<PAGE>
FORM 10-KSB\A-2
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] Amendment No. 1 to Annual Report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the fiscal year ended December 31,
1995.
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
Commission file number: 1-8334
REGAL INTERNATIONAL, INC.
(Exact name of Registrant as specified in its charter)
Delaware 75-1071589
(State or other jurisdiction of (I.R.S. Employer
incorporation of organization Identification No.)
52/F Bank of China Tower
1 Garden Road
Hong Kong
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (852) 2514-0300
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
-------------------
Common Stock, $.01 par value
Check whether the Registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act during the past 12 months(or
for such shorter period that the Registrant was required to file such report)
and (2) has been subject to such filing requirements for the past 90 days.
yes [x] no [ ]
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [x]
Revenues for the year ended December 31, 1995 were $7,591,000
The aggregate market value of the common stock of the Registrant held by
non-affiliates of the Registrant on March 15, 1996 was $913,623. The aggregate
market value was computed by reference to the average bid and asked prices for
the Common Stock on March 15, 1996. Solely for the purposes of this response,
executive officers and directors are considered the affiliates of the Company at
that date.
As of March 15, 1996, 81,806,198 common shares were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None
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PART I.
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
In February and September, 1996, Regal International, Inc. (the "Registrant"
or the "Company"), which term shall include, when the context so requires, its
subsidiaries, completed a series of transactions which resulted in the
Registrant's acquisition of a new businesses and disposition of its existing
business assets and liabilities. The information set herein discloses
information required by Form 10-KSB with respect to business of the Registrant
(i) prior to the acquisition of the new business (Acewin Profits Limited) in
February 1996, (ii) after the acquisition of Acewin Profits Limited in February
1996 and sale of the then existing business, and (ii) after the sale of Acewin
Profits Limited and acquisition of the new assets (Westronix Limited) in
September 1996. The information presented herein with respect to the
Registrant's business prior to February 1996 (for the fiscal year ended December
31, 1995 and the period from January 1, 1996 through February 19, 1996) and for
the period of February, 1996 through September, 1996 is presented to reflect the
historical business and operations of the Registrant for the year ended December
31, 1995 and the respective periods of fiscal 1996, prior to the acquisition of
the Registrant's current business. Since all of the assets and liabilities
relating to the business of the Registrant during those respective periods have
been sold and assumed respectively, the following information should be
considered for historical purposes only and does not in any way reflect the
current business and operations of the Registrant.
FORMATION AND DEVELOPMENT OF REGISTRANT
On May 10, 1982 the Registrant became a separately publicly held corporation
as a result of a spin-off from Texas International Company. Shareholders of
Texas International Company were issued one share of the Registrant's common
stock for each two shares of Texas International's Common Stock.
The Company changed its state of incorporation to Delaware in March 1982
through a merger with a wholly-owned subsidiary organized for that purpose. The
surviving Company's authorized capital stock consisted of 20,000,000 shares of
common, par value $.10 per share ("Common Stock") and 10,000,000 shares per
preferred stock, par value $.10 per share, ("Preferred Stock"). At the November
17, 1987 Annual Meeting, shareholders voted to increase the authorized number of
shares of Common Stock to 75,000,000. At the May 25, 1993 Annual Meeting, the
shareholders voted to change the par value of Common Stock from $.10 per share
to $.01 per share and to increase the authorized number of shares of Common
Stock to 150,000,000.
In 1987 the Company acquired all of the issued and outstanding common stock
of Bell Petroleum Services, Inc. ("Bell"), an oilfield products and services
company.
On December 7, 1994 the New York Stock Exchange ("NYSE") suspended trading of
the Company's Common Stock pending delisting as the Company did not meet the
NYSE's criteria for continued listing. The Company decided not to contest the
delisting and the Common Stock was removed from listing and registration on the
NYSE effective February 9, 1995. The Company's Common Stock began trading on the
NASD Electronic Bulletin Board in August, 1995.
1
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BACKGROUND OF RECENT TRANSACTIONS
On February 19, 1996, the Registrant acquired all the issued and outstanding
shares of capital stock of Acewin Profits Limited, a British Virgin Islands
corporation ("Acewin"), from China Strategic Holdings Limited, a Hong Kong
company ("CSH") listed on The Hong Kong Stock Exchange Limited. Acewin's sole
asset is all the issued and outstanding shares of China Machine (Holdings)
Limited, a Hong Kong company ("CMHL"). CMHL's sole asset is a 55% joint venture
equity interest in Wuxi CSI Vibration Isolator Co., Ltd. ("Wuxi CSI"), a
Sino-foreign joint venture established in September 1993.
The consideration paid by the Registrant for the Acewin Stock was $13.5
million. In determining the consideration paid by the Company for Acewin stock,
the Company took into consideration the following factors: the indicated profit
after tax ("PAT") of Wuxi (the operating subsidiary of Acewin) and
profit/earnings forecasts for that company. In determining the consideration of
$13.5 million, the Company used in its calculations 3.3 PAT and 7.5 P/E. In
addition, to ensure fair purchase price, the purchase agreement provided for an
adjustment to the purchase price, in case of adjustments made after the
completion of the audit of Acewin. The valuation of Acewin stock by the Company
was validated as fair when the unrelated party paid more than $13.5 million for
the Wuxi business in September of 1996. Said purchase price was paid by the
Registrant's delivery of its Convertible Note bearing interest at the rate of
nine percent (9%) per annum after an initial six (6) month interest-free period
(the "Convertible Note"). Interest on the Convertible Note was payable on an
annual basis, with all principal being due and payable on January 31, 1999. The
principal and any unpaid interest owing on the Convertible Note were convertible
into shares of the Common Stock, $0.01 par value, of the Registrant ("Common
Stock") at a conversion price of $0.0302 per share. The Convertible Note was
secured by a Pledge Agreement granting CSH a security interest in the Acewin
Stock. The Convertible Note was fully repaid upon the sale of Acewin Stock, as
described below.
Immediately following the acquisition of the Acewin Stock and as a condition
thereto, the Registrant sold and transferred the existing operating assets and
real property of the Registrant to a newly formed corporation, Regal (New)
International, Inc. ("New Regal") in exchange for New Regal's assumption of all
liabilities of the Registrant, other than the Convertible Note, and $2.5
million, all in accordance with the terms and conditions of a certain Asset
Purchase Agreement, dated as of February 8, 1996, by and between Registrant and
New Regal.
The $2.5 million purchase price was paid as follows: $800,000 in cash and the
balance by delivery of two (2) Promissory Notes, one in the principal amount of
$900,000 (the "$900,000 Note") and the second in the principal amount of
$800,000 (the "$800,000 Note"). The $900,000 Note bears interest at 9% per annum
and is payable in sixty (60) equal monthly installments of principal and
interest. The $800,000 Note bears no interest and is due and payable in one
installment on January 31, 2001. New Regal's obligations under the $900,000 Note
and the $800,000 Note are secured by a pledge of all of the issued and
outstanding shares of capital stock of New Regal. All the issued and outstanding
shares of New Regal were owned by Harlequin Investment Holdings Limited
("Harlequin"). Harlequin was at the time of this transaction the beneficial
owner of approximately fifty-five percent (55%) of then currently outstanding
shares of the Registrant's Common Stock. Subsequent to this transaction,
Harlequin reduced its beneficial ownership of the Registrant to less than one
percent. See Item 11 - Security Ownership of Certain Beneficial Owners and Item
13 - Certain Relationships and Related Transactions.
In connection with the above-described transactions, Janak Desai, Nils
Ollquist and Girish Sharma resigned as directors of the Registrant, and Oei Hong
Leong, the Chairman of CSH, Chung Cho Yee Mico, and Ma Wai Man Catherine were
elected to fill the vacancies created by such resignations.
2
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On March 8, 1996, Horler Holdings Limited ("Horler") purchased 40,500,000
shares of common stock representing 49.51% of the then issued and outstanding
share capital of Regal from a major shareholder of the Company for $1,223,000,
thus becoming its major shareholder.
On September 10, 1996, the Registrant acquired all the issued and outstanding
shares of Westronix Limited, a British Virgin Islands corporation ("Westronix"),
from China Strategic Holdings Limited, a Hong Kong company ("CSH") pursuant to
the terms of the Acquisition Agreement entered into on September 10, 1996.
Westronix's sole asset is a 100% equity interest in China Construction Holdings
Limited, a Hong Kong company ("China Construction") which owns 51% joint venture
interest in Hangzhou Zhongche Huantong Development Co., Ltd. ("HZHD"), a
Sino-foreign joint venture established in Hangzhou, Zhejiang Province, the
People's Republic of China ("China") on June 23, 1993. The consideration paid by
the Registrant is a $30 million Convertible Note bearing interest at the rate of
nine percent (9%) per annum after an initial six (6) month interest-free period
(the "Note").
The Note is payable interest only on an annual basis, with all principal
being due and payable on September 10, 1999. The principal and any unpaid
interest due on the Note are convertible into shares of Common Stock, $0.01 par
value, of the Registrant ("Common Stock") at a conversion price of $0.0302 per
share. The consideration for the acquisition of Westronix was deemed fair
pursuant to the fairness report issued by the independent third party engaged by
the Registrant.
CSH from whom the Registrant acquired HZHD, is an affiliate of the Registrant
and the major shareholder of the Registrant's common stock. Three directors of
the Registrant are also the directors of CSH.
On September 11, 1996, the Registrant disposed of all the issued and
outstanding shares of Acewin to BTR China Holdings B.V., a Netherlands company
(the "Purchaser") pursuant to the terms of the Agreement relating to the sale
and purchase of the entire issued share capital of Acewin (the "Agreement")
entered into on September 11, 1996. Acewin's sole asset was a 100% equity
interest in, China Machine, which owned 55% joint venture interest in Wuxi CSI.
The consideration paid by the Purchaser was $13,950,000 (the "Purchase
Price"). The major portion of the proceeds were then used to repay the
$13,500,000 Convertible Note payable to Horler, and issued by the Registrant in
connection with the acquisition of Wuxi CSI in February of 1996.
The Board of Directors of the Registrant determined that disposition of Wuxi
CSI was in the best interest of the Registrant and was advantageous to the
Registrant's plans to concentrate the resources of the Registrant in
infrastructure projects in China in connection with the Registrant's recent
acquisition.
As of December 31, 1996, the Company had the following subsidiaries:
Westronix Limited ("Westronix") - a holding company incorporated in the
British Virgin Islands.
China Construction Holdings Limited ("China Construction") - a company
incorporated in Hong Kong and formally known as China Construction
International Group Limited.
Hangzhou Zhongche Huantong Development Co., Ltd. ("HZHD"), a Sino-
foreign equity joint venture located in Hangzhou, Zhejiang Province,
China.
The Company holds a 100% interest in Westronix. Westronix holds a 100%
interest in China Construction which in turn holds a 51% interest in HZHD.
3
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REGAL INTERNATIONAL, INC.
ORGANIZATION CHART
-----------------------------
| Regal International Inc. |
| (Delaware) |
-----------------------------
| 100%
|
-----------------------------
| Westronix Limited |
| (BVI) |
-----------------------------
| 100%
|
-----------------------------
| China Construction |
| Holdings Limited |
| (Hong Kong) |
-----------------------------
|
| 51%
-----------------------------
| Hangzhou Zhongche |
| Huantong Development Co.|
| Ltd. (PRC) |
-----------------------------
4
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ITEM 1 - DESCRIPTION OF THE BUSINESS OF REGISTRANT PRIOR TO FEBRUARY 19,
1996
GENERAL
- -------
The following discussion is intended to describe the business of the
Registrant during the twelve (12) month period ending December 31, 1995 and the
period from December 31, 1995 to February 19, 1996.
RECENT FINANCIAL PERFORMANCE AND SIGNIFICANT EVENTS
During the Second Quarter of 1995, the Registrant sold equipment pertaining
to a certain product line. The sale resulted in a gain of $300,000.
On December 18, 1995 a conditional Joint Venture Agreement between Mardec
Berhad, a company incorporated in Malaysia, and the Registrant was consummated.
Subject to various conditions and approvals, specific machinery and equipment
and technical knowledge of the Registrant, will be transferred to Malaysia. The
Joint Venture is to manufacture products for the international oil and gas
industry. The Registrant's 49% equity interest was contributed in the form of an
agreed upon value for the transfer of machinery and equipment and technology.
This joint venture interest was transferred to New Regal as part of the February
19, 1996 sale of assets.
5
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The 1995 net income of $28,000 is an increase of $560,000 from 1994 net loss
of $532,000. This favorable outcome was primarily the result of a $500,000
decrease in revenue and a gain on the sale of assets of $345,000. Revenues in
1995 were $7,591,000 as compared to $7,091,000 in 1994.
In 1992 the Registrant entered into a financing agreement which provided for
advances on selected accounts receivable. The balance outstanding at December
31, 1995 was $175,000 as compared to $283,000 at December 31, 1994. In December,
1995 the Registrant entered into a new financing arrangement, funded in January,
1996, to replace the existing facility. The new Agreement provides for financing
on both accounts receivable and inventory. This financing arrangement was
assumed by New Regal.
PRODUCTS AND MARKETS
The Registrant's primary business was the manufacturing and sale of oilfield
and marine rubber products. The Registrant also provided safety services for
oilfield drilling, production and workover activities.
The oilfield rubber products primarily consisted of drill pipe protectors,
swab cups, and replacement elements for blow-out preventers ("BOP") for use in
onshore and offshore drilling and production activities. The marine rubber
products group mainly includes shock absorbers and contact surfaces for use in
bumper systems on offshore oil and gas platforms.
Total operating revenues were as follows:
Operating Revenues As a % of Continuing
In Thousands Operating Revenues
1995 1994 1995 1994
---- ---- ---- ----
OILFIELD, MARINE AND
CUSTOM MOLDED PRODUCTS
Oilfield Products $5,793 $5,129 76.3% 72.3%
Marne Products 967 937 12.7 13.3
Custom Molded Products 341 307 4.5 4.3
--- --- --- ---
Total 7,101 6,373 93.5 89.0
ENERGY SERVICES
Safety Services 490 718 6.5 10.1
Total Operating Revenues $7,591 $7,091 100.0% 100.0%
------ ------ ------ ------
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OILFIELD RUBBER PRODUCTS:
- -------------------------
The Registrant produced and sold several lines of products for the oil and
gas industry that historically have been its major source of revenue. This
product group served two primary markets: (1) exploration and development
drilling and (2) well completion, production and servicing. Both markets include
onshore and offshore activities.
The following is a summary description of the Registrant's major oilfield
rubber products:
DRILL PIPE PROTECTORS - Expendable collars attached to the drill pipe string
during drilling to protect the drill pipe and casing string against severe wear
as the drill pipe rotates within the casing. Drill pipe protectors are
particularly desirable for wells requiring more than twenty days of drilling
through casing, directionally drilled wells (such as those drilled from offshore
platforms) and wells with directional problems.
BLOWOUT PREVENTER REPLACEMENT ELEMENTS - A BOP is a heavy metal valve system
that permits a well to be shut-off in an emergency during drilling or servicing
of the well. The rubber elements of a BOP play a critical part in its
performance. As a result of frequent testing and closing during normal drilling
or well servicing operations, BOP rubber parts are subject to deterioration and
require frequent replacement.
SWAB CUPS - Swab cups are used to remove fluids from wells, to test
production rates or to cause a well to flow naturally. Generally, swabbing is
accomplished by attaching the swab cup to a metal connector which is then
lowered on a cable into the well by a servicing rig. As the cable is withdrawn,
the swab cup lifts the fluids and other substances to the surface. Swabbing a
new well removes completion fluids left in the hole while old wells treated with
remedial fluids are swabbed to clean out the wells. The life of a swab cup is
relatively unpredictable depending largely upon downhole conditions in the well.
Ordinarily, swab cups must be replaced after a few swabbing runs.
The Registrant produced a broad line of swab cups to fit various tubing and
casing sizes and for a variety of downhole conditions including sandy fluids and
high water content.
OTHER OILFIELD PRODUCTS - The Registrant also manufactured and sold: (1) rod
and tubing stripper rubbers used to control well pressures while circulating
during well servicing; (2) oil saver rubbers, which are replacement items used
on wireline strippers to clean fluids from the wirelines being removed from the
well during servicing; (3) pipe wipers, which are circular elements used to
remove drilling mud, oil and other fluids from tubing and drill pipe as they are
removed from the well; (4) rod and tubing guides, which enhance pump efficiency
and reduce sucker rod and tubing wear in producing wells; (5) control line
protectors, to protect cables that go "downhole" into the well; and (6)
pulsation dampener bladders, that are used in equipment designed to minimize the
effects of pressure changes.
MARINE RUBBER PRODUCTS:
- -----------------------
The Registrant manufactured and sold barge bumpers and shock-mounted boat
landings used to protect offshore platforms from the combined effects of wave
forces and service vessel impacts. These products, more particularly described
below, are available as complete systems, as individual shock absorbing
components for new platforms or as retrofit systems for existing platforms.
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REGAL DEFENDER SYSTEM - The Regal DEFENDER is a patented bumper system
consisting primarily of two shock cells with eccentric bumper rings attached to
a steel contact surface. When installed on an offshore drilling or production
platform, this system provides omnidirectional shock absorption that protects
the platform and service vessels. The Registrant's DEFENDER System provides
substantially greater protection than rubber bumpers or similar devices
frequently used on offshore platforms. Available as a standard product in a
number of different design configurations, the DEFENDER System can be
individually adjusted to suit each specific platform application. Individual
DEFENDER System components are also sold for use on offshore platforms. DEFENDER
is a registered trademark of the Registrant.
ENERGY SERVICES:
- ----------------
Bell Energy Services provides H2S Safety Services. H2S Safety Services are
primarily utilized during drilling and workover operations of oil and gas wells
in known "sour gas" locations or zones. Equipment is made available for the
detection of and protection from the adverse consequences of these harmful
gases.
MANUFACTURING AND QUALITY CONTROL
- ---------------------------------
A central element of the Registrant's competitive strategy in oilfield and
marine rubber products was a highly integrated manufacturing operation which
enables the Registrant to maintain quality standards over each step of its
production process. The process begins with the blending of unvulcanized natural
or synthetic rubbers, reinforcing agents and curing agents. The Registrant
blends the rubber compounds used in each product and over the years has
developed substantial experience in creating compounds with specific performance
characteristics. After blending, the rubber is extruded and sized for the
specific product. The extruded rubber and any necessary metal parts are then
placed in a mold and a press, subjecting the rubber to heat and pressure that
vulcanizes and bonds it to the metal. Metal components used in marine products
are generally fabricated by the Registrant.
The Registrant exercised quality control over each step of the production
process. A sample of each batch of rubber compounds was tested to assure
acceptability. Each product was put under numerous quality control checks during
extrusion and molding. Finished products were subjected to further testing. Some
products were sampled and underwent simple functional tests, while others were
individually tested for performance. The Registrant achieved International
Standards Organization (ISO) 9001 certification through Lloyd's Register Quality
Assurance, Ltd. on March 1, 1995. The Quality Management System was applicable
to the design, development, manufacture and distribution of rubber products and
ancillary metal products for oilfield, offshore, marine and customized
applications.
RAW MATERIALS
- -------------
Significant raw materials used by the Registrant were natural and synthetic
rubber and metal stock. Natural rubber used by the Registrant, produced
primarily in Malaysia, was purchased through import brokers and was readily
available. Synthetic rubber, metal inserts, and metal stock were available from
a number of suppliers in the United States.
PATENTS
- -------
Many of the Registrant's oilfield and marine rubber products were proprietary
products, several of which are covered by patents. In the opinion of management,
no single patent was essential to the Registrant's operations and the loss or
invalidity of a single patent would not have a material adverse effect on the
business or financial condition of the Registrant.
8
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SALES AND DISTRIBUTION
- ----------------------
The Registrant marketed its products and services, both domestically and
internationally, through a network of sales representatives and agents. In
addition to its sales headquarters located in Corsicana, Texas, the Registrant
maintained a sales office in Houston, Texas and was represented worldwide in all
major oil and gas producing areas. Export sales totaled $2.1 million in 1995,
and $1.5 million in 1994.
EMPLOYEES
- ---------
At February 19, 1996, the Registrant employed 87 persons. The Registrant was
a party to a three-year contract executed on May 21, 1993 with the Registrant's
50 plant workers who are represented by the United Rubber, Cork, Linoleum and
Plastic Workers of America. The Registrant had not experienced a strike in the
last 15 years and believes that management has good relations with all of the
Registrant's employees and the Union. Most of the employees have joined New
Regal.
BACKLOG
- -------
Backlog at December 31, 1995 totaled $131,000, consisting of $1,000 for
oilfield rubber products, $128,000 for marine products, and $2,000 for contract
molding products. At December 31, 1994 backlog totaled $155,000 consisting of
$18,000 for oilfield rubber products, $129,000 for marine rubber products, and
$8,000 for contract molding products. All backlog orders were expected to be
completed before December 1996 and all orders were transferred to New Regal.
OPERATING RISKS AND INSURANCE
- -----------------------------
The Registrant's products and oilfield services were used in drilling,
workover, and production operations. These operations are subject to inherent
risks such as blow-outs and other oilfield hazards, any of which can cause
personal injury and loss of life, damage or destroy equipment, suspend
production operations, or cause damage to property of others.
The Registrant maintained public liability, product liability, property
damage, workers' compensation insurance, and occupational accident and liability
policies.
9
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BUSINESS OF REGISTRANT AFTER FEBRUARY 19, 1996
- ----------------------------------------------
After February 19, 1996 the Registrant owned, as its sole asset, all the
issued and outstanding capital stock of Acewin, a company which owned all the
outstanding capital stock of CMHL.
CMHL was the holder of a 55% interest in Wuxi CSI. Wuxi CSI was the only
operating subsidiary of the Registrant. Wuxi CSI, established in September 21,
1993, was a Sino-foreign joint venture in the Peoples Republic of China ("PRC")
between CMHL and Wuxi Vibration Isolator Factory. Wuxi Vibration Isolator
Factory, built in 1960, is a National Grade II Enterprise (the National Grade
System grades all factories in terms of size, profitability, sales, productivity
and excellence in products; there are only a few Grade I Enterprises in each
province). Wuxi CSI, a primary supplier to domestically produced Volkswagens,
Peugeots and Audis and has developed close ties to China's burgeoning automobile
industry.
Wuxi CSI, with registered capital of $8.0 million, occupies 39,540 square
meters of land, including a building area of 45,504 square meters and workshop
area of 37,232 square meters.
The factory is situated in Wuxi City which is located in Southern Jiangsu
Province, at the center of the "golden delta" of the Yangtze River, bordering
Suzhou in the East and the Hangzhou in the West. It is 128 km. apart from
Shanghai; 183 km. from Nangjing and 40 km. away from the natural port of
Zhangjiagang. The urban area around Wuxi City covers 397 square km. with a
population of 0.928 million. Wuxi City has become a major international
open-port city at the mouth of the Yangtze River.
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BUSINESS OF WUXI CSI VIBRATION ISOLATOR
- ---------------------------------------
Wuxi CSI was engaged in the manufacture and sale of vibration isolators,
rubber damping materials, stainless steel bellows expansion joint and similar
products, which were primarily sold within China. Its primary customer base was
in Shanghai, although the distribution of its sales was regional. Being located
only 128 km. from Shanghai where three (3) of the largest automobile
manufacturers in China produce over 50% of the entire automobile market of the
PRC, Wuxi CSI supplied approximately 70%-100% of each of these three (3)
factory's demand. These factories were producers of the domestically produced
Volkswagens, Peugeots and Audis. Over 70% of Wuxi CSI's total sales were to
Shanghai Volkswagen.
WUXI CSI SALES FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994
- -------------------------------------------------------------
Sales increased by 49% to Rmb 108.41 million in 1995 from Rmb 72.57 million
in 1994 (See Table 1 - Sales Analysis). This increase was principally
attributable to substantial increases in unit sales of vibration isolators to
the manufacturer of Santana Volkswagen and Audi automobiles.
TABLE 1 SALES ANALYSIS
(Rmb in thousands)
1994 1995 % Change
---- ---- -------
Sales 72,570 108,408 49%
Gross Profit 26,357 43,623 66%
Operating income (1) 12,184 27,981 130%
Net income 7,531 16,871 124%
- -------------------------
(1) Operating income means income before minority interest, income tax, net
interest expense and other income.
PRODUCTS AND MARKETS
- --------------------
Wuxi CSI produces a complete range of the following products under the brand
name "Xizhen" (See Table 2 - Sales by Units).
(1) RUBBER-METAL VIBRATION ISOLATORS
Minimizes harmful vibrations and noise. Widely utilized in automobiles,
ships, trains and heavy machinery.
(2) METAL BELLOWS
Widely used in the shipbuilding, petroleum, chemical, industry, railway,
construction, electric power and nuclear industries.
(3) BITUMEN DAMPING MATERIALS
Reduces vibration and noise from mechanical equipment installed in
automobiles, refrigerators, fans and machinery.
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TABLE 2 SALES BY UNITS
Type of Vibration Isolator 1994 1995 % Change Market
- -------------------------- ---- ---- -------- ------
- -General Vehicle Vibration
Isolator 388,007 353,774 -8.8% Auto
- -Santana (Volkswagen) 1,795,260 3,133,754 74.6% Auto
- -Audi 97,833 161,992 65.6% Auto
- -Damping Materials and Damp-
ing Materials with fabrics 1,511,007 4,691,384 210.0% Auto
Others 285,032 253,631 -11.0% Auto
Approximately 74% of Wuxi CSI's total sales in 1995 were made to Shanghai
Volkswagen. Shanghai Volkswagen manufactures the "Santana". Compared to the
Shanghai region, sales to other regions were relatively small. Sales to Jilin
and Jiangsu come in second and third place but only accounted for 5.4% and 3.5%
of total sales, respectively. (See Table 3 Geographical Sales Distribution).
TABLE 3 GEOGRAPHICAL SALES DISTRIBUTION - 1995
Region % of total sales
- ------- ----------------
Shanghai 74.1
Jilin 5.4
Jiangsu 3.5
Guangdong 0.2
Sichuan 0.1
Jiangxi 0.8
Shandong 1.3
Others(1) 14.6
- --------- ----
Total 100.0%
(1) Others refer to regions which are not listed above in the table
OVERVIEW OF AUTOMOBILE INDUSTRY IN CHINA
- ----------------------------------------
In the past 14 years, growth in China's motor vehicle sector has been
phenomenal, reporting average annual increases of 23%, with the total number of
vehicles swelling to 9.40 million in 1994 from 1.68 million in 1980. Unit sales
performance has been even more impressive, reflecting an annual 1995 sales of
1.435 million vehicles, up 19% from 1,206 million in 1994. The Volkswagen
Santana continues to be the volume leader among passenger cars, as output topped
127,000 in 1995 for the first time. Approximately 26,000 Jeep Cherokees were
built in 1995 at Chrysler's Beijing Jeep joint venture.
Among the leaders, First Auto Works saw production increase 8% to 202,197
units; Shanghai-Volkswagen (Santana) output topped 160,000 units, a 39% rise;
Beijing Automobile Industry Corp. production hit 161,418 - including 50,058 at
Beijing Jeep, a 19% hike from 1994 levels. Dongfeng production, at 141,228, was
down 15% from 166,247. Dongfeng built less than 4,000 Citroen ZX-based Fukang
cars. Tianjin production, at 130,848, was up 6.8%.
12
<PAGE>
Most industry forecasts call for Chinese vehicle production to finish among
1.6 million and 1.7 million units in 1996. The industry is highly fragmented,
with more than 130 manufacturers. Some are state-owned giants, but many are
garage-sized operations that turn out only a dozen cars a year, each one
different. In 1994, the U.S. market for passenger cars was 8.9 million vehicles,
behind Western Europe with 11.9 million. In contrast, China, with more than four
times the population of the U.S., had a passenger car market of approximately
300,000 vehicles.
The Chinese government has indicated it wants to consolidate the industry
into three or four large-scale operations, together with a few niche players,
that can survive on a supply of locally produced parts and are efficient enough
to compete in export markets. It hopes to achieve this ambitious goal in the
coming 10 years. Given this mandate, it is anticipated that several years of
consolidation are likely as the industry's weaker players go bankrupt and the
survivors scramble to fortify their positions.
Regardless of the anticipated consolidation, China's motor vehicle production
is expected to accelerate since the automobile industry has been designated as a
"pillar" industry in China. On a go forward basis, industry experts expect
growth to moderate but remain strong, registering a Compound Annual Growth Rate
("CAGR") of 7% for the 1995-2000 period, with unit sales volume surpassing 2.1
million vehicles Per annum by the turn of the century
DEMAND AND SALES
The principal buyers of motor vehicles in the PRC are government entities,
state-owned enterprises, collective enterprises, private companies and
enterprises with foreign investment. Individuals currently account for only a
small number of vehicle purchases.
Sales of motor vehicles generally have reflected strong demand since the PRC
adopted its open door policy in 1979. Although there have been periods of sales
declines, this demand has contributed to strong long-term growth, particularly
from 1989 through 1993 when total vehicle unit sales grew at an annual compound
rate of 22%. Motor vehicle sales historically have been strong influenced by
government spending and economic growth.
Companies 1994 1995
- ----------- ---- ----
First Auto 15.10% 14.10%
Beijing Auto 11.30% 11.20%
Shanghai - VW 9.60% 11.20%
Dongfeng 13.80% 9.80%
Tianjin 10.20% 9.10%
Nanjing 6.10% 5.60%
Jinbei 1.60% 0.10%
Other
Source: Automotive Industry of China
TABLE 5 PASSENGER CAR MARKET SHARE BY MAKE AND MODEL, 1994
VW Santana 51%
Daihatsu Charade 26%
Audi 100 9%
Suzuki Alto 4%
Citroen ZX 4%
VW Jetta 3%
----
Peugeot 505 100%
Source: Automotive Industry of China
13
<PAGE>
RAW MATERIALS
- -------------
Wuxi CSI's raw materials mainly consisted of natural/synthetic rubber, steel
and semi-finished goods. Semi-finished goods accounted for approximately 72% of
total raw materials cost in 1995 and raw materials represented approximately 80%
of total manufacturing cost in 1995. As indicated below, prices of
natural/synthetic rubber and steel increased in 1994 and 1995. However, the
prices of semi-finished goods maintained a fairly stable level during 1994 and
1995, because Wuxi CSI was able to set the purchase price for such goods with
suppliers at the beginning of the year. Prices of semi-finished goods were
determined by negotiations between Wuxi CSI and suppliers. Due to its status as
a primary buyer to these suppliers, Wuxi CSI was able to negotiate favorable
prices and terms. Wuxi CSI also used to purchase semi-finished goods from its
related company - Jieda Vibration Isolator Factory. Prices of these goods were
relatively stable partly because of established long-term cooperation
relationship between the two companies. In addition, Jieda was selling 95% of
its products to Wuxi CSI (See Table 6).
TABLE 6 TABLE OF RAW MATERIAL COSTS:
(Rmb in thousands)
1994 1995
---- ----
Average Average
Input material cost per ton Total cost cost per ton Total cost
- ---------------- ------------ ---------- ------------ ----------
1) Natural and
synthetic rubber 19.0 6,250 21.5 9,300
2) Steel 4.9 1,490 6.8 2,480
3) Semi-finished 29,780 36,940
4) Others 1,290 2,340
----- -----
Total 38,810 51,060
Wuxi CSI sourced all of its raw materials domestically in China from the
following suppliers: China Shipbuilding Industrial Material Corp., Shanghai
Baoshan Iron and Steel Corp., Shanghai No. 5 Iron and Steel Factory, Henan
Wuyian Iron and Steel Factory. Imported raw material was sourced by Wuxi CSI
from local import-export companies. According to a raw material cost analysis
from Wuxi CSI, the cost per ton of chemicals increased by 13% in 1995. The
company raised its selling price of vibration isolators for Santana accordingly,
therefore the negative impact of cost increases in these major raw materials was
offset by higher selling price.
Almost 100% of the rubber used in production was imported material acquired
from a local chemical company in Wuxi, while steel is supplied domestically. The
Company's purchasing department was continuously searching the market for
quality materials at the best price and terms. Shortages of raw materials rarely
occurred in the Company.
14
<PAGE>
MANAGEMENT AND EMPLOYEES
- ------------------------
The management of Wuxi CSI consisted of a seven (7) member Board of Directors
consisting of four (4) directors appointed by CMHL and three (3) directors
appointed by Wuxi Vibration Isolator Factory. Day-to-day management was
conducted by a committee headed by a General Manager. The General Manager's
management team consisted of a Deputy General Manager, a Chief Engineer and a
Chief Accountant. Mr. Shi Le Yi is the General Manager of Wuxi CSI.
As of December 1995, Wuxi CSI had approximately 800 employees, 76% of whom
were production workers, 11% of whom were managerial staff and 13% of whom were
engineering and technical staff. In general, Wuxi CSI had entered into
employment contracts with its workers, with wages to be decided annually by the
enterprise's Board of Directors in accordance with applicable Chinese
regulations governing the labor management of Sino- foreign equity joint venture
enterprises. The total cost of Wuxi CSI salaries was approximately 8.7% of total
production costs in 1995.
The average annual cash compensation for employees of Wuxi CSI employees in
1995 was approximately Rmb 12,000 ($1,442). Salaries and wages of employees
increase 20-30% every year, while the inflation rate remains around 15-20%.
Trade Unions fees accounted for 2% of total salaries and wages. In addition to
cash compensation, employer-funded benefits included pension funds, free meals
and medical costs. Wuxi CSI maintained a bonus program based on its production
volume and profit.
All employees of Wuxi CSI, including members of senior management, were
members of a trade union. Wuxi CSI had not suffered from strikes or other
significant labor disputes and believes it had a good relationship with all of
its employees and unions.
COMPETITION
- -----------
Wuxi CSI competed based upon the following factors:
VARIETY OF PRODUCTS. Wuxi CSI produced 19 models of vibration isolators; 24
models of damping materials, 8 models of bitumen damping materials and over 50
models of metal bellows (metal bellows are made in small batches and low
volumes).
The products of its competitors in the PRC were relatively homogeneous and
less efficient in being able to meet changing demand from customers.
QUALITY AND TECHNOLOGICAL ADVANCEMENT. Products of Wuxi CSI were made
with the support of advanced technologies and machinery imported such as
testing instruments from West Germany, U.S.A. and injection machines from
Taiwan.
GUARANTEED SUPPLY OF COMPONENTS. Since Wuxi CSI also produced many of the
components for its vibration isolator manufacturing, both the quality and stable
supply of a significant portion of the components can be guaranteed. Because of
its ability to produce components, Wuxi CSI was able to service orders of
specified design products and small quantity orders of which the profit margin
is higher. Moreover, such a self relationship reduced the production cost of
Wuxi CSI's final output and, in turn, increases the competition of Wuxi CSI's
products.
15
<PAGE>
LOW PRODUCTION COSTS. Vibration isolator manufacturing was a labor intensive
industry which gives low wage countries such as the PRC a significant advantage.
In addition, Wuxi CSI was a Sino-foreign joint venture that enjoyed special
benefits of tax exemption during the first three years of operation and a 50%
reduction in tax rate for the following two years of operation.
FLEXIBILITY. Wuxi CSI's sales were customized for customers. This increased
the popularity and flexibility of Wuxi CSI's products because the product was
made according to customers' requests. Such a demand driven sales policy reduces
the risk of producing unwanted products.
Wuxi CSI's primary competitors were Ninghai Dipu Co., Nanjing Vibration
Isolator Factory and Shenyang Vibration Isolator Factory.
There were no direct foreign competitors due to high import tariffs of 40% on
vibration isolator products.
Other competitors included Chengdu Auto Shock Absorber Manufacturer, Dongfeng
Automotive Drive Shaft Manufacturer, Dongfeng Automotive Powered Metal Parts
Manufacturer, Guangdong National Fengshun Shock Absorber Manufacturer, Hangzhou
Founding Traffic Parts Co., Ltd., Jiangzhi Auto Shock Absorber Manufacturer,
Shandong Heze Auto Accessories Manufacturer, Shanghai Auto Chassis Manufacturer,
Shenyang Auto Shock Absorber General Manufacturer Sichuan, Chuannan Shock
Absorber Co., Ltd., and Tianjin Auto Shock Absorber Manufacturer.
RESEARCH & DEVELOPMENT
- ----------------------
The Wuxi CSI factory emphasized technical improvements. During the period of
the seventh five year plan (1986-1989), the factory spent about Rmb 20 million
to install a state of the art damping material production line from West
Germany. This damping material production line produces the automobile products
and noise-reducing products.
During the eighth five year plan (1991-1995), the factory invested Rmb 30
million to upgrade its vulcanization workshop and to introduce from abroad
advanced testing instruments and production equipment.
The Research and Development Department, headed by the Chief Engineer, had
over 30 engineering technicians. This department was responsible for developing
and testing new products to keep the company on a competitive edge in the
vibration isolator market.
During the ninth five year plan (1996-2000), Wuxi CSI intended to invest Rmb
190 million in technical advancements with anticipated results of increasing
manufacturing twofold by 1997.
Funds used in research and development activities each year account for
approximately 1 to 2% of annual sales.
INSURANCE
- ---------
Wuxi CSI maintained insurance coverage with the Pacific Insurance Company,
covering its assets in the amount of approximately Rmb 118.7 million. Wuxi CSI
paid a premium of approximately Rmb 200,000 each year.
DISTRIBUTIONS FROM WUXI CSI
- ---------------------------
Applicable Chinese laws and regulations require that, before a Sino- foreign
equity joint venture enterprise (such as each Operating Subsidiary) distributes
profits to investors, it must: (I) satisfy all tax liabilities; (2) provide for
losses in previous years; and (3) make allocations, in proportions determined at
the sole discretion of the Board of Directors, to a general reserve fund, an
enterprise expansion fund and a staff welfare and employee bonus fund. For 1995
and 1994, Wuxi CSI contributed 15% and 10%, respectively, of after-tax profits
as determined under Chinese accounting principles for such purposes.
Distributions of profits by the Wuxi CSI to the Registrant and its other equity
investors were required to be in proportion to each party's investment in the
joint venture. To date, the Registrant and the Chinese joint venture partners
plan to re-invest their respective share of the retained earnings in Wuxi CSI as
additional paid-in capital. This arrangement was subject to approvals from the
relevant government authorities.
16
<PAGE>
OPERATING IN CHINA
- ------------------
ECONOMIC POLICIES. General economic conditions in China could have a
significant impact on the Wuxi CSI. The economy of China differs in certain
material respects from that of the United States, including its structure,
levels of development, capital reinvestment, growth rate, government
involvement, resource allocation, rate of inflation and balance of payments
position. Although the majority of China's productive assets are still owned by
the state, the adoption of economic reform policies since 1978 has resulted in
its' gradual reduction in the role of state economic plans, allocation of
resources, pricing and management of such assets. The economic reform policies
have increased emphasis on the utilization of market forces and rapid growth of
the Chinese economy. The success of the Wuxi CSI depends in part on the
continued economic growth of China.
INFLATION. The general inflation rate in the PRC was approximately 13.2%,
21.7% and 14.8% per annum in 1993, 1994 and 1995 respectively. Accordingly, the
Chinese government has taken steps to control inflation by means of credit
restrictions and an increase in interest rates which, in turn, may lead to a
slow down of the Chinese economy. Nevertheless, Wuxi CSI has been able to
control production costs by implementing a variety of cost control measures.
These measures included utilizing internal production resources to minimize
sub-contracting expenses and purchasing from suppliers who offer the lowest
price. In recent years, the Chinese economy has experienced periods of rapid
economic growth as well as high rates of inflation, which in turn, has resulted
in the adoption by the Chinese government from time to time of various
corrective measures designated to regulate growth and contain inflation. Since
1993, the Chinese government has implemented an economic program to control
inflation which has resulted in the tightening of credit available to Chinese
state-owned enterprises.
FOREIGN CURRENCY EXCHANGE. Prior to January 1, 1994, all foreign exchange
transactions involving Renminbi ("Rmb") in the PRC had to take place either
through authorized financial institutions at the official exchange rate set by
the State Administration of Exchange Control ("SAEC"), the PRC Government
department responsible for foreign exchange administration or at local swap
centers at exchange rates largely determined by supply and demand. However,
transaction, effected through swap centers still required the prior approval of
the SAEC.
On January 1, 1994, the PRC Government implemented a controlled floating
exchange rate system based on market supply and demand and established a managed
foreign exchange system. In place of the official rate and swap center rate, the
People's Bank of China ("PBOC") now publishes a daily exchange rate (the "PBOC
Exchange Rate") for Renminbi based on the previous day's dealings. The financial
institutions authorized to deal in foreign currency may enter into foreign
exchange transactions at exchange rates within a set range above or below the
PBOC Exchange Rate, according to market conditions. In furtherance of these
currency reforms, the China Foreign Exchange Trading Center ("CFETC") was
formally established in Shanghai and came into operation in April 1994. The
establishment of CFETC was originally intended to coincide with the phasing out
of the swap centers. However, the swap centers have been retained as an interim
measure and it is envisaged that the local centers will be phased out gradually.
Currently, foreign investment enterprises ("FIE") in the PRC (including
Sino-foreign equity and co-operative joint ventures) are required to apply to
the local bureau of the SAEC for "foreign exchange registration certificates for
foreign investment enterprises". With such foreign exchange registration
certificates (which are annually reviewed by the local bureau of the SAEC) or
with the foreign exchange sales notice from the local bureau of the SAEC, FIEs
may enter into foreign exchange transactions at the swap center, or in the
future, through the unified market when all swap centers are connected to CFETC.
On January 29, 1996, the State Council promulgated the regulations of the
People's Republic of China Regarding Foreign Exchange Control (the
"Regulations") which came into effect on April 1, 1996. Pursuant to the
Regulations, conversion of RMB into foreign exchange for the use of recurring
items, including the distribution of dividends and profits to foreign investors
of joint ventures, is permissible. FIEs are permitted to remit its foreign
exchange from its foreign exchange bank account in the PRC on the basis of the
relevant joint venture contracts, the board resolution declaring the
distribution of payment of the dividend, etc. Conversion of RMB into foreign
exchange for capital items, such as direct investment, loans, security
investment are still under control.
17
<PAGE>
In general, currently there are no restrictions on repatriation of earnings.
Earnings paid out in foreign currency are free of any restrictions, however,
earnings in Rmb must be converted into foreign currency before the actual
repatriation can take place. Prior to January 1, 1994 Rmb that were earned
within the PRC were not freely convertible into foreign currencies except with
government permission, at rates determined in place at swap centers, where the
exchange rates often differed substantially from the official rates quoted by
the People's Bank of China. On January 1, 1994, the People's Bank of China
introduced a managed floating exchange rate system based on the market supply
and demand and proposed to establish a unified foreign exchange, inter-bank
market among designated banks. As a result of the unitary exchange rate system
introduced on January 1, 1994, the official bank exchange rate for conversion of
Rmb to U.S. dollar experienced a devaluation of approximately 50%. In place of
the official rate and the swap center rate, the People's Bank of China publishes
a daily exchange rate for Rmb based on the previous day's dealings in the
inter-bank market. It is expected that swap centers will be phased out in due
course. However, the unification of exchange rates does not imply full
convertibility of Rmb into US Dollars or other foreign currencies. Payment for
imported materials and remittance of earnings outside of China are subject to
the availability of foreign currency which, is dependent on the foreign currency
denominated earnings of the entity or allocated to the Company by the government
at official exchange rates or otherwise arranged through a swap center with
government approval. Approval for exchange at the exchange center is granted to
enterprises in China for valid reasons such as purchases of imported goods and
remittance of earnings. While conversion of Rmb into US Dollars or other foreign
currencies can generally be effected at the exchange center, there is no
guarantee that it can be effected at all times.
The exchange rate between the Renminbi and the U.S. Dollar as quoted by the
Bank of China ranged between Rmb 8.44 and Rmb 8.33 to $1.00 in 1995.
The following table sets forth certain information providing the fluctuation
of the exchange rates between Renminbi ("Rmb") and U.S. dollars for the periods
indicated:
Noon Buying Rate (1)
Period Period End (2) Average (2)(3) High (2) Low (2)
- ----------------------------------------------------------------------------
1991 5.4478 5.3343 5.4478 5.2352
1992 5.7662 5.5214 5.9007 5.4124
1993 5.8145 5.7769 5.8245 5.7076
1994 8.4662 8.6303 8.7409 8.4662
1995 8.3374 8.3685 8.4584 8.3203
1996 8.2982 8.3139 8.3338 8.2970
Source: Federal Reserve Bank of New York
(1) The Noon Buying Rate did not differ significantly from the Official Rate
prior to January 1, 1994, the date on which the Official Rate was
abolished. Prior to the adoption of the PBOC Rate, there was significant
variation between the Official Rate and the rates obtainable at Swap
Centers, such as the Shanghai Swap Center. After January 1, 1994, there
have not been significant differences between the Noon Buying Rate, the
PBOC Rate and the Shanghai Swap Center Rate.
(2) Rmb per US dollar
(3) Determined by averaging the rates on the last business day of each month.
The Company recognizes that there is always a risk associated with the
convertibility of Rmb. However, based upon the Company's past experience in that
area, it believes that such risk is insignificant. Since its economic reform in
1978, China adopted a prudent monetary policy geared to strengthen its currency
in international exchange markets. China has presently a comfortable current
account and its foreign exchange reserve well exceeds its foreign currency debts
[source: People's Bank of China ]. Based upon the above facts, the Company does
not believe that it is necessary to take steps to mitigate such inconvertibility
risk.
Due to no existing market of currency SWAP contracts, the Company has not
been able to hedge foreign currency risks for its net investment. Nevertheless,
the Company has adopted an informal policy of financing as much as possible in
Rmb within the PRC.
18
<PAGE>
LEGAL SYSTEM. Since 1979, many laws and regulations dealing with economic
matters in general and foreign investment in particular have been promulgated in
China.. The Chinese Constitution, adopted in 1989, authorizes foreign
investment, and guarantees the "lawful rights and interests" of foreign
investors in China. The trend of legislation over the past twelve years has
significantly enhanced the protection afforded foreign investment and allowed
for more active control by foreign parties of foreign investment enterprises in
China.
There can be no assurance, however, that the current trend and economic
legislation toward promoting market reforms and experimentation will not be
slowed, curtailed or reversed, especially in the event of a change in
leadership, social or political disruption, or unforeseen circumstances
affecting China's political, economic or social life.
Despite some progress in developing a legal system, China does not have a
comprehensive system of laws. The interpretation of Chinese laws may be subject
to policy changes reflecting domestic political factors. Enforcement of existing
laws may be uncertain and sporadic, and implementation and interpretation may be
inconsistent. The Chinese judiciary is relatively inexperienced in enforcing the
laws or terms of contracts, leading to a higher than usual degree of uncertainty
in the outcome of litigation. Even where adequate laws exist in China, it may be
impossible to obtain swift and equitable law enforcement, or to obtain
enforcement of a judgment by a court of another jurisdiction. As the Chinese
legal system develops, the promulgation of new laws, changes to existing laws
and the preemption of local regulations by national laws may adversely affect
foreign investors, such as the Registrant.
Wuxi CSI's activities in China may be subject, in some cases, to
administrative review and approval by various national, provincial and municipal
authorities of the Chinese government. While China has promulgated an
administrative procedural law permitting redress to the courts with respect to
certain administrative actions, this law appears to be largely untested in its
context.
LEGAL STRUCTURE OF WUXI CSI
- ---------------------------
Wuxi CSI Vibration Isolator Company Limited was organized under Chinese law
as a Sino-foreign equity joint venture enterprise, which is a distinct legal
entity with limited liability. Such entities are governed by the Law of the
People's Republic of China on Joint Ventures Using Chinese and Foreign
Investments and implementing regulations related thereto (the "Equity Joint
Venture Law"). The parties to an equity joint venture have rights in the returns
of the joint venture in proportion to the joint venture interests that they
hold. The operations of equity joint ventures are subject to an extensive body
of law governing such matters as formation, registration, capital contribution,
capital distributions, accounting, taxation, foreign exchange, labor and
liquidation. The transfer or increase of an interest in a Sino-foreign equity
joint venture enterprise requires agreement among the parties to the venture and
is effective upon the approval of relevant government agencies.
TAXATION
- --------
A Sino-foreign equity joint venture with a term of 10 years or more and
engaged in production is exempt from state income tax for the first two years
after it attains profitability, and for three years thereafter it is eligible
for a 50% reduction in the state income tax. Wuxi CSI has elected to have its
two year tax exemption period begin in 1994.
GOVERNANCE, OPERATIONS AND DISCUSSION
- -------------------------------------
Governance, operations and dissolution of a Sino-foreign equity joint venture
enterprise are governed by the Equity Joint Venture Law and by the parties'
joint venture contract and the joint venture's articles of association. Pursuant
to the joint venture contracts and articles of association of Wuxi CSI, Wuxi CSI
has a 50-year term and is governed by a Board of Directors consisting of seven
members appointed for 4-year terms. CMHL appoints four directors, including the
chairman, to Wuxi CSI, while the Chinese joint venture partner appoints the
remaining three directors, including the Vice Chairman.
The Board of Directors of Wuxi CSI exercised authority by majority vote over
major corporate decisions, including the appointment of officers, strategic
planning, budgeting, employee compensation and welfare and distribution of
after-tax profits. Management of Wuxi CSI was conducted by a management
committee headed by a General Manager and one or two Deputy General Managers,
who act on behalf of Wuxi CSI pursuant to the direction and guidance of its
Board of Directors.
19
<PAGE>
Pursuant to relevant Chinese Law, certain major actions of Wuxi CSI require
unanimous approval by all the directors present at the meeting called to decide
upon the following actions: amendments to its contract and articles of
association; increases in, or assignment of, the registered capital of the joint
venture; a merger of the joint venture with another entity; or dissolution of
the enterprise.
Wuxi CSI is subject to the Sino-foreign Equity Joint Venture Enterprise Labor
Management Regulations. In compliance with these regulations, the management may
hire and discharge employees and make other determinations with respect to
wages, welfare, insurance and discipline of its employees.
As set forth in the joint venture contract of Wuxi CSI, applicable Chinese
laws and regulations provide that after payment of taxes, provision for losses
of prior years and contribution to special funds for enterprise expansion,
employee welfare, bonuses and a general reserve fund, the profits of Wuxi CSI
are available for distribution to the Company and the Chinese joint venture
partner in proportion to their respective shareholdings. The amount of after-tax
profits allocated to the special funds is determined at the discretion of Wuxi
CSI on a yearly basis. For 1995, the Board of Directors of Wuxi CSI designated
that total amounts equal to 15% of after tax profits be allocated to the special
funds.
Pursuant to the Equity Joint Venture Law, Sino-foreign equity joint venture
enterprises may be terminated in certain limited circumstances, including the
inability of the enterprise to conduct its business owing to a breach by one of
its parties, insolvency, force majeure, or confiscation of the enterprise's
assets by the government. Upon termination, the board of directors establishes a
liquidating committee to dissolve the enterprise, which dissolution is subject
to government review and approval.
Resort to Chinese courts to enforce a joint venture contract or to resolve
disputes between the parties over the terms of the contracts is permissible. In
practice, however, disputes between the parties are often resolved by
negotiation. The Company believes that it has good working relationships with
its joint venture partners and that it will be able to reach agreement with them
on business policies and decisions for Wuxi CSI.
NEW TAX REGULATIONS
- -------------------
Under new tax regulations which came into effect from January 1, 1994, the
Wuxi CSI was subject to value added tax ("VAT") which is the principal indirect
tax in the PRC on the sale of tangible goods and the provision of certain
services and has replaced the previous Industrial and Commercial Consolidated
Tax ("ICCT") and Product Tax. The general VAT rate applicable to the PRC
Operating Subsidiaries is 17.0%.
BUSINESS OF REGISTRANT AFTER SEPTEMBER 10, 1996
On September 10, 1996 the Registrant acquired, as its sole asset, all the
issued and outstanding capital stock of Westronix Limited, a company which owns
all the outstanding capital stock of China Construction Holdings Limited ("China
Construction"). China Construction is a holder of a 51% interest in Hangzhou
Zhongche Huantong Development Co., Ltd. ("HZHD"). HZHD is the only operating
subsidiary of the Registrant. HZHD established on June 23, 1993, is a
Sino-foreign joint venture in China between CCHL and its Chinese partner,
Hangzhou City Transportation Development Company.
HZHD has been established to develop the construction project called
"Hangzhou Ring Road". The Hangzhou Ring Road is designed to direct the congested
traffic both inside and outside the city of Hangzhou. The city of Hangzhou,
which covers an area of approximately 16,000 square kilometers and has a
population of approximately 5.6 million, is the capital of Zhejiang Province in
China. The city is located about 150 kilometers from Shanghai and has
experienced rapid growth in its light manufacturing industry in recent years,
most notably in electronic instruments, refined chemicals, machinery and
electrical appliances.
20
<PAGE>
Infrastructure projects, like Hangzhou Ring Road, became a priority to the
government of China in recent years. According to directives of the 10- year
program (1991 - 2000) of the government of China, one of its key national goals
is to build more basic industry and infrastructure projects during the 1990s.
Preference is given to the construction of the principal national trunk
highways. In addition, highway construction in coastal regions is prioritized.
The Hangzhou Ring Road was approved as a priority project by the Hangzhou
Municipal Planning Committee in 1992. HZHD has registered capital of RMB200
million and total investment of RMB600 million. The Chinese partner contributed
RMB98 million by injecting the existing Class 2 toll road, and China
Construction contributed RMB102 million in cash. The principal asset of HZHD is
its 100% interest in a 30-year joint venture consisting of the Hangzhou Ring
Road, a three-section toll road surrounding the city of Hangzhou, which was
completed in December 1997. Two of the three sections of the road were
completed in December 1996.
When Hangzhou Ring Road is fully completed, it will be 38.2 km long and
comprised of:
- -13.2 km of existing Class 2 wide single carriageway linking Jichang (Airport)
Road to Xiangfuqiao. The traffic capacity is estimated at about 20,000 vehicles
per day (two way flow).
- -25.0 km of Class 1 construction (6km of four-lane wide single carriageway with
slow lanes and 19km of dual two-lanes with hard shoulders for emergency)
including 21 bridges and three grade-separated junctions. The implementation of
this section of the toll road consists of two phases: Northwest section
(Xiangfuqiao to Liuxai, 13.7 km) which was completed in December, 1996 and West
section (Liuxai to Lingjiaqiao, 11.3 km), which was completed in December, 1997.
This section encompasses extensive bridge works including:
* river crossing bridges
* bridges for road interchanges
* underpasses and underground crossings for pedestrians and vehicles
21
<PAGE>
The section of the road from Jichang Road to Xiangfuqiao is now in operation
and has been generating revenues from toll collection from the toll plazas at
Xiangfuqiao. The section from Xiangfuqiao to Liuxai was completed in December
1996 and obtained approval from the government to collect tolls starting from
March 1997. The section from Liuxai to Lingjiaqiao was completed in December
1997. Upon full completion, toll plazas are expected to operate at Xiangfuqiao
(already in operation), Liuxai and Lingjiaqiao.
The Company is in a process of installing electronic surveillance systems
along with utilizing computerized toll collection systems and the manual
collection of tolls in toll plazas. The government of Zhejiang Province
approved a toll increase of 100% for the newly completed second phase of the
Hangzhou Ring Road, effective from March 1, 1997.
Overview of Transportation Infrastructure in China
- ---------------------------------------------------
History
- -------
The earliest highway appeared in China at the beginning of this century.
Up to the founding of China in 1949, the country had merely 75,000
kilometers of highways, most of them cobblestone roads. During the second half
of the century, however, highway construction in China experienced rapid
development. By the end of 1995, total highway mileage had reached 1.14 million
kilometers. So far, highways have extended to all counties throughout the
country, and 98 percent of China's townships and 80 percent of villages have bus
service.
China's highway construction after 1949 can be divided into three periods.
The first period was between 1949 and 1957, when emphasis was put on filling
in the main arteries of the country. The second period, 1958-1980, experienced a
rapid popularization of highways throughout the country. During this period
highway mileage increased from 254,600 kilometers to 888,000 kilometers, and 90
percent of all counties and townships were made accessible by roads.
In the third period, which started in 1981, China is seeking the
popularization of highways with improvements in road quality. Priority is now
given to the latter. With high grade highways and expressways being built in the
remotest areas, highway construction in China entered a period of rapid
development.
Recent Developments
- -------------------
Since the implementation of "reform and opening", along with the transition
from a planned economy to a "socialist market economy", traffic between
different cities and between urban and rural areas in China has increased. This
has resulted in a sharp increase in demand for medium- and short-distance
small-scale freight transport, a large increase in passenger flow and a steep
rise in highway traffic. Many highways have actual traffic volumes of four to
five times more than their designed capacity. Traffic congestion has become an
outstanding bottleneck hindering economic development. To meet the need of rapid
economic development, China's communication bureaus have shifted emphasis onto
the economically developed regions where there are urgent traffic problems,
constructing and renovating roads radiating from economic centers and coastal
areas to neighboring and hinterland areas. At the same time, in line with the
increase in traffic, highways connecting energy bases, harbors and large and
medium-sized cities, tributary roads to railways, arteries connecting economic
zones and important townships, tourist highways, and roads for poor areas
transportation, are to be built or renovated. In addition, a certain number of
expressways will be constructed according to necessity.
22
<PAGE>
The construction of the Shenyang-Dalian Expressway in 1987, the first of its
kind in China, has ushered in a new era. So far, more than 20 expressways,
totaling 2,100 kilometers, have been built through China. Completed and opened
on September 1, 1990, it has greatly shortened the time and distance between the
two largest cities in north-eastern China, producing considerable economic
benefit. The Shenyang-Dalian Expressway, the first of its kind in China, has
greatly promoted and accelerated highway and expressway construction throughout
the country, especially in the economically developed areas. So far China has a
total of 33 major highways, including those still under construction.
Highways in China are no longer the cart roads of the old. They have become
fully facilitated, with smooth surfaces and clear and neat traffic markings.
Sichuan Province, which had very poor transportation, now has a complete
transportation network. The expressway connecting Chengdu and Chongqing has
reduced the time between the two cities to a little over three hours.
Compared with the sharp increase in transportation volume, however, highway
construction is still lagging behind. To solve this problem, the Chinese
government has mapped out a long-term plan to improve the country's
transportation network. The plan covers the construction of highways, waterway
transportation network and related safety systems. According to the key highway
construction projects in the plan, since 1990, construction has begun for 35,000
kilometers of highway network of 12 national arteries connecting Beijing and the
provincial capitals, major cities, important communication hubs and key ports
throughout the country to form a nationwide passageway for rapid transportation.
The 12 arteries that make up the national highway network will include five
north-south highways from Tongjiang to Sanya, Beijing to Fuzhou, Erenhot to
Hekou and Chongqing to Zhanjiang, and seven east-west arteries from Suifenhe to
Manzhouli, Dandong to Lhasa, Qingdao to Yinchuan, Lianyungang to Korgas,
Shanghai to Chengdu, Shanghai to Ruili and Hengyang to Kunming. These highway
arteries will link up more than 200 cities, covering a population of 600
million. They will be able to shoulder more than 20 percent of the country's
total traffic.
These highway arteries will be composed mainly of expressways and grade-1 and
grade-2 special roads,and will be well-equipped with complete safety,
telecommunications and administration systems. With the help of modern traffic
monitoring, all information relating to the traffic situation, accidents, road
surface conditions and weather, will be fed back to a computer system in the
traffic control center. Processed information will then be transmitted back and
displayed on information panels erected along the roads.
23
<PAGE>
Raw Materials
- -------------
The raw materials utilized by the Company in construction of the Hangzhou
Ring Road consist mainly of cement, gravel and steel rebar. The third and final
section of the Hangzhou Ring Road, currently under construction, is being built
by a general construction firm hired by the Company. The general contractor is
responsible for procuring all raw materials necessary for completion of the
project, and has not experienced shortages of any raw materials.
In general, the cement industry in China is competitive and supply shortages
are rare. Since there is a lack of obvious product differentiation,
manufacturers compete based primarily on price and timely delivery. Currently,
there are approximately 7,700 cement plants in China, of which 67 are
state-owned enterprises and are capable of producing high grade cement. The
average annual output of these plants is approximately 660,000 tons. The
production cost of cement in China varies with regions, ranging from RMB150 to
RMB250 per ton. Fuel and electricity account for 40% of the total production
cost, while labor accounts for only about 5% of the total production cost. Since
1993, the government has relaxed state control of cement prices and allowed
cement prices to fluctuate according to market condition determined by demand
and supply. The uneven distribution of resources and differences in the pace of
economic development in different regions of China, result in the movement of
cement prices. In the southeast coastal provinces and the Yangtze river valley,
the average price is comparatively higher than the national level.
Since 1978 the Chinese steel industry has grown rapidly. At the end of 1992
there were 1,744 iron and steel enterprises in China (including mining
companies) and 3.8 million iron and steel workers as compared with 1,322
companies and 2.4 million workers in 1980. From 1980 through 1992, steel
production increased at a compound annual growth rate of 6.7% with growth of
13.9% in 1992 and 16.2% in 1993. In 1994, with total steel production of 91.5
million tons, China became the world's second largest steel producer behind
Japan.
The rate of growth in steel production in China also increased. This
accelerated growth is primarily due to the fact that, under China's new economic
policies, demand for steel as a raw material for various industries and for the
building and rebuilding of China's infrastructure has increased substantially.
Furthermore, with changes in the pricing system, profitability has improved and
production capacity has increased accordingly.
Since 1980, steel-making technology in China has experienced significant
improvements. Measures have been taken to modernize steel enterprises by merging
and expanding existing facilities and improving and upgrading technologies.
Although in the past three years the steel industry has grown rapidly with an
annual average increase in production of 16%, domestic supply is still far from
meeting demand. Therefore China must continue to import a certain amount of
steel from foreign sources. During periods when importation is permitted the
steel products producers in China generally experience decreased sales, as
currently the Chinese steel industry cannot compete with producers of imported
steel products with respect to price and, in some cases, quality.
24
<PAGE>
Management and Employees
- ------------------------
The Board of Directors of HZHD consists of seven members; three directors
appointed by China partner and four directors appointed by the Hong Kong
partner, CCHL. The General Manager, who reports directly to the Board of
Directors of HZHD, is responsible for the day-to-day operations of the joint
venture. HZHD employs approximately 140 employees on a full time basis.
Competition
- -----------
The Company's potential depends on its ability to identify and implement
attractive transportation infrastructure development opportunities in China and
to negotiate successfully to enter into joint ventures to develop or operate
such projects. In this regard, the Company faces competition from infrastructure
development businesses currently operating in China, and in addition from
foreign investors who may wish to invest in infrastructure projects, thereby
competing with the Company.
With respect to transportation infrastructure projects such as toll roads,
there is no assurance that alternate routes which avoid toll charges or a charge
lower toll will not be built.
In late 1995, the Hangzhou section of the Shanghai-Hangzhou Expressway was
opened. The Company expects, based on the report from its traffic consultant,
that this would cause diversion of traffic from the Hangzhou Ring Road and would
reduce the flow through the southern toll plaza of the Hangzhou Ring Road by
approximately 30%. On the other hand, the opening of the north-western and
western sections of the Hangzhou Ring Road would provide new traffic sources.
Furthermore, the Hangzhou Ring Road will also be used by local traffic and as
the city of Hangzhou develops, this component of traffic is expected to grow. In
addition, on the opening of the north-western and western sections of the
Hangzhou Ring Road, heavy vehicles will be discouraged from proceeding on the
road going through the city, and thus diversion to the Hangzhou Ring Road can be
expected to be high, since about half of the vehicles will be affected by the
restrictions on entering Hangzhou.
The Company is also facing competition from the Hangzhou section of the
Shanghai - Ningbo Expressway, which was opened in 1996. The diversion of traffic
from the Hangzhou Ring Road resulted in reduction of traffic volume from 6.1
million vehicles in 1995 to 5.2 million vehicles in 1996.
The Company believes that, despite competition, the need of China for further
transportation infrastructure projects will continue to provide development
opportunities for the Company that will yield satisfactory return.
Research and Development
- ------------------------
The Company did not engage in any research and development activities with
respect to its infrastructure project in fiscal 1996.
Distributions From HZHD
- -----------------------
Applicable Chinese laws and regulations require that, before a Sino- foreign
equity joint venture enterprise (such as the Operating Subsidiary) distributes
profits to investors, it must: (1) satisfy all tax liabilities; (2) provide for
losses in previous years; and (3) make allocations, in proportions determined at
the sole discretion of the Board of Directors, to a general reserve fund, an
enterprise expansion fund and a staff welfare and employee bonus fund. Since the
establishment of HZHD joint venture, each year the Company generated profits.
However, each year both joint venture partners have agreed to retain the profits
within the joint venture.
25
<PAGE>
Operating In China
- ------------------
ECONOMIC POLICIES. General economic conditions in China could have a
significant impact on the Company's Hangzhou Ring Road project. The economy of
China differs in certain material respects from that of the United States,
including its structure, level of development, capital reinvestment, growth
rate, government involvement, resource allocation, rate of inflation and balance
of payments position. Although the majority of China's productive assets are
still owned by the state, the adoption of economic reform policies since 1978
has resulted in its' gradual reduction in the role of state economic plans,
allocation of resources, pricing and management of such assets. The economic
reform policies have increased emphasis on the utilization of market forces and
rapid growth of the Chinese economy. The success of the Company's infrastructure
project depends in part on the continued economic growth of China.
INFLATION. The general inflation rate in China was approximately 21.7%, 14.8%
and 6.3% per annum in 1994, 1995 and 1996 respectively. Accordingly, the Chinese
government has taken steps to control inflation by means of credit restrictions
and an increase in interest rates which, in turn, may lead to a slow down of the
Chinese economy. In recent years, the Chinese economy has experienced periods of
rapid economic growth as well as high rates of inflation, which in turn, has
resulted in the adoption by the Chinese government from time to time of various
corrective measures designated to regulate growth and contain inflation. Since
1993, the Chinese government has implemented an economic program to control
inflation which has resulted in the tightening of credit available to Chinese
state-owned enterprises.
FOREIGN CURRENCY EXCHANGE. Prior to January 1, 1994, all foreign exchange
transactions involving Renminbi ("Rmb") in China had to take place either
through authorized financial institutions at the official exchange rate set by
the State Administration of Exchange Control ("SAEC"), the department of the
government of China responsible for foreign exchange administration or at local
swap centers at exchange rates largely determined by supply and demand. However,
transactions effected through swap centers still required the prior approval of
the SAEC.
On January 1, 1994, the government of China implemented a controlled floating
exchange rate system based on market supply and demand and established a managed
foreign exchange system. In place of the official rate and swap center rate, the
People's Bank of China ("PBOC") now publishes a daily exchange rate (the "PBOC
Exchange Rate") for Renminbi based on the previous day's dealings. The financial
institutions authorized to deal in foreign currency may enter into foreign
exchange transactions at exchange rates within a set range above or below the
PBOC Exchange Rate, according to market conditions. In furtherance of these
currency reforms, the China Foreign Exchange Trading Center ("CFETC") was
formally established in Shanghai and came into operation in April 1994. The
establishment of CFETC was originally intended to coincide with the phasing out
of the swap centers. However, the swap centers have been retained as an interim
measure and it is envisaged that the local centers will be phased out gradually.
Currently, foreign investment enterprises ("FIE") in China (including
Sino-foreign equity and cooperative joint ventures) are required to apply to the
local bureau of the SAEC for "foreign exchange registration certificates for
foreign investment enterprises". With such foreign exchange registration
certificates (which are annually reviewed by the local bureau of the SAEC)or
with the foreign exchange sales notice from the local bureau of the SAEC, FIEs
may enter into foreign exchange transactions at the swap center, or in the
future, through the unified market when all swap centers are connected to CFETC.
On January 29, 1996, the State Council promulgated the regulations of China
Regarding Foreign Exchange Control (the "Regulations") which came into effect on
April 1, 1996. Pursuant to the Regulations, conversion of RMB into foreign
exchange for the use of recurring items, including the distribution of dividends
and profits to foreign investors of joint ventures, is permissible. FIEs are
permitted to remit its foreign exchange from its foreign exchange bank account
in China on the basis of the relevant joint venture contracts and the board
resolution declaring the distribution of payment of the dividend, etc.
Conversion of RMB into foreign exchange for capital items, such as direct
investment, loans, security investment are still under control.
26
<PAGE>
The exchange rate between the Renminbi and the U.S. Dollar as quoted by the
Bank of China ranged between Rmb 8.33 and Rmb 8.29 to $1.00 in 1996.
LEGAL SYSTEM. Since 1979, many laws and regulations dealing with economic
matters in general and foreign investment in particular have been promulgated in
China. The Chinese Constitution, adopted in 1989, authorizes foreign investment,
and guarantees the "lawful rights and interests" of foreign investors in China.
The trend of legislation over the past twelve years has significantly enhanced
the protection afforded foreign investment and allowed for more active control
by foreign parties of foreign investment enterprises in China.
There can be no assurance, however, that the current trend and economic
legislation toward promoting market reforms and experimentation will not be
slowed, curtailed or reversed, especially in the event of a change in
leadership, social or political disruption, or unforeseen circumstances
affecting China's political, economic or social life.
Despite some progress in developing a legal system, China does not have a
comprehensive system of laws. The interpretation of Chinese laws may be subject
to policy changes reflecting domestic political factors. Enforcement of existing
laws may be uncertain and sporadic, and implementation and interpretation may be
inconsistent. The Chinese judiciary is relatively inexperienced in enforcing the
laws or terms of contracts, leading to a higher than usual degree of uncertainty
in the outcome of litigation. Even where adequate laws exist in China, it may be
impossible to obtain swift and equitable law enforcement, or to obtain
enforcement of a judgment by a court of another jurisdiction. As the Chinese
legal system develops, the promulgation of new laws, changes to existing laws
and the preemption of local regulations by national laws may adversely affect
foreign investors, such as the Registrant.
HZHD's activities in China may be subject, in some cases, to administrative
review and approval by various national, provincial and municipal authorities of
the Chinese government. While China has promulgated an administrative procedural
law permitting redress to the courts with respect to certain administrative
actions, this law appears to be largely untested in its context.
Legal Structure of HZHD
- -----------------------
Hangzhou Zhongche Huantong Development Company, Ltd. was organized under
Chinese law as a Sino-foreign equity joint venture enterprise, which is a
distinct legal entity with limited liability. The term of HZHD joint venture is
30 years, after which time Hangzhou Ring Road, the only asset of the joint
venture, will revert back to HZHD's Chinese partner. Such entities are governed
by the Law of China on Joint Ventures Using Chinese and Foreign Investments and
implementing regulations related thereto (the "Equity Joint Venture Law"). The
parties to an equity joint venture have rights in the returns of the joint
venture in proportion to the joint venture interests that they hold. The
operations of equity joint ventures are subject to an extensive body of law
governing such matters as formation, registration, capital contribution, capital
distributions, accounting, taxation, foreign exchange, labor and liquidation.
The transfer or increase of an interest in a Sino-foreign equity joint venture
enterprise requires agreement among the parties to the venture and is effective
upon the approval of relevant government agencies.
27
<PAGE>
Taxation
- --------
A Sino-foreign equity joint venture with a term of 10 years or more and
engaged in production is exempt from state income tax for the first two years
after it attains profitability, and for three years thereafter it is eligible
for a 50% reduction in the state income tax. HZHD will be fully exempted from
Chinese state unified income tax of 30% as well as the local income tax of 3%
for two years starting from the first profit-making year followed by a 50%
reduction of the Chinese state unified income tax for the next three years.
Governance, Operations And Dissolution
- --------------------------------------
Governance, operations and dissolution of a Sino-foreign equity joint venture
enterprise are governed by the Equity Joint Venture Law and by the parties'
joint venture contract and the joint venture's articles of association. Pursuant
to the joint venture contracts and articles of association of HZHD, it has a
30-year term and is governed by a Board of Directors consisting of seven members
appointed for 4-year terms. CCHL appoints four directors, including the
chairman, to HZHD, while the Chinese joint venture partner appoints the
remaining three directors, including the Vice Chairman.
The Board of Directors of HZHD exercises authority by majority vote over
major corporate decisions, including the appointment of officers, strategic
planning, budgeting, employee compensation and welfare and distribution of
after-tax profits. Management of HZHD is conducted by a management committee
headed by a General Manager and one or two Deputy General Managers, who act on
behalf of HZHD pursuant to the direction and guidance of its Board of Directors.
Pursuant to relevant Chinese Law, certain major actions of HZHD require
unanimous approval by all the directors present at a meeting called to decide
upon the following actions: amendments to it's contract and articles of
association; increases in, or assignment of, the registered capital of the joint
venture; a merger of the joint venture with another entity; or dissolution of
the enterprise.
HZHD is subject to the Sino-foreign Equity Joint Venture Enterprise Labor
Management Regulations. In compliance with these regulations, the management may
hire and discharge employees and make other determinations with respect to
wages, welfare, insurance and discipline of its employees.
Pursuant to the Equity Joint Venture Law, Sino-foreign equity joint venture
enterprises may be terminated in certain limited circumstances, including the
inability of the enterprise to conduct its business owing to a breach by one of
its parties, insolvency, force majeure, or confiscation of the enterprise's
assets by the government. Upon termination, the Board of Directors establishes a
liquidating committee to dissolve the enterprise, which dissolution is subject
to government review and approval.
Resort to Chinese courts to enforce a joint venture contract or to resolve
disputes between the parties over the terms of the contracts is permissible. In
practice, however, disputes between the parties are often resolved by
negotiation. The Company believes that it has a good working relationship with
its joint venture partner and that it will be able to reach agreements with it
on business policies and decisions for HZHD.
28
<PAGE>
Government Regulations
- ----------------------
Any increase in toll rates proposed by HZHD is subject to approval by the
Zhejiang Provincial Government and Hangzhou Municipal Government and City of
Hangzhou Transportation Department. There are no assurances that such proposals
will be approved by these government authorities. If such proposals are denied,
toll revenues of HZHD may be affected.
The government of Zhejiang Province has approved a toll increase of 100% for
the newly completed second phase of Hangzhou Ring Road, effective from March 1,
1997.
Compliance with Environmental Laws
- ----------------------------------
HZHD is not aware of any Chinese government environmental regulations which
would have an adverse impact on the Company's operations.
ITEM 2. DESCRIPTION OF PROPERTIES OF THE REGISTRANT
Prior to February, 1996, the Registrant's materially important physical
properties were located in Corsicana, Midland and Odessa. The Corsicana, Texas
facility was a 100,000 square feet manufacturing plant on 70 acres of land and
was owned by the Registrant. The Midland, Texas facility was leased from a third
party.
The Registrant's land and equipment in Corsicana were pledged to secure
various Registrant obligations . All land and equipment of the Registrant were
transferred to New Regal. On August 31, 1996, the Registrant had no office or
facility for U.S. operations, but rented a small office at its predecessor's
facility in Corsicana, Texas.
Wuxi CSI occupied a gross land area of 39,985 square meters in Wuxi City. The
main production area for manufacturing vibration isolators consisted of 7
separate buildings encompassing approximately 17,178 square meters. The Research
and Development department, laboratories and related technology departments were
located in supplementary rooms in the main factory buildings.
There were two three-story administrative buildings in the main manufacturing
area. One building was occupied by the accounting department, management offices
and production department. The other building was occupied by the personnel
department, trade union and functions as a warehouse. The total floor area
occupied by these two buildings was approximately 2,936 square meters.
The City of Wuxi government has granted its approval to Wuxi Vibration
Isolator Factory ("Wuxi Factory"), the Chinese joint venture partner of Wuxi
CSI, to use the parcel of land on which Wuxi CSI's main factory is located.
Under the terms of the joint venture agreement and the subsequent confirmation
from Wuxi Factory, it has agreed to provide for the use of the land by Wuxi CSI
for the 50-year term of the joint venture. Wuxi Factory does not currently
charge Wuxi CSI for the use of the land. Under current PRC regulations, where
land use rights are granted to Sino-foreign equity joint venture, the joint
venture would pay no land use fees during an initial five-year period and a 50%
reduction for the next five-year period.
The annual land use fee has been estimated by management to be approximately
RMB600. Should Wuxi CSI wish to obtain title to the land use rights, a premium
may be levied by the relevant government authorities for the transfer.
As of March 31, 1997, the Company had no office or facility for U.S.
operations. The Company shares the office space at 52/F, Bank of China Tower, 1
Garden Road, Hong Kong and administrative support, with China Strategic Holdings
Limited, a major shareholder of the Company ("CSH"). In fiscal 1996, the Company
was charged RMB 1.29 million by CSH as a management fee for the use of the
office space and staff support.
All land in the PRC is owned by the government. According to the PRC law,
land may be leased (under land use rights) for certain periods of time to
businesses. Therefore, the fact that the Hangzhou Toll Road does not have title
but only a land use right is the norm in the PRC for businesses. While Chinese
law expressly protects the status and rights of Sino-foreign joint venture
enterprises, including their right to use land during the term of their
respective joint venture contracts, the state reserves the right, in extreme and
exceptional circumstances, to terminate the joint venture and provide
compensation therefor. In such an event, a joint venture's right to use land
would terminate and all facilities would revert to the state in exchange for
just compensation. Although management sees little risk in not having title to
the land use rights, no assurances can be given that such land use rights may be
not be terminated by the PRC.
29
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
Neither the Registrant nor its subsidiaries are a party to any material
pending legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1995.
PART II.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Registrant's Common Stock was listed on the New York Stock Exchange
("NYSE") (symbol: RGL) until December 7, 1994, at which time the NYSE suspended
trading since the Registrant did not meet the continued listing requirements. On
February 9, 1995, the Common Stock was removed from registration and listing on
the NYSE. The Registrant's Common Stock began trading on the NASD Electronic
Bulletin Board in August 1995. The following table sets forth the high and low
prices of the Common Stock as reported in the consolidated transaction reporting
system during the periods indicated:
Quarter Ended High Low
- ------------- ---- ---
March 31, 1994 1/8 1/8
June 30, 1994 3/8 1/8
September 30, 1994 1/4 1/8
December 31, 1994* 1/8 1/16
March 31, 1995* 1/40
June 30, 1995* 1/40
September 30, 1995* 1/40
December 31, 1995* 1/40
- ---------------------------
* The low price reflects the average of the bid and asked prices
As of March 13, 1996, there were 7,637 holders of record of the shares of the
Registrant's Common Stock.
30
<PAGE>
Dividend Policy
The Registrant has never paid a cash dividend. It is the current policy of
the Board to retain earnings, if any, to provide funds for the Company's
operations. The payment of dividends is at the discretion of the Board, and
dividends may be paid only out of current earnings and profits or retained
earnings. The Company had an accumulated deficit of $18,487,000 at December 31,
1995. No funds have been legally available for the payment of dividends since at
least January 1, 1983.
SELECTED FINANCIAL DATA
Selected Proforma Financial Data - Wuxi CSI
- -------------------------------------------
The following table presents the selected proforma financial information of
the Registrant as of and for the year ended December 31, 1994 and 1995 assuming
that the Registrant had owned the shares of Acewin Stock in 1994 and 1995 and
had sold other assets and disposed of its other assets and liabilities. The
information was extracted from the audited financial statement of Acewin Profits
Limited and subsidiaries prepared under US GAAP (See Table 7 Summary of Proforma
Financial Results - 1994 & 1995).
TABLE 7 SUMMARY OF PROFORMA FINANCIAL RESULTS - 1994 & 1995
1994 1995
(Amount in thousand) Rmb(a) USD(a) Rmb(a) USD
--- --- --- ---
Income Statement Date
Sales 72,570 8,712 108,408 13,014
Gross Profit (b) 26,357 3,164 43,623 5,237
Income before income tax (c) 12,769 1,533 30,257 3,632
Net income 7,531 904 16,871 2,025
Balance Sheet Data
Total assets 134,539 16,151 168,566 20,236
Current liabilities 36,120 4,336 42,398 5,090
Long-term bank loan 16,140 1,938 15,490 1,860
Shareholders' equity 7,718 927 24,298 2,917
- --------------------------------
(a). The U.S. dollar convenience translation amount have been translated using
the unified exchange rate quoted by the Bank of China on December 31, 1994 and
1995 of $1.00 = Rmb 8.33 and $1.00 = Rmb 8.33, respectively. No representation
is made that the Renminbi amounts could have been, or could be, converted into
U.S. dollar at those rates on December 31, 1994 and 1995 or at any other certain
rate.
31
<PAGE>
SWAP CENTER RATES/UNIFIED EXCHANGE RATE
Year Ending December 31
Rmb equivalent to $1.00 1994 1995
---- ----
- End of year 8.44 8.33
- High 8.70 8.44
- Low 8.44 8.30
- Average 8.62 8.35
(b) Gross profit is defined as sales less cost of goods sold.
(c) As of December 31, 1994 and 1995, Wuxi CSI did not make any provision for
PRC profits tax as it has a joint venture term of not less than 10 years and is
engaged in production, is fully exempt from the Chinese State unified income tax
for two years starting from profit-making year, followed by a 50% reduction of
the Chinese State unified income tax for the next three years thereafter ("tax
holiday"). In accordance with the same tax laws, the PRC Operating Subsidiaries
are also exempt from the PRC local income tax. The Chinese State unified income
tax rate for the coming three years, 1996, 1997, and 1998 will be 12% and
resumed to 24% thereafter.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (AFTER ACQUISITION OF WUXI CSI)
OVERVIEW
- --------
On February 19, 1996, the Registrant acquired all the issued and outstanding
shares of Capital Stock of Acewin Profits Limited, a British Virgin Islands
corporation ("Acewin"), from China Strategic Holdings Limited, a Hong Kong
company ("CSH") listed on The Hong Kong Stock Exchange Limited. Acewin's sole
asset is all the issued and outstanding shares of China Machine (Holdings)
Limited, a Hong Kong company ("CMHL"). CMHL's sole asset is a 55% joint venture
equity interest in Wuxi CSI Vibration Isolator Co., Ltd. ("Wuxi CSI"), a
Sino-foreign joint venture established in September 1993.
The consideration paid by the Registrant for the Acewin stock was $13.5
million. In determining the consideration paid by the Company for Acewin stock,
the Company took into consideration the following factors: the indicated profit
after tax ("PAT") of Wuxi CSI (the operating subsidiary of Acewin) and
profit/earnings forecasts for that company. In determining the consideration of
$13.5 million, the Company used in its calculations 3.3 PAT and 7.5 P/E. In
addition, to ensure fair purchase price, the purchase agreement provided for an
adjustment to the purchase price, in case of adjustments made after the
completion of the audit of Acewin. The valuation of Acewin stock by the Company
was validated as fair when the unrelated party paid more than $13.5 million for
the Wuxi CSI business in September of 1996. Said purchase price was paid by the
Registrant's delivery of its Convertible Note bearing interest at the rate of
nine percent (9%) per annum after an initial six (6) month interest-free period
(the "Convertible Note"). Interest on the Convertible Note was payable on an
annual basis, with all principal being due and payable on January 31, 1999. The
principal and any unpaid interest owing on the Convertible Note were convertible
into shares of the Common Stock, $0.01 par value, of the Registrant ("Common
Stock") at a conversion price of $0.0302 per share. The Convertible Note was
secured by a Pledge Agreement granting CSH a security interest in the Acewin
stock. The Convertible Note was fully repaid upon the sale of Acewin stock, as
described herein.
The following discussion and financial information relates solely to Wuxi CSI
and the business which was acquired by the Registrant in February 1996.
32
<PAGE>
RESULTS OF OPERATIONS - 1994 COMPARED TO 1995
- ---------------------------------------------
TABLE 8. WUXI CSI - SUMMARY FINANCIAL INFORMATION
% change
1994 1995 from prior year
---- ---- ---------------
(Rmb in million)
Sales 72.57 108.41 49%
Gross Profit 26.36 43.62 66%
Operating Income(1) 12.18 27.89 130%
Net Income(2) 7.53 16.87 124%
- ----------------------
(1) Operating income means income before minority interest, income tax, net
interest expense and other income.
(2) Before minority interest
SALES
- -----
Sales increased by 49% to Rmb 108.41 million in 1995 from Rmb 72.57 million
in 1994. This increase was principally attributable to a substantial increase in
unit sales of Santana Volkswagen and Audi isolators and damping materials during
1995. Unit sales to Shanghai Volkswagen accounted for approximately 41% and 51%
of total sales in 1994 and 1995, respectively, representing approximately 3.1
million units in 1995 compared to 1.8 million units in 1994. The annual
adjustment of the selling price of isolators for Shanghai Volkswagen's Santana,
amounted to a 5% unit price increase in 1995 as compared to 1994. In addition,
sales of damping materials and damping materials with fabrics, which altogether
accounted for approximately 25% of the total sales in these two years, increased
to approximately Rmb 27.5 million in 1995 from approximately Rmb 17.3 million in
1994.
GROSS PROFIT
- ------------
Wuxi CSI's gross profit increased 66% to Rmb 43.6 million in 1995 from 26.4
million in 1994, and also as a percentage to sales to 40% in 1995 compared to
36% in 1994. This was contrary to the general increase in raw materials price in
1995. It was because production output of Wuxi CSI increased substantially
during 1994 and 1995. The fixed manufacturing cost apportioned to unit output
reduced consequently. On the other hand, the sub-contracting expenses of Wuxi
CSI were reduced as Wuxi CSI utilized internal slack resources to produce what
formerly had been subcontracted. In addition, a bonus based compensation system
increased the productivity of workers. Although unit production output increased
substantially, the number of workers did not increase during 1994 and 1995.
33
<PAGE>
SELLING AND ADMINISTRATION EXPENSES
- -----------------------------------
Selling and administration expense for Wuxi CSI increased by 10% to Rmb 15.6
million in 1995, as compared to Rmb 14.2 million in 1994. This increase was
lower than the percentage increase in sales volume and general inflation rate in
1995 and reflects Wuxi CSI adopting a strict expenditure control policy. Only
those expenditures considered necessary and unavoidable were approved by
management. Selling and administrative expenses as a percentage of sales was
14.4% in 1995 as compared to 19.5 % in 1994.
INTEREST EXPENSE
- ----------------
Interest expense increased by 23% to Rmb 2.7 million in 1995 from Rmb 2.2
million in 1994. The increase was mainly attributable to the general increase in
loan interest rates in the PRC during 1995. On the other hand, interest income
increased by 90% to Rmb 4 million in 1995 from Rmb 2.1 million in 1994. The
substantial increase in interest income was due to a net cash increase of
approximately Rmb 20 million in 1995. Wuxi CSI enjoyed a preferential interest
rate for its large deposit balances, some of which had an annual interest rate
of 18%, resulting in net interest income of Rmb 649 thousand in 1995.
In 1994, an exchange loss of Rmb 1 million was incurred due to a devaluation
of US dollar against the Renminbi. This exchange loss, combined with interest
income of approximately Rmb 1.1 million, resulted in net interest income of
approximately Rmb 104 thousand.
OPERATING INCOME
- ----------------
Operating income increased 130% to Rmb 27.98 million in 1995 from Rmb 12.18
million in 1994. Operating income as a percentage of sales increased to 26% in
1995 as compared to 17% in 1994. This was primarily due to the increase of gross
profit during the period.
NET INCOME
- ----------
Net income increased 115% to Rmb 16.9 million in 1995 from Rmb 7.53 million
1994. Net income as a percentage of sales increased to 16% in 1995 as compared
to 10% in 1994. This was due to an increase in operating and interest income in
1995.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Operating Activities
During the year ended December 31, 1995 net cash provided by operating
activities was approximately Rmb 40.5 million. The major sources of 1995 cash
flows from operating activities included net income of Rmb 16.9 million and
minority interest net income of Rmb 13.4 million. Cash outflows in investing
activities, totaling Rmb 15.2 million, were principally used on the purchase of
property, plant and equipment. The equipment was acquired with the intent of
expediting plant automation and enhancing production efficiency. Cash used in
financing activities was Rmb 5.5 million. This was primarily attributable to net
movement of long-term bank loans during the year, reflecting repayment of Rmb
17.9 million, which was offset by proceeds of Rmb 14.3 million. As a result of
the above, the cash position of the company was further strengthened. Cash and
cash equivalents increased by Rmb 19.9 million to Rmb 50.3 million at the end of
1995.
During the year ended December 31, 1994, net cash provided by operating
activities was approximately Rmb 4.5 million. The major sources of 1994 net cash
flows from operating activities included net income of Rmb 7.5 million and
minority interest net income of Rmb 5.2 million. Cash flows in investing
activities, totaling Rmb 4.6 million, were principally used for the purchase of
property, plant and equipment. Net cash flows from financing activities were Rmb
3.6 million, and reflect the fact that China Strategic Holdings Limited, through
an operating subsidiary, increased its capital contribution in the Operating
Subsidiary by Rmb 3.6 million. The year ended with an increase in cash and cash
equivalents of Rmb 1.6 million producing a balance of cash and cash equivalents
as at December 31, 1994 of Rmb 30.4 million.
34
<PAGE>
Commitments for Capital Expenditure
At year end 1995, Wuxi CSI had capital commitments to acquire machinery and
equipment of approximately Rmb 10.8 million, as compared to Rmb 30.3 million at
year end 1994. In addition, the subsidiary entered into an agreement with a
German company to form a joint venture company in Wuxi City, and the capital
commitment for this was estimated to be approximately Rmb 16.0 million. Wuxi CSI
has a 49% interest in this joint venture company, which was formed to
manufacture couplings for the automobile market in China.
Management believes that Wuxi CSI has sufficient cash flow from operations,
combined with bank balances and bank borrowings, to provide sufficient cash to
finance internal growth, capital projects and debt service requirements for the
foreseeable future.
Financing Activities
Wuxi CSI relies on both short-term and long-term bank loans from Chinese
banks to support its operating and capital requirements. On December 31, 1995,
Wuxi CSI had short-term and long-term bank loans of Rmb 3.5 million and Rmb 31.4
million, respectively. Short-term loans have repayment terms ranging from three
months to one year. Long-term loans have repayment terms ranging from one to two
years. All of the short-term and long-term loans are unsecured. Historically,
Wuxi CSI has not experienced any difficulty in loan rollover, and Management has
no reason to believe that this practice will not continue.
Effect of Inflation
The general inflation rate in terms of the Retail Price Index in China was
approximately 13.2%, 21.7% and 14.8% for 1993, 1994 and 1995 respectively.
Management believes that inflation has not had a significant impact on Wuxi
CSI's cost of components and raw materials in view of the fact that Wuxi CSI
entered into fixed price agreements with key suppliers for supplying
semi-finished goods. Inflation has resulted in upward pressure on wages and
salaries for its employees. However, Management does not expect inflation to
have a substantial effect on profit margins and income, since Wuxi CSI has been
able to pass on such cost increases to customers.
Seasonal Aspects
Wuxi CSI's products have almost no seasonal fluctuations, especially for
Santana vibration isolators. Wuxi CSI's primary customer, Shanghai Volkswagen,
usually provides an annual production quota of vibration isolators at the
beginning of the year to help Wuxi CSI lay out its production plan. However,
sales are typically higher in the second half of the year as compared to the
first half due to the Lunar Chinese New Year holidays.
35
<PAGE>
SPECIAL NOTE
- ------------
The following includes financial information prior to September 10, 1993, when
Wuxi CSI was incorporated in the People's Republic of China as a Sino- foreign
equity joint venture enterprise, and operated as Wuxi Vibration Isolator
Factory. Therefore, the following comparative financial information is provided
for general information purposes only.
RESULTS OF OPERATIONS - 1993 COMPARED TO 1994
- ---------------------------------------------
TABLE 9 WUXI CSI - SUMMARY FINANCIAL INFORMATION
% change
1994 1995 from prior year
---- ---- ---------------
(Rmb in million)
Sales 57.76 72.57 26%
Gross Profit 19.85 26.36 33%
Operating Income(1) 8.02 12.18 52%
Net Income 6.30 7.53 20%
(1) Operating income means income before minority interest, income tax, net
interest expense and other income.
Sales
Sales of Wuxi CSI increased by approximately 26%, to Rmb 72.6 million in
1994, as compared to Rmb 57.8 million in 1993. This was attributable to the
continued growth of the Chinese automobile industry. Demand from its major
customer, Shanghai Volkswagen manufacturer, increased significantly in 1994 as
compared to 1993. Unit sales to Shanghai Volkswagen accounted for approximately
41% - 51% of total sales in 1994, representing approximately 1.8 million units.
Gross Profit
Gross profit of Wuxi CSI increased 33% to Rmb 26.4 million in 1994, as
compared to 19.9 million in 1993. Gross profit as a percentage of sales
increased to 36.3% in 1994, as compared to 34.4% in 1993 (whole year). The
increase in gross profit was primarily the result of two factors. First, Wuxi
CSI increased productivity which resulted in a decrease of fixed overhead as
related to production volume. Second, as a result of the improved production
efficiencies, there was an overall reduction in scrap loss.
Selling and Administrative Expenses
Selling and administrative expense increased by 19.8% or Rmb 14.2 million in
1994 compared to Rmb 11.83 million in 1993 (whole year). The increase was
attributable to a general increase in expenses as a result of higher sales
volume, general inflation and a 30% increase in wage expenses. Selling and
administrative expense as a percentage of sales were 19.5% in 1994, as compared
to 20.5% in 1993 (whole year).
36
<PAGE>
Interest Expense
Interest expense amounted to Rmb 2.2 million in 1994 and Rmb 2.1 million in
1993 (whole year). Outstanding bank loans were maintained at approximately the
same level during these periods. Interest income increased by 950% to 2.1
million in 1994 from 0.2 million in 1993 (whole year). The increase reflects
Interest income accrued on USD cash invested by China Machinery, however, such
income was partially offset by a devaluation of USD against Renminbi during
1994. Consequently, there was net interest income of approximately Rmb 104
thousand in 1994 as compared to a net interest expense of Rmb 201 thousand in
1993.
Operating Income
Operating income increased 52% to Rmb 12.18 million in 1994, as compared to
Rmb 8.02 million in 1993 (whole year). Operating income as a percentage of sales
was 16.8% in 1994, as compared to 13.9% in 1993 (whole year). The increase in
operating income as a percentage of sales was due primarily to an increase in
gross profit.
Net Income
Net income increased 20% to 7.53 million in 1994, as compared to Rmb 6.30
million in 1993 (whole year). Net income as a percentage of sales decreased to
10.4% in 1994, as compared to 10.9% in 1993 (whole year). The increase in net
income was attributable to an increase in operating income and also reflects
Wuxi CSI starting its income tax holiday in 1994.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Operating Activities
During the year ended December 31, 1994, net cash provided by operating
activities was approximately Rmb 4.5 million, which came primarily from net
income and minority interest contributions. Net cash from investing activities
were used in the acquisition of property, plant and equipment and amounted to
net 4.6 million. Net cash provided by financing activities amounted to Rmb 1.7
million. This was mainly because China Strategic Holdings Limited, through an
operating subsidiary, increased its capital contribution in the Operating
Subsidiary by Rmb 3.6 million. The year ended with an increase in cash and cash
equivalents of Rmb 1.6 million, producing a balance of cash and cash equivalents
as at December 31, 1994 of Rmb 30.4 million.
During the year ended December 31, 1993, net cash used in operating
activities was approximately Rmb 7.63 million, which primarily reflected
accounts receivable, inventories, prepayments, accrued expenses and other
payables. Net cash flows from investing activities were used in the acquisition
of property, plant and equipment and amounted to net Rmb 13 million, including
sales proceeds from the disposal of fixed assets of Rmb 8.5 million. Net cash
provided by financing activities amounted to Rmb 44.2 million. This amount
reflects China Strategic Holdings Limited, through an operating subsidiary,
making a capital contribution of Rmb 34.7 million. The year ended with an
increase in cash and cash equivalents of Rmb 23.6 million, producing a balance
of cash and cash equivalents as at December 31, 1993 of Rmb 28.8 million.
37
<PAGE>
Commitments for Capital Expenditure
At the end of the year 1994, Wuxi CSI had capital commitment to acquire
machinery and equipment of approximately Rmb 30.3 million as compared to Rmb
13.6 million at year end 1993. Management believes that Wuxi CSI has sufficient
cash flow from operations, combined with bank balances and bank borrowings, to
provide sufficient cash to finance internal growth, capital projects and debt
service requirements for the foreseeable future.
Financing Activities
Wuxi CSI relies on both short-term and long-term bank loans from Chinese
banks to support its operating and capital requirements. On December 31, 1994,
Wuxi CSI had short-term and long-term bank loans of Rmb 3.5 million and Rmb 35
million respectively. Short-term loans have repayment terms ranging from three
months to one year. Long-term loans have repayment terms ranging from one to two
years. All of the short-term and long-term loans are unsecured. Historically,
Wuxi CSI had not experienced any difficulty in loan rollover, and Management has
no reason to believe that this practice will not continue.
Effect of Inflation
The general inflation rate in terms of the Retail Price Index in China was
approximately 21.7% in 1994 and 13.2% in 1993. Management believes that
inflation has not had significant impact on the Operating Subsidiary's cost of
components and raw materials in view of the fact that the Operating Subsidiary
entered into fixed price agreements key suppliers for supplying semi-finished
goods. Inflation has resulted in upward pressure on wages and salaries for
employees at the Operating Subsidiary. However, Management does not expect
inflation to have a material effect on profit margins and income, since Wuxi CSI
has been able to pass on such cost increases to customers.
Seasonal Aspects
Wuxi CSI's products have almost no seasonal fluctuations especially for
Santana vibration Isolators. Wuxi CSI's primary customer, Shanghai Volkswagen,
usually provides an annual production quota of vibration isolators at the
beginning of the year to help the company lay out its production plan. However,
sales are typically higher in the second half of the year as compared to the
first half due to the Lunar Chinese New Year holidays.
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS PRIOR TO FEBRUARY 19,
1996 (PRIOR TO ACQUISITION OF WUXI CSI).
(1) LIQUIDITY
The Registrant's working capital at December 31, 1995 was $2,080,000, a
decrease of $38,000 from the December 31, 1994 balance of $2,118,000. This
decrease was due to several factors. An increase in the current maturities of
long-term debt of $324,000 results from the proper classification of notes in
accordance with the note repayment schedules. A decrease in cash balances of
$189,000 was the result of timing differences in cash payments in December,
1994. A large increase in Fourth Quarter 1995 sales as compared to 1994 were
primarily responsible for the increases of $676,000 in accounts receivable,
$244,0()0 in accounts payable and $170,000 in other accrued expenses.
The Registrant continued to utilize the financing obtained in September 1992
to compensate for shortages in working capital during 1994. The net amounts due
on such loans were $175,000 and $283,000 at December 31, 1995 and 1994,
respectively.
(2) CAPITAL RESOURCES
The Registrant had commitments for purchases of property, plant and equipment
of approximately $35,000 at December 31, 1995. Additional purchases of equipment
may be required as new markets and products are developed. The Registrant's
working capital comes from operations, the sale of excess or unprofitable plants
and equipment, and from financing.
(3) RESULTS OF OPERATIONS
Revenues from continuing operations for 1995 were $7,591,000, an increase of
7% from 1994 revenues of $7,091,000. This was primarily the result of an
increase in international oilfield rubber product sales.
Cost of Sales as a percentage of revenue was 2% lower in 1995 as compared to
1994. An increase in sales volume while the fixed overhead costs such as
depreciation, rent and taxes, remain substantially unchanged, causes cost of
sales as a percentage of sales to decrease.
Selling and Marketing expense of $1,402,000 increased by $162,000 from 1994
expense of $1,240,000. The increase was primarily due to increased distribution
costs related to the higher sales volume.
General and Administrative expenses decreased by $113,000 from $1,369,000 in
1994. The increase was primarily attributable to a decline in the amount of
legal and professional fees, and engineering expenses.
38
<PAGE>
Interest expense decreased due to more efficient utilization of third party
financing.
Other income in 1994 was higher due to the gain on the sale of assets of
$345,000 in 1995.
The specific source of profits and losses for 1995 and 1994 are shown below:
1995 1994
---- ----
Corsciana manufacturing operation $ 83,000 $(106,000)
Energy Services (72,000) (38,000)
Gain on the sale of assets 345,000 8,000
Interest (328,000) (396,000)
--------- ---------
$28,000 $(532,000)
========= =========
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements and Supplementary Data for the Registrant for the
period ended December 31, 1995 and 1994 are set forth on pages ____hereto and
made a part hereof. The following are (i) the Consolidated Financial Statements
of Regal International, Inc. for the years ended December 31, 1995 and 1994
(prior to acquisition of Acewin Profits Limited); (ii) the Consolidated
Financial Statements of Acewin Profits Limited and Subsidiaries as of December
31, 1993, 1994 and 1995, (ii) the Statements of Income and Related Reports of
Wuxi CSI for the nine months ended September 30, 1993 and (iii)the Unaudited
Proforma Consolidated Financial Statements of the Registrant as of December 31,
1995.
39
<PAGE>
FINANCIAL STATEMENTS OF REGAL INTERNATIONAL, INC.
FOR YEARS ENDED DECEMBER 31, 1995 AND 1994
40
<PAGE>
PANNELL
KERR
FORSTER
of
TEXAS, P.C.
Certified Public Accountants
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
Regal International, Inc.
Corsicana, Texas
We have audited the consolidated balance sheets of Regal International, Inc. and
subsidiaries ("the Company") as of December 31, 1995 and 1994, and the related
consolidated Statements of operations, stockholders' equity and cash flows for
the years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on the
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, an a test basis, evidence supporting
the amounts and disclosures In the financial statements.
All audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial petition of Regal
International, Inc. and subsidiaries at December 31, 1995 and 1994 and the
consolidated results of their operations and their cash flows for the years then
ended In conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has historically incurred
operating losses which raises substantial doubt about its ability to continue as
a going concern. There is no assurance that the Company will be able to realize
its recorded assets and liquidate its liabilities in the ordinary course of
business. Management's plans are also described in Note 1. The consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ Pannell Kerr Forster of Texas, P.C.
PANNELL KERR FORSTER OF TEXAS, P,C.
February 9, 1996
5847 San Felipe, Suite 2300 Houston, Texas 77057 - Telephone (713) 700-8007
Fax (713) 764-3360
41
<PAGE>
REGAL INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
Year Ended December
---------------------
1995 1994
------- -------
ASSETS
CURRENT ASSETS:
Cash $ 11 $ 200
Restricted Cash 19 15
Accounts Receivable, less
allowance for doubtful accounts
of $53 and $74, respectively 1,583 907
Inventories 2,460 2,426
Prepaid expenses 219 69
-------- -------
Total Current Assets 4,292 3,617
PROPERTY PLANT AND EQUIPMENT, less
accumulated depreciation of $8,230 and
$8,448 respectively 1,836 2,229
OTHER ASSETS 16 36
-------- --------
TOTAL ASSETS $ 6,144 $ 5,882
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt, including
$577 and $248 due to related parties,
respectively $ 865 $ 541
Accounts payable 752 508
Accrued Interest 10 35
Other accrued expenses 585 415
-------- --------
Total Current Liabilities 2,212 1,499
LONG-TERM DEBT, including $819 and $1,036
due to related parties. Respectively 1,294 1,773
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock - $.O1 par value: 150,000,000
shares authorized;. 81,806,211 shares issued
and outstanding in 1995 and 81,803,198 in 1994 818 818
Additional paid-in capital 20,307 20,307
Deficit (18,487) (18,515)
-------- --------
Total Stockholders' Equity 2,638 2,610
-------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 6,144 $ 5,882
======== ========
The accompanying notes are an Integral part of these financial statements..
42
<PAGE>
REGAL INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share data)
Year Ended December 31
-------------------------
1995 1994
----------- -----------
REVENUES $ 7,591 $ 7,091
COSTS AND EXPENSES:
Cost of Sales 5,022 4,831
Selling and marketing 1,402 1,240
General and administrative 1,258 1,369
----------- -----------
7,682 7,440
----------- -----------
OPERATING LOSS (91) (349)
----------- -----------
OTHER INCOME (EXPENSES)
Interest Expense, Including $131 and
$189 to related parties (328) (396)
Other Income
Gain on sale of fixed assets 345 8
Gain on settlements of liabilities 11 116
Other 91 89
---------- ----------
NET INCOME (LOSS) $ 28 $ (532)
========== ==========
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING 81,806 53,331
========== ==========
NET INCOME (LOSS) PER COMMON SHARE $ 0.000 $ (0.010)
========== ==========
The accompanying notes are an integral part of these financial statements,
43
<PAGE>
<TABLE>
REGAL INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except per share data)
<CAPTION>
Convertible
Preferred stock
Series A and B Common Stock Additional
----------------------- --------------------
Number of Number of Paid-in
shares Amount shares Amount Capital Deficit Total
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER
31, 1993 2,630,134 $ 263 53,330,164 $ 633 $ 19,327 $ (17,983) $ 2,140
Conversion of
Series B preferred
Stock to Common
Stock (130,134) (13) 923,952 9 4 -
Conversion of Series
A preferred Stock
to Common Stock (2,500,000) (250) 7,500,000 75 175
Conversion of
$1,002,604 Harlequin
Debt to Common Stock 20,052,082 201 801 1,002
Net Loss (532) (532)
---------- ------- ---------- ------ --------- -------- ---------
BALANCE, DECEMBER
31, 1994 - - 81,806,198 818 20,307 $ (18,515) $ 2,610
---------- ------- ---------- ------ ---------- --------- ----------
Conversion of Series B Preferred
Stock to Common Stock 13
Net Income 28 28
--------- -------- ---------- ------ ---------- --------- ----------
BALANCE, DECEMBER
31, 1995 - $ - 81,806,211 $ 818 $ 20,307 $ (18,487) $ 2,638
========= ======== ========== ====== ========== ========== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
44
<PAGE>
REGAL INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
----------------------
1995 1994
-------- --------
Cash flows from operating activities:
Net Income (loss): $ 28 $ (532)
Adjustments to reconcile net Income (loss) to
net cash provided by (used in) operations:
Depreciation 317 338
Provision for losses on accounts receivable 24 3
Gain on sale of assets (345) (44)
Gain on debt restructured (11) (8)
Changes In assets and liabilities:
Decrease (increase) in accounts receivable (700) 792
Decrease (increase) in restricted cash (4) 31
Decrease in Inventories 72 67
Increase In prepaid expenses (7) (21)
Decrease (increase) in other asset 20 (33)
Increase (decrease) in accounts payable 244 (215)
Increase in accrued interest and
other currant liabilities 157 90
-------- ---------
Not cash provided by (used in) operating activities (205) 468
Cash flows from Investing activities:
Proceeds from the sale of fixed assets 324 8
Capital expenditures (153) (173)
-------- --------
Net cash provided by (used in) Investing
activities 171 (165)
Cash flows from financing activities:
Proceeds from borrowing 114 26
Principal payment on debt (269) 157
-------- --------
Not cash used in investing activities (155) (131)
-------- --------
Net Increase (decrease) in cash (189) 172
Cash at beginning of year 200 28
Cash at end of year $ 11 $ 200
========= ========
The accompanying notes are an integral part of these financial statements.
45
<PAGE>
REGAL INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994 (in thousands,
except share and per share data)
Supplemental disclosure of cash flow information (in thousands):
Cash paid for interest during the years ended December 31, 1995 and 1994 was
$333 and $352, respectively.
Supplemental schedule of noncash investing and financing activities (in
thousands, except share data):
Holders of Series B Preferred Stock exchanged 130,134 of such shares into
923,952 shares of Common Stock during December 1994.
Long-term debt to related party of $1,002 was converted to Common Stock of $201
and additional paid-in capital of $801 during 1994.
Holders of 2,500,000 shares of Series A Preferred Stock converted their shares
into 7,500,000 shares of Common Stock during 1994.
During 1995, in connection with the Company's restructuring, $99,000 of Notes
Payable were retired of which $30,000 was paid in cash by Harlequin (a
wholly-owned subsidiary of a pension fund of which a Director is Trustee) on
behalf of Regal and $69K of old Notes Payable to Harlequin were converted to new
Notes Payable to Harlequin.
46
<PAGE>
REGAL INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER, 31, 1995
(1) CONTINUING OPERATIONS AND BASIS OF PRESENTATION:
The consolidated financial statements include the accounts of Regal
International, Inc. ("Regal") and its wholly owned subsidiaries
(collectively, the "Company") which are Regal Rubber Products, Inc.
("Regal Rubber"), and Bell Petroleum Services, Inc. ("Bell"). All
significant intercompany balances and transactions are eliminated in
consolidation.
The Company is primarily engaged in manufacturing and selling various expendable
rubber products and providing oilfield safety services. The Company's products
are used to support drilling, completion and workover of oil and gas wells as
well as production from completed wells. The Company also produces rubber
products for industrial, construction and other uses.
The Company's consolidated financial statements have been prepared using
accounting principles applicable to a going concern which contemplates the
realization of assets and liquidation of liabilities in the ordinary course of
business. The consolidated financial statements do not include any adjustments
relating to the recoverability and classification of recorded assets or
liabilities that might be necessary should the Company be unable to continue in
existence.
Management of the Company is pursuing several alternatives to return the Company
to consistent profitability. During 1995 the Company successfully secured an
asset-based lending arrangement to allow for more flexible and less costly
working capital financing. In addition, increased sales efforts are being made
to further penetrate international markets. The Company's certification by the
International Standards Organization (ISO 9001) for its quality program will
assist in the marketing of its rubber products internationally. See also Note
(13) Subsequent Events, for further discussion regarding the Company's future
operations.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Cash Equivalents
- ----------------
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
Inventories
- -----------
Inventories are valued at the lower of cost or market determined on a first-in,
first-out basis. The company periodically evaluates its inventory to determine
if any unsalable or obsolete inventory exists and adjusts its reserves as
necessary. These evaluations are performed, at a minimum. on an annual basis.
47
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
Property, Plant and Equipment
- -----------------------------
Property, plant and equipment are carried at cost. Depreciation is computed
using the straight-line method over the estimated useful lives for financial
reporting purposes and by accelerated methods for income tax reporting purposes.
As assets are retired or otherwise disposed of, the cost and related accumulated
depreciation arc removed from the accounts and the resulting gain or loss is
reflected in operations. The cost of maintenance and repairs is charged to
operations as incurred; significant renewals and betterments are capitalized.
Financial Instruments and Concentrations of Credit Risk
- -------------------------------------------------------
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of cash and accounts receivable. The Company
maintains its cash with major domestic banks. The terms of these deposits are on
demand to minimize risk. The Company also has certificates of deposit totaling
$28,000 an $46,000 at December 31, 1995 and 1994, respectively, The Company has
$19,000 and $15,000 classified as restricted cash and $9,000 and $31,000
classified as other assets in 1995 and 1994, respectively. The Certificates of
Deposit mature on various dates through 1998. These certificates of deposit
represent collateral for outstanding letters of credit. The Company has not
incurred losses related to these cash deposits.
Accounts receivable consist of uncollateralized receivables from domestic and
international customers in the oil and gas drilling industry, To minimize risk
associated with international transactions, all sales are in U.S. currency. The
Company routinely assesses the financial strength of its customers. The Company
establishes an allowance for doubtful accounts based upon factors surrounding
the credit risk of specific customers, historical trends and other information.
The carrying value of the Company's financial instruments approximates their
fair value at December 31, 1995 and 1994.
Estimates
- ---------
The preparation of financial statements in conformity with generally accepted
accounting principals requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Concentrations
- --------------
Approximately 60% of the Company's labor force is covered by a collective
bargaining agreement which expires in May 1996.
48
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
Income Taxes
- ------------
Statement of Financial Accounting Standards No. 109 requires the use of an asset
and liability approach for financial accounting and reporting purposes. The
statement also requires deferred tax balances to be adjusted to reflect the tax
rates in effect when those amounts are expected to be payable or refundable.
Deferred income taxes are provided for differences in timing of reporting
certain expenses for financial statement and tax purposes. Deferred tax
liabilities result primarily from the use of accelerated depreciation for tax
reporting and straight-line depreciation for financial statement reporting.
Deferred tax assets relate to (i) expenses recorded for financial statement
purposes that are not currently deductible for tax purposes and (ii) net
operating loss carryforwards and tax credits remaining at December 31, 1995. If
it is likely that some portion or all of a deferred tax asset will not be
realized, a valuation allowance is recognized (See Note 7).
Net Income(Loss) Per Share
- --------------------------
The net income or net loss per share calculation is based on the weighted
average number of shares of Common Stork and Common Stock equivalents
outstanding during the year.
(3) ACCOUNTS RECEIVABLE
On September 23, 1992 the Company entered into a renewable financing agreement
with a third party lender. The agreement provides for advances on selected
accounts receivable of Regal not to exceed an aggregate outstanding balance of
$1,200,000. (Total cumulative advances for the years ended December 31, 1995 and
December 31, 1994 were $2,061,000 and $2,176,000, respectively.) Advances are
limited to 80% of the selected account balances and are recorded as a reduction
of accounts receivable and the related fees are included in interest expense.
The fees charged range from 2.25% to 6.25% of the face value of such invoices
and is calculated based on the period outstanding, The minimum fee is $2,500 per
month. This agreement is collateralized by all Regal and Bell accounts
receivable, inventory, machinery and equipment, and intangibles.
On December 21, 1995, the Company entered into a new two-year asset-based
lending agreement with another third-party lender. On January 16, 1996 a portion
of the proceeds were used to retire the outstanding balance of the above prior
receivable financing agreement. The maximum outstanding balance of $1,500,000 is
also subject to limits of 80% of eligible accounts receivable and 50% of
eligible inventory. It is secured by liens on the Company's accounts receivable,
inventory, equipment and intangibles. The Agreement is subject to certain
positive and negative covenants.
49
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
(4) INVENTORIES
Inventories consist of:
December 31,
------------------
1995 1994
-------- --------
(in thousands)
Raw materials, net of allowance for
obsolescence of $24 and $25,
respectively $ 207 $ 188
Work in process, not of allowance for
obsolescence of $24 and $25,
respectively 525 626
Finished goods, not of allowance
for obsolescence of $306 and
$423, respectively 1,728 1,612
-------- -------
$ 2,460 $ 2,426
======== ========
(5) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of:
Estimated December 31,
Useful Life 1995 1994
----------------- ------------------
(in thousands)
Land $ 101 $ 216
Building and improvements 5-25 years 1,357 1,520
Manufacturing equipment 4-10 years 7,798 8,074
Other property & equipment 3-5 years 810 865
-------- -------
10,066 10,675
Less: Accumulated depreciation (8,230) (8,446)
-------- -------
$ 1,836 $ 2,229
======== =======
During 1995 Regal disposed of certain manufacturing equipment and related
materials in exchange for $50,000 cash and a merchandise credit of $250,000 to
be used for the purchase of rubber goods from the purchaser of the equipment. In
connection with this transaction Regal has committed to purchase inventory
through October 1998. The Company recognized a gain of $280,000 from this
disposition.
50
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
(6) LONG-TERM DEBT:
Long-term debt is summarized as follows:
December 31,
-----------------
1995 1994
-------- --------
(in thousands)
Secured Promissory Notes (a) $ 2,058 $ 2,100
Secured Promissory Notes (b) 54 125
Capitalized Leases and Transportation
Equipment Notes (c) 47 89
-------- --------
2,159 2,314
Less current maturities (865) (541)
-------- --------
Total long-term debt $ 1,294 $ 1,773
======== ========
Annual maturities of long-term debt are $865,000, $548,000. $694,000 and $52,000
for the years ended December 31, 1996, 1997, 1998, and 1999, respectively.
(a) The Company restructured a total of $2,081,000 of its debt in 1994. In the
restructuring, new notes were issued for the full principal amount of the old
notes. Noteholders were given the option of restructuring the note over 48
months or the purchase of the note by the Company's majority shareholder. The
restructuring incorporated both secured promissory notes and unsecured
promissory notes. The new notes called for a principal reduction of 5%, paid in
January 1995, interest only for six months and 42 equal monthly installments of
the remaining principal and interest until maturity. Notes of approximately
$19,000 were paid in full as part of the restructuring. Notes payable to related
parties of $1,396,000 and $1,284,000 are included in the December 31, 1995 and
1994 balances outstanding, respectively. Several of the noteholders did not
accept the restructuring. See (b) below.
(b) These notes are in default at December 31, 1995. The holders of the notes
were given the opportunity to restructure their notes or to accept Harlequin's
offer to buy their notes in December 1994 but did not accept either offer.
(c) These notes are payable in monthly installments through various dates in
1997 and bear interest at varying rates.
51
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
(7) INCOME TAXES:
The Company files a consolidated federal income tax return. At December 31, 1995
the Company had available unused operating loss carryforwards and tax credit
carryforwards that expire as follows:
<TABLE>
<CAPTION>
Net operating Percentage
Expiring Loss Depletion Contribution combined
December 31, Carryforwards Carryforwards Carryforwards Carryforwards
- -------------- ----------------- --------------- ------------- ---------------
<S> <C> <C> <C> <C>
1906 $ $ $ 2,000 $ 2,000
1997 12,000 12,000
1998 802,000 11,000 813,000
1999 3,671,000 8,000 3,679,000
2000 2,609,000 6,000 2,615,000
2001 6,392,000 4,000 6,396,000
2003 4,039,000 4,039,000
2004 2,423,000 2,423,000
2005 2,050,000 2,050,000
2006 3,430,000 3,430,000
2007 562,000 562,000
2009 413,000 413,000
--------------- ----------------- -------------- --------------
TOTALS 26,391,000 $ 41,000 $ 2,000 26,434,000
=============== ================= ============== ==============
</TABLE>
<TABLE>
<CAPTION>
Research and
Development Employee Stock Investment Combined
Expiring Tax credit Ownership Plan Tax Credit Tax Credit
December 31, Carryforwards Tax Credit Carryforwards Carryforwards
- ------------- ------------- --------------- ------------- -------------
<C> <C> <C> <C> <C>
1996 $ 3,000 $ $ 179,000 $ 182,000
1997 5,000 28,000 76,000 109,000
1998 8,000 13,000 99,000 120,000
1999 4,000 16,000 74,000 94,000
2000 16,000 16,000
2001 10,000 10,000
------------- --------------- ------------ --------------
TOTALS $ 20,000 $ 83,000 $ 428,000 $ 531,000
============= =============== ============ ===============
</TABLE>
The utilization of these credits and carryforwards is subject to certain
limitations imposed by the 1986 Tax Reform Act and is significantly restricted
by Section 382 of the Internal Revenue Code due to ownership changes. The above
amounts may be subject to separate return limitation rules.
52
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
Deferred tax assets and liabilities total $9,259,000 and $375,000, respectively,
at December 31, 1995 and $9,668,000 and $257,000, respectively, at December 31,
1994.
The current and noncurrent deferred tax assets and liabilities are comprised of
the following:
Current Non-Current
------- -----------
Deferred tax liability:
Depreciation $ (375,000)
Deferred tax assets:
Loss Carryforwards 8,973,000
Other Tax Credits 195,000
Accruals $ 73,000
Allowance for Doubtful Accounts 18,000 -
--------- ------------
91,000 8,793,000
Less Valuation Allowance (91,000) (8,793,000)
--------- ------------
Net Deferred Tax Assets -0- -0-
========= ============
The valuation allowance decreased by approximately $528,000 from January 1, 1995
to December 31, 1995 primarily as a result of the expiration of net operating
loss carryforwards.
The following reconciles the expected tax provision by applying statutory rates
to 1995 pre-tax income:
Expected tax provision $ 9,923
Excess book depreciation 35,487
Additional bad debt expense (7,364)
Additional warranty expense (1,650)
Gain on Sale of Assets 12,754
Nondeductible Interest Expense 64,667
Nondeductible Vacation Expense 6,326
Other Nondeductible Expenses 2,509
Tax Benefit of NOL Carryforwards (122,652)
----------
$ -0-
==========
53
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
(8) STOCKHOLDERS' EQUITY
As part of the 1994 restructuring described in Note (6), the holders of Series A
Preferred Stock and 50,000 shares of Series B Preferred Stock voted to convert
their shares. The terms of both Preferred Stock Series A and B state that if a
majority of shareholders vote as a single class to convert their shares, then
all shares shall be deemed converted. As a result, all of the Preferred Stock
was converted to Common Stock. Additionally, the accumulated Preferred Stock
dividends and liquidation preference were eliminated. The effects of the
restructuring are reflected in the accompanying financial statements as of
December 31, 1994.
The following tables summarize the activity of warrants and options:
During 1987 and 1988, the Company issued five-year Common Stock options in
conjunction with its financing activities to various promissory note holders and
other selected creditors. During 1989, the Company issued five and ten-year
stock options in an additional financing and extension of debt.
COMMON STOCK OPTIONS
1995 1994
---- ----
Shares under option beginning of year 150,000 328,000
Expired - (178,000)
--------- ---------
Shares under option end of year 150,000 150,000
========= =========
Average exercise price of outstanding
options $.156 $.156
Exercisable at end of year 150,000 150,000
========= =========
In December 1991 the Board of Directors approved the issuance of Common Stock
options to members of the Board of Directors. The options were to expire in five
years and be issued at 110% of market value on the date of grant.
COMMON STOCK OPTIONS
1995 1994
---- ----
Options at beginning of year 1,000,000 1,000,000
Issued 300,000 -
Restated - 50,000
Expired (300,000) (50,000)
---------- ----------
Shares under option end of year 1,000,000 1,000,000
========== ==========
Average exercise price of
outstanding options $ .14 $ .14
---------- ----------
Exercisable at end of year 1,000,000 1,000,000
========== ==========
54
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
The Company has never paid a cash dividend. It is the current policy of the
Board to retain earnings, if any, to provide funds for the Company's operations.
The payment of dividends is at the discretion of the Board, and dividends may be
paid only out of current earnings and profits or retained earnings. The Company
had an accumulated deficit of $18,487,000. No funds have been legally available
for the payment of dividends since 1983.
(9) EXPORT SALES:
The Company is represented worldwide in all oil and gas producing areas. Export
sales totaled $2,074,000 in 1995 and $1,500,000 in 1994.
(10) COMMITMENTS AND CONTINGENCIES:
Leases
- ------
The Company has operating leases covering equipment and various warehouse and
office locations. No contingent rentals are involved and management expects that
most of these will be renewed or replaced by other leases in the normal course
of business.
Future minimum payments under operating leases at December 31, 1995 are
approximately $72,000 in 1996, $74,000 in 1997, $59,000 in 1998 and $23,000 in
1999. Total rent expense under operating leases was $69,000, and $67,000 in 1995
and 1994, respectively.
Legal Proceedings
- -----------------
The Company is involved in lawsuits arising in the ordinary course of business.
Management is unable to predict the ultimate outcome of these suits, but intends
to contest them vigorously and believes that the disposition of all the suits
individually and in the aggregate, after taking into account the available
insurance coverages, should not have a material adverse affect on the Company's
operations or financial condition.
Insurance
- ---------
The Company maintains public liability, product liability, property damage,
workers' compensation insurance. The public and product liability policies cover
losses which occur during the respective policy periods.
Insurance companies provide coverage over specified individual and group
retention levels for employee health insurance costs. The Company self insures
claims under those retention levels. The self funded claims arc accrued based on
actuarial estimates of the Company's exposure for the plan year. These claims
are paid as incurred.
55
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
Letters of Credit
- -----------------
Regal has restricted cash in interest bearing Certificates of Deposit which are
pledged against outstanding letters of Credit that mature at various dates
through 1998. At December 31, 1995, Regal had $28,000 in restricted cash of
which $9,000 was included in Other Assets and $19,000 was classified as
Restricted Cash. At December 31, 1994, Regal had $46,000 in restricted cash of
which $31,000 was included in Other Assets and $15,000 was classified as
Restricted Cash. These Letters of Credit are required as performance guarantees
by certain foreign customers.
(11) EMPLOYEE BENEFIT PLAN:
In October 1991, the Company adopted an Internal Revenue Code (Section 401K)
Plan for all of its eligible employees. The plan has a 6 year vesting schedule
and allows a discretionary employer match of contributions made by employees.
(12) RELATED PARTY TRANSACTIONS:
As a part of the Company's restructuring, Harlequin converted $1,002,604 of debt
into 20,052,082 shares of Common Stock in 1994. In addition, notes totaling
$1,366,000 were purchased by Harlequin pursuant to an offer to the noteholders
to buy their notes.
During 1995, Harlequin advanced $100,000 to the Company. Notes to Harlequin
accrue interest at rates ranging from 9% to 10%. Interest expense for the year
was $131,000, Accrued interest at December 31, 1995 was $190,000 and is included
in Other Accrued Expenses.
During 1995, directors fees of $9,500, $6,000 and $11,000 were paid to
Messrs. Sharma, Furner and Ollquist. respectively and $60,000 payable to
Mr. Richard Gray was accrued.
During 1994, Directors' Fees of $30,000, $30,000, $12,000 and $6,500 were paid
to Messrs. Plunkett, Beinhocker, Ollquist and Sharma, respectively and $60,000
payable to Mr. Richard Gray was accrued.
Amounts due Richard Gray, or companies affiliated with Mr. Gray, at December 31,
1995 and 1994 were $92,000 and $34,000, respectively, and are included in Other
Accrued Expenses.
During 1994, the following interest payments were made to related parties:
Whistling, Ltd; (a company wholly owned by the children of a Regal Director),
$18,000, Bermuda Holding Company (a company wholly owned by the wife of a Regal
Director), $29,000; The Plunkett Family (relatives of a Director), $28,000; and
Gary Sherman Investments, Inc. ("GSI") (a company wholly owned by a Director),
$25,000. Interest expense payable to Harlequin was $75,000 of which $25,000 was
paid and $50,000 was classified as Other Accrued Expenses at December 31, 1994.
56
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,1995
(13) SUBSEQUENT EVENTS:
On January 31, 1996 Regal acquired all the issued and outstanding shares of
Acewin Profits Limited, a British Virgin Islands corporation ("Acewin"), from
China Strategic Holdings Limited, a Hong Kong company ("CSH"). Acewin's sole
asset is a 55% joint venture interest in Wuxi CSI Vibration Isolator Co., Ltd.
("Wuxi"), a Sino-foreign joint venture. Regal paid $13.5 million for the shares
of Acewin common stock. Such purchase price was paid by delivery of a $13.5
million Convertible Note bearing interest at the rate of nine percent (9%) per
annum (the "Convertible Note"').
The Convertible Note is payable interest only on an annual basis, with all
principal being due and payable on January 31, 1999, The principal and any
unpaid interest owing on the Convertible Note are convertible into shares of
Regal Common Stock at a conversion price of $0.0302 per share. The principal
amount of the Convertible Note will be reduced if the audited financial
statements of Wuxi for the year ended December 31, 1995 reflect all after tax
profit of less than $3.0 million. The adjustment is a formula designed to assure
the purchase price paid by the Regal for the Wuxi interest does not exceed eight
(8) times Wuxi's 1995 after-tax earnings. Assuming no adjustment, the
Convertible Note is convertible into 84.5% of Regal's current outstanding shares
of Common Stock. The Convertible Note is secured by a Pledge Agreement granting
CSH a security interest in the shares of Acewin capital stock.
Immediately following the acquisition of the shares of Acewin capital stock and
as a condition thereto, Regal sold and transferred all the existing operating
assets and real property of Regal to a newly formed corporation, Regal (New)
International, Inc. ("New Regal") in exchange for $2.5 million and New Regal's
assumption of all outstanding liabilities of Regal, other than tile Convertible
Note, New Regal is a wholly-owned subsidiary of Harlequin Investment Holdings
Limited ("Harlequin"). The $2.5 million portion of the purchase price was paid
as follows: $800,000 in cash and the balance by delivery to Regal of two
promissory notes, one in the principal amount of $900,000 (tile "$900,000 Note")
and the second in the principal amount of $800,000 (tile "$800,000 Note"). The
$900,000 Note bears interest at 9% per annum and is payable in sixty (60) equal
monthly installments of principal and interest. The $800,000 Note bears no
interest and is due and payable in one installment on January 31, 2001. New
Regal's obligations under the $900,000 Note and the $800,000 Note are secured by
a pledge of all of the issued and outstanding shares of capital stock of New
Regal.
In connection with the above-described transactions, Janak Desai, Nils Ollquist
and Girish Sharma resigned as Directors of Regal, and Oei Hong Leong, the
Chairman of CSH, Chung Cho Yee Mico, and Ma Wai Man were elected to fill the
vacancies created by such resignations. See Note (1) Continuing Operations and
Basis of Presentation.
57
<PAGE>
ARTHUR
ANDERSEN
ARTHUR ANDERSEN & CO. SC
Arthur Andersen & Co.
Certified Public Accountants
----------------------------
25/F., Wing On Centre
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS 111 Connaught Road Central
Hong Kong
To Acewin Profits Limited:
We have audited the accompanying consolidated balance sheets of Acewin Profits
Limited (incorporated in the British Virgin Islands) and its subsidiaries as of
December 31, 1993, 1994 and 1995, and the related consolidated statements of
income, cash flows and changes in shareholder's equity for the three months
ended December 31, 1993 and the years ended December 31, 1994 and 1995,
expressed in Chinese Renminbi. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred above present
fairly, in all material respects, the financial positions of Acewin Profits
Limited and its subsidiaries as of December 31, 1993, 1994 and 1995, and the
results of their operations and their cash flows for the three months ended
December 31, 1993 and the years ended December 31, 1994 and 1995 in conformity
with generally accepted accounting principles in the United States of America.
/s/Arthur Andersen & Co.
Hong Kong,
April 5, 1996.
58
<PAGE>
ACEWIN PROFITS LIMITED AND SUBSIDIARIES
---------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
---------------------------------
FOR THE PERIOD FROM OCTOBER 1, 1993 TO DECEMBER 31,1993 AND
-----------------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31,1994 AND 1995
----------------------------------------------
(Amounts in thousands)
Three months
ended
December 31 Year ended December 31,
----------------------------------
1993 1994 1995 1995
---------- ---------- ---------- ----------
Rmb Rmb Rmb US$
Sales 14,940 72,570 108,408 13,014
Cost of goods sold 11,198 46,213 64,785 7,777
Selling and administrative
expenses 3,784 14,173 15,642 1,878
Interest expense (income), net 480 (104) (1,627) (195)
Other income, net (648) (481) (649) (78)
Total cost and expenses 14,814 59,801 78,151 9,382
---------- ---------- ---------- ----------
Income before income taxes
and minority interests 126 12,769 30,257 3,632
Provision for income taxes (78) - - -
Income before minority
interests 48 12,769 30,257 3,632
Minority interests 138 (5,238) (13,386) (1,607)
---------- ---------- ---------- ---------
Net income 186 7,531 16,871 2,025
========== ========== ========== ==========
Translation of amounts from Renminbi (Rmb) into United States Dollars (US$) for
the convenience of the reader has been made at the unified exchange rate quoted
by the Bank of China on March 31, 1996 of US$1.00 = Rmb8.33. No representation
is made that the Renminbi amounts could have been, or could be, converted into
United States Dollars at that rate on March 31, 1996 or at any other certain
rate.
The accompanying notes are an integral part of these consolidated statements of
income.
59
<PAGE>
ACEWIN PROFITS LIMITED AND SUBSIDIARIES
---------------------------------------
<TABLE>
CONSOLIDATED BALANCE SHEETS AS OF
----------------------------------
DECEMBER 31, 1993, 1994 AND 1995
--------------------------------
(Amounts in thousands, except number of shares and share data)
<CAPTION>
December 31,
----------------------------------------------
1993 1994 1995 1995
---------- ---------- ---------- ----------
Rmb Rmb Rmb US$
<S> <C> <C> <C> <C>
ASSETS
Current assets
Cash and cash equivalents 28,857 30,440 50,320 6,041
Accounts receivable, net 11,224 13,781 15,977 1,918
Inventories 15,920 14,801 16,369 1,965
Prepayments and other current
assets 11,219 14,245 11,233 1,349
Due from related companies 1,149 3,130 4,166 500
---------- --------- ---------- ---------
Total current assets 68,369 76,397 98,065 11,773
---------- --------- ---------- ---------
Property, plant and equipment,
net 52,037 54,621 67,222 8,070
Long-term investment 2,543 2,348 2,278 273
Intangibles 1,345 1,173 1,001 120
--------- ---------- ---------- ---------
Total assets 124,294 134,539 168,566 20,236
========= ========== ========== =========
LIABILITIES AND
SHAREHOLDER'S EQUITY
- ----------------------
Current liabilities
Short-term bank loans 3,450 3,450 3,450 414
Long-term bank loans - current
portion 15,000 18,850 15,900 1,909
Accounts payable 4,390 4,248 8,796 1,056
Accrued expenses and other
payables 10,160 7,823 10,819 1,299
Taxes other than income 453 535 715 86
Due to related companies 3,037 1,214 2,718 326
---------- ---------- ---------- ---------
Total current liabilities 36,490 36,120 42,398 5,090
---------- ---------- ---------- ---------
Long-term bank loans 20,740 16,140 15,490 1,860
Loans from related parties 470 120 - -
Due to Chinese joint venture
partner 963 1,319 13,397 1,608
Due to China Strategic Holdings
Limited 34,262 36,702 36,550 4,388
Minority interests 31,182 36,420 36,433 4,373
Obligations and commitments
(Note 10)
</TABLE>
60
<PAGE>
ACEWIN PROFITS LIMITED AND SUBSIDIARIES
---------------------------------------
CONSOLIDATED BALANCE SHEETS AS OF
----------------------------------
DECEMBER 31, 1993, 1994 AND 1995 (Cont'd)
-----------------------------------------
(Amounts in thousands, except number of shares and share data)
December 31,
---------------------------------------------
1993 1994 1995 1995
---------- ---------- ---------- ----------
Rmb Rmb Rmb US$
Shareholder's equity:
Common stock, par value US$l
each, 50,000 shares authorized;
1 share outstanding 1 1 1 1
Dedicated capital 1 781 1,689 202
Retained earnings 185 6,936 22,608 2,714
---------- --------- ---------- ----------
Total shareholder's equity 187 7,718 24,298 2,917
---------- --------- ---------- ----------
Total liabilities and
shareholder's equity 124,294 134,539 168,566 20,236
========== ========= ========== ==========
Translation of amounts from Renminbi (Rmb) into United States Dollars (US$) for
the convenience of the reader has been made at the unified exchange rate quoted
by the Bank of China on March 31, 1996 of US$1.00 = Rmb8.33. No representation
is made that the Renminbi amounts could have been, or could be, converted into
United States Dollars at that rate on March 31, 1996 or at any other certain
rate.
The accompanying notes are an integral part of these consolidated balance
sheets.
61
<PAGE>
ACEWIN PROFITS LIMITED AND SUBSIDIARIES
---------------------------------------
<TABLE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
FOR THE PERIOD FROM OCTOBER 1, 1993 TO DECEMBER 31, 1993 AND
------------------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31.1994 AND 1995
---------------------------------------------
(Amounts in thousands)
<CAPTION>
Three months
ended
December 31 Year ended December 31,
----------- ---------------------------------
1993 1994 1995 1995
---------- ---------- ---------- ---------
Rmb Rmb Rmb US$
<S> <C> <C> <C> <C>
Cashflows from operating
activities:
Net income 186 7,531 16,871 2,025
Adjustments to reconcile net
income to net cash provided
by operating activities:
Minority interests (138) 5,238 13,386 1,607
Depreciation and
amortization 462 2,359 2,942 353
(Gain) loss on disposal of
fixed assets (588) 31 (99) (12)
Allowance for doubtful
accounts 225 1,807 - -
(Increase) decrease in assets:
Accounts receivable (5,560) (4,364) (2,196) (264)
Inventories 515 1,119 (1,568) (188)
Prepayments and other
current assets (6,424) (3,026) 3,012 362
Due from related companies (1,149) (1,981) (1,036) (124)
Increase (decrease) in
liabilities:
Accounts payable 3,194 (142) 4,548 546
Accrued expenses and other
payables 6,492 (2,337) 2,996 360
Taxes other than income (395) 82 180 22
Due to related companies 3,037 (1,823) 1,504 180
---------- ----------- --------- ----------
Net cash (used in) provided by
operating activities (143) 4,494 40,540 4,867
----------- ----------- ---------- ----------
Cash flows from investing
activities:
Redemption of government
bonds - 195 70 8
Acquisition of property, plant
and equipment (18,757) (4,805) (15,454) (1,855)
Sales proceeds from disposal of
fixed assets 8,525 3 182 22
------------ ----------- ----------- ---------
Net cash used in investing
activities (10,232) (4,607) (15,202) (1,825)
----------- ----------- ----------- ---------
</TABLE>
62
<PAGE>
ACEWIN PROFITS LIMITED AND SUBSIDIARIES
---------------------------------------
<TABLE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------
FOR THE PERIOD FROM OCTOBER 1, 1993 TO DECEMBER 31,1993 AND FOR
---------------------------------------------------------------
THE YEARS ENDED DECEMBER 31,1994 AND 1995
-----------------------------------------
(Amounts in thousands)
<CAPTION>
Three months
ended
December 31 Year ended December 31,
------------ ----------------------------------
1993 1994 1995 1995
---------- ---------- ---------- ----------
Rmb Rmb Rmb US$
<S> <C> <C> <C> <C>
Cash flows from financing
activities:
Repayment of loans from
related parties - (350) (120) (14)
Proceeds of long-term bank
loans 8,900 14,250 14,250 1,710
Repayment of long-term bank
loans (7,400) (15,000) (17,850) (2,143)
Due to Chinese joint venture
partner 963 356 (1,295) (155)
Due to China Strategic
Holdings Limited ("CSH") (442) (1,136) (443) (53)
Capital contribution to
Operating Subsidiary by
CSH 34,704 3,576 - -
---------- ---------- ---------- ----------
Net cash provided by (used in)
financing activities 36,725 1,696 (5,458) (655)
Net increase in cash and cash
equivalents 26,350 1,583 19,880 2,387
Cash and cash equivalents, at
beginning of period/year 2,507 28,857 30,440 3,654
---------- ---------- ---------- ----------
Cash and cash equivalents, at end
of period/year 28,857 30,440 50,320 6,041
========== ========== ========== ==========
</TABLE>
Translation of amounts from Renminbi (Rmb) into United States Dollars (US$) for
the convenience of the reader has been made at the unified exchange rate quoted
by the Bank of China on March 31,1996 of US$1.00 = Rmb8.33. No representation is
made that the Renminbi amounts could have been, or could be, converted into
United States Dollars at that rate on March 31, 1996 or at any other certain
rate.
The accompanying notes are an integral part of these consolidated statements of
cash flows.
63
<PAGE>
ACEWIN PROFITS LIMITED AND SUBSIDIARIES
---------------------------------------
<TABLE>
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY
----------------------------------------------------------
FOR THE PERIOD FROM OCTOBER 1, 1993 TO DECEMBER 31 1993 AND
-----------------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31,1994 AND 1995
---------------------------------------------
(Amounts in thousands, except number of shares)
<CAPTION>
Shares of
Common Stock Common Stock Dedicated Retained
Capital Earnings Total
------------ ------------ ------------ ------------ ---------
Number Rmb Rmb Rmb Rmb
<S> <C> <C> <C> <C> <C>
Balance at October 30, 1993 1 1 - - 1
Net income - - - 186 186
Transfer to dedicated capital - - 1 (1) -
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1993 1 1 1 185 187
Net income - - - 7,531 7,531
Transfer to dedicated capital - - 780 (780) -
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1994 1 1 781 6,936 7,718
Net income - - - 16,871 16,871
Transfer to dedicated capital - - 908 (908) -
Dividend declared - - - (291) (291)
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1995 1 1 1,689 22,608 24,298
============ ============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated statements of
changes in shareholder's equity.
64
<PAGE>
ACEWIN PROFITS LIMITED AND SUBSIDIARIES
----------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
(Amounts in thousands, except number of shares,
per share data and unless otherwise stated)
1. ORGANIZATION AND PRINCIPAL ACTIVITIES
- -----------------------------------------
Acewin Profits Limited ("the Company") was incorporated in the British Virgin
Islands on October 4, 1993 with an authorized share capital of 50,000 common
shares with a par value of US$1 each, one share was issued at its par value to
China Strategic Holdings Limited ("CSH") (formerly known as China Strategic
Investment Limited), a company incorporated in Hong Kong whose shares are listed
on the Stock Exchange of Hong Kong.
The Company is a holding company established to hold a 100% interest in China
Machine (Holdings) Limited ("CMHL") (formerly known as Hank Reddit Limited), a
company incorporated in Hong Kong. CMHL, in turn, holds a 55% interest in Wuxi
CSI Vibration Isolator Co., Ltd. (the "Operating Subsidiary" or "Wuxi CSI").
CMHL's interests in Wuxi CSI was transferred from China Machinery Holdings
Limited ("China Machinery"), a company incorporated in Hong Kong and a
wholly-owned subsidiary of CSH, pursuant to a shareholder's resolution dated
December 13, 1995.
Wuxi CSI is a Sino-foreign joint venture enterprise established on September 10,
1993 in the City of Wuxi, Jiangsu Province in the People's Republic of China
(the "PRC"). The total cash consideration paid by China Machinery for its
interests in Wuxi CSI amounted to RMB38,280, equivalent to US$4,400 at the date
of acquisition. In addition to the initial capital contribution, China Machinery
and the Chinese joint venture partner also capitalized their respective share of
distributable profits for the year ended December 31, 1994 as additional paid-in
capital.
Key provisions of the joint venture agreement of Wuxi CSI include:
the joint venture period is 50 years from the date of formation;
the profit and loss sharing ratio is the same as the percentage of equity
interest; and
the Board of Directors consists of 7 members: 4 designated by CMHL and 3
designated by Wuxi Vibration Isolator Factory, the Chinese joint venture partner
of Wuxi CSI.
65
<PAGE>
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Cont'd)
- --------------------------------------------------
The acquisition of the Operating Subsidiary by China Machinery has been
accounted for by the purchase method of accounting. The tangible assets were
valued in the acquisition at the estimated fair value, which approximated
historical net book value. The results of the Operating Subsidiary are included
in the consolidated statements of income from the effective date of the joint
venture, October 1, 1993. As a result of the allocation of income to minority
interests and reductions in the income tax and sales tax rates, the consolidated
statement of income of the Company and its subsidiaries for the three months
ended December 31, 1993, and the years ended December 31, 1994 and 1995 are not
comparable to the results of operations of Wuxi CSI for the nine months ended
September 30, 1993 ("the Pre-joint Venture period") in certain material
respects.
China Machinery's interests in Wuxi CSI were transferred to CMHL at historical
net book value of Rmb8,377 in exchange for CMHL's assumption of China
Machinery's liability to CSH in an equal amount. The transfer of CSH's interest
in CMHL to the Company was also effected at historical net book value. The
transfer to CMHL by China Machinery of its interests in the Operating Subsidiary
and the transfer of CSH's interest in CMHL to the Company were a result of a
re-organization of companies under common control and have been accounted for
effectively as poolings of interests. The accompanying consolidated financial
statements of the Company have been restated to present the acquisition of the
Operating Subsidiary as if it had been made in October 1993 by CMHL and the
transfer of CSH's interest in CMHL to the Company had occurred on October 1,
1993.
Wuxi CSI operates in the PRC and accordingly is subject to special
considerations and significant risks not typically associated with investments
in equity securities of-United States and Western European companies. These
include risks associated with, among others, the political, economic and legal
environments and foreign currency exchange. These are described further in the
following paragraphs:
Political Environment
The value of the Company's interests in the Operating Subsidiary may be
adversely affected by significant political, economic and social uncertainties
in the PRC. A change in policies by the Chinese government could adversely
affect the Company's interests in the Operating Subsidiary by, among other
factors: changes in laws, regulations or the interpretation thereof;
confiscatory taxation; restrictions on foreign currency conversion, imports or
sources of suppliers; or the expropriation or nationalization of private
enterprises.
Economic Environment
The economy of the PRC differs significantly from the economies of the United
States and Western Europe in such respects as structure, level of development,
gross national product, growth rate, capital reinvestment, resource allocation,
self-sufficiency, rate of inflation and balance of payments position, among
others. Only recently has the Chinese government encouraged substantial private
economic activities.
66
<PAGE>
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Cont'd)
- --------------------------------------------------
The Chinese economy has experienced significant growth in the past five years,
but such growth has been uneven among various sectors of the economy and
geographic regions. Actions by the Chinese central government to control
inflation have significantly restrained economic expansion recently.
Similar actions by the central government of the PRC in the future could have a
significant adverse effect on economic conditions in the PRC and the economic
prospects for the Operating Subsidiary and the Company.
Foreign Currency Exchange
The Chinese central government imposes control over its foreign currency
reserves through control over imports and through direct regulation of the
conversion of its national currency into foreign currencies. As a result, the
Renminbi is not freely convertible into foreign currencies.
The Operating Subsidiary conducts substantially all of its business in the PRC,
and its financial performance and condition are measured in terms of Renminbi.
Any devaluation of the Renminbi against the United States Dollar would
consequently have an adverse effect on the financial performance and asset
values of the Company when measured in terms of United States Dollars.
The Operating Subsidiary's products are primarily sold in the PRC for Renminbi.
Thus, their revenues and profits are predominantly denominated in Renminbi, and
will have to be converted to pay dividends to the Company in United States
Dollars or Hong Kong Dollars. Should the Renminbi devalue against the United
States Dollar, such devaluation would have a material adverse effect on the
Company's profits and the foreign currency equivalent of such profits
repatriated by the Operating Subsidiary to the Company. The Company currently is
not able to hedge its Renminbi - Dollar exchange rate exposure in the PRC
because neither the banks in the PRC nor any other financial institution
authorized to engage in foreign exchange transactions offer forward exchange
contracts.
Import Restrictions and the World Trade Organization
The PRC levies a tariff on imported vibration isolators or shock absorbers; this
duty is intended in part to encourage the development of the domestic vehicle
accessories industry.
The PRC is currently seeking to become a member of the World Trade Organization,
which regulates trading among its signatory countries. If the PRC becomes a
member of the World Trade Organization, import restrictions on vehicle
accessories could be reduced. If such restrictions were removed, the Operating
Subsidiary would face increasing competition from imported foreign vehicle
accessory products.
Legal System
Since 1979, many laws and regulations dealing with economic matters in general
and foreign investment in particular have been enacted in the PRC. However, the
PRC still does not have a comprehensive system of laws and enforcement of
existing laws may be uncertain and sporadic.
67
<PAGE>
2. BASIS OF PRESENTATION
- --------------------------
The accompanying consolidated financial statements were prepared in accordance
with generally accepted accounting principles in the United States of America
("U.S. GAAP"). This basis of accounting differs from that used in the statutory
financial statements of the operating Subsidiary, which were prepared in
accordance with the accounting principles and the relevant financial regulations
applicable to joint venture enterprises as established by the Ministry of
Finance of China ("PRC GAAP").
The principal adjustments made to conform the statutory financial statements of
the Operating Subsidiary to U.S. GAAP included the following:
Addition of an allowance for doubtful accounts receivable;
Addition of a provision to reduce the carrying value of inventories to net
realizable value;
Reclassification of certain items, designated as "reserves appropriated
from net income", as a charge to income;
Restatement of monetary assets and liabilities denominated in foreign
currencies to reflect the exchange rates prevailing at the balance sheet dates;
and
Adjustment to recognize sales and cost of sales upon delivery and acceptance
of goods by customers.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ----------------------------------------------
a. Basis of Consolidation
----------------------
The consolidated financial statements include the financial statements of the
Company and its majority owned and controlled subsidiaries. All material
intercompany balances and transactions have been eliminated on consolidation.
b. Sales
-----
Sales represent the invoiced value of goods, net of sales taxes, supplied to
unrelated customers. Sales are recognized upon delivery and acceptance of goods
by the customers.
c. Cash and Cash Equivalents
-------------------------
Cash and cash equivalents include cash on hand, demand deposits with banks and
liquid investments with an original maturity of three months or less. Cash and
cash equivalents included United States Dollar deposits of US$2,841 (Rmb24,717),
US$2,831 (Rmb23,894) and US$1,912 (Rmb15,908) as of December 31, 1993, 1994 and
1995 respectively.
68
<PAGE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
- -------------------------------------------------------
d. Inventories
-----------
Inventories are stated at the lower of cost, on a first-in first-out basis, or
net realizable value. Costs of work-in-progress and finished goods comprise
direct materials, direct labor and an attributable portion of production
overheads.
e. Property, Plant and Equipment
-----------------------------
Property, plant and equipment are stated at cost less accumulated depreciation.
Depreciation of property, plant and equipment is computed using the straight
line method over the assets' estimated useful lives, taking into account the
estimated residual value of 10% of the cost of fixed assets. The estimated
useful lives are as follows:
Plant and office buildings 8 - 30 years
Machinery and equipment 3 - 20 years
Motor vehicles 2 - 10 years
Furniture, fixtures and office equipment 2 - 10 years
Construction-in-progress (see Note 6) represents factory and office buildings
under construction and plant and machinery pending installation. This includes
the costs of construction, the costs of plant and machinery and interest charges
arising from borrowings used to finance these assets during the period of
construction or installation. Interest capitalized amounted to Rmb441, Rmb1,244
and Rmb1,456 respectively for the three months ended December 31, 1993 and for
the years ended December 31, 1994 and 1995 respectively.
f. Taxation: Income Taxes
----------------------
The Company was incorporated under the laws of the British Virgin Islands, and
under current British Virgin Islands law, the Company is not subject to tax on
income or on capital gains.
The Company and its subsidiaries provide for Hong Kong profits tax on the basis
of its income for financial reporting purposes, adjusted for income and expense
items which are not assessable or deductible for profits tax purposes. As of
December 31, 1993, the Company and its subsidiaries made provisions for Hong
Kong profits tax of approximately Rmb77. The Company and its subsidiaries had no
profits assessable to Hong Kong profits tax for the years ended December 31,
1994 and 1995.
69
<PAGE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
- -------------------------------------------------------
f. Taxation- Income Taxes (Cont'd)
-------------------------------
Wuxi CSI is subject to Chinese income taxes at the applicable tax rate for
Sino-foreign equity joint venture enterprises (currently 27%) on the taxable
income as reported in its statutory accounts adjusted for taxation in accordance
with ' the relevant income tax laws applicable to Sino-foreign equity joint
venture enterprises. Pursuant to the same income tax laws, Wuxi CSI, with a
joint venture term of not less than 10 years and engaged in production, will be
fully exempt from Chinese state unified income tax of 24% for two years starting
from the first profit-making year followed by a 50% reduction of the Chinese
state unified income tax for the next three years ("tax holiday"). Wuxi CSI will
be fully exempt from the Chinese local income tax of 3% for five years starting
from the first profit-making year.
Wuxi CSI has obtained approval from the Wuxi Tax Bureau to delay the
commencement of the tax holiday to January 1, 1994. Accordingly, from the date
of its incorporation to December 31, 1993, Wuxi CSI was subject to Chinese state
income tax at the rate of 24% plus Chinese local income tax at 3%. If the
Operating Subsidiary had not been in the tax holiday period, the Company would
have recorded additional income tax expense of Rmb3,143 and Rmb8,032, and net
income of the Company would have been reduced by Rmb1,729 and Rmb4,418 for the
years ended December 31, 1994 and 1995 respectively.
The Company provides for deferred income taxes using the liability method, by
which deferred income taxes are recognized for all significant temporary
differences between the tax and financial statement bases of assets and
liabilities. The tax consequences of those differences are classified as current
or non-current based upon the classification of the related assets or
liabilities in the financial statements.
g. Taxation: Sales and Value-added Taxes
-------------------------------------
Sales and value-added taxes are recognized on the accrual basis and sales are
recorded net of these taxes.
Prior to December 31, 1993, the Operating Subsidiary was subject to Consolidated
Industrial and Commercial Tax at a rate of 5.05% on the invoiced value of goods
sold.
In December 1993, the Chinese government promulgated several major new tax
regulations which came into effect on January 1, 1994. These new tax regulations
replaced a number of former tax laws and regulations including the Consolidated
Industrial and Commercial Tax. Under these new tax regulations, the Operating
Subsidiary is subject to value-added tax ("VAT") which is the principal indirect
tax on the sales of tangible goods and the provision of certain specified
services ("output VAT") and replaces the old Consolidated Industrial and
Commercial Tax ("CICT") and Product Tax. The general VAT rate applicable to the
Operating Subsidiary is 17.0%.
70
<PAGE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
- ------------------------------------------------------
g. Taxation: Sales and Value-added Taxes (Cont'd)
----------------------------------------------
Pursuant to a supplementary notice (the "notice") issued by the Ministry of
Finance and the State Administration of Taxation ("SAT"), a deemed input VAT
credit, calculated at 14.0% of the inventory balance as of January 1, 1994 was
segregated from the carrying value of opening inventory balances of the
Operating Subsidiary as of January 1, 1994. As a result, an amount of
approximately Rmb1,977, being the deemed input VAT paid, was transferred from
opening inventory balances and recorded as deferred assets in the statutory
accounts of the Operating Subsidiary on January 1, 1994. The notice also
stipulated that these deferred assets would be available to offset future VAT
payable under certain specific circumstances. As of December 31, 1995 the full
amount of Rmb1,977 had been utilized by the Operating Subsidiary to offset
against VAT payable of the 1994 and 1995 fiscal years.
There is also a "grandfather" provision issued by the National People's Congress
on December 29, 1993 for foreign invested enterprises previously paying CICT.
The provision states that where the tax burden of foreign invested enterprises
established before December 31, 1993 increases due to the above noted change in
tax laws, such enterprises may, upon application to and with the approval of the
tax authorities, obtain a refund of any tax paid in excess of the amount which
would have been paid under previous CICT legislation. The maximum limit for
application of this provision is five years from January 1, 1994.
According to a circular ("the Circular") issued by SAT in September 1994, which
further clarified the inter-play between the deemed input credit and the
grandfather provision, the computed grandfather refund of excess tax liability
is to be firstly reduced by the unutilized balance of deemed input VAT credit.
After the deemed input VAT credit is fully offset in this manner, any remaining
balance of the grandfather refund would be refunded through a reduction in VAT
liability for that period or in cash.
As of December 31, 1994 and 1995, the Operating Subsidiary claimed from the
local tax bureau an aggregate amount of approximately Rmb2,141 and Rmb1,249 as
grandfather refunds. Approximately Rmb9OO was received in the form of cash for
1995, while the remaining Rmb2,141 and Rmb349 for 1994 and 1995 respectively was
utilized to offset against VAT payable for 1994 and 1995 respectively. The
grandfather refunds have been included in the accompanying financial statements
as a reduction in cost of goods sold for the years ended December 31, 1994 and
1995 respectively.
71
<PAGE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
- -------------------------------------------------------
h. Foreign Currency Translation
----------------------------
The Operating Subsidiary maintains its books and records in Renminbi. Foreign
currency transactions are translated into Renminbi at the applicable unified
rates of exchange or the applicable rates of exchange quoted by the applicable
foreign exchange adjustment center ("swap center"), prevailing at the dates of
the transactions. Monetary assets and liabilities denominated in foreign
currencies are translated into Renminbi using the applicable unified rates of
exchange or the applicable swap center rates prevailing at the balance sheet
dates. The resulting exchange differences are included in the determination of
income.
The Company's registered capital is denominated in United States Dollars and the
reporting currency is Renminbi. For financial reporting purposes, the United
States Dollars capital amounts have been translated into Renminbi at the swap
centre rates prevailing at the capital injection date.
The Renminbi is not freely convertible into foreign currencies. All foreign
exchange transactions involving Renminbi must take place either through the Bank
of China or other institutions authorized to buy and sell foreign currencies, or
at a swap center. Before January 1, 1994, the exchange rates used for
transactions through the Bank of China and other authorized institutions were
set by the government (the "official exchange rate") from time to time whereas
the exchange rates available at the swap centers (the 'swap center rates") were
determined largely by supply and demand. The Chinese government announced the
unification of the two-tier exchange rate systems in December 1993 effective
January 1, 1994. The unification brought the official exchange rate of the
Renminbi in line with the swap center rate. The unification did not have a major
impact on the consolidated financial statements of the Company under U.S. GAAP.
Sino-foreign equity joint venture enterprises can enter into exchange
transactions at swap centers. Payment for imported materials and remittance of
earnings outside of the PRC are subject to the availability of foreign currency
which is dependent on the foreign currency denominated earnings of the entity or
must be arranged through a swap center. Approval for exchange at the swap center
is granted to joint venture enterprises for valid reasons such as the purchase
of imported materials and remittance of earnings.
The official exchange rates, unified exchange rates and Shanghai swap center
rates as of December 31, 1993, December 31, 1994 and December 31, 1995 were as
follows:
December 31,
--------------------------------------------
1993 1994 1995
----------- ----------- -----------
Rmb equivalents of US$1
Official exchange rate 5.80 N/A N/A
Unified exchange rate N/A 8.44 8.32
Shanghai swap center rate 8.70 8.44 8.32
72
<PAGE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
- -------------------------------------------------------
i. Dedicated Capital
-----------------
In accordance with the relevant laws and regulations for Sino-foreign equity
joint venture enterprises, the Operating Subsidiary maintains discretionary
dedicated capital, which includes a general reserve fund, an enterprise
expansion fund and a staff welfare and incentive bonus fund. The Board of
Directors of the Operating Subsidiary will determine on an annual basis the
amount of the annual appropriations to dedicated capital. For the three months
ended December 31, 1993 and for the year ended December 31, 1994, the Operating
Subsidiary appropriated 5% of the after-tax profits as reflected in its
statutory financial statements to each of the above three funds. For the year
ended December 31, 1995, the Operating Subsidiary appropriated 5% of the
after-tax profits as reflected in its statutory financial statements to each of
the general reserve fund and the staff welfare and incentive bonus fund. Such
appropriations are reflected in the year end consolidated balance sheets under
shareholder's equity as dedicated capital; however, the appropriation for the
staff welfare and incentive bonus fund is charged to income before arriving at
net income and the unused portion is recorded as a current liability.
j. Long-term investment
--------------------
Long-term investment includes Chinese government bonds and unlisted investments
held for the long-term and are stated at cost less provision for permanent
diminution in value.
Income from investments is accounted for to the extent of dividends received and
receivable.
4. ACCOUNTS RECEIVABLE
- ------------------------
Accounts receivable consists of:
December 31,
--------------------------------------
1993 1994 1995
----------- ------------- ----------
Rmb Rmb Rmb
Trade and other receivables 11,449 15,813 18,009
Less: Allowance for doubtful accounts (225) (2,032) (2,032)
----------- ------------- ----------
Accounts receivable, net 11,224 13,781 15,977
============ ============ ==========
Wuxi CSI had a trade receivable with one of its customers, which accounted for
approximately Nil%, 12% and 11% of the accounts receivable as of December 31,
1993, 1994 and 1995 respectively. Sales to two major customers under the
ownership of the same ultimate holding company accounted for approximately 45%,
70% and 85% of the total sales for the three months ended December 31, 1993 and
the years ended December 31, 1994 and 1995 respectively. Sales to the third
largest customer accounted for approximately 4%, 11 % and 10% for the respective
period/years mentioned above.
73
<PAGE>
5. INVENTORIES
- ---------------
December 31,
------------------------------------------
1993 1994 1995
---------- ---------- ----------
Rmb Rmb Rmb
Raw materials 7,834 5,504 5.866
Work-in-progress 2,221 2,432 2,636
Finished goods 5,865 6,865 7,867
Less: Provision for obsolescence - - -
---------- ---------- ----------
15,920 14,801 16,369
========== ========== ==========
6. PROPERTY, PLANT AND EQUIPMENT
- -----------------------------------
December 31,
------------------------------------------
1993 1994 1995
---------- ---------- ----------
Rmb Rmb Rmb
Plant and office buildings 12,775 15,516 20,021
Machinery and equipment 21,965 25,154 38,550
Motor vehicles 1,559 2,641 2,773
Furniture, fixtures and office
equipment 611 2,157 2,847
Construction-in-progress 15,561 11,740 8,375
Less: Accumulated depreciation (434) (2,587) (5,344)
---------- ---------- ---------
Net book value 52,037 54,621 67,222
========== ========== ==========
7. LONG-TERM INVESTMENT
- --------------------------
Long-term investment comprised:
December 31,
-----------------------------------------------
1993 1994 1995
---------- ---------- ----------
Rmb Rmb Rmb
Unlisted investments, at cost 2,088 2,088 2,088
Government debentures 455 260 190
---------- ----------- -----------
2,543 2,348 2,278
========== =========== ===========
74
<PAGE>
7. LONG-TERM INVESTMENT Cont'd
- -------------------------------
The directors are of the opinion that the underlying values of the investments
were not less than their carrying values as of December 31, 1993, 1994 and 1995
respectively.
There was no dividend income received or receivable from these long-term
investments for the three months ended December 31, 1993. Dividend income
received for the years ended December 31,1994 and 1995 amounted to Rmb427 and
Rmb452 respectively.
8. SHORT-TERM BANK LOANS
- ---------------------------
Short-term bank loans were unsecured and were denominated in Renminbi with
repayment terms ranging from three months to one year.
Supplemental information with respect to short-term bank loans for the year
ended December 31, 1995 were as follows:
Maximum amount outstanding during the year: Rmb 4,950
Average amount outstanding during the year: Rmb 3,825
Weighted average interest rate at the end of the year: 11.07% per annum
Weighted average interest rate during the year: 10.67% per annum
9. LONG-TERM BANK LOANS
- ------------------------
Long-term bank loans, all of which were unsecured, bear average interest rates
at approximately 13% (December 31, 1994 - 9.7% and December 31, 1993 - 7.5 %)
and are repayable as follows:
December 31,
1995
--------------
Rmb
1996 15,900
1997 15,490
-------------
Total 31,390
=============
All the long-term bank loans are denominated in Renminbi.
75
<PAGE>
10. OBLIGATIONS AND COMMITMENTS
- --------------------------------
As of December 31, 1995, the Company had outstanding capital commitments for
purchases of machinery and equipment of approximately Rmb10,776. As of December
31, 1995, the Operating Subsidiary had also entered into a joint venture
agreement with a German company for the formation of a joint venture company in
Wuxi City, Jiangsu Province in the PRC. Total capital commitments as of March
25, 1996 (date of formation of the joint venture company) amounted to US$1,960
(see Note 17.a).
11. DISTRIBUTION OF PROFIT
- ----------------------------
Dividends from the Operating Subsidiary will be declared based on the profits as
reported in the statutory financial statements. Such profits will be different
from the amounts reported under U.S. GAAP. As of December 31, 1995, the
Operating Subsidiary had distributed all available retained earnings of
Rmb29,718 as reported in its statutory financial statements.
12. RELATED PARTY TRANSACTIONS AND ARRANGEMENTS
- -------------------------------------------------
a. Guarantee of related party loan
-------------------------------
During the year ended December 31, 1995, the Operating Subsidiary extended a
corporate guarantee to a related company of CSH for bank borrowings of Rmb800.
b. Land use right
--------------
The Wuxi City government has granted its approval to Wuxi Vibration Isolator
Factory ("Wuxi Factory"), the Chinese joint venture partner of Wuxi CSl, to use
the parcel of land on which Wuxi CSI's main factory is located. Under the terms
of the joint venture agreement and a subsequent confirmation from Wuxi Factory,
it has agreed to provide for the use of the land by Wuxi CSI for the 50 year
term of the joint venture. Wuxi Factory does not currently charge Wuxi CSI for
the use of the land. Under current PRC regulations, where land use rights are
granted to a Sino-foreign equity joint venture, the joint venture would pay no
land use fees during an initial five-year period and a 50% reduction for the
next five-year period. The annual land use fee has been estimated by management
to be approximately Rmb600. Should Wuxi CSI wish to obtain title to the land use
rights, a premium may be levied by the relevant government authorities for the
transfer.
76
<PAGE>
13. DUE TO CHINESE JOINT VENTURE PARTNER
- ------------------------------------------
The amounts due to Chinese joint venture partner represent the excess of the
book value of the net assets contributed by the Chinese joint venture partner
upon the formation of the Operating Subsidiary over its share of the registered
capital of the joint venture enterprise.
The balance as of December 31, 1995 included dividends payable to the Chinese
joint venture partner of Rmb13,373 which represented its share of the
distribution of the profit after appropriations to dedicated capital for the
year ended December 31, 1995 as reflected in the statutory financial statements
of the Operating Subsidiary.
These amounts are unsecured, non-interest bearing and have no fixed repayment
date.
14. RETIREMENT PLANS
- ----------------------
As stipulated by the regulations of the Chinese government, all of the Chinese
staff of the Operating Subsidiary are entitled to an annual pension on
retirement, which is equal to their basic salaries at their retirement dates.
The Chinese government is responsible for the pension liability to these retired
staff. The Operating Subsidiary is only required to make specified contributions
to the state-sponsored retirement plan calculated at 23.5% (for 1993) and 25.5%
(for 1994 and 1995) of the basic salary of the staff. The expenses reported in
the consolidated financial statements related to these arrangements were Rmb379
for the three months ended December 31,1993, and Rmb2,125 and Rmb2,222 for the
years ended December 31, 1994 and 1995 respectively.
77
<PAGE>
15. SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION
- -------------------------------------------------------
Three months
ended
December 31, Year ended December 31,
---------------- ---------------------------
1993 1994 1995
---------------- ------------ ------------
Rmb Rmb Rmb
Cash paid for:
Interest expense (net of amount
capitalized) 1,375 2,166 2,696
Income taxes 77 - -
Non-cash investing and financing
activities:
Paid-in capital from the Chinese
joint venture partner through the
injection of the net book value of
the fixed assets of the predecessor
plant 31,320 - -
16. OTHER SUPPLEMENTAL INFORMATION
- -----------------------------------
The following items are included in the consolidated statements of income:
Three months
ended
December 31, Year ended December 31,
----------------- ---------------------------
1993 1994 1995
--------------- ------------ ------------
Rmb Rmb Rmb
Foreign exchange gain 11 191 476
Interest income 216 2,096 4,009
Sales taxes 850 - -
Provision for doubtful accounts 225 1,807 -
17. SUBSEQUENT EVENTS
- ----------------------
a. Pursuant to a joint venture agreement signed in December 1995 by the
Operating Subsidiary with Vulkan Kupplungs - U Getriebebau B. Hackforth GMBH &
Co. KG, a Germany incorporated company, the Operating Subsidiary formed a new
Sino-foreign joint venture enterprise established in the City of Wuxi, Jiangsu
Province in the PRC. Details of the provisions in the joint venture agreement
are as follows:
78
<PAGE>
17. SUBSEQUENT EVENTS (Cont'd)
- ------------------------------
<TABLE>
<CAPTION>
Percentage of
Name of joint interest held Date of Total Registered Principal
venture company by Wuxi CSI formation investment capital activities
- --------------- ------------- ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
Wuxi Vulkan 49% March 25,1996 US$ $8,000 US $4,000 Production of
Couplings Co., Couplings
Ltd. ("WVCC")
</TABLE>
WVCC will have a duration of fifty years.
b. Pursuant to an acquisition agreement dated February 8, 1996 between Regal
International Inc., ("Regal"), a Delaware Corporation whose shares are listed on
the National Association of Securities Dealers Automated Quotations ("NASDAQ"),
Acewin Profits Limited ("the Company") and China Strategic Holdings Limited
("CSH"), Regal acquired all the issued and outstanding shares of the Company at
a consideration of US$13.5 million to be satisfied through the issuance of a
US$13.5 million Convertible Note (the "Convertible Note") by Regal to CSH
bearing interest at 9% per annum after an initial 6-month interest-free period.
The principal and any unpaid interest owing on the Convertible Note can be
convertible into shares of the Common Stock, US$0.01 par value, of Regal
("Common Stock") at a conversion price of US$0.0302 per share. The Convertible
Note, if exercised by CSH would give CSH a controlling interest of more than 80%
in Regal. This Convertible Note is secured by a pledge of Regal's interest in
the shares of the Company in favour of CSH.
Pursuant to the acquisition agreement, the principal amount of the Convertible
Note will be reduced by a pre-determined formula if the audited financial
statements of Wuxi CSI for the year ended December 31, 1995 reflect an after tax
profit of less than US$3 million.
c. Pursuant to an agreement signed between CSH and the Company dated January 19,
1996, the payable balance of Rmb36,550 due to CSH as of December 31, 1995 will
be contributed by CSH into the Company as additional paid-in capital and shall
only be payable upon liquidation of the Company.
79
<PAGE>
FINANCIAL STATEMENTS OF ACEWIN PROFITS LIMITED
----------------------------------------------
PART II
-------
80
<PAGE>
ARTHUR
ANDERSEN
ARTHUR ANDERSEN & CO., SC
Arthur Andersen & Co.
Certified Public Accountants
----------------------------
25/F., Wing On Centre
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS 111 Connaught Road Central
Hong Kong
To Acewin Profits Limited:
We have audited the accompanying statements of income, cash flows and changes in
equity of Wuxi CSI Vibration Isolator Co., Ltd. ("Wuxi CSI"), incorporated in
the People's Republic of China, for the nine months ended September 30, 1993,
expressed in Chinese Renminbi. The financial statements are the responsibility
of the Wuxi CSI's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the results of its operations and cash flows of Wuxi CSI
for the nine months ended September 30, 1993, in conformity with generally
accepted accounting principles in the United States of America.
/s/ Arthur Andersen & Co.
Hong Kong,
April 5, 1996.
81
<PAGE>
WUXI CSI VIBRATION ISOLATOR CO., LTD
------------------------------------
STATEMENT OF INCOME
--------------------
FOR THE NINE MONTHS ENDED SEPTEMBER 30,1993
-------------------------------------------
(THE "1993 PRE-JOINT VENTURE PERIOD")
-------------------------------------
(Amounts in thousands)
1993 Pre-joint
Venture
Period
----------------
Rmb
Sales 42,817
---------------
Cost of goods sold (26,713)
Selling and administrative expenses (8,046)
Interest expense, net (681)
Other expense, net (418)
---------------
Total costs and expenses (35,858)
---------------
Income before income taxes 6,959
Provision for income taxes (850)
--------------
Net income 6,109
==============
The accompanying notes are an integral part of this statement of income.
82
<PAGE>
WUXI CSI VIBRATION ISOLATOR CO., LTD
-------------------------------------
STATEMENT OF CASH FLOWS
-----------------------
FOR THE NINE MONTHS ENDED SEPTEMBER 30,1993
--------------------------------------------
(THE "1993" PRE-JOINT VENTURE PERIOD")
--------------------------------------
(Amounts in thousands)
1993 Pre-joint
Venture
Period
----------------
Rmb
Cash flows from operating activities:
Net income 6,109
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 1,617
Allowance for doubtful accounts 214
Loss on disposal of fixed assets 239
Increase in assets:
Accounts receivable (2,976)
Inventories (2,823)
Prepayments and other current assets (2,882)
Increase (decrease) in liabilities:
Accounts payable 480
Accrued expenses and other payables (7,693)
Taxes other than income 229
---------------
Net cash used in operating activities (7,486)
---------------
Cash flows from investing activities:
Acquisition of property, plant and equipment (1,887)
Investments in investee companies (1,005)
Redemption of government debentures 110
--------------
Net cash used in investing activities (2,782)
--------------
Cash flows from financing activities:
Net proceeds from short-term bank loans 55
Proceeds from long-term bank loans 12,985
Repayment of long-term bank loans (7,019)
Contribution from Chinese partner, net 1,474
---------------
Net cash provided by financing activities 7,495
---------------
Net increase in cash and cash equivalents (2,773)
Cash and cash equivalents, at beginning of period 5,280
--------------
Cash and cash equivalents, at end of period 2,507
=============
The accompanying notes are an integral part of this statement of cash flows.
83
<PAGE>
WUXI CSI VIBRATION ISOLATOR CO., LTD
------------------------------------
STATEMENT OF CHANGES IN EQUITY
------------------------------
FOR THE NINE MONTHS ENDED SEPTEMBER 30,1993
-------------------------------------------
(THE "1993" PRE-JOINT VENTURE PERIOD")
--------------------------------------
(Amounts in thousands)
Dedicated Retained
Capital Earnings Total
------------ ------------ -----------
Rmb Rmb Rmb
Balance at December 31, 1992 22,678 925 23,603
Net income - 6,109 6,109
Transfer to dedicated capital 8,101 (8,101) -
Contribution from former
Chinese partner - 1,474 1,474
------------ ----------- -----------
Balance at end of 1993 Pre-
Joint Venture Period 30,779 407 31,186
============ ============ ===========
The accompanying notes are an integral part of this statement of changes in
equity.
84
<PAGE>
WUXI CSI VIBRATION ISOLATOR CO., LTD
------------------------------------
NOTES TO FINANCIAL STATEMENTS
------------------------------
(Amounts expressed in thousands unless otherwise stated)
1. ORGANIZATION AND PRINCIPAL ACTIVITIES
- -----------------------------------------
Wuxi CSI Vibration Isolator Co., Ltd. (hereinafter, together with its
Predecessor, referred to as the "Operating Subsidiary") was incorporated in the
People's Republic of China (the 'PRC") as a Sino-foreign equity joint venture
enterprise on September 10, 1993 under "The Law of China on joint Ventures using
Chinese and Foreign Investment". Prior to its incorporation as a Sino-foreign
equity joint venture enterprise, the Operating Subsidiary was owned by the
municipal government of Wuxi City. The ultimate holding company of Wuxi CSI is
currently China Strategic Holdings Limited ('CSH"), a Hong Kong corporation. The
cash consideration paid by CSH for the acquisition of its interests in Wuxi CSI
was US$4,400. The Operating Subsidiary was initially formed between China
Machinery Holdings Limited ("China Machinery"), a company incorporated in Hong
Kong and a wholly -owned subsidiary of CSH. Pursuant to a shareholder's
resolution dated December 13, 1995 and approved by the relevant PRC authorities,
China Machinery's interest in Wuxi CSI was transferred to China Machine
(Holdings) Limited ("CMHL"). Details of the equity capital of the Operating
Subsidiary as of December 31, 1995 are as follows:
Wuxi CSI Vibration Isolator Co., Ltd.
- -------------------------------------
Contribution
to Registered Ownership
Capital Percentage
------------- ------------
Rmb
CMHL 44,937 55%
Wuxi Vibration Isolator Factory 36,766 45%
------------- ------------
81,703 100%
============= ============
Key provisions of the joint venture agreement of Wuxi CSI include:
the joint venture period is 50 years from the date of formation;
the profit and loss sharing ratio is the same as the percentage of equity
interest, and
the Board of Directors consists of 7 members: 4 designated by CMHL and 3
designated by Wuxi Vibration Isolator Factory, the Chinese joint venture partner
of Wuxi CSI.
85
<PAGE>
2. BASIS OF PRESENTATION
- -------------------------
The accompanying financial statements present the results of operations and cash
flows of the business of the Predecessor for the nine-month period ended
September 30, 1993 prior to its incorporation as a Sino-foreign equity joint
venture enterprise and the acquisition by China Machinery (the "1993 Pre-joint
Venture Period").
The accompanying financial statements are prepared in accordance with generally
accepted accounting principles in the United States of America ("U.S. GAAP").
This basis of accounting differs from that used in the statutory accounts of the
Predecessor, which were prepared in accordance with the accounting principles
and the relevant financial regulations applicable to state-owned enterprises as
established by the Ministry of Finance of China ("PRC GAAP").
The principal adjustments made to conform the statutory accounts of the
Predecessor to U.S. GAAP included the following:
Addition of an allowance for doubtful accounts receivable;
Addition of a provision to reduce the carrying value of inventories to
net realizable value;
Reclassification of certain items, designated as "reserves appropriated
from net income", as a charge to income;
Restatement of monetary assets and liabilities denominated in foreign
currency to reflect the exchange rates prevailing at the balance sheet dates;
and
Adjustment to recognize sales and cost of sales upon delivery and acceptance
of goods by customers.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ------------------------------------------------
a. Sales
-----
Sales represent the invoiced value of goods, net of sales taxes, supplied to
unrelated customers. Sales are recognized upon delivery and acceptance of goods
by the customers.
b. Taxation
--------
The Predecessor, being a state-owned enterprise, was subject to Chinese income
taxes in accordance with tax regulations applicable to state-owned enterprises.
During the 1993 pre-joint venture period, the Predecessor, with the approval of
the local Tax Bureau, was liable to pay tax at a fixed amount of Rmb850.
86
<PAGE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
- -------------------------------------------------------
b. Taxation (cont'd)
-----------------
The Predecessor was subject to value added tax applicable to state-owned
enterprises during the 1993 pre-joint venture period at a rate of 14% of the
invoiced value of goods sold.
The Company provides for deferred income taxes using the liability method, by
which deferred income taxes are recognized for an significant temporary
differences between the tax and financial statement bases of assets and
liabilities. The tax consequences of those differences are classified as current
or non-current based upon the classification of the related assets or
liabilities in the financial statements.
C. Foreign Currency Translation
----------------------------
The Operating Subsidiary maintains its books and records in Renminbi. Foreign
currency transactions are translated into Renminbi at the applicable unified
rates of exchange or the applicable rates of exchange quoted by the applicable
foreign exchange adjustment center ("swap center"), prevailing at the dates of
the transactions. Monetary assets and liabilities denominated in foreign
currencies are translated into Renminbi using the applicable unified rates of
exchange or the applicable swap center rates prevailing at the balance sheet
date. The resulting exchange differences are included in the determination of
income.
4. FOREIGN CURRENCY EXCHANGE
- -----------------------------
The Renminbi is not freely convertible into foreign currencies. All foreign
exchange transactions involving Renminbi must take place either through the Bank
of China or other institutions authorized to buy and sell foreign exchange or at
a swap center. The exchange rates used for transactions through the Bank of
China and other authorized banks are set by the Chinese government from time to
time whereas the exchange rates available at a swap center are determined
largely by supply and demand. Sino-foreign equity joint venture enterprises can
enter into exchange transactions at swap centers. As a state-owned enterprise,
the Predecessor did not have access to swap centers. Payment for imported
materials and remittance of earnings outside of China are subject to the
availability of foreign currency which is dependent on the foreign currency
denominated earnings of the entity or must be arranged through a swap center.
Approval for exchange at the swap center is granted to joint venture enterprises
for valid reasons such as purchase of imported materials and remittance of
earnings.
The official exchange rates and Shanghai swap center rates as of September 30,
1993 were as follows:
1993
---------
Rmb equivalent of US$1
- - Official exchange rate 5.8
- - Shanghai swap center rate 8.7
87
<PAGE>
5. RETIREMENT PLAN
- --------------------
All of the Company's Chinese staff are entitled to an annual pension equal to
their ending basic salaries at their retirement dates. The Chinese government is
responsible for the pension liability to these retired staff.
The Operating Subsidiary is only required to make specified contributions to
the state sponsored retirement plan. The expense reported in the financial
statements related to these arrangements was Rmbl,108 in the 1993 Pre-joint
Venture Period.
6. SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION
- ------------------------------------------------------
During the period, the Operating Subsidiary contributed cash and certain assets
into three investee companies ("the investee companies") in consideration of
non-controlling interests in each of the investee companies. Details of the
contributions made by the Operating Subsidiary were as follows:
1993 Pre-joint
Venture
Period
----------------
Rmb
Cash 1,005
Inventories 593
Fixed assets - at cost 239
- valuation surplus 151
Goodwill 100
----------------
Total 2,088
================
7. OTHER SUPPLEMENTAL INFORMATION
- ----------------------------------
The following items are included in the statement of income:
1993 Pre-Joint
Venture
Period
---------------
Rmb
Interest income 15
Sales taxes (VAT) 3,507
88
<PAGE>
REGAL INTERNATIONAL, INC.
=========================
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
-----------------------------------------------------
AS OF DECEMBER 31 1995
-----------------------
89
<PAGE>
INTRODUCTION TO UNAUDITED PRO FORMA
-----------------------------------
CONSOLIDATED FINANCIAL STATEMENTS
---------------------------------
OF REGAL INTERNATIONAL, INC. AND SUBSIDIARIES
---------------------------------------------
The unaudited pro forma consolidated financial statements as of and for the year
ended December 31, 1995 have been prepared to give effect to:
(i) the acquisition by Regal International, Inc. ('Regal") of China Strategic
Holdings Limited's ("CSH") entire interests in Acewin Profits Limited and its
subsidiaries, pursuant to an Acquisition Agreement dated February 8, 1996; and
(ii) the sale and transfer of certain operating assets and real property by
Regal to Regal (New) International, Inc. ("New Regal"), pursuant to an Asset
Purchase Agreement dated February 8, 1996.
The unaudited pro forma consolidated financial statements are based upon the
historical consolidated financial statements of Regal International, Inc. as of
December 31, 1995 after giving effect to the pro forma adjustments described in
the notes thereto as if the acquisition of Acewin Profits Limited and its
subsidiaries by Regal as described in (i) above and sale and transfer of assets
to New Regal by Regal as described by (ii) above had occurred on January 1,
1995.
The unaudited pro forma consolidated financial statements do not purport to
represent what the financial positions and results of operations of Regal would
actually have been if the events described above had in fact occurred on January
1, 1995, or to project the financial positions and results of operations of
Regal for any future date or period.
The unaudited pro forma consolidated financial statements should be read in
conjunction with the consolidated financial statements of Regal International,
Inc. and of Acewin Profits Limited and its subsidiaries, including the notes
thereto.
90
<PAGE>
REGAL INTERNATIONAL, INC. AND SUBSIDIARIES
------------------------------------------
<TABLE>
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF INCOME
----------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,1995
------------------------------------
(Amounts expressed in United States dollars)
<CAPTION>
Historical As adjusted Historical
---------- ----------- ----------
Notes to Pro forma
unaudited consolidated
pro forma statement of
Regal Regal Acewin Profits consolidated income of Regal
International, International, Limited and financial Pro forma International,
Inc. Inc. Subsidiaries statements adjustments Inc.
-------------- -------------- -------------- ------------- ------------ --------------
$'000 $'000 $'000 $'000 $'000
(Note 1) (Note 2)
<S> <C> <C> <C> <C>
Sales 7,591 - 12,967 12,967
-------------- -------------- -------------- ------------- ------------ --------------
Cost of goods
sold 5,022 - 7,749 7,749
Selling and
administrative
expenses 2,660 - 1,871 1,871
Interest expenses
(income), net 328 - (195) (195)
Other income, net (447) - (77) (77)
-------------- -------------- -------------- ------------- ------------ -------------
Total costs and
expenses 7,563 - 9,348 9,348
-------------- -------------- -------------- ------------- ------------ -------------
Income from
continuing
operations before
income tax 28 - 3,619 3,619
Provision for income
tax - - - -
-------------- -------------- -------------- ------------- ------------ ------------
Income from
continuing
operations 28 - 3,619 3,619
Income from
discontinued
operations - 28 - 28
-------------- -------------- -------------- ------------- ------------ -------------
Income before
minority
interests 28 28 3,619 3,647
Minority
interests - - (1,601) (1,601)
-------------- -------------- -------------- ------------- ------------- -------------
Net income 28 2 2,018 2,046
============== ============== ============== ============= ============= =============
</TABLE>
The accompanying notes are an integral part of this
unaudited pro forma consolidated statement of income.
91
<PAGE>
REGAL INTERNATIONAL, INC. AND SUBSIDIARIES
------------------------------------------
<TABLE>
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
----------------------------------------------
AS OF DECEMBER 31,1995
-----------------------
(Amounts expressed in United States dollars)
<CAPTION>
Historical As adjusted Historical
---------- ----------- ----------
Notes to Pro forma
unaudited consolidated
pro forma statement of
Regal Regal Acewin Profits consolidated income of Regal
International, International, Limited and financial Pro forma International,
Inc. Inc. Subsidiaries statements adjustments Inc.
-------------- -------------- -------------- ------------- ------------ --------------
$'000 $'000 $'000 $'000 $'000
(Note 1) (Note 2) (Note 3)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
- -------
Current assets
Cash and cash
equivalents 11 800 6,026 6,826
Restricted cash 19 - - -
Note - 149 - 149
Accounts receivable,
net 1,583 - 1,913 1,913
Inventories 2,460 - 1,960 1,960
Prepayments and
other current
assets 219 - 1,345 1,345
Due from related
companies - - 499 499
-------------- -------------- -------------- ------------- ------------ --------------
Total current
assets 4,292 949 11,743 12,692
-------------- -------------- -------------- ------------- ------------ --------------
Property,
plant and
equipment net 1,836 - 8.050 8,050
Long-term
investment 16 13,500 273 (c) (13,500) 273
Note receivable - 1,551 - 1,551
Intangibles - - 120 120
-------------- -------------- -------------- ------------- ------------ --------------
Total assets 6,144 16,000 20,186 22,686
============== ============== ============== ============= ============ =============
LIABILITES AND
SHAREHOLDERS'
EQUITY
- ---------------
Current liabilities
Short-term bank
loans - - 413 413
Long-term loans -
current portion 865 - 1,904 1,904
Accounts
payable 752 - 1,053 1,053
Accrued expenses
and other
payables 595 - 1,296 1,296
Taxes other than
income - - 86 86
Due to related
companies - - 326 326
-------------- -------------- -------------- ------------- ------------ --------------
Total current
liabilities 2,212 - 5,078 5,078
-------------- -------------- -------------- ------------- ------------ --------------
</TABLE>
92
<PAGE>
REGAL INTERNATIONAL, INC. AND SUBSIDIARIES
------------------------------------------
<TABLE>
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
----------------------------------------------
AS OF DECEMBER 31,1995
----------------------
(Amounts expressed in United States dollars)
<CAPTION>
Historical As adjusted Historical
---------- ----------- ----------
Notes to Pro forma
unaudited consolidated
pro forma statement of
Regal Regal Acewin Profits consolidated income of Regal
International, International, Limited and financial Pro forma International,
Inc. Inc. Subsidiaries statements adjustments Inc.
-------------- -------------- -------------- ------------- ------------ --------------
$'000 $'000 $'000 $'000 $'000
(Note 1) (Note 2) (Note 3)
<S> <C> <C> <C> <C> <C> <C>
Convertible Note
payable - 13,500 (b) (13,500) -
Long-term loans 475 - 1,855 1,855
Loans from related
parties 819 - - -
Due to Chinese joint
venture partner - - 1,604 1,604
Due to China
Strategic Holdings
Limited - - 4,377 (a) (4,377) -
Minority interests - - 4,363 4,363
Shareholders' equity:
Common stock 818 818 1 (b) 4,470 5,288
(c) (1)
Additional paid-in
capital 20,307 20,169 - (b) 9,030 20,077
(a) 4,377
(c) (13,499)
Dedicated Capital - - 202 202
(Accumulated
deficits)
Retained
earnings (18,487) (18,487) 2,695 (15,792)
Cumulative
translation
adjustments - - 11 11
-------------- -------------- -------------- ------------- ------------ --------------
Total shareholders'
equity 2,638 2,500 2,909 9,786
-------------- -------------- -------------- ------------- ------------ --------------
Total liabilities and'
shareholders'
equity
6,144 16,000 20,186 22,686
============== ============== ============== ============= ============ =============
</TABLE>
The accompanying, notes are an integral part of this unaudited consolidated
balance sheet.
93
<PAGE>
REGAL INTERNATIONAL, INC. AND SUBSIDIARIES
------------------------------------------
NOTES TO UNAUDITED PRO FORMA
----------------------------
CONSOLIDATED FINANCIAL STATEMENTS
---------------------------------
1. ADJUSTMENTS TO REGAL INTERNATIONAL, INC.'S HISTORICAL
FINANCIAL STATEMENTS
------------------------------------------------------
Pursuant to an Acquisition Agreement dated February 8, 1996 between Regal
International, Inc. ("Regal'), Acewin Profits Limited ("AP"), a British Virgin
Islands corporation and China Strategic Holdings Limited ("CSH"), a Hong Kong
company, Regal acquired all the issued and outstanding shares of AP at a
consideration of US$13.5 million to be satisfied through the issuance of a
US$13.5 million Convertible Note (the "Convertible Note") by Regal to CSH
bearing interest at 9% per annum after an initial 6-month interest-free period.
The principal and any unpaid interest owing on the Convertible Note can be
convertible into shares of the Common Stock, US$0.01 par value, of Regal
("Common Stock") at a conversion price of US$0.0302 per share. Acewin's sole
asset is a 55% joint venture interest in Wuxi CSI Vibration Isolator Co. Ltd., a
Sino-foreign equity joint venture incorporated in the People's Republic of
China, held through an intermediate Hong Kong company, China Machine (Holdings)
Limited.
Pursuant to another Asset Purchase Agreement ("the agreement") dated February 8,
1996 between Regal International, Inc. ("Regal") and Regal (New) International,
Inc. ("New Regal"), Regal sold and transferred the existing operating assets and
real property of Regal to New Regal in exchange for US$2.5 million and New
Regal's assumption of all liabilities of Regal, other than the Convertible Note.
Pursuant to the agreement, the US$2.5 million portion of the purchase price was
paid as follows: US$800,000 in cash and the balance by delivery of two
promissory notes, one in the principal amount of US$900,000 (the "US$900,000
Note") and the second in the principal amount of US$800,000 (the "US$800,000
Note"). The US$900,000 Note bears interest at 9% per annum and is payable in
sixty equal monthly installments of principal and interest. The US$800,000 Note
bears no interest and is due and payable in one installment on January 31, 2001.
Adjustments have been made to reflect the financial positions of Regal as if the
net operating assets had been sold and transferred to New Regal as of December
31, 1995 and the acquisition of the interests in AP had occurred as of January
1, 1995. Income from continuing operations of Regal for the year ended December
31, 1995 had been reclassified as "Income from discontinued operations" as a
result of the disposal of the net operating assets to New Regal.
The transfer of CSH's equity interest i AP to Regal has been accounted for as a
pooling- of interests in the accompanying unaudited pro forma consolidated
financial statements as the transfer is considered a transfer of assets between
entities under common control.
94
<PAGE>
2. FOREIGN CURRENCY TRANSLATION TO REPORTING CURRENCY
--------------------------------------------------
The financial statements of Acewin Profits Limited and its subsidiaries are
translated into United States dollars using the closing rate method, whereby the
balance sheet items are translated into United States dollars using the exchange
rate prevailing at year end. Profit and loss items are translated at the average
rate. for the year. The cumulative translation adjustment arising therefrom is
shown as a separate component of shareholders' equity.
3. DESCRIPTION OF PRO FORMA ADJUSTMENTS
------------------------------------
(a) To reflect the contribution by CSH to additional paid-in capital of AP,
originally recorded as a payable to CSH, pursuant to an agreement signed between
CSH and AP dated January 19, 1996.
(b) To adjust the share capital and additional paid-in capital as if the
Convertible Note of Regal had been exercised by CSH as of December 31, 1995.
(c) To eliminate the investment in AP on consolidation. The difference between
CSH's historical cost of investment in AP and the acquisition cost to Regal has
been treated as reduction of additional paid-in capital as the transfer is
considered a transfer of assets between entities under common control.
4. INCOME TAXES
------------
No provision for United States federal income taxes or tax benefits on the
undistributed earnings and/or losses of the PRC Operating Subsidiary has been
provided as the earnings have been reinvested and, in the opinion of management
will continue to be reinvested indefinitely.
95
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURES
The Board of Directors of the Registrant has elected to change its
independent accountants from Pannell Kerr Forster of Texas P.C. ("Pannell Kerr")
to Arthur Anderson & Co. The decision resulted from the fact that after February
19, 1996 the Registrant's sole operating subsidiary is located in China, where
Arthur Anderson has greater resources in the Registrant's areas of operation,
and a prior, ongoing business relationship with the Registrant. Although
Pannell Kerr's report on the Registrant's audited financial statements
for the fiscal year ended December 31, 1994 and 1995 contained a "going concern"
qualification, the change in independent accountants is not related to such
qualification or to any disagreement with Pannell Kerr.
During the prior two fiscal years of the Registrant and any subsequent
interim period preceding the change of the Registrant's accountants, there were
no disagreements with Pannell Kerr on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure.
PART III.
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Listed below are the names, ages and positions as of August 31, 1996 of the
executive officers and directors of the Company. The Company's executive
officers are appointed by the Board of Directors to serve in their respective
capacities until their successors are duly appointed by the Directors and
qualified to serve. The Certificate of Incorporation of the Company provides for
classification of the Board of Directors into three classes (Class I, Class II
and Class III) having staggered terms of three years each. The Board of
Directors of the Company shall consist of not less than five nor more than
twelve members as determined by resolution of the Board or by the Stockholders
at any annual meeting. At present, the Company's Board of Directors consist of
five directors who serve during the term of their class, or until their class is
assigned, and until their successor is appointed:
Name Age Position and office
- ---- --- -------------------
Oei Hong Leong (2) 48 Chairman of the Board of Directors
Richard N. Gray (1) 50 Director
Martin Furner (1) 43 Director
Chung Cho Yee Mico (2) 35 Director
Ma Wai Man (Catherine) (2) 30 Director and Secretary
- ---------------------------
(1) No Class Assigned. The Directors were chosen to fill a newly created
directorship and shall hold office until the next annual election and until his
successor is duly qualified and elected.
(2) No Class Assigned. The Directors were chosen to fill vacancies and shall
hold office until the next annual election and until his successor is duly
qualified and elected.
96
<PAGE>
Oei Hong Leong, Chairman of the Board of Directors, 48. Mr. Oei was elected
to Regal's Board of Directors in February 1996 and as Chairman of the Board of
Directors in June, 1996. Mr. Oei is the founder and Chairman of the Board of
China Strategic Holdings Limited ("CSH"), having formed such company in 1991.
CSH is a holding company formed to invest in China in enterprises which can
benefit from improved production, financial assistance and marketing management.
CSH has acquired interests in many industries, including the manufacturer of
beer, tires and paper. Mr. Oei is the Chairman of China Tire Holdings Limited
("CTHL"), a subsidiary of CSH listed on the New York Stock Exchange and he is
also the Chairman of MRI Holdings Limited ("MRI") and Bolton Group
(International) Limited ("Bolton"), associate companies listed on the Australia
Exchange and the London Stock Exchange respectively.
Richard Gray, Director, 50. Mr. Gray, a Trustee of GHL (Senior) Pension
Fund that has as its wholly owned subsidiary Harlequin Investment Holdings
Limited, a British Virgin Islands company, was elected to the Board of
Directors on September 24, 1993, succeeding Girish Sharma. Mr. Gray is a
practicing Chartered Accountant and Business Consultant who has substantial
experience in establishing new businesses, particularly international
trading companies.
Martin Furner, Director, 43. Mr. Furner was elected to Regal's Board of
Directors on February 1, 1995. Mr. Furner is the Chairman of the Board of
Tapestry Holidays, a specialist tour operator in the UK. Mr. Furner is
member of the Association of Certified Management Accountants and the
Institute of Travel and Tourism, and holds a Wine & Spirits Education Trust
Higher Certificate.
Chung Cho Yee, Mico, Director, 35. Mr. Chung is a solicitor by profession
and has extensive experience in corporate finance. Mr. Chung graduated from
London University and previously worked for a law firm and an investment
bank. Mr. Chung sits on the board of CSH and several other companies listed
on foreign exchanges, including CSH, CTHL, MRI and Bolton.
Ma Wai Man, Catherine, Director and Secretary, 30. Ms. Ma is a chartered
secretary and has over 9 years of working experience in the company
secretarial profession. Ms. Ma is a Director of CSH and MRI. She is also the
Secretary of CTHL and Bolton.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth a summary of the compensation paid to the
Chief Executive Officer of the Company during the fiscal year ended December 31,
1995. No other officer of the Company received salary and bonus in excess of
$100,000 during such period. Janak N. Desai, the President and Chief Executive
Officer of the Registrant, resigned as an officer and director of the Company
effective February 19, 1996. The Board of Directors have not elected a person to
fill this position.
TABLE 10 SUMMARY OF COMPENSATION
Annual Long-Term Compensation
Compensation Award Stock Underlying
Name and Position Year Salary ($) Options
- ----------------- ---- ---------- -------
Janak N. Desai 1995 $108,000 -0-
President and Chief 1994 $107,000 -0-
Executive Officer 1993 $99,000 -0-
STOCK OPTIONS
- -------------
No Stock options or stock appreciation rights were granted to Janak N.
Desai.
DIRECTORS FEES
- --------------
During the fiscal year ended December 31, 1995, Directors were reimbursed for
travel and other expenses relating to Board and committee meetings. The Chairman
of the Board was paid $5,000 monthly. Other non-employee Directors received
$500, an additional $500 for serving on the Compensation Committee or Audit
Committee, and an additional $1,500 for serving on the Executive Committee, paid
on a monthly basis. The Board has not determined what, if any, fees will be paid
to Directors during fiscal 1996.
97
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
OWNERS AND MANAGEMENT
- ---------------------
a) The following sets forth the only persons known to the Company to be
beneficial owners as of August 15, 1996, of more than five percent (5%) of the
Company's Common Stock:
COMMON STOCK
Name and Address of Stockholders Number of Shares Owner Percentage of Class
- -------------------------------- ---------------------- -------------------
China Strategic Holdings Ltd. (1) 487,519,868 92.2% (2)
52/F Bank of China Tower
1 Garden Road, Hong Kong
Harlequin Investment Holdings
Ltd. (3) (4) 12,452,082 15.22%
Creque Building
Tortola, British Virgin Islands
- ------------------
(1) China Strategic Holdings Limited has sole voting and investment power with
respect to 447,019,868 shares issuable upon the conversion of a $13.5 million
Convertible Note and indirect voting and investment power of 40,500,000 shares
held by Horler Holdings Limited, P.O. Box 71, Craigmuer Chamber, Road Town,
Tortola, British Virgin Islands, a wholly owned subsidiary of China Strategic
Holdings Limited.
(2) Percent of Class is based upon 81,806,198 shares of Common Stock outstanding
at August 15, 1996 and 447,019,868 shares of Common Stock issuable upon
conversion of the $13.5 million Convertible Note.
(3) Harlequin Investment Holdings Limited has sole voting and investment power
with respect to the shares of Common Stock. Does not include 8 million shares of
Common Stock which can be acquired at any time upon exercise of a Stock Purchase
Option granted by China Strategic Holdings Limited to Harlequin. The percentage
of class is based on 81,806,198 shares of Common Stock outstanding at August 15,
1996.
(4) Harlequin Investment Holdings Limited is a wholly owned subsidiary of GHL
(Senior) Pension fund, Noble House, Queens Road, St. Peter Port, Guernsey,
Channel Islands. Richard N. Gray and Overseas Trust Company Limited are trustees
of GHL (Senior) Pension Fund and have the same address (as of August 31, 1996).
Mr. Gray and Overseas Trust Company Limited each disclaim beneficial
ownership of the shares of Common Stock.
98
<PAGE>
b) The following table sets forth information as of August 15, 1996 regarding
beneficial ownership of Common Stock of the Company by (I) each director of the
Company and (ii) all directors and officers as a group:
Number of Shares of
Common Stock Percentage
Name Beneficially Owned of Class
- ---- ------------------ --------
Richard N. Gray (B) 12,452,082 15.22%
Oei Hong Leong (A)(C) 487,519,868 91.2%
Chung Cho Yee Mico (A)(C) 487,519,868 91.2%
Ma Wai Man (A) 487,519,868 91.2%(D)
Martin Furner - *
All Directors and Officers
as a Group (5 persons) 499,971,950 94.54%
- ----------------------------
* Ownership of less than one percent (1%)
(A) Elected a director on February 19, 1996.
(B) See notes (3) and (4) above.
(C) See notes (1) and (2) above.
(D) Percent of Class for all officers and directors as a group is based upon
Common Stock which are owned or may be acquired by the group upon exercise of
option and conversion of $13.5 million Convertible Note.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ACQUISITION OF WUXI CSI
- -----------------------
On February 19, 1996, the Registrant acquired all the issued and outstanding
shares of Acewin Profits Limited, a British Virgin Islands corporation
("Acewin"), from China Strategic Holdings Limited, a Hong Kong company ("CSH").
Acewin's sole asset is a 55% joint venture interest in Wuxi CSI Vibration
Isolator Co., Ltd. ("Wuxi CSI"), a Sino-foreign joint venture. Regal paid $13.5
million for the shares of Acewin capital stock. Such purchase price was paid by
delivery of a $13.5 million Convertible Note bearing interest at the rate of
nine percent (9%) per annum (the "Convertible Note").
The Convertible Note is payable interest only on an annual basis, with all
principal being due and payable on January 31, 1999. The principal and any
unpaid interest owing on the Convertible Note are convertible into shares of
Regal Common Stock at a conversion price of $0.0302 per share. The purchase
price was approved by the Board of Directors of the Registrant based upon Wuxi
CSI having an after-tax profit of not less than $3.0 million so that the
purchase price paid by the Company for the Wuxi CSI interest would not exceed
eight (8) times Wuxi CSI's 1995 after-tax earrings. The Convertible Note is
secured by a Pledge Agreement granting CSH a security interest in the shares of
Acewin capital stock. In connection with the above-described transactions, Janak
Desai, Nils Ollquist and Garish Sharma resigned as directors of Regal, and Oei
Hong Leong, the Chairman of CSH, Chung Cho Yee Mico, and Ma Wai Man were elected
to fill the vacancies created by such resignations. As a result of this
transaction, CSH became a principal stockholder of the Company. Oei Hong Leong,
Chung Cho Yee Mico and Ma Wai Man are Chairman of the Board, Executive Director
and Company Secretary, respectively, of CSH.
99
<PAGE>
SALE OF ASSETS
- --------------
Immediately following the acquisition of the shares of Acewin capital stock
and as a condition thereto, the Registrant sold and transferred all its existing
operating assets and real property of the Registrant to a newly formed
corporation, Regal (New) International, Inc. ("New Regal") in exchange for $2.5
million and New Regal's assumption of all outstanding liabilities of the
Registrant, other than the Convertible Note. The $2.5 million portion of the
purchase price was paid as follows: $800,000 in cash and the balance by delivery
to the Registrant of two (2) promissory notes, one in the principal amount of
$900,000 (the "$900,000 Note") and the second in the principal amount of
$800,000 (the "$800,000 Note"). The $900,000 Note bears interest at 9% per annum
and is payable in sixty (60) equal monthly installments of principal and
interest. The $800,000 Note bears no interest and is due and payable in one
installment on January 31, 2001. New Regal's obligations under the $900,000 Note
and the $800,000 Note are secured by a pledge to the Registrant of all the
issued and outstanding shares of capital stock of New Regal.
Harlequin Investment Holdings, Inc., a principal stockholder of the Company
("Harlequin"), owns all the outstanding capital stock of New Regal. Harlequin is
a wholly owned subsidiary of GHL (Senior) Pension Fund. Mr. Gray, the Director
of the Board of the Company, is a trustee of GHL (Senior) Pension Fund (as of
August 31, 1996).
100
<PAGE>
SALE OF HARLEQUIN STOCK
- -----------------------
In April 1996, Horler Holdings Limited, a wholly owned subsidiary of CSH,
acquired 40,500,000 shares of outstanding Common Stock of the Company from
Harlequin in exchange for $1,223,000. The purchase price was paid as follows:
(I) $209,328 in cash, (ii) $211,672 by cancellation of a certain promissory
note, dated August 8, 1994, from Harlequin to CSH and (iii) $800,000 by
cancellation of another promissory note from Harlequin to CSH.
ACQUISITION OF HANGZHOU HUANTONG
- --------------------------------
On September 10, 1996, the Registrant has consummated a transaction whereby the
Registrant acquired all the issued and outstanding shares of Westronix Limited,
a British Virgin Islands corporation ("Westronix"),from CSH pursuant to the
terms of the Acquisition Agreement entered into on September 10, 1996.
Westronix's sole asset is a 100% equity interest in China Construction Holdings
Limited, a Hong Kong Limited ("China Construction") which owns 51% joint venture
interest in Hangzhou Zhongche Huantong Development Co., Ltd. ("HZHD"), a
Sino-foreign joint venture established in Hangzhou, Zhejiang Province, China on
June 23, 1993. The consideration paid by the Registrant was a $30 million
Convertible Note bearing interest at the rate of nine percent (9%) per annum
after an initial six (6) month interest-free period (the "Note").
The Note is payable interest only on an annual basis, with all principal being
due and payable on September 10, 1999. The principal and any unpaid interest due
on the Note are convertible into shares of Common Stock, $0.01 par value, of the
Registrant at a conversion price of $0.0302 per share. The Note is secured by
all assets of Westronix and its related subsidiaries.
HZHD is a joint venture between China Construction (51%) and Hangzhou
Transportation Development Corporation (49%). CSH from whom the Registrant
acquired HZHD, is an affiliate of the Registrant and the major shareholder of
the Registrant's common stock. Three directors of the Registrant are also the
directors of CSH.
The Company shares the office space and administrative support, with CSH, a
major shareholder of the Company. In fiscal 1996, the Company was charged RMB
1.29 million by CSH as a management fee for the use of the office space and
staff support.
DISPOSITION OF ACEWIN PROFITS LIMITED (WUXI CSI)
- ------------------------------------------------
On September 11, 1996, the Registrant disposed of all the issued and
outstanding shares of Acewin Profits Limited, to BTR China Holdings B.V., a
Netherlands company (the "Purchaser") pursuant to the terms of the Agreement
relating to the sale and purchase of the entire issued share capital of Acewin
(the "Agreement") entered into on September 11, 1996. Acewin's sole asset was a
100% equity interest in, China Machine Holdings Limited ("China Machine"), a
Hong Kong company, which owned 55% joint venture interest in Wuxi CSI Vibration
Isolator Co., Ltd.
The consideration paid by the Purchaser consisted of $13,950,000 (the
"Purchase Price"). The major portion of the proceeds were then used to repay the
$13,500,000 Convertible Note payable to Horler Holdings Limited ("Horler"), a
wholly-owned subsidiary of CSH, and issued by the Registrant in connection with
the acquisition of Wuxi in February of 1996.
The Board of Directors of the Registrant determined that disposition of
Wuxi was in the best interest of the Registrant and was advantageous to the
Registrant's plans to concentrate the resources of the Registrant in
infrastructure projects in China in connection with the Registrant's recent
acquisition. The disposition of Acewin was approved by the stockholders of the
Registrant in a consent action in writing of the majority stockholders.
OTHER MATTERS
- -------------
During the fiscal year ended December 31, 1995, the Company paid interest on
loans made by Harlequin of $131,000.
During 1995, directors fees of $9,500, $6,000 and $11,000 were paid to
Messrs. Sharma, Furner and Ollquist, respectively, and $60,000 payable to
Mr. Richard Gray was accrued during 1995. Messrs. Sharma and Ollquist have
subsequently resigned as directors.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
101
<PAGE>
(a) Exhibits
--------
Exhibit 21 - Subsidiaries of the Registrant.
(b) Reports on Form 8-K/A
---------------------
The Registrant filed.
102
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereto duly authorized.
REGAL INTERNATIONAL, INC.
By: /s/Oei Hong Leong
---------------------------------
Oei Hong Leong
Chairman of the Board of Directors
Date: 2/22/98
Pursuant to the Securities Exchange Act of 1934, this report has been signed by
the following persons on behalf of the Registrant and in the capacities and on
the dates indicated.
By: /s/Chung Cho Yee, Mico Date: 2/22/98
------------------------------- -------------------
Chung Cho Yee, Mico
Director
By: /s/ Ma Wai Man, Catherine Date: 2/22/98
------------------------------- -------------------
Ma Wai Man, Catherine
Director
By: /s/ Richard N. Gray Date: 2/22/98
------------------------------- -------------------
Richard N Gray
Director
By: /s/ Martin Furner Date: 2/22/98
------------------------------- --------------------
Martin Furner
Director
103
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
-------------------------------
Prior to September 10, 1996
Acewin Profits Limited, a British Virgin Islands corporation
China Machine Holdings Limited, a Hong Kong corporation
Wuxi CSI Vibration Isolator Co., Ltd. (55%), a Sino-foreign joint venture
After September 10, 1996
Westronix Limited, a British Virgin Islands corporation
China Construction Holdings Limited, a Hong Kong corporation
Hangzhou Zhongche Huatong Development Co., Ltd. (51%), a Sino-foreign joint
venture
104
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