investment

Yeah, anothr thing, another application, is it possibly that they can use this in motor oils and lubricants, because of oil has a thermal breakdown for heat. I understand NPCC is very good for thermal, heat resistant properties. And I was wondering, if this could be used in motor oils of all types, as well as lubricants?

Anhui Guo

(Translated)

Okay, definitely and I thank you for all these suggestions and NPCC is a very -- this product has been -- it can be used in many, many different industries, thank you for your ideas. And however, we do need to kind think down, which industry we would like to target, and we need a plan it out and also work with our research and development teams in order to kind of come up with applications for these different industries.

Crocker Coulson

Operator, I think we got to move to our next question. We can come back later to Mr. Allen.

Operator

Thank you. Our next question comes from the line of Andrew Braswell with iNano Capital. Please proceed.

Andrew Braswell - iNano Capital

Thank you. It appears that the ASPs, the selling prices for NPCC were up 10 to 15 metric ton from the fourth quarter of ’07, so I was hoping for a comment on trends in pricing, both domestically and in the new international markets that we are now shipping?

Linda Ni

Sure.

Crocker Coulson

Okay.

Linda Ni

Go ahead Crocker.

Crocker Coulson

Go ahead and translate and. I will clarify it.

Anhui Guo

(Translated)

Did you mean that -- did you ask for whether -- why it was increased or decreased, Andrew?

Andrew Braswell - iNano Capital

It looks like in the recent quarter, in the March quarter we were up from…

Linda Ni

Up?

Andrew Braswell - iNano Capital

Up from the fourth quarter of '07. So just looking forward or what are the trends, should we expect continued…

Linda Ni

Okay.

Crocker Coulson

I don't think that's actually true. Our ASP for NPCC in Q1 of 2008 was $398 per metric ton.

Linda Ni

Yeah.

Crocker Coulson

This was off a little bit from the fourth quarter of 2007 when we were at 405, or $405 per metric tons.

Andrew Braswell - iNano Capital

We were at 405 in the fourth quarter?

Crocker Coulson

Yeah.

Andrew Braswell - iNano Capital

Yes, that's the number that I have.

Crocker Coulson

So, why don't you ask the management to comment on pricing trends for NPCC products and also difference between exports and domestic.

Anhui Guo

(Translated)

Okay. Actually the price range for the NPCC -- from her point of view for now, it's about $300 to $425 per ton. That should be the range from the average price for NPCC.

Andrew Braswell - iNano Capital

Can you repeat that range please?

Anhui Guo

(Translated)

$300 to $425 per ton.

Andrew Braswell - iNano Capital

Okay. $300 on the low end?

Anhui Guo

Yeah. $300 on the low end.

Andrew Braswell - iNano Capital

Okay.

Anhui Guo

(Translated)

Now, I maybe add some more point, the pricing trend of NPCC now is almost stable and the price range maybe extended with, say, high-value NPCC products in the coming years with high prices, and then the prices for medium-end and low-end products would be lowered. So, currently the prices of our NPCC products stay in the range of US$300 to US$425 per metric ton.

Andrew Braswell - iNano Capital

So, that range is --.

Linda Ni

The ow-end to high-end range, from low-end product to high-end products.

Andrew Braswell - iNano Capital

Understood, thank you.

Linda Ni

Okay.

Andrew Braswell - iNano Capital

And now I see that I was comparing year-over-year. It looks like we're up about 10% from first quarter of '07. So, it was my mistake.

Crocker Coulson

Yes, that's correct.

Andrew Braswell - iNano Capital

That's where it leads to my next question, asphalt. Very interesting, certainly a large market, but seemingly lower value, perhaps lower value to volume at least than some of them, perhaps tires or papers, some of the other markets that we're serving. What exactly would the higher value raw material in asphalt would NPCC be used to substitute for?

Anhui Guo

(Translated)

She said that as far as NPCC portion, it's about 4% to 5% of the asphalt.

Crocker Coulson

I think he is asking what does it substitute for. What does it take on?

Linda Ni

(Translated)

What does it substitute for, okay…

Anhui Guo

(Translated)

Okay. It was the most expensive part of asphalt, basically a part of…

Crocker Coulson

I think we heard that it was silicon oxide. Is that correct?

Linda Ni

Yes. Silicon dioxide.

Andrew Braswell - iNano Capital

Silicon dioxide?

Crocker Coulson

Yes.

Andrew Braswell - iNano Capital

Very good. That's what I was looking for. Thank you. And last question is on the chemical side of the business. It looks like there was a change in language from the 10-K. Well, it looks like increasing potential for regulatory impact on the chemicals business either forcing a temporary shutdown or a relocation of that business.

Can you provide a little bit of color on what might be the political or regulatory changes that are driving that? And the most important part is what percentage of the current chemical production is at risk? Is a 100% of the production located adjacent to residential districts that it might be impacted?

Crocker Coulson

Okay. So that the question, Linda, is that we indicated in our filings that there maybe potential to have to relocate our chemical production, and we'd like some more details on that and what caused the change in the environment.

Anhui Guo

(Translated)

Okay. So, the first part of the question is regarding relocating the factories at the end of 2008 or the beginning of 2009. And let me ask her the second part of question.

Crocker Coulson

Let me clarify that. See, the answer is, and you can translate this back to make sure I got it right, but the company currently expects that they might receive first notice at the end of 2008 or beginning of 2009 that they would have to relocate.

And usually, the government will provide about six months to comply. And the company's strategy would be to relocate potentially in conjunction with an acquisition or potentially not.

And they believe, based on their strong government relations, that they can negotiate for additional time and they also estimate that the total downtime as a result of this relocation would be in the range of one to two months.

But there is also potential to get a partial offset from the government due to the positive contribution they've been making to the environment in the region.

Anhui Guo

(Translated)

Okay. Crocker is partially right, but she wanted to add a couple of more things. She has not received the notice from the government yet, so they have not received that notice yet. But what Crocker was saying before, potentially, we could be looking at acquisitions, and if we do move into the factory that the -- that is related of course -another acquisition type will be chemical related. If we do move into that factory facility, this will actually decrease our investment cost, the initial investment cost. But the products might be slightly different, so not the same as what we currently produce. And as the downtime is about one to two months. That is correct, if all goes smoothly.

Andrew Braswell - iNano Capital

Okay. Thank you very much.

Operator

And now our next question coming from the line of Alex Harbin with Toll Cross Securities. Please proceed.

Alex Harbin - Toll Cross Securities

Hi, guys. I was wondering maybe a little bit of clarification on the chemical acquisitions. Are you looking at someone specifically now, I don't know if that was mentioned in last conference call, but I know you guys were looking at somebody in the chemical industry. So wanted to know if specifically you are looking at as some body now?

And in terms of the company that you are looking at, will the products be necessarily the same thing that you are producing now or would it be something complimentary?

Linda Ni

Okay. (Foreign Language)

Anhui Guo

(Translated)

Okay. So, we do have a pretty much a specific target for acquisitions at this point and they are also a similar product to what we are already producing but not exactly the same, not exactly the same and we believe that the acquisition, the target, the company will add definitely add value on our chemical side of the business and also will contribute positively to our financials.

Crocker Coulson

So, and maybe I just make a caveat to that which is that the company has been evaluating different targets in with any acquisitions. It is not done until it’s done. So they have nothing definitive at this point, but they are definitely in the process of evaluation and believe there are very attractive targets.

Alex Harbin - Toll Cross Securities

What kind of size are we looking at, in yearly revenue kind of thing?

Linda Ni

Okay. (Foreign Language)

Anhui Guo

(Translated)

Okay. So, she cannot comment on the size of the revenue at this point, we are still considering different acquisition targets, so we are finalizing but we are still evaluating.

Alex Harbin - Toll Cross Securities

Okay. All right, I guess that's it. Thanks.

Crocker Coulson

Thanks Alex.

Operator

And our next question comes from the line of David Dulley with Merriman. Please *

Okay, got it.

Crocker Coulson

So, let's take one question at a time. So that should help.

Linda Ni

Sure.

Crocker Coulson

How will we produce it above our designed capacity?

Linda Ni

Okay, got it, Crocker.

Anhui Guo

(Translated)

First question regarding the capacity how we can achieve over the stated capacity? Actually the 120,000 is based on 300 day working days in a year, however, in reality we think that we can definitely achieve 340 days. So 15% over what the stated capacity is a norm for the way we calculate.

David Dulley - Merriman Curhan Ford

Great.

Linda Ni

Okay. And the second question I will ask now. Okay. (Foreign Language)

Anhui Guo

(Translated)

Okay. She said that, paint.

David Dulley - Merriman Curhan Ford

Pardon?

Linda Ni

Paint, painting.

Anhui Guo

(Translated)

Oil or ink?

David Dulley - Merriman Curhan Ford

Okay, great. And the follow-up question from me is, you continue to improve the growth margins in your chemical business. Should we assume the current level of margins is what we can achieve going forward there and what would depreciation expense be in Q2?

Anhui Guo

In Q2? Okay. There are two questions.

Crocker Coulson

Two questions, gross margin expectations in chemicals and then forecast depreciation starting in Q2.

Linda Ni

Yes, okay. (Foreign Language)

Anhui Guo

(Translated)

Okay. So, regarding the margins on the chemical side, yes. Ms. Guo said yes. For first quarter, the margin is quite high. She is mentioning in the next five years, we will see that the margins industry-wide is very optimistic. So, in the next few years, you should see good margins from this business. Does that answer your question?

David Dulley - Merriman Curhan Ford

Yes. So, I guess what I'm interpreting that as the level that we achieved in Q1 will continue to be achieved in the balance of the year.

Anhui Guo

(Translated)

Okay. So, she said that from her experience, I mean she cannot give you a promise in even higher margin than what we are achieving now, but she said from her experience, she thinks that this industry will continue to grow in the very big market. So..

Crocker Coulson

Okay. And shifting now to the products competition quarter-to-quarter does tend to change a little bit, and the company makes adjustments to its production based on pricing. So, I think what we are saying is that we think the overall trend is positive for the next several years, but every quarter, there will be some fluctuations and they are difficult to predict on a very exact level.

David Dulley - Merriman Curhan Ford

Understood.

Linda Ni

Okay. So, I'll ask you second part of the question regarding depreciation for second quarter. (Foreign Language)

Anhui Guo

(Translated)

Okay. So, for second quarter, the depreciation expense will be a little higher, because as you know, in April, we just installed 60,000 metric ton of the three lines, the stainless steel production line. So, we will start, I guess, calculating the depreciation expenses from second quarter on, on those three lines.

David Dulley - Merriman Curhan Ford

Okay, and final thing from me, just another market potential question, which we had lot of today. I just want a clarification. When you talk about the plastic PVC market, that does not include the polyethylene market, correct? And I am wondering if the polyethylene market or PE market is as big as PVC?

Crocker Coulson

I mean I can definitely clarify that the polyethylene and polypropylene markets is considered to be a different market from PVC. And maybe you want to ask Mr. Chen or Miss Guo the relative size potential of PE relative to PVC.

Linda Ni

Okay. The PVC as large PE in two different markets and the market potential on those two, right?

Crocker Coulson

Yes. Just how does the polyethylene compare to PVC in terms of market size?

Linda Ni

Got it. Okay. (Foreign Language)

Anhui Guo

So, Ms. Guo actually gave me some specific numbers on the market side for PVC and PE. It was quite fast, so I did not get a chance to write them all down.

Crocker Coulson

Okay, let me give the basics on the polyethylene and polypropylene. The industry of course that we can find suggest that polypropylene and polyethylene take in together is about 14 million metric tons annually in China. And worldwide it's about 80 million to 90 million metric tons. Our estimates are that NPCC can displace about 4% to 5% of the finished products, if adopted. So that would put the potential domestic demand at somewhere on average of 560,000 to 700,000 metric tons per year.

David Dulley - Merriman Curhan Ford

Right, that exactly what I am trying to get out of it.

Crocker Coulson

Worldwide it would be somewhere between 3.2 million to 4.5 million metric tons. So you can see it's a very large market. It is a question of penetrating; it's not just that there is absence of opportunity.

David Dulley - Merriman Curhan Ford

No, I guess what I am trying to drive at really here is to just to flush out how big the markets are for everybody and clearly a domestic market for you guys is greater than $1 billion, and when you loot at you worldwide, it's vastly larger. So, again congratulation on a nice quarter. That's all from me.

Linda Ni

Okay.

Operator

And our next question comes from the line of Chris Pauli with The Crown Advisors. Please proceed.

Chris Pauli - The Crown Advisors

Thank you. Could you please explain to me how you can have total operating expenses of only 4.1%? That's quite extraordinary.

Linda Ni

Can you repeat the question?

Crocker Coulson

Linda the question is, how did we achieve such low operating expenses?

Linda Ni

Okay.

Crocker Coulson

He said that, OpEx at 4.1% is very low. How did we do that?

Linda Ni

Okay. (Foreign Language)

Anhui Guo

(Translated)

Okay. She said that we are -- as our business grows and our business expands, we are getting better and better at controlling our expenses, and we have also developed a lot of strategy, in terms of how to eliminate certain costs over the years, such as decreasing administrative expenses and other expenses. So this is how we were able to -- it’s over three years of experience.

Crocker Coulson

I think the short answer is they have a very good CFO. How many people are represented…

Linda Ni

So they have developed good expense control -- kind of, policies. They have developed policies in terms of controlling their expenses. So…

Chris Pauli - The Crown Advisors

How many people are represented by that number?

Linda Ni

How many people? You mean by now how many people are working at the company?

Chris Pauli - The Crown Advisors

Well, you sort of answered that, yes…

Crocker Coulson

He means not in the factory. But he is asking, in the sales and administrative parts of the company, how many employees?

Chris Pauli - The Crown Advisors

Why don't you break? Why don't you tell me how many employees total? How many employees are represented into the cost of goods, and how many employees on the SG&A side, and how many are represented by those numbers?

Linda Ni

Okay. (Foreign Language)

Anhui Guo

(Translated)

Okay, so that Ms. Guo is saying that on the SG&A area, there is about 37 people in terms of the sales team and the managing team is about 9% of the overall, of the total employees at ShengdaTech.

Chris Pauli - The Crown Advisors

So, what's the total employee count, just so we can get a sense of the scale?

Linda Ni

Okay. (Foreign Language)

Anhui Guo

(Translated)

1200 people, a little over 1200 people.

Chris Pauli - The Crown Advisors

So, let us just clarify it further, there is 1200 total employees, 37 approximately in the sales function.

Linda Ni

Yes, and 9% of 1200 is about….

Crocker Coulson

There is 100 people in the administration.

Linda Ni

Yeah.

Chris Pauli - The Crown Advisors

So there is a 100 people in administration, a 108 people and the balance is in manufacturing. Is that correct?

Linda Ni

Okay. (Foreign Language)

Anhui Guo

(Translated)

Okay. The rest of people, she said if we minus about 100-something people from that for the administrative, so you have about 1,000 people on the production side, working in the facilities.

Chris Pauli - Crown Advisor

Okay. Thank you.

Anhui Guo

(Translated)

Okay. 13 people in R&D department.

Chris Pauli - Crown Advisor

Okay. Thank you very much.

Linda Ni

Thank you.

Operator

And our next question comes from the line of [Wayne Brown - Altium Securities]. Please proceed.

Wayne Brown - Altium Securities

Yes, thank you. Is it possible that the company will entertain expansion of their facilities or their capacity to meet client demand, I should say, through any sort of joint venturing or licensing, given the fact that they have patent technology license in China?

Anhui Guo

(Translated)

At this point, we have not considered this option.

Wayne Brown - Altium Securities

Okay. Thank you. And also, you mentioned on the tax rate, it will sunset after '09. Can you give me the effective tax rate after that?

Crocker Coulson

Yes, so just to make it clear that the different facilities have a different sunset. For the facilities currently in Shandong, it's end of 2009. For the facility on Xian, it's end of 2010. And China's government earlier this year adopted new unified tax rate of 25%. So, I'm pretty sure that at the end of that, they would go to that new unified tax rate. So, why don't you translate that to Ms. Guo and make sure I am correct.

Linda Ni

Okay. (Foreign Language)

Anhui Guo

(Translated)

Okay, all right. So, in China, as of January 1st, 2008, all the companies are paying to 25%. And so, for our ShengdaTech, in the Shandong facility in 2008 and 2009, we are paying 16.5% for the tax. And then in Shaanxi Province facility, we are also paying 16.5. And 2011 for Shaanxi, we will start paying 25% for tax rate.

Crocker Coulson

So, by 2011, all the current facilities will be at a 25% unified tax rate.

Linda Ni

Yes.

Wayne Brown - Altium Securities

Okay. Thank you. And the proposed new facility would then have a holiday for three years, would it be?

Crocker Coulson

I don't think they are still granting us holidays. Let's ask.

Linda Ni

Okay. (Foreign Language)

Anhui Guo

(Translated)

No, they will not get the tax holiday on the new facilities, no.

Crocker Coulson

Yeah, the window closed at the end of last year to qualify for those breaks. In special economic zones, either there are still other breaks available, but in most of China, they are not available, no.

Wayne Brown - Altium Securities

Well, thank you very much. I appreciate it, and congratulations.

Crocker Coulson

Thank you.

Operator

And our next question comes as a follow-up question from James Allen with James Allen Investment. Please proceed.

James Allen - James Allen Investment

Good morning. Just want to mention something that I think needs to be addressed. I've made many a calls, of up to a dozen calls to Investor Relations since June, and not once have I ever had a return phone call from Crocker Coulson who I've left a dozen messages with since June. And I think Investor Relations, that what it was supposed to be about is relations with the investor, shareholders, and I think that's wrong that nobody had the decency to return my calls.

Crocker Coulson

Okay. Mr. Allen, thank you for comment. As you know, I called you back at least three times this week. So, free feel to translate that. But I think we've heard your comment. Thank you. Next question. And this will be our last question.

Operator

And there are no questions at this time.

Crocker Coulson

Great. Well, we want to thank all of you for your participation in the call. This obviously ran a lot longer than we were expecting. And feel free if you have any additional questions to follow up, and we'd be happy to get you response on a timely basis.

Thank you very much. And we look forward to coming back to you later this year and talking about our second quarter results.

Operator

This concludes your presentation. You may now disconnect, and have a great day.

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