[CONFORMED]
SECURITIES AND EXCHANGE COMMISSION
FORM 20-F
[ ]REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES
EXCHANGE ACT OF 1934
OR
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
- - For the fiscal year ended December 31, 1997
OR
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 - For the transition period from ______________ to
____________
Commission file number 1-14606
China Energy Resources Corporation
(Exact name of Registrant as specified in its charter)
British Virgin Islands
(Jurisdiction of incorporation or organization)
Citco Building, Wickhams Cay c/o Arimoto, Ogasawara & Mo
P.O. Box 662, Road Town 276 Fifth Avenue, Suite 703
Tortola, British Virgin Islands New York, NY 10001
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the
Act.
Title of Each Class Name of Each Exchange
on Which Registered
Common Stock, par value $0.01 per share American Stock Exchange
Securities registered or to be registered pursuant to Section 12(g) of the
Act.
None
Securities for which there is a reporting obligation pursuant to Section 15(d)
of the Act.
None
Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of the close of the period covered by the annual
report.
As of December 31, 1997, 3,248,494 common shares, par value $0.01 per share
(the "Common Stock"), were issued and outstanding.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes _____ No __X__
Indicate by check mark which financial statement item the registrant has
elected to follow.
Item 17______ Item 18 __X__
1
TABLE OF CONTENTS Page
PART I
ITEM 1. DESCRIPTION OF BUSINESS 3
ITEM 2. DESCRIPTION OF PROPERTIES 12
ITEM 3. LEGAL PROCEEDINGS 13
ITEM 4. CONTROL OF REGISTRANT 14
ITEM 5. NATURE OF TRADING MARKET 15
ITEM 6. EXCHANGE CONTROLS AND OTHER LIMITATIONS AFFECTING
SECURITY HOLDERS 15
ITEM 7. TAXATION 17
ITEM 8. SELECTED FINANCIAL DATA 20
ITEM 9. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 25
ITEM 10. DIRECTORS AND OFFICERS OF REGISTRANT 31
ITEM 11. COMPENSATION OF DIRECTORS AND OFFICERS 32
ITEM 12. OPTIONS TO PURCHASE SECURITIES FROM REGISTRANT OR
SUBSIDIARIES 33
ITEM 13. INTEREST OF MANAGEMENT IN CERTAIN TRANSACTIONS 34
PART II
ITEM 14. DESCRIPTION OF SECURITIES TO BE REGISTERED 34
PART III
ITEM 15. DEFAULTS UPON SENIOR SECURITIES 34
ITEM 16. CHANGES IN SECURITIES AND CHANGES IN SECURITY FOR
REGISTERED SECURITIES 34
PART IV
ITEM 17. FINANCIAL STATEMENTS 34
ITEM 18. FINANCIAL STATEMENTS 35
ITEM 19. FINANCIAL STATEMENTS AND EXHIBIT 35
2
Certain Definitions and Supplemental Information
All references to "China" or "PRC" in this Annual Report are references
to The People's Republic of China. Unless otherwise specified, all references
in this Annual Report to "U.S. dollars," "dollars," or "$" are to United
States Dollars; all references to "Renminbi" or "Rmb" are to Renminbi, which
is the official currency of China. Unless otherwise specified, translation of
amounts from Renminbi to U.S. dollars for the convenience of the reader have
been made in this Annual Report at the exchange rates indicated in Item 8.
"Selected Financial Data -- Exchange Rate Information," as quoted by the
People's Bank of China. No representation is made that the Renminbi amounts
could have been, or could be, converted into U.S. dollars at that rate or at
any other rate. See Item 6. "-- Exchange Controls and Other Limitations
Affecting Security Holders -- PRC."
The financial statements of China Energy Resources Corporation (the
"Company") are presented in U.S. dollars. All financial statements of the
Company presented herein have been prepared in conformity with United States
generally accepted accounting principles ("U.S. GAAP").
Forward-Looking Statements
This Annual Report may contain "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, including
(without limitation) under Item 1. "Description of Business," Item 2.
"Properties," Item 6. "Exchange Controls and Other Limitations Affecting
Security Holders" and Item 9. "Management's Discussion and Analysis of
Financial Condition and Results of Operations." Such statements are not
guarantees of future performance and involve a number of risks and
uncertainties that could affect the Operating Company's operations, markets,
prices and other factors and hence the results of the Company. Among the
factors that could cause actual results to differ are changes in the planned
economic development of the PRC, competitive pressures, delays or
difficulties in increasing capacity utilization at existing production
facilities, delays in development of mining operations, a significant
increase in PRC coal production capacity or a significant decrease in demand
for the Operating Company's products, changes in PRC regulation or taxation
of foreign equity joint ventures, increased PRC regulations of the mining,
production and sale of coal under the recently enacted National Coal Act,
increased or more stringent PRC environmental regulations and the tightening
of PRC exchange controls. The Company has been experiencing difficulty in
generating sufficient cash flow to enable it to operate all its facilities
and develop its coal mine use right and/or to obtain additional financing
or refinancing as may be required. These difficulties have raised
substantial doubt about the Company's ability to continue as going cocern.
Management's plans concerning these matters are described in "Item 1. -
Implementation of Business Strategy" and in note 3 to the Financial
Statements.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
Historical Background
China Energy Resources Corporation (the "Company") was incorporated on
March 15, 1996 under the International Business Companies Act of the British
Virgin Islands. The Company is a holding company which is the sole
shareholder of China Coal Mining (B.V.I.) Co. Ltd. ("CCM"), a corporation
organized under the International Business Companies Act of the British
Virgin Islands. Pursuant to a joint venture agreement dated September 16,
1995, CCM acquired an eighty percent (80%) interest in Mishan Hua Xing Coke
Limited ("MHXC"), a newly formed Sino-foreign equity joint venture company
organized in the People's Republic of China (the "PRC"). Pursuant to this
agreement, CCM paid cash in the amount of $7,886,000 for its 80% interest in
MHXC. The MHXC joint venture period, which was initially established for a
term of 20 years from the joint venture's date of formation, was subsequently
extended by the parties for an additional 10 years and may be extended by
unanimous resolution of the board of directors of MHXC subject to the
approval of the relevant authorities. CCM purchased its interest in MHXC
from the government of the PRC, which remains the owner of a 20% interest in
MHXC. MHXC succeeded to the business of Mishan Coal Chemical Holding Company,
a PRC government-owned enterprise ("MCCH"), which owned and operated two
production factories: Mishan City Coke Factory ("MCCF") and Qitaihe City Coal
Factory ("QCCF"). Prior to the acquisition by MCCH in 1994, MCCF was a PRC
government-owned enterprise and QCCF was part of a different PRC government
owned enterprise.
3
In December 1995, the principals of the Company entered into a
definitive agreement (the "Merger Agreement") for the merger of Jackson
Holding Corp. ("JHC"), with and into the Company. JHC was incorporated in
the State of New York on February 22, 1994 for the sole purpose of acquiring
or merging with an unspecified operating business. On January 9, 1995, JHC
commenced a "blank check" offering pursuant to Rule 419 under the Securities
Act of 1933, as amended (the "1933 Act"). JHC had approximately 170
shareholders of its common stock. The Merger Agreement was approved by
unanimous written consent by the Board of Directors of the Company dated
March 22, 1996. In July 1996, the shareholders of JHC voted in favor of the
Merger. On September 10, 1996, the Company filed a Registration Statement
on Form F-4 with the U.S. Securities and Exchange Commission to effect the
merger. The Company's Registration Statement on Form F-4 was declared
effective on October 4, 1996 by the U.S. Securities and Exchange Commission.
In connection with the merger, the Company issued 109,850 common shares
to the shareholders of JHC in exchange for the entire issued share capital of
JHC. At the time of the merger, JHC had no operating assets.
On April 21, 1997, the Company listed 5,898,436 of its common shares
(the "Common Stock") on the American Stock Exchange, which included 3,248,494
shares outstanding and 2,649,942 shares reserved for issuance.
General
All of the Company's operations are conducted through its operating
subsidiary, CCM, and in turn through the PRC-based MHXC joint venture to
which CCM is a party (referred to hereinafter as the "Operating Company").
The Operating Company has two wholly-owned coal refining operations, MCCF and
QCCF.
MCCF
MCCF engages primarily in the production and sale of metallurgical coke.
MCCF completed its steam coal preparation facility in 1993. In 1995, MCCF
completed construction of an additional production facility to process steam
coal into metallurgical coke and foundry coke. This facility has been
designed for annual production capacities of approximately 200,000 tons of
steam coal, approximately 85,000 tons of metallurgical coke and approximately
56,000 tons of foundry coke. The total output of metallurgical coke only
reached 21,783 tons in 1997, accounting for 26% of its production capacity
for metallurgical coke. Improvements to the facility, which cost
approximately $3,000,000, were financed through an unsecured loan by a local
PRC bank at a fixed term rate of 15.3%. These improvements enabled MCCF to
produce metallurgical coke and foundry coke which it was unable to do prior
to such improvements. Presently, the main product of the MCCF plant is
metallurgical coke and low-end metallurgical coke.
On June 20, 1995, the Mishan City Municipal Government granted MCCF
exclusive underground rights to mine coal from certain coal reserves located
in Mishan City, within Heilongjiang Province, PRC. MCCF's mining rights (the
"coal mine use rights") were granted on June 20, 1995 and continue in force
for 100 years. See "--Government Regulation." Upon the formation of the
Operating Company, the PRC joint venture partner made an interest free loan
in the amount of $7,906,000 to MCCF to partially finance the acquisition of
the coal mine use rights.
The reserves are located within approximately 10 kilometers of the MCCF
production facility. Present access to these reserves is solely by way of an
undeveloped road system. The coal reserves are located in the districts of
Dalizi, Jinshazi, Beiyinzi, Dazhushan and Zhushan. These five districts
collectively produce the following types of coal: coking; fat; gas; and
meager. The combination of these four types of coal is required to produce
high quality foundry coke. MCCF is not presently involved in the mining of
these reserves due to the lack of funds available for this purpose. MCCF has
been engaged in conducting mine site surveys, clearing the surface of
potential mine entrance sites, performing geological surveys and preparing
mining plans. The Company believes that these activities will enable MCCF to
begin its mining operations as soon as practicable after sufficient funds are
available. The costs associated with mining preparation work have been
capitalized as part of MCCF's coal mine use rights.
4
As a result of the macro-economic adjustments and related credit policy
advocated by the central PRC government, MCCF was not able to obtain working
capital from local banks after the completion of its production facilities in
1995. Due to this lack of working capital, in June 1996, operation of the
MCCF plant was subcontracted to a company under the control of the PRC's
Ministry of Coal. According to the subcontract, the party which operated the
plant (i) was obligated to meet all the operating expenses of the plant, (ii)
was entitled to receive all the revenues from the plant's operation and (iii)
paid to MCCF a subcontracting fee. This subcontract was terminated on March
31, 1997 and MCCF resumed the production and sales of metallurgical coke
during the second quarter of 1997. In order to expand sales and fully
utilize the existing facilities, MCCF also produced some low-end
metallurgical coke. Total production and sales by MCCF during 1997 after the
termination of the subcontracting agreement amounted to 61,009 tons of
regular and low-end metallurgical coke generating gross revenue of
$1,313,000. However, in March of 1998, MCCF ceased operations due to its
inability to collect trade receivables which adversely affected the working
capital needed for production and sales activities.
In addition, during 1997, the Company terminated the services of the
MCCF plant manager, however, prior to his termination, this individual signed
various documents that provided collateral to bank lenders of MCCF over MCCF
assets.
Currently, the local government is assisting the Company to supervise
the daily operations of MCCF. The majority of work force has been dismissed
with approximately 55 workers remaining on the premises.
QCCF
QCCF engages in the production and sale of steam coal. The QCCF factory
was constructed in 1993 and employs the "air-heavy medium fluid bed" dry
process of coal preparation, which management of the Operating Company
believes is a leading production technology worldwide and is appropriate for
production in cold and dry regions such as the region where QCCF's factory is
located. QCCF's annual production capacity is approximately 750,000 tons of
steam coal and the factory operated at 53% of its capacity in 1997.
Historically, a substantial percentage of the sales of QCCF have been to
one customer, Mudanjiang No. 2 Power Plant ("Mudanjiang") in Heilongjiang
Province, PRC. On an annual basis, the PRC government designates the quota
of steam coal that will be purchased for each of its power plants and the
districts from which such coal will be supplied. Each power plant can then
determine which suppliers within each district it will contract with for the
year. In 1995 and 1996, QCCF contracted to supply 312,000 tons and 390,890,
respectively, tons of steam coal to Mudanjiang. QCCF sold 312,000 tons,
390,890 tons and 327,743 tons of steam coal to Mudanjiang in 1995, 1996 and
1997 respectively. Overall sales volume decreased in 1997 due to the
shortage of transportation capacity as a result of a good harvest in the
Heilongjiang Province which occupied most of the transportation capacity
during the second quarter of 1997. QCCF produced according to purchased
orders received.
In order to assure that its customers will receive steam coal on a
timely basis, QCCF needs to secure sufficient transportation capacity. In
1996, QCCF entered into a cooperative agreement with a unrelated party under
the control of the Railroad Transportation Department whereby QCCF would be
entitled to transportation capacity for 400,000 tons of steam coal annually in
exchange for a negotiated fee.
Business Strategy
Through offerings of convertible notes and warrants in November 1996 and
January 1997 in exempt transactions pursuant to Regulation S under the 1933
Act, the Company raised net proceeds of approximately $5,400,000. These
proceeds were primarily used as follows: $2,014,000 for purchase of raw coal
and working capital of MCCF, $648,000 for bank loan repayment by QCCF,
$1,268,000 for a loan to the former owner of QCCF, $337,000 for the
administrative expenses of Heilongjiang representative office which was set
up in 1997, unauthorized withdrawl of $286,000 by the former Chariman,
$577,000 for the Company's administrative and reporting expenses with the
remaining of $270,000 of cash on hand.
MCCF working capital was entirely depleted due to a large amount of
uncollected trade receivables and poor operating management. The situation
5
was exacerbated by the refusal of local banks and raw coal suppliers to
advance further credit. As a result, MCCF ceased operations in March of
1998. MCCF will not resume production until a strategic partner or
qualified management team is found. At the current stage, MCCF only retains
a minimum workforce and incurs minimum expenses to maintain its facility.
QCCFs business strategy is to increase sales in the PRC of steam coal
by increasing production capacities and marketing additional coal products.
It is expected that QCCF will utilize existing cash flow from operations
to approach the maximum steam coal production capacities of its existing
plant and equipment. Management believes that steam coal production can be
increased by a substantial percentage without any significant capital
improvements, as QCCF has the plant and equipment necessary to support this
business expansion.
Additionally, the Operating Company intends to explore its ability to
produce foundry coke in commercial quantities which meet international
quality standards for sales in the PRC and for export subject to the
availability of working capital. With its existing technology, management
believes that the MCCF facility is capable of producing high quality foundry
coke within international standards. Foundry coke is widely used in the
production of specialty steel, the raw material used in high performance
steel products such as automobile and airplane engines. The high temperature
requirements for foundry coke require a high quality raw coal, as measured by
low sulfur, phosphorous and ash contents and a high caloric value.
Presently, the Operating Company's factories purchase a majority of
their raw coal from coal mine operations of unrelated parties. Management
intends to apply some excess cash flow, if available, to begin mining the
coal reserves to which MCCF has exclusive mining rights. It is hoped that,
once such mining activities are fully operational, the MCCF reserves will
supply a major portion of the raw mined coal for production in the Operating
Company's factories. Management believes that such mining operations will
result in lower costs to MCCF for raw materials and an increase in the
Operating Company's gross profit and net income. Construction of MCCF's coal
mining facilities is expected to require a substantial investment in mining
equipment or the acquisition of an existing coal mining operation. The
Operating Company expects that it will cost in excess of $3,000,000 to
commence such mining operations, including but not limited to equipment for
digging, mining, safety, ventilation and transportation. The Company expects
such construction would take approximately one year from commencement to
completion.
Implementation of Business Strategy
The implementation of the Company's business strategy and its
continuation as a going concern is conditioned upon the Company's ability
to obtain additional financing as needed and the Company's ability to
generate sufficient cash flow to enable it to operate all of its facilities
and develop its coal mine use right. The difficulties recently
encountered by the Company include the following:
During 1997, the Company terminated the services of the MCCF plant
manager, however, prior to his termination this individual signed various
documents that provided collateral to bank lenders of MCCF over MCCF assets.
In 1997,as a result of cash flow shortages, various problems with local
management and other operational issues, the facility at MCCF did not operate
at full capacity resulting in the closure of that facility in March, 1998.
The Company intends to reopen the facilities when the Company has raised
additional finance as the Company anticipates that operating the plant will
generate positive cash flows and therefore, no provision for impairment is
required.
MHXC owns the right to mine coal at certain coal mines located in Mishan.
The Company plans for these mines to supply coking coal for use in production
by MCCF. During 1997, the company continued its efforts in preparing the mine
sites for mining operations and in October 1997 obtained a report prepared by
international mining and geological consultants on the coking coal reserve
base and associated coal quality. This report recommended that the Company
implement various programs to expand the demonstrated coal reserve base and
provide support for coal qualiity documentation, see "Item 1.-Coal Reserve".
Due to inadequate working capital the Company has not been able to conduct
further mine surveys and the Company has been in contact with potential
strategic partners to assist in development. The Company needs to complete
additional work on the survey and mining plans before the mine is ready for
use.
6
Sales and Marketing
MCCF's primary product is high quality metallurgical coke, which is sold
to steel mills. Due to a shortage of working capital, the MCCF factory
operated substantially below capacity. During the first half of 1996, MCCF
sold certain residual products which were below the factory's quality
standards. Subsequently, during the second half of 1996 and the first
quarter of 1997, the operation of the MCCF plant was subcontracted to a
company under the control of the PRC's Ministry of Coal. Therefore, the
sales volume of the MCCF factory attributable to the Operating Company showed a
significant decrease for 1996, as well as a decrease in the average net sales
price per ton from the 1995 level. As a result of the working capital raised
in 1996 and early 1997, the MCCF subcontracting agreement was terminated on
March 31, 1997 and MCCF's management was focusing on the process of
rebuilding its workforce, production and sales operations in the remaining
quarters of 1997. MCCF produced low-end as well as standard metallurgical
coke in order to increase sales and fill back order. Unfortunately, due to
poor credit management and collection efforts, most of the MCCF's trade
receivables were not collected. By the beginning of 1998, MCCF did not have
sufficient working capital to continue its operations. Thus, the production
at the facility was halted in March of 1998.
<TABLE>
MCCF reported the following sales of metallurgical coke for the previous
three fiscal years:
<CAPTION>
1995 1996 1997
<S> <C> <C> <C>
Sales volume (in tons)
-metallurgical coke 33,000 6,758 21,783
-low-end metallurgical coke - - 39,226
Average net sales price (per ton)*
-metallurgical coke $57.39 $38.32 $41.73
-low-end metallurgical coke - - $10.30
<FN>
_______________
*Sales prices indicated are net of discounts and returns.
</FN>
</TABLE>
QCCF's primary product is steam coal, which is used by thermal power
plants. Since 1995, the sales volume of QCCF has increased at an annual
rate of over 20% but in 1997, the sales volume decreased by 17% as compared
to 1996 due to the shortage of transportation capacity. The QCCF factory
employs the "air-heavy medium fluid bed" dry process of coal preparation.
QCCF believes that this process is well-suited to the cold climate where its
products are used and that this processing technology provides it with a
competitive advantage over other suppliers within the Qitaihe City region
which use alternative technologies.
In order to ensure a stable demand for its products along with a source
of working capital, QCCF has entered into various long-term coal supply
contracts with its major electric utility customers. These contracts
generally stipulate that the utility company will provide a certain amount of
working capital to QCCF in return for QCCF's obligation to supply coal at the
prevailing market price. In addition, pursuant to these contracts, the
utility companies are generally responsible for obtaining transportation
capacity for which they earn a fee on a per ton basis.
QCCF implemented certain self-assessed "penalty" policies in its sales
contracts as a method to emphasize quality control and customer satisfaction
in the marketing of its products. Its sales contracts specify quality
standards for the coal to be delivered, generally in terms of the coal's BTU
and burn characteristics. To the extent that any QCCF product fails to meet
the agreed upon standard, QCCF will rebate a set amount to its customer.
Similarly, if QCCF delivers a tonnage that is higher than the quantity
purchased, QCCF does not charge the customer for the freight cost of
transporting the excess goods.
7
<TABLE>
QCCF reported the following sales of steam coal for the previous three
fiscal years:
<CAPTION>
1995 1996 1997
<S> <C> <C> <C>
Sales volume (in tons) 390,000 475,305 396,627
Average net sales price (per ton)* $15.52 $15.86 $19.52
<FN>
_______________
*Sales prices indicated are net of discounts and returns.
</FN>
</TABLE>
Dependence on One Major Customer
Historically, a substantial percentage of the sales of QCCF (and its
predecessor companies) have been to one customer, Mudanjiang No. 2 Power
Plant ("Mudanjiang"), in Heilongjiang Province, PRC, which accounted for
approximately 80%, 82% and 80% of QCCF's net sales and approximately 71%, 80%
and 69% of the Operating Company's net sales for the years ended December 31,
1995, 1996 and 1997, respectively. On an annual basis, the PRC government
designates the quota of steam coal that will be purchased for each of its
power plants and the districts from which such coal will be supplied. Each
power plant can then determine which suppliers within each district it will
contract with for the year. In 1995 and 1996, QCCF sold 312,000 tons and
390,890 tons, respectively, of steam coal to Mudanjiang. On December 31, 1996,
QCCF signed a long-term supply contract with Mudanjiang for a term of
seven years from January 1, 1997 to January 1, 2004 (See Exhibit 2.1).
According to the contract, QCCF has agreed to supply up to 900,000 tons to
Mudanjiang each year, subject to QCCF's ability to obtain sufficient
transportation capacity. The actual sales volume to Mudanjiang totaled
327,743 tons in 1997. See "--General--QCCF." The loss of Mudanjiang as a
customer of QCCF would have a material adverse effect on both the Operating
Company's and the Company's financial condition, results of operations, cash
flows, business and prospects. QCCF started to diversify its customer base by
establishing business relation with other power plants. In December of 1997,
QCCF started to supply steam coal to Harbin Power Plant. Sales to Harbin
Power Plant amounted to 19,515 tons in the month of December 1997 and
contributed 5% of sales for the year.
Transportation
Transportation is an important factor in coal marketing in the PRC
because a significant portion of the cost of processed coal is attributable
to transportation. The availability and cost of such transportation has a
significant effect upon the marketability of coal. During 1997 the local
government in Heilongjiang utilized more transportation capacity for
agricultural products because of good harvest in the North-east part of China.
As a result, QCCF suffered from a shortage of rail transportation and its
revenue decreased in 1997. Generally, the cost of transportation from the
Operating Company's two factories to their customers are incurred by the
factories.
The development of the PRC railway system still lags behind the growth
of the PRC economy as a whole, and discrepancies between the capacity and
volume of transportation are severe in many areas of the PRC. Currently,
most of the customers of the Operating Company's factories are located within
their respective regions, and the factories utilize the PRC's rail transport
system to deliver substantially all of their products to their customers.
With the Operating Company's ongoing efforts to develop new customers as well
the intention for MCCF to export products to Southeast Asia, it is expected
that the number of customers located in areas other than the PRC's northeast
region will increase. Accordingly, alternative means of transportation may
be required to accommodate future product transportation needs. Although the
Company believes that the Operating Company's factories will be able to
satisfy their transportation needs for the foreseeable future based on their
current production capacities and that sufficient rail transportation will be
made available to the factories to meet any increases in production
capacities, there can be no assurance that either of the Operating Company's
factories will continue to receive a sufficient amount of rail transport
capacity. Additionally, there can be no assurance that either of the
factories will be able to develop alternative means of transportation that
are reliable and cost-efficient.
8
Coal Reserve
The raw coal that is mined in the Mishan City area contains high
quality coal for use in coke production. This type of raw coal generally has
low sulfur and phosphorus contents and strong cohesiveness. All of these
qualities together produce a high quality coke coal, with the exception of
the ash content in the raw coal which, according to an independent
governmental test conducted in Beijing, is between 17% and 24%. An ash
content of between 8% and 9% is considered to be the international standard
for high quality foundry coke. The Company engaged John T. Boyd Company, a
leading U.S. geologist, to review and comment on the availability and
reliability of the coking coal reserve base tonnage and quality to supply
coal to MCCF. Boyd's personnel spent 12 days in-country reviewing supporting
documentation of the coal reserve base, discussing reserve and coal quality
parameters for the reserve base and visiting selected underground mining
sites. All source data were provided by or at the direction of the Company
and/or subsidiary companies and were utilized as provided with no independent
verification by Boyd as to its accuracy. According to the report issued by
Boyd in October 1997, based on the existing MCCF coking production capacity
of 56,000 tons per year, the remaining demonstrated coal reserve equates to
approximately 60 years of production. Using the current expansion plans for
the coking facility at 156,000 tons per year, the remaining life of the
demonstrated reserve base is about 21 years. Subject to future confirmation
via on-site exploration, there are additional 9.4 million recoverable tons of
coking coal reserve base available for expansion and/or continuation of
operations. This report recommended that the Company implement various
programs to expand the demonstrated coal reserve base and provide supporting
coal quality documentation. Due to inadequate working capital, the Company
has not been able to conduct further mine surveys. The Company needs to
complete additional work on the survey and mining plans before the mine is
ready for use.
Technology
MCCF employs the "heavy medium flow-rotator coal preparation technique,
"an advanced processing technology developed by the Tangshan Branch of China
Coal Industry Research Institute. Management believes that by employing this
technique MCCF has the capability to meet the rigorous quality standards
required for export. With the use of this technology, the ash content of the
cleaned coal can be kept between 7.0 - 8.0%, thus providing cleaned coal with a
reduced ash content for the production of foundry coke. The Operating
Company believes that the flow-rotator process is more economical than the
widely-used jigging method which has been the standard process for the past
several decades. While management believes that the advanced flow-rotator
process produces a significantly higher yield of clean coal, a higher rate of
reclaim and a lower ash content than the jigging method, there can be no
assurance that MCCF's existing technology will enable it to produce foundry
coke that meets international quality standards.
The processing plant at QCCF employs the "air-heavy medium fluid bed"
dry process of coal preparation, which the Company believes is a leading
technology worldwide. This process was the result of ten years' research by
China Minerals University, which has patented the technology. This process
provides a new method for coal sorting in areas where water resources are in
short supply and where it is severely cold. Management of the Operating
Company believes that this process is more environmentally friendly than the
wet separation processes because it produces no waste water and slime. Due
to certain deficiencies in the implementation of this technology during the
summer rainy season, the Operating Company intends to employ working capital,
if available, to improve upon this technology.
9
Government Regulation
Companies operating in the PRC are subject to certain laws, rules and
regulations promulgated by the government thereof. PRC laws applicable to
the mining, production and utilization of coal include the Mineral Resources
Law of the PRC (1996, revising the 1986 law) and the Regulations for the
Implementation of the Mineral Resources Law of the PRC (1994). In
particular, the Operating Company is subject to the Coal Law of the People's
Republic of China, which became effective on December 1, 1996 (the "National
Coal Law"), and which comprehensively regulates the mining of the PRC's coal
resources, the production of coal and related business operations. The
planned mining operations of the Operating Company may, under the National
Coal Law, require approval by the Heilongjiang Provincial Coke and Coal
Bureau. Rules to be promulgated by the State Council under the National Coal
Law could impose substantial substantive regulation of the production and
pricing of coal and coke. There can be no assurance that the National Coal
Law and the rules and regulations promulgated thereunder will not have an
adverse effect on the business or operations of the Operating Company or the
coal mine use rights of MCCF. In addition, prior to the export of coke or
coal, the Operating Company must obtain an export license from the Ministry
of Foreign Trade and Economic Cooperation ("MOFTEC"), which, under the
National Coal Law, may be authorized to grant such licenses only to large
scale coal-production enterprises. While management believes that it will be
able to obtain such a license once it is in a position to begin exporting,
there can be no assurance that such a license will be obtained by the
Operating Company.
The Operating Company is subject to certain PRC laws and regulations
applicable to Sino-foreign equity joint ventures. The laws related to PRC
Sino-Foreign Joint Equity Enterprise (the "Joint Venture Law") establishes a
comprehensive regulatory and corporate governance framework with respect to
Sino-foreign equity joint ventures. Some pertinent provisions of the Joint
Venture Law provide as follows: (i) Article 4 requires that the transfer of
one party's share be effected only with the consent of the other party or
parties; (ii) Article 5 provides that if site-use rights are not part of the
Chinese partner's investment contribution, the joint venture shall pay fees
to the government for such usage; (iii) Article 9 requires that the
production and operational plans of a joint venture be filed with the
relevant authorities and (iv) Article 12 requires approval by the government
for any extension of a joint venture's term. More detailed restrictions are
provided in Regulations for the Implementation of the Law of the PRC on
Sino-Foreign Joint Equity Enterprise. In addition, the Regulations on Labor
Management in Foreign Investment Enterprises set forth certain restrictions,
including, but not limited, to restrictions on the hiring and discharge of
employees, establishment of wages, maintenance of insurance and welfare and
other benefits. The Operating Company is also subject to certain PRC
national and local environmental regulations with which it must comply in the
production of its coal and coke products. See "--Environmental Protection."
Environmental Protection
The Company is subject to PRC national and local environmental
protection regulations which currently impose fees for the discharge of
waste substances, require the payment of fines for pollution, and provide for
the closure by the PRC government of any facility that fails to comply with
orders requiring it to cease or cure certain activities causing environmental
damage. Due to the nature of the Operating Company's business, the
Operating Company produces significant amounts of waste water, coal dust,
solid waste materials, and noise during the course of its production of coke
and coal. The Operating Company has established environmental protection
systems to treat certain of its waste materials, to safeguard against
accidents and to reduce noise. The Operating Company believes that its
environmental protection facilities and systems are adequate for it to
comply with the existing national and local environmental protection
regulations. However, there can be no assurance that the PRC national or
local authorities will not impose additional or more stringent regulations
which would require additional expenditure on environmental matters, changes
in the Operating Company's processes or systems and/or plant closures.
The Operating Company regards environmental protection as a priority and
maintains an environmental protection department which is responsible for
coordinating its environmental protection systems. The Operating Company
believes that it is in substantial compliance with all applicable
environmental statutes and regulations.
10
Competition
MCCF - Metallurgical and Foundry Coke
The coke produced in the PRC is mainly of the metallurgical quality.
Generally, coke quality is measured by its low contents of sulfur,
phosphorous and ash, and high caloric value. Metallurgical coke is
considered to be a lesser grade of coke than foundry coke due to its ash,
sulfur and phosphorous contents. The output of foundry coke in the PRC
remains low due to highly technological production requirements.
Within the Operating Company's region, the Operating Company believes
that the Jixi City Coal Preparation Plant ("Jixi"), which produces mainly
metallurgical coke, is its only major competitor. The Operating Company
believes that MCCF's preparation process can achieve a lower ash content for
coke than is possible with the process employed by Jixi. A low ash content
is required to meet international standards for foundry coke. The Operating
Company believes that its coke products are priced competitively with those
of Jixi.
The Operating Company believes that its potential major competitors for
the production of foundry coke in the PRC are Zhenjiang Coking Chemical Plant
and Beijing Coking Chemical Plant. Because both of these plants are located
in the central regions of the PRC, the Operating Company believes that
transportation costs have been, and will continue to be, a factor which
increases the cost of coke delivered by these plants to customers in the PRC
regions served by the Operating Company. The Operating Company believes that
such increased costs of delivery may provide an effective barrier to
competition from these other producers until such time as the transportation
system in the PRC is better developed. In addition, the Operating Company
believes that both of these other plants produce only limited quantities of
foundry coke.
QCCF - Steam Coal
QCCF presently processes steam coal for use by thermal power generating
plants in its region. The Operating Company has not experienced significant
competition in the sale of steam coal produced by QCCF due to the strong
demand for steam coal in the PRC. In QCCF's region, Heilongjiang Province,
there are four major production districts, which include Jixi, Hegang,
Qitaihe and Shuangyashan. Within each of these districts are many
government-owned steam coal production facilities, all of which represent
competition to QCCF within the region in which QCCF operates. The Operating
Company is not aware of any available statistics regarding these government-
owned facilities, some of which may have significantly greater production
capacities than the combined capacities of the Operating Company.
International
The Operating Company has not engaged in any sales of its coal or coke
products to customers located outside of the PRC. The Operating Company
plans to explore the possibility of exporting a portion of its coke and coal
production, subject to its ability to increase production capacities in order
to produce coke and coal products in commercial quantities which meet
international quality standards, obtain sufficient transport capacity and any
required regulatory approvals. There are many coke and coal producers
worldwide that have significantly greater resources and experience in
international sales than the Operating Company, and which may have an
established customer base for their coal and coke production. The Operating
Company expects that its major competition in the international markets would
be from coal and coke producers located in the United States, Australia and
Canada.
11
Employees
As of December 31, 1997, the Company and CCM each had 1 full-time
employee. As of December 31, 1997, the Operating Company, including its two
factories, had approximately 1,043 employees, of whom 471 worked for QCCF and
572 worked for MCCF. Of the Operating Company's total number of employees,
approximately 91% were production workers, approximately 7% were managerial
staff and approximately 2% were engineering and technical staff. As MCCF
ceased its operations in March 1998, the majority of its work force were
dismissed with approximately 55 workers remaining in the factory . Generally,
the MCCF and QCCF factories have entered into employment contracts with their
workers, which contracts typically are subject to annual renewal, contain
annual wage determination provisions and provisions regarding pension and
medical benefits in accordance with applicable PRC regulations governing the
management of labor. In addition to cash compensation, each of the factories
provides certain pension funds and costs of medical care to their employees.
ITEM 2. DESCRIPTION OF PROPERTIES
Properties
Substantially all of the operations of the Operating Company and CCM are
conducted at the facilities of the Operating Company.
The Operating Company owns and operates two coal production factories,
MCCF and QCCF, in the northeast region of the PRC. These factories include
certain buildings, fixtures and equipment necessary for the production
of steam coal and metallurgical and foundry coke. These factories are owned
by the Operating Company.
The MCCF factory and raw material stockpiles are located on a 127,000
square meter site located in Mishan City, Heilongjiang Province, PRC. MCCF
has been granted certain land use rights by the Mishan City government in
connection with the real property that MCCF occupies. Pursuant to these
rights, MCCF has the exclusive right to use and occupy the real property for
a period of 50 years, commencing September 16, 1995. MCCF also owns and
operates 1.13 kilometers of railroad track located on the real property,
which it uses exclusively in connection with its business. The real property
on which the railroad track is located is also subject to the 50-year land
use rights mentioned above. The MCCF factory has the capacity to produce
approximately 200,000 tons of steam coal, 85,000 tons of metallurgical coke
and 56,000 tons of foundry coke per year.
According to the Administrative Bureau for Coal Mining of Heilongjiang,
the coal reserves which have been assigned to MCCF have the potential to mine
raw recoverable coal of the following types: Dalizi - coke and fat coal;
Jinshazi - fat and gas coal; Beiyinzi - coke coal; Dazhushan - gas; and
Zhushan - meager coal. The Operating Company has completed an initial
feasibility study related to the coal reserves has engaged an independent
expert, John T. Boyd Company to verify the quantity of these reserves.
According to the Boyd report which was based upon source data provided by or
at the direction of the Company, without independent verification as to its
accuracy, MCCF controls coal reserves sufficient to produce high quality
foundry coke for 20-60 years and there are an additional 9.4 million
recoverable tons of coking reserve base.
While the Operating Company has the right to mine coal from these
reserves, it has not yet done so. The Operating Company estimates that it
will require in excess of $3,000,000 to commence mining operations. To date,
the Operating Company has engaged in conducting mine site surveys, clearing
the surface of potential mine entrance sites, performing geological surveys
and preparing mining plans. The Operating Company has commenced these
activities to enable it to begin mining operations as soon as possible after
sufficient funds become available, if such funds become available. The costs
associated with mining preparation work have been capitalized as part of
MCCF's coal mine use rights.
The QCCF factory and raw material stockpiles are located on a 150,000
square meter site located in Qitaihe City, Heilongjiang Province, PRC. QCCF
has been granted certain land use rights by the Qitaihe City government in
connection with the real property that QCCF occupies. Pursuant to these
rights QCCF has the exclusive right to use and occupy the real property for a
period of 30 years commencing September 16, 1995. The QCCF factory has the
capacity to produce approximately 750,000 tons of steam coal per year and was
operated at approximately 53% of capacity in 1997.
12
The MCCF and QCCF factories of the Operating Company are located in
Mishan City and Qitaihe City, respectively, in the PRC. Firefighting and
disaster relief or assistance in the PRC are primitive by Western standards.
The Operating Company and its factories do not currently maintain personal
injury, fire, casualty or other property insurance covering their raw
materials, environmental damage, work in progress, furniture, equipment or
factory buildings in the PRC. Any damage or loss relating to the Operating
Company or its facilities would have a material adverse effect on both the
Operating Company's and the Company's business, results of operations and
financial condition.
Neither the Company nor the Operating Company and its factories maintain
any business interruption insurance.
ITEM 3.LEGAL PROCEEDINGS
Legal Proceedings
Neither the Company nor CCM is a party to, nor is the property of the
Company or CCM subject to any pending legal proceedings which are potentially
material to the Company or CCM.
13
ITEM 4.CONTROL OF REGISTRANT
<TABLE>
The following table sets forth certain information regarding ownership
of the Company's shares of Common Stock as of June 30, 1998 by (i) all
persons who own more than ten percent (10%) of the outstanding shares of
Common Stock and (ii) all officers and directors of the Company as a group.
<CAPTION>
Title of Identity of Amount Percent
Class Person or Group Owned of Class
<S> <C> <C> <C>
Common Stock Hualong Holding Co. Ltd. 1,250,000 38%
Common Stock Rana Energy Investment Ltd. 734,444 23%
Common Stock All officers and directors
as a group 23,998 0.7%
</TABLE>
The Company issued total of 52,000 options to a consulting firm, the
Equity Group, on July 22, 1997 and January 15, 1998: 32,000 options are fully
vested with an exercise price of $5.00 per share, and 20,000 options are
fully vested with an exercise price of $3.50 or at a lower price at which the
Company issues additional equity or warrants between January 22, 1998 and
January 21, 1999.
As of December 31, 1997 there were 3,248,494 shares of Common Stock
issued and outstanding. In the event that the remaining holders of the
outstanding $3,237,500 principal amount of Convertible Notes exercise their
conversion rights to convert the principal amount and accrued interest at
the floor price of $3.50 per share and all the Warrants and Options holders
exercise their purchase rights at the floor price of $3.50 and $5.00
respectively, the result would be a total of 6,202,887 shares of Common
Stock issued and outstanding. Dilution to the existing shareholders would be
approximately 47.63%.
Assuming full conversion (in the case of $3,237,500 Convertible Notes)
or exercise (in the case of 1,946,143 Warrants and Options) of the remaining
outstanding Convertible Notes, Warrants and Options, the following table
sets forth information regarding ownership of the Company's shares of Common
Stock on a fully diluted basis by (i) all persons who own more than ten
percent (10%) of the outstanding shares of Common Stock and (ii) all officers
and directors of the Company as a group.
<TABLE>
<CAPTION>
Title of Identity of Amount Percent
Class Person or Group Owned of class
<S> <C> <C> <C>
Common Stock Hualong Holding Co. Ltd. 1,250,000 20%
Common Stock Rana Energy Investment Ltd. 734,444 12%
Common Stock All officers and directors
as a group 23,998 0.4%
</TABLE>
The Company is not aware of any other arrangement which may at a subsequent
date result in a change of control of the Company.
14
ITEM 5. NATURE OF TRADING MARKET
The Common Stock of the Company is listed on the American Stock
Exchange (the "AMEX"). The AMEX is the principal trading market for the
Common Stock, which is not listed on any other exchanges within or without
the United States. The Common Stock commenced trading on the AMEX on April
21, 1997 under the symbol "CHG."
<TABLE>
The high and low sales prices for shares of the Common Stock on the
AMEX for the period indicated were as follows:
<CAPTION>
High Low
<S> <C> <C>
1997 Second Quarter $ 6 $ 4 9/16
1997 Third Quarter 5 1/8 3 1/8
1997 Fourth Quarter 3 7/8 1 5/8
1998 First Quarter 2 15/16 1 1/2
1998 Second Quarter 2 1/8 1 1/2
</TABLE>
As of June 30, 1998, there were 3,248,494 shares of Common Stock issued
and outstanding, 1,467,694 of which were held of record by approximately 296
holders with addresses in the United States.
ITEM 6. EXCHANGE CONTROLS AND OTHER LIMITATIONS AFFECTING SECURITY HOLDERS
PRC
The Operating Company receives almost all of its revenues in Renminbi,
which is not freely convertible into foreign exchange. However, the
Operating Company may require foreign currency to convert profits, if any,
into U.S. dollars in the amounts needed for the Company to pay dividends, if
any, and to discharge obligations denominated in foreign currency. The
Company has not paid any dividends and has no current plans to pay any
dividends.
The PRC government imposes control over its foreign currency reserves
in part through direct regulation of the conversion of Renminbi into foreign
exchange and through restrictions on foreign trade. Prior to January 1,
1994, the PRC had a dual exchange rate system, which consisted of the rate
fixed from time-to-time by the PRC State Administration of Exchange Control
(the "SAEC") and the rates prevailing in the various swap centers around the
country (the "Swap Rates"). In most cases, foreign enterprises satisfied
their need for foreign exchange through such means as exporting products for
foreign currency, selling "import substitute" products in the PRC for
payment in foreign currency, or accessing a swap center. Among the more
widely used Swap Rates was the rate at the swap center in Shanghai.
Effective January 1, 1994, a new unitary, managed floating-rate system was
introduced in the PRC to replace the previous dual-track foreign exchange
system, which was abolished pursuant to the Notice of the People's Bank of
China Concerning Further Reform of the Foreign Currency Control System (the
"PBOC Notice"). The conversion of Renminbi into U.S. dollars must now be
based on the rate set by the People's Bank of China, which is set based on
the previous day's PRC interbank foreign exchange market rate and with
reference to current exchange rates on the world financial markets. In
furtherance of these currency reforms, the China Foreign Exchange Trading
Center (the "CFETC") was formally established in Shanghai and began operating
in April 1994. The establishment of the 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
swap centers will be phased out gradually.
Currently, foreign investment enterprises ("FIEs") 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." Upon the presentation of appropriate
documentation, FIEs may enter into foreign exchange transactions at swap
centers, or in the future, in the event the unitary exchange rate system is
implemented as anticipated, through the unified market when all swap centers
are consolidated under the 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 Renminbi into foreign
15
exchange for current account items is permissible. Conversion of Renminbi
into foreign exchange for capital items, such as direct investment, loans
or security is still under the sole jurisdiction and requires approval of the
SAEC.
As a result of the adoption of the unitary exchange rate system on
January 1, 1994, the official bank exchange rate for Renminbi to U.S. dollars
experienced an immediate devaluation of approximately 50% to US$1.00 = Rmb
8.7000. Any future volatility or devaluation of the Renminbi could have a
material adverse effect on the Company's business, results of operations and
financial condition.
Management believes that the Operating Company will be able to obtain all
required approvals for the conversion and remittance abroad of foreign
currency necessary for the operations of both the Operating Company's and the
Company's businesses. However, such approvals do not guarantee the
availability of foreign currency and no assurance can be given that the
Operating Company will be able to convert sufficient amounts of foreign
currency in the PRC's foreign exchange markets in the future at acceptable
rates, or at all, for the repayment of debt, payments of interest, purchases
of equipment or payment of dividends, if any, and payments for services and
other contracts. To the extent that the Operating Company is restricted from
distributing dividends and profits to CCM, such restrictions could have a
material adverse effect on the Company's business, results of operations and
financial condition.
Certain Foreign Issuer Considerations
The Company is an International Business Company ("IBC") incorporated
under the provisions of the International Business Companies Act (the "Act")
of the British Virgin Islands (the "BVI"). The transfer of shares between
persons regarded as resident outside of the BVI is not subject to any
exchange controls. Likewise, issues and transfers of shares involving any
person regarded as resident in the BVI are not subject to exchange control
approval. There are no limitations on the rights of non-BVI owners of the
Company's Common Stock to hold or vote their shares. Because the Company is
an IBC, there are no restrictions on its ability to transfer funds into and
out of the BVI or to pay dividends to U.S. residents who are holders of the
Company's Common Stock.
In accordance with the Company's Memorandum and Articles of Association,
share certificates are only issued as shares registered on the books of the
Company. In the case of a representative acting in a special capacity (for
example, as an executor or trustee), share certificates should record the
capacity in which the representative is acting. Notwithstanding the
recording of any such special capacity, the Company is not bound to
investigate or incur any responsibility in respect of the proper
administration of any such estate or trust. The Company takes no notice of
any trust applicable to any of its shares whether or not it had notice of
such trust.
As an IBC, the Company may not engage in the following activities: (i)
carry on business with persons resident in the BVI except as set out in
Section 5(2) of the Act; (ii) own an interest in real property situate in the
BVI, other than a lease of property for use as an office from which to
communicate with shareholders or where books and records of the Company are
prepared and maintained; (iii) carry on a banking or trust business, unless
it is licensed under the BVI Banks and Trusts Companies Act 1990; (iv) carry
on business as an insurance or a reinsurance company, insurance agency or
insurance broker, unless it is licensed under an enactment authorizing it to
carry on that business; (v) carry on the business of company management
unless it is licensed under the BVI Company Management Act, 1990; or (vi)
carry on the business of providing a registered office or act as the
registered agent for companies incorporated in the BVI.
There are no restrictions on the degree of foreign ownership of the
Company. The Company is subject neither to taxes on its income or dividends
nor to any foreign exchange controls in the BVI. In addition, the Company is
not subject to capital gains tax in the BVI, and profits can be accumulated
by the Company, as deemed by management to be required, without limitation.
16
ITEM 7.TAXATION
The following discussion summarizes certain tax consequences to a
holder of Common Stock of the Company under present British Virgin Islands
tax laws, People's Republic of China tax laws and United States federal
income tax laws. The discussion does not deal with all possible tax
consequences relating to the Company's operations or ownership of the Common
Stock and does not purport to deal with the tax consequences applicable to
particular investors, some of which (including banks, securities dealers,
insurance companies and tax-exempt entities) may be subject to special rules.
In particular, the discussion does not address the tax consequences under
state, local and other national (i.e., non-BVI, non-PRC and non-United States
federal) tax laws. The following discussion is based upon laws and relevant
interpretations thereof in effect as of the date of this Annual Report, all
of which are subject to change.
British Virgin Islands Taxation
Under the International Business Companies Act of the British Virgin
Islands (the "International Business Companies Act") as currently in effect,
a holder of Common Stock of the Company who is not a resident of the BVI is
exempt from BVI income tax on dividends paid with respect to the Common Stock
of the Company. A holder of Common Stock of the Company is not liable for
BVI income tax on gains realized on the sale or disposal of such shares. The
BVI does not impose a withholding tax on dividends paid by the Company to its
shareholders due to its incorporation under the International Business
Companies Act.
There are no capital gains or income taxes levied by the BVI on
companies incorporated under the International Business Companies Act. In
addition, the Common Stock of the Company is not subject to transfer taxes,
stamp duties or similar charges.
There is no income tax treaty or convention currently in effect between
the United States and the BVI.
As an exempted company, the Company is required to pay the BVI
government an annual license fee based on the Company's stated authorized
capital.
PRC Taxation
The income tax rate in the PRC for Sino-foreign equity joint ventures is
governed by the Income Tax Law for Enterprises with Foreign Investment and
Foreign Enterprises and its Implementation Rules of 1991 (the "PRC Income Tax
Law"). Under the PRC Income Tax Law, the standard tax rate for Sino-foreign
equity joint ventures is 33%, comprised of a national income tax of 30% and a
local tax of 3%. The national tax rate of 30% is reduced to 15% for joint
ventures engaged in certain priority projects, including, but not limited to,
energy and transportation. The 15% tax rate also applies to joint ventures
established in one of five special economic zones and to joint ventures of a
productive nature located in one of certain economic and technological
development zones in the coastal open cities. Joint ventures which are
established in designated coastal economic development zones or in the old
urban areas of special economic zones or economic and technological
development zones and engage in productive activities are entitled to a
reduced national tax rate of 24%. The 3% local tax may also be reduced or
waived by the local government of the province or locality in which a joint
venture is located. The Operating Company does not currently benefit from
any of the aforementioned tax rate reductions.
Sino-foreign equity joint ventures engaged in productive activities and
which have a term of at least 10 years, such as the Operating Company, are
exempt from income tax for their first two profitable years and are entitled
to a 50% reduction of the otherwise applicable income tax rate during the
subsequent three-year period.
United States Federal Income Taxation
Taxation of Shareholders
The following discussion addresses certain of the U.S. federal income
tax consequences to a United States person (i.e., a citizen or resident of
17
the United States, a corporation, partnership or other entity created or
organized under the laws of the United States or any political subdivision
thereof, an estate the income of which is subject to United States income
taxation regardless of its source or a trust if a court within the United
States is able to exercise primary supervision over the administration of the
trust and one or more U.S. fiduciaries have the authority to control all
substantial decisions of the trust (a "U.S. Investor") who is a holder of
Common Stock. The following discussion does not address the U.S. federal
income tax treatment applicable to certain types of investors (e.g., dealers
in securities or currencies, financial institutions, life insurance
companies, tax-exempt organizations and holders of 10% or more of the Common
Stock of the Company) or to persons other than U.S. Investors, all of whom
may be subject to tax rules that differ significantly from those summarized
below. The summary of U.S. federal income taxation deals only with Common
Stock held as a capital asset by U.S. Investors whose "functional currency"
is the United States dollar. If a U.S. Investor holds its Common Stock
through a foreign branch or other foreign business unit, the following
discussion may not be accurate in all respects as to such investor. In
addition, future changes to U.S. federal income tax laws could have an effect
on the U.S. federal income tax consequences of the purchase, ownership and
disposition of Common Stock.
A U.S. Investor receiving a distribution in respect of the Common Stock
will be required to include such distribution in gross income as a taxable
dividend to the extent such distribution is paid from earnings and profits of
the Company as determined under U.S. federal income tax law. A distribution
in excess of the earnings and profits of the Company first will be treated,
for U.S. federal income tax purposes, as a nontaxable return of capital to
the extent of the U.S. Investor's basis in the Common Stock, and to the
extent in excess of such basis, as capital gain. Any amount treated as a
dividend for U.S. federal income tax purposes generally will constitute
foreign source "passive income" (or, in the case of certain holders,
"financial services income") and will not be eligible for the dividends
received deduction generally allowed to corporate shareholders. Except for
corporations that own 10% or more of the Common Stock of the Company, no
shareholder will be entitled to claim a foreign tax credit against U.S.
federal income tax for any tax paid by the Company or any entity in which
the Company invests, directly or indirectly. For reporting purposes, any
dividends that are paid in any currency other than U.S. dollars must be
translated into U.S. dollars at the spot rate on the date the dividends are
distributed by the Company, regardless of whether the dividend received is in
fact converted into U.S. dollars.
With certain exceptions, gain or loss on the sale or exchange of the
Common Stock will be treated as capital gain or loss. Such capital gain or
loss will be long-term capital gain or loss if the U.S. Investor has held the
Common Stock for more than one year at the time of the sale or exchange. In
general, gains realized upon the disposition of Common Stock will be U.S.
source gain for U.S. federal income tax purposes. Under existing
authorities, it is unclear whether a loss on the sale of Common Stock would
be treated as U.S. source or foreign source income for U.S. federal income
tax purposes.
Various provisions contained in the Internal Revenue Code of 1986, as
amended (the "Code") impose special taxes in certain circumstances on
non-U.S. corporations and their shareholders. The following is a summary of
certain provisions that could have an adverse impact on the Company and its
U.S. Investors.
Personal Holding Companies
Sections 541 through 547 of the Code relate to the classification of
certain corporations (including foreign corporations) as personal holding
companies ("PHCs") and the consequent taxation of such corporations on
certain of their U.S. source income (and certain types of foreign source
income which are effectively connected with the conduct of a U.S. trade or
business) to the extent amounts at least equal to such income are not
distributed to their shareholders. A PHC is a corporation (i) more than 50%
of the value of the stock of which is owned, directly or indirectly, by five
or fewer individuals (without regard to their citizenship or residence), and
(ii) which, if a foreign corporation, receives 60% or more of such U.S.-
related gross income, as specifically adjusted, from certain passive sources
(such as dividends, interest, royalties or rents). If the Company is
classified as a PHC, a tax will be levied at the rate of 39.6% on the Company's
undistributed U.S. taxable income.
18
Foreign Personal Holding Companies
Sections 551 and 558 of the Code relate to foreign personal holding
companies ("FPHCs") and impute undistributed income of certain foreign
corporations to U.S. persons who are shareholders of such corporations. A
foreign corporation will be classified as a FPHC if (i) five or fewer
individuals, who are U.S. citizens or residents, directly, indirectly or
constructively own more than 50% of the corporation's stock (measured either
by voting power or value) (the "shareholder test") and (ii) the corporation
receives 60% (50% for subsequent years) or more of its gross income
(regardless of source), as specially adjusted, from certain passive sources
(the "income test").
If the Company is classified as a FPHC after applications of the
shareholder test and the income test, a U.S. Investor may be required to
include in income a constructive dividend equal to its pro rata share of the
Company's "undistributed foreign personal holding company income" for that
year whether or not such amounts were actually distributed by the Company.
Various other adverse consequences will also result if the Company is
treated as a FPHC including, for example, denial of basis step-up on the
death of a holder of Common Stock.
Controlled Foreign Corporations
Sections 951 through 964 and section 1248 of the Code relate to
controlled foreign corporations ("CFCs") and impute undistributed income to
certain shareholders and convert into dividend income gains on dispositions
of shares which would otherwise qualify for capital gains treatment. A
corporation will be classified as a controlled foreign corporation if U.S.
persons who own, directly or indirectly, 10% or more of the Common Stock of
the Company ("10% Shareholders"), own, in the aggregate, more than 50%
(measured by voting power or value) of the shares of a foreign corporation.
In the event the Company is classified as a CFC, all U.S. Investors that
own 10% or more of the Common Stock of the Company will be subject to
taxation under Subpart F of the Code, including possible taxation of such U.S.
Investors based on certain income of the Company even in the absence of
distributions of such income by the Company.
Passive Foreign Investment Companies
A foreign corporation is classified as a "passive foreign investment
company" (a "PFIC") for United States federal income tax purposes if either
(i) 75% or more of its gross income in a taxable year is passive income or
(ii) the average percentage of its assets by value during a taxable year
which produce or are held for the production of passive income is at least
50% of the average fair market value of all of the Company's assets for such
year. For the purpose of the PFIC tests, if a foreign corporation owns
directly or indirectly at least 25% by value of the stock of another
corporation, the foreign corporation is treated as owning its proportionate
share of the assets of the other corporation, and as if it had received
directly its proportionate share of the income of such other corporation.
The effect of this special provision with respect to the Company and its
direct and indirect ownership of its subsidiaries is that the Company, for
purposes of the income and assets test described above, will be treated as
owning directly its proportionate share of each of those companies' income,
if any, so long as the Company owns, directly or indirectly, at least 25% by
value of the particular company's stock. Active business income of the
Company's subsidiaries will be treated as active business income of the
Company, rather than as passive income.
If the Company were to be classified as a PFIC, a U.S. Investor would be
subject to various adverse U.S. tax consequences. Such adverse consequences
include an interest charge on taxes deemed deferred by them on receipt of
certain "excess" dividend distributions by the Company to the U.S. Investor
and on realization of gain on disposition of any of the Common Stock owned
by the U.S. Investor (all of which distributions and gains would be taxable
as ordinary income), or if a U.S. Investor were to so elect to, and the
Company were to agree to comply with certain reporting requirements, such U.S.
Investor currently would be taxable on such U.S. Investor's pro rata share of
the Company's ordinary earnings and profits and long-term capital gains for
each year (at ordinary income or capital gains rates, respectively), even if
no dividend distributions were received.
United States Backup Withholding
19
A holder of Common Stock of the Company may be subject to "backup
withholding" at the rate of 31% with respect to dividends paid on such
Common Stock if such dividends are paid by a paying agent, broker or other
intermediary in the United States or by a U.S. broker or certain United
States-related brokers to such holder outside the United States. Actual
backup withholding may be avoided by the holder of Common Stock of the Company
if such holder (i) certifies its status as a non-U.S. holder under penalties
of perjury or otherwise establishes an exemption or (ii) provides a correct
taxpayer identification number, certifies that such holder is not subject to
backup withholding and otherwise complies with the backup withholding rules.
Any amounts withheld under the backup withholding rules from a payment
to a holder will be refunded (or credited against the holder's U.S. federal
income tax liability, if any) provided that the required information is
furnished to the United States Internal Revenue Service.
ITEM 8. SELECTED FINANCIAL DATA
Summary Financial and Operating Data
The selected information set forth below should be read in conjunction
with, and is qualified in its entirety by reference to, the consolidated
financial statements of the Company and the financial statements of CCM and
MCCH included in this Annual Report. The Company prepares its financial
statements in accordance with U.S. GAAP.
The Company was incorporated for the sole purpose of holding 100% of
the capital stock of CCM and being the surviving entity of the merger with
JHC. The selected consolidated pro forma financial information of CCM for
1995 set forth below is based on the assumption that CCM had been formed on
and owned its 80% interest in the Operating Company on and as of January 1,
1995. The Operating Company is a Sino-foreign equity joint venture company
which succeeded to the business of MCCH. MCCH owned and operated two
production factories: MCCF and QCCF. The figures below reflect primarily the
financial operating results of MCCF and QCCF.
20
<TABLE>
The Company:
<CAPTION>
Actual Actual Pro-Forma Actual Actual
Pre-Joint Post-Joint Year Year Year
Venture Venture Ended Ended Ended
Period 1995 Period 1995 12/31/95 12/31/96 12/31/97
(unaudited)(1) (audited)(2) (unaudited)(3) (audited)(5) (audited)(5)
(amounts in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Consolidated Statement of
Operations Data:
Net sales $ 5,896 $ 2,050 $ 7,946 $ 7,801 $9,053
Subcontracting income 0 0 0 723 362
Cost of sales (4,121) (1,115) (5,272) (5,584) (5,516)
------- ------ ------ ------ ------
Gross profit 1,775 935 2,674 2,940 3,899
Selling, general and
administrative expenses ( 796) ( 314) ( 736) ( 961) (4,921)
Write off of advances to
related parties 0 0 0 0 (1,768)
------- ------ ------ ------ -------
Operating income/(loss) 979 621 1,938 1,979 (2,790)
Interest expenses (154) (198) (526) (422) (1,056)
Other income/(expenses) 16 10 30 46 (190)
-------- ------ ------ ------ -------
Income before income taxes
and minority interest 841 433 1,442 1,603 (4,036)
Income tax 0 0 0 0 0
------- ------ ------ ------ -------
Income before minority
interest 841 433 1,442 1,603 (4,036)
Minority interest 0 (87) ( 288) ( 345) 494
------- ------ ------- ------- -------
Net income $ 841 $ 346 $ 1,154 $ 1,258 $(3,542)
Earnings per share (4) - $0.346 $ 1,154 $ 0.66 $(1.18)
Dividends per share - - - - -
Weighted average number of
shares outstanding (4) - 1 1 1,918 2,994
Consolidated Balance Sheet
Data (at period end):
Working capital 6,289 14,706 N/A 1,804 (4,447)
Total assets 16,058 24,814 N/A 28,833 27,393
Total long-term debts 1,564 4,364 N/A 5,369 4,761
Minority interest 0 2,109 N/A 2,377 1,739
Shareholders' equity 4,725 8,233 N/A 12,156 7,582
Consolidated Cash Flow
Statement Data:
Net cash provided by/(used in)
operating activities 91 611 N/A 1,953 (3,704)
Net cash used in
investment activities 899 7,968 N/A 1,028 1,250
Net cash provided by
financing activities 760 7,578 N/A 3,802 773
Additions to property, plant
and equipment 899 123 N/A 1,028 997
Depreciation 357 130 N/A 863 643
Statistical Data:
Gross margin 30.1% 45.6% 33.7% 28.4% 39.1%
Operating margin 16.6% 30.3% 24.4% 16.1% (30.8)%
</TABLE>
21
(1) See Statement of Operations of MCCH for the nine months ended September 30,
1995.
(2) See Consolidated Statement of Operations of the Company for the period
from August 18, 1995 to December 31, 1995.
(3) See Unaudited Pro Forma Consolidated Statement of Operations of CCM for
the year ended December 31, 1995. Pursuant to a joint venture agreement
dated September 16, 1995, CCM acquired an 80% interest in MHXC. The
selected unaudited pro forma financial information has been prepared based
upon the historical financial statements of MCCH as if the acquisition of
CCM's interest had occurred on January 1, 1995.
(4) The calculation of actual earnings per share of Common Stock for 1997 and
1996 are based on the weighted average number of shares outstanding during
the year ended December 31, 1997 and 1996, whereas the calculation of pro
forma earnings per share for 1995 is based on the pro forma number of common
shares outstanding for CCM.
The pro forma assumptions and adjustments made for the pro forma 1995
Statement of Operations include the following:
(a)The acquisition of CCM by the Company and the acquisition of the 80%
interest in MHXC by CCM were assumed to have occurred on January 1, 1995.
(b)The Company did not have any revenues except for those attributed to
its 80% consolidated interest in MHXC.
(c)MXHC will be entitled to the tax exemptions granted under the current
tax regulations of Sino-foreign equity joint venture enterprises.
(d)Provision for amortization of the land use rights acquired on the
formation of the MXHC joint venture.
(e)Minority interest of 20% in the earnings of MHXC was recorded.
(5) See Consolidated Statement of Operations of the Company for the year
ended December 31, 1997 and 1996.
22
Following are certain operating results, set forth separately, of the Company,
MCCF and QCCF. These operating results form the basis for the Consolidated
Statement of Operations Data for the Company.
<TABLE>
The Company:
<CAPTION>
Pro Forma Actual Actual
Year Ended Year Ended Year Ended
12/31/95 12/31/96 12/31/97
(expressed in thousands)
<S> <C> <C> <C>
Statement of Operations Data
(Unconsolidated)
Net Sales $ - $ 0 $ 0
Cost of sales - 0 0
------ ------- ------
Gross profit - 0 0
Selling, general and administrative
expenses - (96) (953)
------ ------- ------
Operating income - (96) (953)
Interest expenses - (47) (483)
Other expenses - 0 (199)
------ ------- ------
Income before income taxes and
minority interest - (143) (1,635)
Income tax - 0 0
------ ------- ------
Income before minority interest - (143) (1,635)
Minority interest - 0 0
------ ------- ------
Net income $ - $ (143) $ (1,635)
</TABLE>
<TABLE>
MCCF:
<CAPTION>
Pro Forma Actual Actual
Year Ended Year Ended Year Ended
12/31/95 12/31/96 12/31/97
(expressed in thousands)
<S> <C> <C> <C>
Statement of Operations Data
(Unconsolidated)
Net Sales $ 1,894 $ 259 $ 1,313
Subcontracting income 0 723 362
Cost of sales (1,267) (684) (1,559)
-------- ------- --------
Gross profit 627 298 116
Selling, general and administrative
expenses (313) (309) (2,116)
-------- ------- --------
Operating income 314 (11) (2,000)
Interest expenses (292) (127) (433)
Other income 17 0 24
------- ------- --------
Income before income taxes and
minority interest 39 (138) (2,409)
Income tax 0 0 0
------- ------- --------
Income before minority interest 39 (138) (2,409)
Minority interest (8) 28 495
------- ------- --------
Net income $ 31 $ (110) $ (1,914)
</TABLE>
23
<TABLE>
QCCF:
<CAPTION>
Pro Forma Actual Actual
Year Ended Year Ended Year Ended
12/31/95 12/31/96 12/31/97
(expressed in thousands)
<S> <C> <C> <C>
Statement of Operations Data
(Unconsolidated)
Net Sales $ 6,052 $ 7,542 $ 7,740
Cost of sales (4,005) (4,900) (3,957)
------- ------- -------
Gross profit 2,047 2,642 3,783
Selling, general and administrative
expenses (423) (556) (1,852)
Write off of advances to related
parties 0 0 (1,768)
------ ------- -------
Operating income 1,624 2,086 163
Interest expenses (230) (248) (140)
Other income/(expenses) 9 46 (15)
------ ------- -------
Income before income taxes and
minority interest 1,403 1,884 8
Income tax 0 0 0
------ ------- -------
Income before minority interest 1,403 1,884 8
Minority interest (280) (373) (1)
------ ------- -------
Net income $ 1,123 $ 1,511 $ 7
</TABLE>
<TABLE>
Operating Company:
<CAPTION>
Production Mix and sales Volume
1995 1996 1997
(expressed in thousands)
<S> <C> <C> <C>
Metallurgical coke:
Sales volume 33,000 6,758 21,783
Average sales price per ton $ 57.39 $ 38.32 $ 41.73
Average production cost per ton $ 38.39 $101.21 $ 55.86
Low-end metallurgical coke:
Sales volume - - 39,226
Average sales price per ton - - $ 10.30
Average production cost per ton - - $ 8.72
Steam coal:
Sales volume 390,000 475,305 396,627
Average sales price per ton $ 15.52 $ 15.86 $ 19.52
Average production cost per ton $ 10.27 $ 10.31 $ 9.98
</TABLE>
Exchange Rate Information
<TABLE>
The following table sets forth the applicable exchange rate used for the
presentation of financial information in this Annual Report and in the
financial statements presented herein:
<CAPTION>
Period Ended Exchange Rate
<S> <C>
September 30, 1995 US$1.00 = Rmb8.3175
December 31, 1995 US$1.00 = Rmb8.3179
December 31, 1996 US$1.00 = Rmb8.2982
December 31, 1997 US$1.00 = Rmb8.2798
</TABLE>
24
ITEM 9. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CCM, which was incorporated on August 18, 1995, entered into the joint
venture which created the Operating Company on September 16, 1995. The
Company was subsequently incorporated on March 15, 1996 to be the sole
shareholder of CCM. All of the Company's operations are conducted through
its operating subsidiary, CCM, and in turn through CCM's interest in the
Operating Company. As a result, the Company's operations and financial
condition depend entirely upon the Operating Company's results of operations
and financial condition.
References to the Company for the year ended 1997 and 1996 are to the
consolidated results of CCM and the Company. References to the Operating
Company for the year ended 1995 are to the consolidated results of the
Operating Company.
The Operating Company has two wholly-owned coal refining operations,
MCCF and QCCF. The Operating Company derives its revenues principally from
two lines of business within the PRC's coal industry: (1) the production and
sale of metallurgical coke to steel mills and machinery manufacturers; and
(2) the production and sale of steam coal to power plants, with all of such
sales to customers located in the PRC.
MCCF
MCCF engages primarily in the production and sale of metallurgical coke.
MCCF completed its steam coal preparation facility in 1993. Subsequently, in
1995, MCCF completed construction of an additional production facility to
process steam coal into metallurgical coke and foundry coke. This facility
has been designed for annual production capacities of approximately 200,000
tons of steam coal, approximately 85,000 tons of metallurgical coke and
approximately 56,000 tons of foundry coke. Improvements to the facility,
which cost approximately $3,000,000, were financed through an unsecured loan
by a local PRC bank at a fixed term rate of 15.3%. These improvements
enabled MCCF to produce metallurgical coke and foundry coke which it was
unable to do prior to such improvements. Presently, the main product of the
MCCF plant is metallurgical coke.
On June 20, 1995, the Mishan City Municipal Government granted MCCF
exclusive underground rights to mine coal from certain coal reserves located
in Mishan City, within Heilongjiang Province, PRC. MCCF's mining rights
were granted on June 20, 1995 and continue in force for 100 years. MCCF is
not presently involved in the mining of these reserves due to the lack of
funds available for this purpose. MCCF has been engaged in conducting mine
site surveys, clearing the surface of potential mine entrance sites,
performing geological surveys and preparing mining plans. The Company
believes that these activities will enable MCCF to begin its mining
operations as soon as practicable after sufficient funds are available. The
costs associated with mining preparation work have been capitalized as part
of MCCF's coal mine use rights.
QCCF
QCCF engages in the production and sale of steam coal. The QCCF factory
was constructed in 1993 and employs the "air-heavy medium fluid bed" dry
process of coal preparation, which management believes is a leading
production technology worldwide and is appropriate for production in cold and
dry regions such as the region where QCCF's factory is located. QCCF's annual
production capacity is approximately 750,000 tons of steam coal and the
factory operated at 53% of capacity in 1997.
25
Results of Operations
1997 Compared to 1996
Net Sales. Net Sales is recorded as gross sales less returns and
discounts. Net sales increased from $7,801,000 in 1996 to $9,053,000 in 1997.
MCCF's sales increased 407% from $259,000 in 1996 to $1,313,000 in 1997.
Net sales of metallurgical coke increased 251% from $259,000 in 1996 to
$909,000 in 1997 while volume increased 222% from 6,758 tons in 1996 to
21,783 tons in 1997. The average unit sales price of metallurgical coke
increased from $38.32 per ton in 1996 to $41.73 per ton in 1997 because the
increase in production improved the quality of product. Upon the receipts of
working capital in March of 1997, MCCF terminated the subcontracting
agreement with a unrelated party. MCCF resumed the operations and production
of metallurgical coke. MCCF produced low-end metallurgical coke as an
additional coke product in order to increase revenue and fill backlog orders.
In order to alleviate the immediate transportation capacity problems in 1997,
MCCF sold 10,466 tons of metallurgical coke at the production point to the
subcontracting party which in turn sold to its customers using its own
transportation capacity.
The subcontracting agreement between MCCF and an unrelated party
entered in June of 1996 was continued until March of 1997. According to this
agreement, the subcontracting party (i) operated the coal production plant
(ii) was obligated to meet all of the operating expenses of the plant, (iii)
was entitled to receive all of the revenues from the plant's operation and
(iv) paid to MCCF a subcontracting fee of $723,000 in 96 and $362,000 in
1997, which MCCF was not able to collect $362,000 in 1997 due to the death of
Chairman of the Company.
QCCF's sales of steam coal increased 2.6% from $7,542,000 in 1996 to
$7,740,000 in 1997. Coal sales volume decreased 17% from 475,305 tons in
1996 to 396,627 tons in 1997. The average net sales price increased from
$15.86 per ton in 1996 to $19.52 per ton in 1997. The decrease in sales
volume was mainly due to the shortage of transportation capacity in May 1997.
The local government utilized the majority of transportation capacity to
transport agricultural products because the harvest was better than expected.
The transportation capacity was still in short supply during the remaining
year. Although QCCF sold approximately 78,678 tons less steam coal in 1997
when compared to 1996, its sales price increased due to stricter quality
control and testing which resulted in higher customer satisfaction and fewer
discounts and rebates. Sales to its major customer, Mudanjiang No. 2 Power
Plant amounted to 327,743 tons in 1997 as compared to 390,890 tons in 1996.
Such decrease was due to a shortage of transportation capacity.
Cost of sales. The cost of coal sales includes the cost of raw
materials, direct labor and benefits, depreciation, transportation and
manufacturing overhead.
MCCF's average unit cost of producing metallurgical coke decreased 45%
from $101.21 in 1996 to $55.86 in 1997 due to economy of scale arising from
increased production volume of metallurgical coke. The average unit cost
of producing low-end metallurgical coke was $8.72 in 1997.
QCCF's average unit cost of producing steam coal decreased slightly from
$10.31 in 1996 to $9.98 in 1997 due to reclassification of selling expenses
from cost of sales in 1996 to selling, general and administrative expenses
in 1997. Selling expenses amounted to $392,000 in 1997.
Gross Profit. Gross profit increased 33% from $2,940,000 in 1996 to
$3,899,000 in 1997. The increase was primarily attributable to (1) MCCF's
gross profit on sales of coke products increased by 42% as the production and
sales increased by 407% and (2) QCCF `s gross profit increased by 43% due to
increase in average sales price. The increase was partially offset by the
decrease in subcontracting income from $723,000 in 1996 to $362,000 in 1997.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased 412% to $4,921,000 in 1997 from $961,000 in
1996. The increase of $3,960,000 is mainly attributable to the following
factors:
26
(1) In 1997, MCCF increased its write-off of trade receivables and
subcontracting income in the amount of $1,556,000 due to poor credit
management and collection efforts. Salaries and selling expenses increased
by $416,000 due to increase in selling effort in 1997. (2) QCCF increased
its $311,000 write off of trade and other receivables; increased its loss of
$152,000 on retirement of certain transportation vehicles. Salaries and
benefits increased by $193,000. Selling expenses increased by $392,000 which
was included in cost of sales in 1996. The Company has opened a
representative office in Heilongjiang in 1997 which increased the office
expenses by $337,000 in 1997 when compared to 1996. (4) The Company
incurred additional approximately $432,000 in professional and administrative
expenses associated with increased reporting obligations of the Company as
the Company is a public entity. There was $88,000 additional amortization of
issuance cost when compared to 1996 due to additional financing closed in
early 1997.
Write off of advances to related parties. In 1997 advances totalling
$1,768,000 were made under the authority of the former chairman of the
Company to the former owner of QCCF which were intended to establish
relationships for potential future business opportunities. As the terms of
the repayment of the advances were unclear, with the death of the Company's
former Chairman, management believes that its ability to realize the advances
has been severely impaired and, accordingly, the amounts have been written
off in 1997. Management is in the process of negotiating with the former
owner of QCCF (an instrumentality of the PRC government) for transfer of
title to certain assets to the Company in the satisfaction of the advances.
The outcome of these negotiations is uncertain at the present time.
Interest expenses. Interest expenses was reported net of interest
income.
Interest income increased by $44,000 from $11,000 in 1996 to $55,000 in
1997.
Interest expenses increased 157% from $433,000 in 1996 to $1,111,000 in
1997. The increase of $678,000 was attributable to the following factors:
(1) The Company incurred additional $480,000 interest expenses on the
$6,122,500 convertible notes; (2) increase in MCCF's interest expenses of
$306,000 as the local bank and one lender did not waive the interest for
1997 whereas they did in 1996. The increase was offset by a decrease in
QCCF interest expenses of $108,000 as average borrowing rate decreased from
18% in 1996 to 9.5% in 1997 and QCCF repaid loan of $648,000 on March 31,
1997 which also reduced QCCF interest expenses. The Operating Company's
average short-term borrowing rate was 17% in 1996 and 13% in 1997, whereas
the long-term borrowing rate was fixed at 14% for both 1996 and 1997.
Commencing October 1, 1995, the Mishan City government agreed to share
one-half of the interest owed by MCCF on certain long-term interest bearing
loans. The government's share of interest expenses was $150,000 in 1997 and
$197,000 in 1996. This agreement was expired on December 31, 1997. Interest
expense in the amount of $341,000 was imputed for the year ended December 31,
1997 on the interest free loan from CCM's joint venture partner at the rate
of 16% per annum. Such interest was capitalized as part of MCCF's coal mine
use rights.
Other expenses. In 1997 the former Chairman of the Company withdrew
fund in an amount totalling $285,562 from MHXC without the authority of the
Company. The Chairman died in October 1997 and the Company has been seeking
to recover these amounts from his estate and family. The Company has
recorded an expense of $184,000 in "other expense" representing the amounts
not yet recovered.
Income taxes. Substantially all of the Company's current profits
accrue in the PRC where the applicable tax rate is currently 33%. However,
pursuant to the PRC Income Tax Law, the Operating Company is exempt from
income tax for its first two profitable years. This two-year "tax holiday"
was to begin with the first profitable year of the Operating Company,
measured from its formation on September 16, 1995. For the following three
years, the Operating Company will pay income tax at a rate of one-half of the
then current tax rate. There is no tax payable in the British Virgin Islands
on dividends paid to CCM and the Company by any of their subsidiaries or
factories. Therefore, there was no provision for income tax for the year
ended December 31, 1997 and 1996.
27
Net Income. The Company incurred a net loss of ($3,542,000) in 1997 as
compared to a net income of $1,258,000 in 1996. The decrease in earnings of
$4,800,000 was mainly attributable to: (1) the increase in the write off of
uncollectible receivable and other assets of $2,019,000; (2) increase in net
interest expenses of $634,000; (3) increase in selling, general and
administration of $857,000 attributable to additional Heilongjiang
representative office, additional professional expenses relates to public
filing and additional financing activities; (4) increase in selling expenses,
salary and benefits in the Operating Company of $1,001,000; (5) additional
expenses due to unauthorized payment withdrawn by deceased Chairman in the
amount of $184,000; (6) additional writes off of $1,768,000 made to the former
owner of QCCF; and (7) decrease in subcontracting income of $361,000. The
decrease in net income was partially offset by the increase in gross profit
attributable from the increase in sale of metallurgical and steam coal in the
amount of 1,320,000 and decrease in minority interest of $839,000.
1996 Compared to Pro Forma 1995
Net Sales. Net Sales is recorded as gross sales less returns and
discounts. Net sales remained essentially unchanged at $7,801,000 in 1996 as
compared to net sales of $7,946,000 in 1995.
MCCF's sales of metallurgical coke decreased 86% from $1,894,000 in 1995
to $259,000 in 1996. Coal sales volume decreased 80% from 33,000 tons in
1995 to 6,758 tons in 1996. The average net sales price decreased from
$57.39 per ton in 1995 to $38.32 per ton in 1996. The reductions in both
sales volume and sales price were due to MCCF's lack of working capital for
the production of metallurgical coke in 1996. MCCF's small sales volume in
1996 was generated from sales of inventory produced in 1995 and from the
sale of below standard metallurgical coke which was generated from efforts to
maintain the MCCF production facility in operational condition. As a result,
the unit sales price and the quality of MCCF's coke decreased when compared
to 1995. In June 1996, operation of the MCCF plant was subcontracted to
a third party. According to the subcontract, the party which operated the
plant (i) was obligated to meet all of the operating expenses of the plant,
(ii) was entitled to receive all of the revenues from the plant's operation
and (iii) paid to MCCF a subcontracting fee of $723,000. This subcontract
was terminated on March 31, 1997.
QCCF's sales of steam coal increased 25% from $6,052,000 in 1995 to
$7,542,000 in 1996. Coal sales volume increased 22% from 390,000 tons in
1995 to 475,305 tons in 1996. The average net sales price increased
moderately from $15.52 per ton in 1995 to $15.86 per ton in 1996. The
increases in both sales volume and sales price were mainly attributable
to the following factors: (1) the improved technological application of the
"air-heavy medium fluid bed" dry process of coal preparation which enhanced
the efficiency of QCCF's production process and improved the quality of the
coal produced; (2) stricter quality control of coal inspection and testing
processes which resulted in fewer returns and higher prices and (3)
increased demand from QCCF's major customer, Mudanjiang No. 2 Power Plant.
Sales to Mudanjiang amounted to 390,890 tons in 1996, representing an
increase of 78,861 tons, or 25%, as compared to 1995. Approximately 80% of
the Operating Company's MCCF's sales were made to Mudanjiang in 1996 as
compared to 70% in 1995.
Cost of sales. The cost of coal sales includes the cost of raw
materials, direct labor and benefits, depreciation, transportation and
manufacturing overhead.
MCCF's cost of sales decreased 46% from $1,267,000 in 1995 to $684,000
in 1996. The decrease was mainly attributable to: (1) MCCF's decreased sales
volume; (2) additional depreciation expenses of $384,000 incurred in 1996 for
the production facility and (3) fixed manufacturing overhead costs which
could not be completely eliminated in 1996. These fixed costs included water
and electricity, indirect labor and the cost of materials which were needed
to maintain the coal production facility in operational condition.
QCCF's cost of sales increased 22% from $4,005,000 in 1995 to $4,900,000
in 1996. The increase was primarily attributable to: (1) QCCF's increase in
sales volume of 85,305 tons and (2) increases in raw material prices and
transportation costs per unit of production. The increase was partially
offset by decreases in labor and manufacturing overhead costs per unit of
production which resulted from production economies of scale.
Gross Profit. Gross profit increased 10% from $2,674,000 in 1995 to
$2,940,000 in 1996 due to an increase of 29% in gross profit generated by
28
QCCF, offset by a decrease of 52% in gross profit for MCCF. MCCF's gross
profit decreased from 1995 to 1996 due to its lack of working capital for the
production of metallurgical coke. QCCF's gross profit increased from 1995 to
1996 primarily as a result of an increase in sales of steam coal.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased 31% to $961,000 in 1996 from $736,000 in
1995. The increase of $225,000 is attributable to (1) QCCF's proportionate
increase of such expenses as its sales increased; (2) $96,000 of additional
travel and professional expenses incurred at the Company level in connection
with the issuance of the Notes and Warrants and expenses associated with
increased reporting obligations of the Company. These increases were offset
only slightly by a marginal reduction in MCCF's selling, general and
administrative expenses as the MCCF plant conducted minimal production and
selling activities in 1996.
Interest expenses. Interest expenses decreased 18% from $526,000 in 1995
to $433,000 in 1996. The decrease of $93,000 was attributable to the
following factors: (1) a local bank granted a one-time waiver of
approximately $166,000 in interest expenses owed by MCCF in 1996; (2) QCCF
incurred an additional $15,000 in interest expenses as its average short-term
borrowing increased during 1996 and (3) the Company incurred $58,000 in
additional interest expenses in 1996 as interest on the Notes. The Operating
Company's average short-term borrowing rate was 17% in 1995 and 1996, whereas
the long-term borrowing rate was fixed at 14% for both 1995 and 1996.
Commencing October 1, 1995, the Mishan City government agreed to share
one-half of the interest owed by MCCF on certain long-term interest bearing
loans. The government's share of interest expenses increased from $50,000 in
1995 to $197,000 in 1996. This agreement expires on December 31, 1997.
interest expense in the amount of $458,000 was imputed for the year ended
December 31, 1996 on the interest free loan from CCM's joint venture partner
at the rate of 16% per annum. Such interest was capitalized as part of
MCCF's coal mine use rights.
Income taxes. Substantially all of the Company's current profits
accrue in the PRC where the applicable tax rate is currently 33%. However,
pursuant to the PRC Income Tax Law, the Operating Company is exempt from
income tax for its first two profitable years. This two-year "tax holiday"
was to begin with the first profitable year of the Operating Company,
measured from its formation on September 16, 1995. For the following three
years, the Operating Company will pay income tax at a rate of one-half of the
then current tax rate. There is no tax payable in the British Virgin Islands
on dividends paid to CCM and the Company by any of their subsidiaries or
factories. Therefore, there was no provision for income tax for the year
ended December 31, 1996 and for the period from September 16, 1995 to
December 31, 1995. For the period from January 1, 1995 to September 15, 1995,
no provision for income tax was made because QCCF was exempted from income
tax under an agreement with its previous owner and MCCF was operating at a
loss during its construction and product testing period.
Net Income. Net income before minority interest increased 9% from
$1,154,000 in 1995 to $1,258,000 in 1996. The $104,000 increase in earnings
was attributable to: (1) the increase of $1,490,000 in sales of steam coal by
QCCF; (2) the subcontracting fee of $723,000 earned by MCCF and (3) certain
interest expenses forfeited or shared by local banks and the Mishan City
government. The increase attributed to these factors was substantially
offset by MCCF's decrease in sales of metallurgical coke of $1,635,000 and
PRC expenses incurred by the Company in connection with the issuance of the
Notes and Warrants.
Liquidity and Capital Resources
As a holding company, the Company's only sources of cash flow are
dividends, if any, paid by the Operating Company and retained net proceeds
from its Regulation S offerings of securities. The Company believes that such
sources of cash flow are sufficient to fund its operating expenses currently.
See "Financing Activities."
Since the completion of the Regulation S offerings in early 1997. The
Company has applied $2,014,000 out of the net proceeds of $5,400,000 to MCCF
primarily for its working capital needs. MCCF purchased raw coal and applied
in other working capital needs to ramp sales and production during the month
of April and November of 1997. Unfortunately, due to poor credit management,
MCCF was not able to collect $1,556,000 of its trade receivables and
subcontracting income. This created a severe cash flow problem for MCCF at
the end of 1997. MCCF's average receivable turnover deteriorated from 135
29
days in 1996 to 313 days in 1997. As a result of the unwillingness of the
local banks and raw coal suppliers to provide credit, MCCF ceased its
operations in March of 1998 and its coking facilities are no longer in
operational mode due to lack of working capital to maintain the minimum
operational condition.
QCCF has generally satisfied its working capital requirements, capital
expenditures and scheduled debt repayments from its operating cash flows.
QCCF average receivable turnover deteriorated from 37 days in 1996 to 73 days
in 1997 because its major customer Mudanjiang No. 2 Power Plant's management
performed the reform in the end period of 1997 and QCCF gave the customer
some credit convenience and did not request the customer to effect the due
payment at the year end. Therefore, QCCF increased its bank loans of $2.6
million in November-December 1997. As of December 31, 1997, QCCF had $3.5
million in short-term loans and no long-term debt. Management believes that
cash generated from operations will continue to be sufficient to meet QCCF's
working capital requirements, planned or anticipated capital expenditures,
scheduled debt repayments and other financial commitments.
Capital Expenditures
Capital expenditures of the Company amounted to $997,000 in 1997, which
mainly represented continued expenditures to modernize its older coal
production facility, improve productivity, purchase equipment, and replace
the transportation equipment and build up the transportation system of QCCF.
The Operating Company does not expect significant capital expenditure in 1998.
Financing Activities
In November 1996, the Company raised net proceeds of approximately
$4,500,000 through an offering of convertible notes and warrants in an exempt
transaction pursuant to Regulation S under the 1933 Act. Subsequently, in
January 1997, the Company raised net proceeds of approximately $900,000 in a
follow-on offering of convertible notes and warrants (on the same terms as
the November 1996 offering) in another exempt transaction pursuant to
Regulation S under the 1933 Act. The convertible notes and the warrants are
referred to hereinafter as the "Notes" and the "Warrants." The aggregate
principal amount of Notes issued in the November 1996 and January 1997
offerings was $6,122,500. Based on a conversion price of $3.50 per share of
Common Stock, the Notes were convertible at the time of issuance into an
aggregate of 1,749,293 shares of Common Stock. In connection with the
purchase of a Note, each purchaser was issued Warrants exercisable for the
same number of shares of Common Stock into which such purchaser's Note was
convertible. Including Warrants issued in payment of offering-related fees,
the Company issued Warrants exercisable for an aggregate of 1,894,150 shares
of Common Stock based on an exercise price of $3.50 per share of Common Stock
at the time of issuance. As of June 30, 1998, Notes in the aggregate
principal amount of $3,237,500 remained outstanding and Warrants to purchase
an aggregate of 1,894,150 shares of Common Stock remained outstanding (based
on the initial conversion price of $3.50 per share).
The Notes bear interest at 8% per annum and the outstanding principal
amount of the Notes and any accrued and unpaid interest thereon are payable
on the maturity date of November 14, 2001. The Warrants became exercisable
to purchase shares of Common Stock on May 14, 1997 and expire on November 14,
1999. The exercise price per share for the Warrants is the same as the
conversion price in effect at such time for the Notes. See "Item 12. Options
to Purchase Securities from Registrant or Subsidiaries."
The proceeds from the offerings are being used primarily as follows:
$2,014,000 for purchase of raw coal and working capital of MCCF, $648,000 for
bank loan repayment in QCCF, $1,268,000 for loan to the former owner of QCCF
government, and $337,000 for the representative office in Heilongjiang,
unauthorized withdrawl of $286,000 by the former Chairman and $577,000 for
the Company's administrative and reporting expenses with the remaining of
$270,000 of cash on hand.
The Company needs to raise additional financing in order to continue its
operation beyond 1998 and there is no assurance that sufficient funds can be
raised.
30
Inflationary Impact
General inflation of costs had no material impact on the Company's
revenues and expenses during the year 1997 and no adverse effects from
inflation are anticipated in 1998. The Company has generally been able to
adjust the price of its products offered to its customers to minimize any
risks associated with inflationary pressures. However, due to the capital-
intensive nature of the Company's activities, inflation may have a significant
impact on the future development or improvement of the coal operations in
the PRC.
Exchange Rate Risk
The exchange rate between the Renminbi and the U.S. dollar as quoted by
the People's Bank of China was US$1.00 = Rmb 8.2798 on December 31, 1997.
During the last few years, the value of the Renminbi generally has
experienced a gradual devaluation against most major currencies, declining
from 5.5309 Renminbi per U.S. dollar on December 31, 1992 to 8.2674 Renminbi
per U.S. dollar on December 31, 1997. As a result of the adoption of the
unitary exchange rate system on January 1, 1994, the official bank exchange
rate for Renminbi to U.S. dollars experienced an immediate devaluation of
approximately 50% to US$1.00 = Rmb 8.7000 on January 1, 1994. Since the
unification of the two-tier exchange rate system effective January 1, 1994,
the Renminbi has strengthened somewhat against the U.S. dollar. Since there
can be no assurance that the Renminbi exchange rate will not again become
volatile or that the Renminbi will not devalue significantly against the U.S.
dollar, the Company believes that exchange rate fluctuations may adversely
affect the Company's financial performance because of its foreign currency
denominated liabilities and may have a material adverse effect on the value,
translated or converted into U.S. dollars, of the Company's assets, earnings
and dividends, if any. The Company does not currently engage in hedging
transactions and does not intend to do so in the future.
ITEM 10.DIRECTORS AND OFFICERS OF REGISTRANT
Directors and Executive Officers of the Company
<TABLE>
Set forth below is certain information regarding the directors and
executive officers of the Company.
<CAPTION>
Date First Elected
Name Position or Appointed
<S> <C> <C>
Wang Gongquan (1) Chairman of the Board November 1997
and President
Luan Jixiang Director April 1997
Wu Chunlai (1) Director April 1997
Zhang Geng Xin (1) Director April 1998
<FN>
(1) Member of Audit Committee.
</FN>
</TABLE>
Directors and Executive Officers of CCM
<TABLE>
Set forth below is certain information regarding the directors and
executive officers of CCM, a wholly-owned subsidiary of the Company.
<CAPTION>
31
Date First Elected
Name Position or Appointed
<S> <C> <C>
Wang Gongquan Chairman of the Board November 1997
and President
</TABLE>
Directors and Executive Officers of the Operating Company
<TABLE>
Set forth below is certain information regarding the directors and
executive officers of the Operating Company, which owns and operates the MCCF
and QCCF factories. An 80% interest in the Operating Company is owned by
CCM.
<CAPTION>
Date First Elected
Name Position or Appointed
<S> <C> <C>
Wang Gongquan Chairman of the Board November 1997
Luan Jixiang Vice President September 1995
Xu Changhai Director September 1995
Yuan Si Xian Director September 1995
Wu Chunlai Director September 1995
Executive Officers and Key Employees of MCCF
</TABLE>
<TABLE>
Set forth below is certain information regarding the executive officers
and key employees of MCCF.
<CAPTION>
Date First Elected
Name Position or Appointed
<S> <C> <C>
Xu Changhai Chief Engineer September 1995
</TABLE>
Executive Officers and Key Employees of QCCF
<TABLE>
Set forth below is certain information regarding the executive officers
and key employees of QCCF:
Date First Elected
Name Position or Appointed
<S> <C> <C>
Luan Jixiang General Manager September 1995
Yuan Si Xian Chief Engineer September 1995
</TABLE>
There is no known family relationship between any director, executive
officer or key employee listed above and any other director, executive
officer or key employee listed above.
ITEM 11.COMPENSATION OF DIRECTORS AND OFFICERS
For the year ended December 31, 1997, the aggregate amount of
compensation and bonuses paid by the company to executive officers of the
Company listed in Item 10 above, for service in all capacities, was
approximately $92,000. The grant of bonuses is determined in the sole
discretion of the Board of Directors of the Company. No compensation was
granted to the Directors listed in Item 10 above.
32
ITEM 12.OPTIONS TO PURCHASE SECURITIES FROM REGISTRANT OR SUBSIDIARIES
In November 1996, the Company raised net proceeds of approximately
$4,500,000 through an offering of Notes and Warrants in an exempt transaction
pursuant to Regulation S under the 1933 Act. Subsequently, in January 1997,
the Company raised net proceeds of approximately $900,000 in a follow-on
offering of Notes and Warrants (on the same terms as the November 1996
offering) in another exempt transaction pursuant to Regulation S under the
1933 Act. The aggregate principal amount of Notes issued in the November
1996 and January 1997 offerings was $6,122,500. Based on a conversion price
of $3.50 per share of Common Stock, the Notes were convertible at the time of
issuance into an aggregate of 1,749,293 shares of Common Stock. In
connection with the purchase of a Note, each purchaser was issued Warrants
exercisable for the same number of shares of Common Stock into which such
purchaser's Note was convertible. Including Warrants issued in payment of
offering-related fees, the Company issued Warrants exercisable for an
aggregate of 1,894,150 shares of Common Stock based on an exercise price of
$3.50 per share of Common Stock at the time of issuance.
The Notes carry interest at 8% per annum and the outstanding principal
amount of the Notes and any accrued and unpaid interest thereon are payable
on the maturity date of November 14, 2001. The Warrants became exercisable
to purchase shares of Common Stock on May 14, 1997 and expire on November 14,
1999. The exercise price per share for the Warrants is the same as the
conversion price in effect at such time for the Notes. The complete terms of
the Notes and the Warrants, along with the applicable conversion and exercise
prices thereof, are set forth in the Notes, Warrants and the subscription
agreements of the purchasers thereof.
The holders of the Notes have the right, prior to the payment in full of
all principal and interest on the Notes, to convert any outstanding and
unpaid principal portion of the Note and accrued and unpaid interest thereon
into fully-paid and nonassessable shares of Common Stock at the conversion
price specified in the Notes. In the event that a holder does not convert
the entire principal amount of its Note and all accrued and unpaid interest
thereon before the maturity date for such Note, then on the maturity date,
the Company has the option of compelling the conversion of such Note or
paying to such holder the remaining unpaid principal and accrued interest
amount on such holder's Note.
The conversion price for the Notes, which is subject to a floor price
of $3.50 and a ceiling price of $8.50, is computed by calculating 60% of the
average closing bid and ask price for a share of the Common Stock on any
securities exchange or other securities market on which the Common Stock is
then being traded for the 10 trading days immediately preceding the
conversion date; provided, that in the event of a public offering or private
placement of securities of the Company resulting in gross proceeds of at
least $10 million, consummated within 18 months of the issuance date of the
Notes (a "Qualifying Offering"), the floor price shall be adjusted to equal
60% of the offering price per share in such Qualifying Offering. Pursuant
to the terms of the Notes, at any time prior to the date on which the Common
Stock has begun trading on a U.S. securities exchange or market (including
the American Stock Exchange), the conversion price would equal $3.50 per
share.
The principal amount outstanding on the Notes, and all interest accrued
and payable thereon, may be prepaid by the Company, in whole but not in part,
on or after November 15, 1997; provided, that the average closing bid price
of the Common Stock has remained at or above $17.00 per share for 30
consecutive business days; and provided, that written notice of prepayment
is delivered to the holder of a Note not more than 60 days nor less than 30
days prior to the applicable prepayment date. A holder has the right to
exercise any conversion rights it may have with respect to its Note until
such time as any prepayment by the Company is made.
The principal amount outstanding on any Note, and all interest accrued
and payable thereon, may be prepaid at the request of the holder thereof, in
whole or in part; provided, that such holder has received a notice from the
Company that a Qualifying Offering has been consummated.
The Company issued total of 52,000 options to a consulting firm, the
Equity Group, on July 22, 1997 and January 15, 1998: 32,000 options is fully
vested with an exercise price of $5.00 per share, and 20,000 options is fully
vested with an exercise price of $3.50 or at a lower price at which the
Company issues new equity or warrants between January 22, 1998 and January
21, 1999.
During 1997, holders of Notes converted principal and accrued interest
in the amount of $2,900,000 into 828,644 shares of Common Stock. As of
June 30, 1998, Notes in the aggregate principal amount of $3,237,500
remained outstanding and Warrants to purchase an aggregate of 1,894,150
shares of Common Stock remained outstanding.
33
No officers or directors of the Company hold any of the Notes or
Warrants.
ITEM 13. INTEREST OF MANAGEMENT IN CERTAIN TRANSACTIONS
None.
PART II
ITEM 14. DESCRIPTION OF SECURITIES TO BE REGISTERED
Not required.
PART III
ITEM 15. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 16. CHANGES IN SECURITIES AND CHANGES IN SECURITY FOR REGISTERED
SECURITIES
None.
PART IV
34
ITEM 17. FINANCIAL STATEMENTS
The Company has elected to provide the financial statements and
related information specified in Item 18 in lieu of Item 17.
ITEM 18. FINANCIAL STATEMENTS
Index to Financial Statements
China Energy Resources Corporation (the "Company")
Independent Auditors' Report F-1
Consolidated Statements of Operations for the years ended December
31, 1997 and 1996 and the period from August 18, 1995
(commencement of operations) to December 31, 1995 F-2
Consolidated Balance Sheets at December 31, 1997 and 1996 F-3
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1997 and 1996 and for the period from August 18, 1995
(commencement of operations) to December 31, 1995 F-4
Consolidated Statement of Cash Flows for the years ended December 31,
1997 and 1996 and for the period from August 18, 1995(commencement
of operations) to December 31, 1995 F-5
Notes to Consolidated Financial Statements F-6
MISHAN COAL CHEMICAL HOLDING COMPANY ("MCCH")
Independent Auditors' Report F-17
Statement of operation for the nine months ended September 30, 1995 F-18
Statement of cash flows for the nine months ended September 30, 1995 F-19
Notes to financial statements F-20
ITEM.19 FINANCIAL STATEMENTS AND EXHIBITS
(a)Financial Statements.
See Item 18 for a list of the financial statements filed as part of this
Annual Report.
35
(b)Exhibits.
Exhibit Number Description of Document
2.1 Long-Term Supply Agreement, dated December 31, 1996, by
and among, QCCF Qitaihe City Coal Mine and Mudanjiang
No. 2 Power Plant.
36
INDEPENDENT AUDITORS' REPORT
To the shareholders and board of directors of
CHINA ENERGY RESOURCES CORPORATION
We have audited the accompanying consolidated balance sheets of China
Energy Resources Corporation (a British Virgin Islands Company) and its
subsidiary as of December 31, 1997 and 1996 and the related consolidated
statements of operations and cash flows for the years ended December 31, 1997
and 1996 and for the period from August 18, 1995 (commencement of operations)
to December 31, 1995. 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 audits.
We conducted our audits in accordance with auditing standards generally
accepted 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, such financial statements referred to above present
fairly, in all material respects, the financial position of China Energy
Resources Corporation and its subsidiary as of December 31, 1997 and 1996
and the results of their operations and their cash flows for the year ended
December 31, 1997 and 1996 and for the period from August 18, 1995
(commencement of operations) to December 31, 1995 in conformity with
accounting principles generally accepted in the United States of America.
The accompanying financial statements for the year ended December 31,
1997 have been prepared assuming that the Company will continue as a going
concern. As discussed in note 3 the Company is experiencing difficulty in
generating sufficient cash flow to enable it to operate all its facilities
and develop its coal mine use right, which raises substantial doubt about
its ability to continue as a going concern. Management's plans concerning
these matters are also described in note 3. The financial statements do not
include any adjustments that might result from the outcome of the
uncertainty.
Deloitte Touche Tohmatsu
Hong Kong
March 31, 1998
F-1
<TABLE>
CHINA ENERGY RESORUCES CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands except per share amounts)
<CAPTION>
Period from
August
Year ended Year ended 18,1995
December December to December
31,1997 31, 1996 31, 1995
<S> <C> <C> <C>
Net sales $ 9,053 $ 7,801 $ 2,050
Subcontracting income (note 1) 362 723 -
Cost of sales (5,516) (5,584) (1,115)
_______ _______ ______
Gross profit 3,899 2,940 935
Selling, general and administrative expenses (4,921) (961) (314)
Write-off of advances to related parties
(note 12) (1,768) - -
______ _______ _______
Operating (loss) income (2,790) 1,979 621
Interest expense (1,056) (422) (198)
Other (expense) income (note 12) (190) 46 10
______ _______ _______
(Loss) income before minority interests (4,036) 1,603 433
Minority interest 494 (345) (87)
______ _______ _______
Net (loss) income $(3,542) $ 1,258 $ 346
______ _______ _______
(Loss) earnings per share - Basic $ (1.18) $ 0.66 $ 0.40
______ ______ _______
- Fully-diluted $ (1.18) $ 0.57 $ 0.40
______ _______ _______
Weighted average number of shares outstanding
- Basic 2,994 1,918 847
______ _______ _______
- Fully-diluted 2,994 2,314 847
______ _______ _______
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<TABLE>
CHINA ENERGY RESOURCES CORPORATION
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share and per share amounts)
<CAPTION>
December 31,
1997 1996
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 767 $ 4,948
Accounts receivable, net of allowance for doubtful
accounts of $1,576 (1996:$211) 2,346 1,244
Prepayments, prepaid expenses, and other assets 1,615 1,471
Inventories (note 6) 4,136 3,072
_______ _______
Total current assets 8,864 10,735
Property, plant and equipment, net (note 7) 18,002 17,926
Value added taxes receivable (note 8) 140 167
Other assets 387 5
_______ _______
Total assets $ 27,393 $ 28,833
_______ _______
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings (note 9) $ 5,057 $ 3,108
Current portion of long-term debt (note 10) 1,812 844
Accounts payable 1,629 1,052
Customer deposits 87 168
Other payables 2,392 1,829
Plant construction payables 77 434
Amount due to PRC joint venture partner - 278
Accrued payroll and employee benefits 474 309
Accrued interest 1,596 901
Other accrued liabilities 187 8
_______ _______
Total current liabilities 13,311 8,931
Long-term debt (note 10)
Related parties 2,414 2,058
Other - 964
Convertible notes (note 11) 2,347 2,347
Minority interests 1,739 2,377
Commitments and contingencies (note 13)
Stockholders' equity:
Preferred shares, $0.01 par value, 2,000,000 shares
authorized, no shares issued and outstanding - -
Common stock, $0.01 par value, 50,000,000 shares authorized,
3,248,494 (1996: 2,399,850) shares issued and outstanding 32 24
Additional paid-in capital 11,762 10,530
(Deficit) retained earnings (1,940) 1,602
Advances receivable from related parties(note 12) (2,272) -
_______ _______
Total stockholders' equity 7,582 12,156
_______ _______
Total liabilities and stockholders' equity $ 27,393 $ 28,833
_______ _______
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<TABLE>
CHINA ENERGY RESORUCES CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Amounts in thousands)
<CAPTION>
Advances Total
Additional Retained receivable stock-
Common stock paid-in earnings from related holders'
Shares Amount capital (deficit) parties equity
<S> <C> <C> <C> <C> <C> <C>
Issue of shares on establishment
of China Coal (note 1) 2,290 $ 23 $ 7,864 $ - $ - $ 7,887
Net income - - - 346 - 346
_______ _______ _______ _______ _______ _______
Balance at December 31, 1995 2,290 23 7,864 346 - 8,233
Merger with Jackson (note 1) 110 1 47 (2) - 46
Amount created on issuance of
convertible notes - - 2,619 - - 2,619
Net income - - - 1,258 - 1,258
_______ _______ _______ _______ _______ ______
Balance at December 31, 1996 2,400 24 10,530 1,602 - 12,156
Issues of shares 848 8 1,232 - - 1,240
Net loss - - - (3,542) - (3,542)
Advances to related parties - - - - (2,272) (2,272)
______ _______ _______ _______ _______ _______
Balance at December 31, 1997 3,248 $ 32 $ 11,762 $(1,940) $ (2,272) $7,582
______ _______ _______ ______ _______ _______
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<TABLE>
CHINA ENERGY RESOURCES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
<CAPTION>
Period from
August
Year ended Year ended 18, 1995 to
December December December
31, 1997 31, 1996 31, 1995
<S> <C> <C> <C>
Cash flow from operating activities:
Net (loss) income $ (3,542) $ 1,258 $ 346
Adjustments to reconcile net (loss)
income to net cash (used in)provided
by operating activities:
Minority interest (494) 345 87
Loss on disposal of property, plant
and equipment 152 - -
Depreciation 643 863 130
Bad debt provisions 1,365 15 1
Write-off of prepaid expenses 289 - -
Value added tax on opening debit balance
utilized 27 53 10
Changes in assets and liabilities:
Accounts receivable (2,467) 1,456 (200)
Inventories (1,064) (105) (178)
Prepayments, prepaid expenses, and other
assets (433) (427) (173)
Accounts payable 577 (581) (577)
Customer deposits (81) (82) 7
Other payables 563 288 667
Amount due to PRC joint venture partner (278) (525) 221
Accrued payroll and employee benefits 165 7 34
Accrued interest 695 (580) 245
Other accrued liabilities 179 (32) 4
______ _______ _______
Net cash (used in) provided by operating
activities (3,704) 1,953 624
______ _______ _______
Cash flow from investing activities:
Sales proceeds of property, plant and
equipment 129 - -
Purchase of property, plant and equipment (997) (1,028) (136)
Purchase of a subsidiary (net of cash
acquired) - - (7,848)
(Addition) realization of other assets (382) - 3
______ _______ _______
Net cash used in investing activities (1,250) (1,028) (7,981)
______ _______ _______
Cash flow from financing activities:
Advances to related parties (2,272) - -
Repayment of long-term debt from related
parties - (1,266) -
Repayment to minority interests (144) (83) -
Increase in short-term borrowings - net 1,949 140 (309)
Issuance of convertible notes - 2,347 -
Issuance of common stock 1,240 2,619 7,887
Cash and cash equivalents acquired on merger
with Jackson - 45 -
_______ _______ _______
Net cash provided by financing activities 773 3,802 7,578
______ _______ _______
(Decrease) increase in cash and cash
equivalents (4,181) 4,727 221
Cash and cash equivalents at beginning
of period 4,948 221 -
_______ _______ _______
Cash and cash equivalents at end of period $ 767 $ 4,948 $ 221
______ _______ _______
Supplementary disclosures of cash flow information
Cash paid during the period for:
Interest $ 405 $ 1,202 $ 64
</TABLE>
See accompanying notes to consolidated financial statements
F-5
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands except per share amounts)
1. ORGANIZATION AND BASIS OF PRESENTATION
China Energy Resources Corporation (the "Company"), a private company
incorporated in the British Virgin Islands, was incorporated on March 15,
1996 for the purpose of holding a 100% interest in China Coal Mining
(B.V.I.) Co. Ltd. ("China Coal") and to enter into an agreement with Jackson
Holding Corp. ("Jackson"), a New York Corporation.
On March 15, 1996 the shareholders in China Coal exchanged their shares in
China Coal for shares in the Company. The exchange of shares has been
accounted for as a reorganization of entities under common control similar
to a pooling of interests. The accompanying financial statements include
the combined results and operations and financial position of the Company,
China Coal and its 80% held subsidiary for all periods presented.
On March 22, 1996, pursuant to an agreement and plan of merger between
the Company and Jackson, Jackson was merged into the Company and the Company
issued 109,850 shares of its common stock to the shareholders of Jackson for
the entire issued share capital of Jackson. Jackson had been established in
1994 for the sole purpose of acquiring or merging with an unspecified
business, and at the time of merger Jackson had no operating assets and had
not engaged in any business activities. The transaction has been accounted
for as a reverse acquisition and the financial statements presented
represent the financial statements of the Company and its subsidiary from
August 18, 1995, the date the subsidiary commenced operations.
China Coal, a private company incorporated in the British Virgin Islands,
was incorporated on August 18, 1995. Pursuant to a joint venture agreement
dated September 16, 1995 between China Coal and Mishan Coal Chemical Holding
Company ("the Factory"), China Coal acquired for cash of Renminbi 65,600
(approximately $7,886) an 80% interest in a new joint venture company,
Mishan Hua Xing Coke Limited ("MHXC"), incorporated in the People's Republic
of China ("PRC"), which has succeeded to the business of the Factory. In
conjunction with the agreement the former owner contributed land use rights
with a fair value of Renminbi 14,806 (approximately $1,780) and coal mine
use right with a contractual value of Renminbi 95,760 (approximately
$11,312) to MHXC. The former owner provided an interest free loan of
Renminbi 65,760 (approximately $7,906) to MHXC to finance the acquisition of
the coal mine use right by MHXC. The coal mine use right and interest free
loan are recorded at estimated fair value determined based on the estimated
net present value of the interest free loan. The joint venture period is 30
years from the date of formation and may be extended by the unanimous
resolution of the board of directors, subject to the approval of the
relevant government authorities. The remaining 20% interest in MHXC is
owned by the former owner of the Factory. The acquisition has been
accounted for as a purchase and the results of the MHXC have been included
in the consolidated financial statements since October 1, 1995. The
purchase price approximated the estimated fair values of MHXC at the date of
acquisition.
MHXC operates two production facilities in Heilongjiang Province, PRC; the
Mishan City Coke Factory ("MCCF") and the Qitaihe City Coal Factory. During
1996 the operation of the MCCF plant was subcontracted to a company under
the control of the central government under an agreement where the Company
received a subcontracting fee of Renminbi 6,000 (approximately $723) and the
other party was entitled to all the revenues from the operations of the
plant and was obligated to meet all the operating expenses of the plant.
MCCF terminated the subcontracting agreement on March 31, 1997 and resumed
the production and sales of metallurgical coke during the second quarter of
1997. In March 1998 MCCF temporarily ceased production (see note 3).
F-6
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands)
2. BASIS OF PREPARATION
The financial statements were prepared in accordance with accounting
principles generally accepted in the United States of America ("U.S. GAAP").
This basis of accounting differs from that used in the statutory accounts of
MHXC, the Company's principal operating subsidiary, which were prepared in
accordance with the accounting principles and the relevant financial
regulations applicable to Sino-foreign equity joint venture enterprises as
established by the Ministry of Finance of China.
The principal adjustments made to conform the statutory accounts of MHXC to
U.S. GAAP included the following:
- Adjustment to record the coal mine use right and interest free loan at
estimated fair value.
- Adjustment to depreciation expense for property, plant and equipment
to reflect more accurately the economic useful life of the assets;
- Adjustment to recognize interest expense on the accruals basis.
- Adjustment to recognize sales and cost of sales upon shipment to
customers.
The preparation of financial statements in conformity with US GAAP requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the 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.
3. GOING CONCERN AND OTHER MATTERS
During 1997 the Company terminated the services of the MCCF plant manager,
however, prior to his termination this individual signed various documents
that provided collateral to bank lenders of MCCF over MCCF assets.
In 1997, as a result of cash flow shortages, various problems with local
management and other operational issues, the facility at MCCF did not
operate at full capacity resulting in the closure of that facility in
March, 1998. At December 31, 1997 the gross assets of MCCF were $8,643.
The Company intends to reopen the facilities when the Company has raised
additional finance as the Company anticipates that operating the plant will
generate positive cash flows and, therefore, no provision for impairment is
required.
F-7
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands)
3. GOING CONCERN AND OTHER MATTERS - (Continued)
MHXC also owns the rights to use the coal mine, which at December 31, 1997
are stated at $7,176, and which are located in Mishan and are planned to
supply coking coal for use in MCCF. During 1997 the Company continued its
efforts in preparing the mine sites for mining operations and in October
1997 obtained a report prepared by international mining and geological
consultants on the coking coal reserve base and associated coal quality.
This report recommended that the Company implement various programs to
expand the demonstrated coal reserve base and provide support for coal
quality documentation. Due to inadequate working capital the Company has
not been able to conduct further mine surveys and the Company has been in
contact with potential strategic partners to assist in development. The
Company needs to complete additional work on the survey and mining plans
before the mine is ready for use. In 1997 the Company capitalized interest
amounting to $341 in the coal mine use right. No provision for impairment
has been made as it is the Company's intention to develop the rights when
additional finance is available.
The Company incurred a loss of $3,542 in 1997 and is continuing to operate
at a loss subsequent to the balance sheet date and at December 31, 1997 the
Company had net current liabilities of $4,447, which excludes any long-term
debt that may become current in the event the Company is unable to continue
as a going concern. These factors among others may indicate that the Company
will be unable to continue as a going concern for a reasonable period of
time.
The financial statements do not include any adjustments relating to the
recoverability of assets and classification of liabilities that might be
necessary should the Company be unable to continue as a going concern. The
Company's continuation as a going concern is dependent upon its ability to
generate sufficient cash flow to meet its obligations on a timely basis, to
obtain additional financing or refinancing as may be required, and
ultimately to attain profitability.
The Company is in discussion with potential investors to obtain additional
equity financing and with governmental agencies to assist in resolving the
management and operational issues relating to MCCF.
F-8
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands)
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of consolidation - The consolidated financial statements include
the assets, liabilities, revenues and expenses of the Company and its
subsidiaries. All material intra-group transactions have been eliminated.
Cash and cash equivalents - Cash and cash equivalents include cash on hand,
demand deposits and highly liquid instruments with a maturity of three
months or less at the time of purchase.
Inventories - Inventories are stated at the lower of cost, determined by the
average cost method, or market. Finished goods inventories consist of raw
materials, direct labor and overhead associated with the manufacturing
process.
Property, plant and equipment - Property, plant and equipment is stated at
cost. Depreciation is provided to write off the cost of property, plant and
equipment over their estimated useful lives in equal instalments as follows:
<TABLE>
<CAPTION>
<S> <C>
Land use rights 30-50 years
Buildings 8-45 years
Plant and machinery 5-20 years
Transportation vehicles 5-10 years
Railway 50 years
</TABLE>
Coal mine use right - Coal mine use right is stated at estimated fair value
at date of acquisition determined based on the estimated market value of the
interest free loan used to finance the acquisition of the asset plus the
costs of preparing the mine site for its intended mining operations.
Interest is capitalized on the coal mine use right during the period in
which activities are in progress necessary to get the mine ready for its
intended mining operations. In 1997, 1996 and 1995 interest capitalized
amounted to $341, $458 and $110, respectively. Amortization will be
provided to write off the value of coal mine use right based on the units
extracted compared with estimated total units to be extracted. The coal
mine use right and the Company's other long-lived assets are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable.
Construction-in-progress represents plant and buildings under construction
and includes cost of construction, purchase of plant and machinery and
interest arising from borrowings used to finance these assets during the
period of construction or installation. No interest was capitalized during
the period. Construction-in-progress is not depreciated until amounts are
reclassified to property when available for use.
Net sales - Net sales represent the invoiced value of products, net of sales
taxes. Sales are recognized when products are shipped to customers.
Foreign currency translation - The consolidated financial statements of the
Company are presented in United States dollars. The Company's principal
operating subsidiary, MHXC, conducts substantially all its business in
Renminbi.
Foreign currency transactions of MHXC are translated into Renminbi at the
applicable rates of exchange quoted by the People's Bank of China (the
"PBOC"), prevailing at the date of the transactions. Monetary assets and
liabilities denominated in foreign currencies are translated into Renminbi
using the applicable PBOC rate prevailing at the relevant balance sheet
date. Substantially all the transactions of MHXC are denominated in
Renminbi and MHXC did not have any material monetary assets or liabilities
denominated in foreign currencies. On consolidation, the assets and
liabilities of MHXC are translated into United States dollars at the year
end rates of exchange and revenues and expenses are translated at average
exchange rates prevailing during the period. Translation adjustments are
included as a separate components of stockholders' equity.
F-9
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands)
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued)
Provisions for doubtful accounts - Provisions for doubtful accounts are
established based on management's assessment of the recoverability of
accounts receivable. The expense amounted to $1,365 in 1997, $15 in 1996
and $1 in 1995.
Repairs and maintenance - Repairs and maintenance costs are charged against
income in the period in which they are incurred. The expense is allocated
to cost of sales and selling, general and administrative expenses. The
aggregate expenses were $47 in 1997, $42 in 1996 and $30 in 1995.
Income taxes - Deferred income taxes are provided using the liability
method. Under the liability method, 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 asset or liability in the financial
statements. During the period there were no significant temporary
differences.
(Loss) earnings per share - Fully diluted (loss) earnings per share is based
on net (loss) income for the period and the weighted average number of
common stock outstanding during each period, plus, the dilutive effect, if
any, of certain shares subject to issue in connection with the conversion of
the outstanding convertible notes and warrants. Such convertible notes and
warrants had no dilutive effect on the loss per share in 1997 but may dilute
future earnings per share.
A reconciliation of the earnings and weighted average number of shares used
to compute basic and fully-diluted earnings per share for the year ended
December 31, 1996 is as follows:
<TABLE>
<CAPTION>
Weighted average
Earnings number of shares
<S> <C> <C>
Basic $ 1,258 1,918
Effect of convertible debt 53 396
_______ _______
$ 1,311 2,314
_______ _______
</TABLE>
New accounting standards not yet adopted - In June 1997, the Financial
Accounting Standards Board (FASB) issued two new disclosure standards.
Results of operations and financial position will be unaffected by
implementation of these new standards.
Statement of Financial Accounting Standards (SFAS) No. 130, Reporting
Comprehensive Income, establishes standards for reporting and display of
comprehensive income, its components and accumulated balances.
Comprehensive income is defined to include all changes in equity except
those resulting from investments by owners and distributions to owners.
Among other disclosures, SFAS No. 130 requires that all items that are
required to be recognized under current accounting standards as components
of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements.
SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information which supersedes SFAS No. 14, Financial Reporting for Segments
of a Business Enterprise, establishes standards for the way that public
enterprises report information about operating segments in financial
statements issued to the public. It also establishes standards for
disclosures regarding products and services, geographic areas and major
customers. SFAS131 defines operating segments as components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance.
Both of these new standards are effective for financial statements for
periods beginning after December 15, 1997 and require comparative
information for earlier years to be restated.
In February 1998, the FASB issued SFAS No. 132, Employers' Disclosures about
Pensions and Other Postretirement Benefits, which amends the disclosure
requirements for pension and other postretirement benefits. Adoption of the
standard will not significantly change the Company's financial statement
disclosures.
F-10
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands)
5. INCOME TAXES
Income is subject to taxation in the various countries in which the Company
and its subsidiary operate. The Company is not taxed in the British Virgin
Islands where it is incorporated. The Company's operations are all in
China.
The Company's subsidiary, MHXC, which is incorporated in China, is subject
to Chinese income taxes at the applicable tax rate (currently 33%) on
taxable income based on income tax laws applicable to foreign enterprises.
Pursuant to the same income tax laws, the subsidiary is fully exempt from
Chinese income tax on its manufacturing operations for two years starting
from the first profit making year and, accordingly, no income taxes were
payable in respect of 1996 or 1995. The subsidiary also has a 50% exemption
from Chinese income tax for the subsequent three years. The exemptions
applicable to these subsidiaries will expire in 1999. At December 31, 1997
the Company and its subsidiaries have no available tax losses.
6. INVENTORIES
<TABLE>
<CAPTION>
December 31,
1997 1996
<S> <C> <C>
Raw materials $ 3,203 $ 3,029
Finished goods 724 34
Consumables 209 9
_______ _______
Total $ 4,136 $ 3,072
_______ _______
</TABLE>
The amount of work-in-progress is insignificant due to the short production
cycle of the manufacturing process.
7. PROPERTY, PLANT AND EQUIPMENT
<TABLE>
<CAPTION>
December 31,
1997 1996
<S> <C> <C>
Coal mine use right $ 7,176 $ 6,725
Land use rights 1,789 1,780
Buildings 6,427 6,378
Plant and machinery 2,213 1,966
Transportation vehicles 727 989
Railway 1,442 1,247
______ _______
Total 19,774 19,085
Less: Accumulated depreciation (1,778) (1,766)
Construction in progress 6 607
_______ _______
Total $ 18,002 $ 17,926
_______ _______
</TABLE>
The coal mine use right is stated at estimated fair value at date of
acquisition determined based on the estimated market value of the interest
free loan used to finance the acquisition of the asset plus the costs of
preparing the mine site for its intended use. The contractual price of the
coal mine use right was $11,312.
Certain property is collateralized for bank borrowings (note 9).
F-11
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands)
8. VALUE ADDED TAXES RECEIVABLE
Value added tax ("VAT") is applicable to MHXC at a rate of 17% on the gross
sales amounts and credit given at the same rate for VAT paid on purchases.
The net VAT payable is accounted for to the tax authorities.
In accordance with notices issued by the government authorities, the Factory
can deem VAT, at the rate of 14%, to have been paid on the opening inventory
amount at January 1, 1995 (the date VAT was introduced) and applied against
future VAT payable based on criteria to be agreed with the local
authorities. This amount has been established as a receivable. The Company
believes that the amount will be recoverable against future VAT payable
subject to approval as to timing by the tax authorities. Amounts of $ 27,
$53 and $10 were utilized in 1997, 1996 and 1995, respectively
9. SHORT-TERM BORROWINGS
Short-term borrowings represent short-term loans provided by banks and other
lenders to the Company's PRC subsidiary.
<TABLE>
<CAPTION>
December 31,
1997 1996
<S> <C> <C>
Short-term borrowings at the end of period $ 5,057 $ 3,108
Weighted average interest rate on borrowings at end of period 13% 17%
</TABLE>
Interest rates are determined periodically by the banks and other lenders in
consultation with the Company's subsidiary and are normally subject to
annual review. There are no formal short-term credit facilities with the
banks and short-term borrowings are negotiated on a loan-by-loan basis.
At December 31, 1997, short-term borrowings of $2,896 and long-term bank
loans of $1,812 were secured over property, plant and equipment with a net
book value of $9,161.
F-12
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands)
10. LONG-TERM DEBT
<TABLE>
December 31,
1997 1996
Long-term debt, which is unsecured, consists of:
<CAPTION>
<S> <C> <C>
Bank loans at fixed interest rates
(14.04% at December 31, 1997)
Due in 1997 $ - $ 844
Due in 1998 1,086 241
Due in 1999 242 241
Due in 2000 242 241
Due in 2001 242 241
_______ _______
1,812 1,808
_______ _______
Interest free loan from PRC joint venture partner
<S> <C> <C>
Due in 2002 1,334 1,331
Due in 2003 1,334 1,331
Due in 2004 1,335 1,332
Due in 2005 1,335 1,332
Due in 2006 1,335 1,332
_______ _______
6,673 6,658
Less: notional interest 4,259 4,600
_______ _______
2,414 2,058
_______ _______
Total 4,226 3,866
Current portion of long-term debt 1,812 844
_______ ______
Long-term debt, less current portion $ 2,414 $ 3,022
_______ _______
</TABLE>
All long-term bank loans are authorized by the provincial or local
governments and are administered by the banks.
The interest free loan from the PRC joint venture partner was raised to
partially finance the acquisition of the coal mine use right. At the date
the loan was obtained it was to be repaid by five equal instalments with
each instalment limited to 40% of the income after tax of the relevant year.
In 1996 the Company made repayments ahead of the original planned payment
schedule and the scheduled repayments of the remaining balance of the loan
were rateably amended. In addition, the scheduled repayments were postponed
by an agreement dated May 11, 1997 for an additional two years. The loan is
stated in the financial statements at the estimated present value calculated
based on the annual discount rate of 16%, being the estimated annual
interest rate for fixed asset lending in the PRC. This estimate of the
market value of the loan is subject to a high degree of uncertainty because
there is no market for the loan, the loan is not transferrable and the
repayment terms are contingent on future operations of the Company.
With effect from October 1, 1995 the government of Mishan City agreed to
share 50 percent of the interest paid by MCCF on the long-term interest -
bearing loans. The government's share of interest expense amounted to $150
in 1997, $197 in 1996 and $50 in 1995. This agreement expired in December
31, 1997. The interest shared by the local government party of $150 in 1997
and $197 in 1996 has been netted against interest expense in the statement of
operations, as well as $166 in 1996 of interest forfeited by the bank lender
of the loan.
During 1997, interest was not paid and became overdue and as a result all
long-term bank loans are currently in default and have been classified as
current liabilities.
F-13
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands)
11. CONVERTIBLE NOTES
At December 31, 1997 the Company had outstanding convertible notes with
detachable warrants amounting to $2,347 which were issued in 1996. These
notes carry interest at 8 percent per annum and the principal amount and
the accrued interest thereon are payable in 2001.
The holders have the right prior to the payment in full of all principal
of and interest on the notes, to convert any outstanding and unpaid
principal portion of the notes and accrued interest into fully paid and
nonassessable shares of common stock, $0.01 par value per share, of the
Company, as such shares exist on the date of issuance of the notes, or any
shares of capital stock of the Company into which such shares have been
changed or reclassified (the "common stock") at the conversion price as
defined in the note. In the event the holders do not convert the entire
principal amount of the notes and all accrued and unpaid interest earned
thereon before the maturity date, then on that date the Company has the
option of compelling the conversion of the notes or paying to the holders
the remaining unpaid principal amount of the notes and interest thereon.
The conversion price is subject to a floor price and a ceiling price (as
defined in the note agreement) and is equal to 60% of the average closing
bid and ask price for the common stock on any securities exchange or other
securities market on which the common stock is then being traded, for the
ten trading days immediately preceding the conversion date; provided,
however, that in the event of a public offering or private placement of
securities of the Company, resulting in gross proceeds of at least $10,000,
consummated within 18 months of the date of the notes, the floor price
shall be adjusted to equal 60 percent of the offering price per share in
such an offering; and provided, further, that the floor price, as adjusted,
(i) shall never be lower than $3.50 per share (the "floor price") and (ii)
shall never exceed $8.50 per share (the "ceiling price"). At any time
prior to the date on which the common stock is traded on the American Stock
Exchange or other U.S. securities exchange or market, the conversion price
for the common stock shall equal $3.50 per share.
The conversion price and number and kind of shares or other securities to
be issued upon conversion is subject to adjustment from time to time upon
the happening of certain events specified in the note agreement while this
conversion right remains outstanding.
The principal amount outstanding on the notes, and all interest accrued and
payable thereon, may be prepaid by the Company, in whole but not in part,
on or after November 15, 1997; provided that the average closing bid price
of the common stock has remained at or above $17.00 per share for thirty
consecutive business days; and provided, further, that written notice of
prepayment is delivered to the holder not more than sixty days nor less
than thirty days prior to the applicable prepayment date. The holder has
the right to exercise any conversion rights it may have hereunder until
such time as any prepayment is made.
Within ten business days after a holder receives notice from the Company
that a qualifying offering has been consummated, the holder may demand in
writing that the principal amount outstanding on the note, and all
interest accrued thereon, be prepaid by the Company, in whole or in part,
but any partial demand shall be in increments of $25. The borrower shall
repay the principal amount outstanding on the note, and all interest
accrued on payable thereon, within 15 days after receipt of such a notice
from the holder.
In 1997 the Company issued convertible notes with a face value of $1,000
and holders converted principal and accrued interest of $2,900 into the
Company's common stock resulting in the issue of 848 shares.
The holders of the warrants detached from the convertible notes are
entitled to purchase from the Company at any time on or after May 14, 1997
or from time to time before 5:00 p.m. on November 14, 1999 fully paid and
nonassessable shares of common stock, $0.1 par value per share, of the
Company, as adjusted in the event that the following computation results in
a greater number of shares: the quotient obtained by dividing the principal
amount of the loan from the holder to the Company pursuant to a note from
the Company to the holder by the purchase price. The purchase price shall
be subject to a floor price and a ceiling price and shall equal 60% of the
average closing bid and ask price for the common stock on any securities
exchange or other securities market on which the common stock is then being
traded, for the ten trading days immediately preceding the date of
exercise; provided, however, that in the event of a qualifying offering,
the floor price shall be adjusted to equal 60% of the offering price per
share in such qualifying offering; and provided, further, that the floor
price, as adjusted, (i) shall never be lower than $3.50 per share and (ii)
shall never exceed $8.50 per share.
F-14
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands)
12. RELATED PARTY TRANSACTIONS
In 1997 advances totalling $1,768 were made under the authority of the
former Chairman of the Company to the former owner of QCCF which were
intended to establish relationships for potential future business
opportunities. As the terms of the repayment of the advances were unclear,
with the death of the former Chairman current management believes that its
ability to realize the advances has been severely impaired and, accordingly,
the amounts have been written off in 1997.
In 1997, the Company advanced $2,272 to the bank of the former owner of QCCF
to settle loans and interest owed by the former owner of QCCF to the bank.
The receivable at December 31, 1997 of $2,272 is repayable on demand and is
interest free.
In 1997 the former Chairman of the Company withdrew amounts totalling $286
from MHXC without authority of the Company. The Chairman died in October
1997 and the Company has been seeking to recover these amounts from his
estate and family. The Company has recorded an expense of $184 in other
income (expense) representing the amounts not yet recovered.
Substantially all of the sales, purchases, raw materials and purchases of
ancillary items the Company's PRC subsidiary are with state-owned
enterprises. Even though such state-owned enterprises may be regarded as
having the same beneficial owner of the PRC joint venture partner of the
Company's subsidiary, the PRC central government, such state-owned
enterprises are frequently under separate control and do not possess any
management, ownership or other interest in each other. As a result, the
Company does not view transactions with such state-owned enterprises as
constituting related party transactions.
13. COMMITMENTS AND CONTINGENCIES
At December 31, 1997, the Company and its subsidiaries had no contracted
capital expenditure.
The Company and its PRC subsidiary do not currently maintain any insurance
coverage on the property, plant and equipment owned by the subsidiary. In
addition, the Company and the subsidiary do not currently carry any business
interruption insurance or any third party liability insurance to cover
claims in respect of bodily injury, property or environmental damages
arising from accidents on the subsidiary's property or relating to its
operations.
14. FOREIGN CURRENCY EXCHANGE
The PRC government imposes control over its foreign currency reserves in
part through direct regulation of the conversion of Renminbi into foreign
exchange and through restrictions on foreign trade. The conversion of
Renminbi into US dollars and other foreign currencies is based on the rate
set by the People's Bank of China, which is set based on the previous day's
PRC interbank foreign exchange market rate and with reference to current
exchange rates on the world financial markets. The exchange rate at
December 31, 1997 was US$1 = Rmb8.2798.
Foreign investment enterprises may generally remit out of the PRC profits or
dividends derived from a source within the PRC, subject to the availability
of foreign currency. Except for such profits or dividends, remittance out
of the PRC by foreign investors of any other amount (including proceeds from
a disposition of an investment in the PRC) is subject to the approval of
State Administration of Foreign Exchange and to the availability of foreign
currency (at the central government or provincial level). In addition, if
there is a deterioration in the PRC's balance of payments or for other
reasons, the PRC may impose restrictions on foreign currency remittances
abroad. No assurance can be given that the Company's PRC subsidiary will be
able or permitted to remit out of the PRC amounts due to the Company.
F-15
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Amounts in thousands)
15. CONCENTRATION OF CREDIT RISK
The subsidiary's trade receivables in respect of sales on credit terms are
subject to a concentration of credit risk with customers in the industrial
sectors of steel making, metallurgy, electricity and other heavy industries.
In addition, the PRC subsidiary has no formal credit terms and its sales are
predominantly to PRC companies. Therefore, the subsidiary's ability to
collect its trade receivables is related to the economic conditions in these
industrial sectors and in the PRC as a whole.
16. FINANCIAL INSTRUMENTS
The carrying values of financial instruments, including cash and cash
equivalents and short-term borrowings, were equal to their approximate fair
value as of December 31, 1997 because of the relatively short maturities of
these investments. At December 31, 1997 the fair value of the bank loans
and the interest free loan from the PRC joint venture partner were
approximately $1,812 and $2,414, respectively, estimated based on the
discount rate the seller would pay to a credit-worthy third party to assume
its obligation.
17. EMPLOYEE RETIREMENT BENEFITS
All the subsidiary's full-time employees are entitled to a retirement
pension calculated with reference to their basic salaries on retirement and
their length of service in accordance with a government managed pension
plan. The PRC government is responsible for the pension obligations of
retired staff. The PRC subsidiary is required to make contributions to the
state retirement plan at 17-25% of the monthly salaries of the current full-
time employees subject to local authorities' discretion. Employees are
required to make contributions at 2-3% of their basic salary. Contract and
part-time employees are not entitled to such benefits. The expense of such
arrangements to the subsidiary was immaterial for the period. The Company
and its subsidiaries are not obligated under any other post-retirement plans
and post-employment benefits are not material.
18. SEGMENT INFORMATION AND CONCENTRATION OF CREDIT RISK AND MAJOR
CUSTOMERS
The Company through its PRC subsidiary is engaged in one industry segment,
the manufacture and sale of coal products in the PRC where the PRC
subsidiary's operations are located. One customer, Mudanjiang No. 2 Power
Plant of Heilongjiang Province, PRC, accounted for 71% of net sales in 1997,
80% in 1996, and 83% in 1995.
F-16
INDEPENDENT AUDITORS' REPORT
To the shareholders and board of directors of
MISHAN COAL CHEMICAL HOLDING COMPANY
We have audited the accompanying statements of operations and cash flows of
Mishan Coal Chemical Holding Company (the "Factory") for the nine months
ended September 30, 1995, all expressed in Renminbi. These financial
statements are the responsibility of the management of China Coal Mining
(B.V.I.) Co. Ltd. and the Factory. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted 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, such financial statements present fairly, in all material
respects, the results of operations and cash flows of the Factory for
the nine months ended September 30, 1995 in conformity with accounting
principles generally accepted in the United States of America.
Deloitte Touche Tohmatsu
Hong Kong
November 13, 1995
F-17
MISHAN COAL CHEMICAL HOLDING COMPANY
STATEMENT OF OPERATIONS
(Amounts in thousands)
<TABLE>
<CAPTION>
Nine months Nine months
ended ended
September September
30, 1995 30, 1995
Rmb US$
<S> <C> <C>
Net sales 49,019 5,896
Cost of sales 34,263 4,121
_______ _____
Gross profit 14,756 1,775
Selling, general and administrative expenses 6,616 796
______ _____
Operating income 8,140 979
Interest expense (1,276) (154)
Other income, net 131 16
______ _____
Income before income taxes 6,995 841
Provision for income taxes (note 4) - -
_______ ______
Net income 6,995 841
_______ _____
</TABLE>
See accompanying notes to financial statements.
F-18
MISHAN COAL CHEMICAL HOLDING COMPANY
STATEMENT OF CASH FLOWS
(Amounts in thousands)
<TABLE>
<CAPTION>
Nine months Nine months
ended ended
September September
30, 1995 30, 1995
Rmb US$
<S> <C> <C>
Cash flow from operating activities:
Net income 6,995 841
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 2,971 357
Changes in assets and liabilities:
Accounts receivable (10,321) (1,242)
Inventories (6,850) (824)
Prepayments and other assets (1,994) (240)
Accounts payable 5,292 637
Customer deposits 769 92
Other payables 899 108
Plant construction payables 2,198 264
Amount due to a former owner (3,581) (430)
Accrued payroll and employee benefits 879 106
Accrued interest 3,679 443
Other accrued liabilities (175) (21)
______ ______
Net cash provided by operating activities 761 91
_______ ______
Cash used in investing activities:
Purchase of property, plant and equipment (7,477) (899)
_______ ______
Cash flow from financing activities:
Increase in short-term borrowings 13,403 1,612
Repayment of short-term borrowings (6,480) (779)
Withdrawal of capital (605) (73)
_______ ______
Net cash provided by financing activities 6,318 760
_______ ______
Decrease in cash and cash equivalents (398) (48)
Cash and cash equivalents at beginning of period 796 96
_______ ______
Cash and cash equivalents at end of period 398 48
_______ ______
Supplemental disclosure of cash flow information
Cash paid during the period for:
Interest 1,648 198
</TABLE>
See accompanying notes to financial statements.
F-19
MISHAN COAL CHEMICAL HOLDING COMPANY
NOTES TO FINANCIAL STATEMENTS
(Amounts in thousands, expressed in Renminbi unless otherwise stated)
1. ORGANIZATION AND BASIS OF PRESENTATION
Effective January 1, 1994, Mishan Coal Chemical Holding Company (the
"Factory"), a state-owned enterprise established in the People's Republic of
China ("PRC"), was formed and pursuant to an agreement dated December 18,
1993 took over the business of Mishan City Coke Factory ("MCCF"), a state-
owned enterprise in the PRC under the same administration as the Factory,
and acquired at their historic costs the property, plant and equipment of
Qitaihe City Coal Factory ("QCCF"), which was part of another PRC state-
owned enterprise. Pursuant to a joint venture agreement dated September 16,
1995 between China Coal Mining (B.V.I.) Co. Ltd. (the "Company"), a private
company incorporated in the British Virgin Islands, and the Factory, the
Company acquired an 80% interest in a new joint venture company, Mishan Hua
Xing Coke Limited ("MHXC") which was established on October 6, 1995 and
which has succeeded to the business of the Factory. The joint venture
period is 30 years from the date of formation and may be extended by the
unanimous resolution of the board of directors, subject to the approval of
the relevant authorities. The remaining 20% interest in MHXC is owned by
the former owner of the Factory.
The accompanying financial statements present the results of operations and
cash flows of the factory from January 1, 1995 to September 30, 1995.
Subsequent to that date MHXC succeeded to the business of the Factory.
2. BASIS OF PREPARATION
The financial statements were prepared in accordance with accounting
principles generally accepted in the United States of America ("U.S. GAAP").
This basis of accounting differs from that used in the statutory accounts of
the Factory, which were prepared in accordance with the accounting
principles and the relevant financial regulations applicable to state-owned
industrial enterprises as established by the Ministry of Finance of China.
The principal adjustments made to conform the statutory accounts of the
Factory to U.S. GAAP included the following:
-Additional allowance for doubtful accounts receivable;
-Adjustment to depreciation expense for property, plant and equipment
to reflect more accurately the economic useful life of the assets;
-Adjustment to recognize interest expense on the accruals basis.
-Adjustment to recognize sales and cost of sales upon shipment to
customers.
-Adjustment to write back excess provisions made by the Factory.
-Adjustment to include the attributable share of transportation cost in
closing inventories.
The preparation of financial statements in conformity with US GAAP requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the 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.
F-20
MISHAN COAL CHEMICAL HOLDING COMPANY
NOTES TO FINANCIAL STATEMENTS
(Amounts in thousands, expressed in Renminbi unless otherwise stated)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and cash equivalents - Cash and cash equivalents include cash on hand,
demand deposits and highly liquid instruments with a maturity of three
months or less at the time of purchase.
Property, plant and equipment - Property, plant and equipment is stated at
cost. Depreciation is provided to write off the cost of property, plant and
equipment over their estimated useful lives in equal instalments as follows:
<TABLE>
<CAPTION>
<S> <C>
Buildings 8-45 years
Plant and machinery 5-20 years
Transportation vehicles 5-10 years
Railway use right 50 years
</TABLE>
Net sales - Net sales represent the invoiced value of products, net of sales
taxes. Sales are recognized when products are shipped to customers.
Foreign currency translation - Foreign currency transactions are translated
into Renminbi at the applicable rates of exchange, quoted by the Shanghai
foreign exchange adjustment centre ("Swap Centre") before January, 1, 1994
and People's Bank of China (the "PBOC") on or after January 1, 1994,
prevailing at the date of the transactions. Monetary assets and liabilities
denominated in foreign currencies are translated into Renminbi using the
applicable Swap Centre or PBOC rate prevailing at the relevant balance sheet
date. Substantially all the transactions of the Factory are denominated in
Renminbi and the Factory did not have any material monetary assets or
liabilities denominated in foreign currencies.
Repairs and maintenance - Repair and maintenance costs are charged against
income in the period in which they are incurred. The expense is allocated
to cost of sales and selling, general and administrative expenses. The
aggregate expenses amounted to Rmb119 for the nine months ended September
30, 1995.
Taxation - The Factory, being a state-owned enterprise, was subject to PRC
income taxes at the applicable tax rate of 33% on the taxable income as
reported in the statutory accounts adjusted for taxation in accordance with
the relevant income tax laws applicable to state-owned enterprises.
Deferred income taxes are provided using the liability method. Under the
liability method, 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 asset or liability in the financial statements. During the periods
presented there were no significant temporary differences.
Translation into United States Dollars - The financial records of the
Factory are maintained, and its financial statements are expressed, in
Renminbi. The translations of Renminbi amounts into US dollars are for
convenience only and have been made at the rates of Rmb8.319 to US$1, the
exchange rate quoted by the PBOC on September 30, 1995. Such translations
should not be construed as representations that the Renminbi amounts could
be converted into US$ dollars, at that rate or any other rate.
F-21
MISHAN COAL CHEMICAL HOLDING COMPANY
NOTES TO FINANCIAL STATEMENTS
(Amounts in thousands, expressed in Renminbi unless otherwise stated)
4. TAXES
Income taxes - Income is subject to taxation in the PRC and the statutory
income tax rate in the PRC was 33% for the nine months ended September 30,
1995. A reconciliation of the statutory income tax rate and the effective
tax rate is as follows:
<TABLE>
<CAPTION>
Nine months
ended
September
30, 1995
%
<S> <C>
Statutory tax rate in PRC 33
Change in valuation allowance due to tax loss of MCCF 3
Tax attributable to income tax liabilities
borne by former owner (see note 6) (29)
Other (7)
______
Effective tax rate -
_______
</TABLE>
During the nine months ended September 30, 1995, no provision for income tax
for MCCF has been made as there is no assessable profit for the relevant
period.
5. VALUE ADDED TAXES RECEIVABLE
Effective January 1, 1994 value added tax ("VAT") was introduced at a rate
applicable to the Factory of 17% on the gross sales amounts and credit given
at the same rate on the VAT paid on purchases. The net VAT payable is
accounted for to the tax authorities.
In accordance with notices issued by the government authorities, the Factory
can deem VAT, at the rate of 14%, to have been paid on the opening inventory
amount and applied against future VAT payable based on criteria to be agreed
with the local authorities. This amount has been established as a
receivable. Management believes that the amount will be recoverable against
future VAT payable subject to approval as to timing by the tax authorities.
No utilization was made for nine months ended September 30, 1995.
F-22
MISHAN COAL CHEMICAL HOLDING COMPANY
NOTES TO FINANCIAL STATEMENTS
(Amounts in thousands, expressed in Renminbi unless otherwise stated)
6. RELATED PARTY TRANSACTIONS
Under an agreement dated and effective January 1, 1994, QCCF has paid an
amount of Rmb4,241 for nine months ended September 30, 1995 to Qitaihe City
Fuel Company ("QCFC"). In return QCFC would be responsible for the income
tax liabilities, certain operating expenses and interest expenses of QCCF.
Without this arrangement, income tax would have been levied on the income of
QCCF at the applicable income tax rate for the nine months ended September
30, 1995 and income tax expense would have been approximately Rmb1,622. The
interest expense borne by QCFC on behalf of QCCF was Rmb1,414 for the nine
months ended September 30, 1995. The above agreement was terminated with
effect from October 1, 1995.
The local government has granted the Factory the rights to use the land on
which the Factory is located without time limit and without charging annual
fees.
Substantially all of the Factory's sales, purchases, raw materials and
purchases of ancillary items are with state-owned enterprises. Even though
such state-owned enterprises may be regarded as having the same beneficial
owner, the PRC central government, such state-owned enterprises are
frequently under separate control and do not possess any management,
ownership or other interest in each other. As a result, the Factory does
not view transactions with such state-owned enterprises as constituting
related party transactions.
7. CONCENTRATION OF CREDIT RISK
The Factory's trade receivables in respect of sales on credit terms are
subject to a concentration of credit risk with customers in the industrial
sectors of steel making, metallurgy, electricity and other heavy industries.
In addition, the Factory has no formal credit terms and its sales are
predominantly to PRC companies. Therefore, the Factory's ability to collect
its trade receivables is related to the economic conditions in these
industrial sectors and in the PRC as a whole.
F-23
MISHAN COAL CHEMICAL HOLDING COMPANY
NOTES TO FINANCIAL STATEMENTS
(Amounts in thousands, expressed in Renminbi unless otherwise stated)
8.EMPLOYEE RETIREMENT BENEFITS
All the Factory's full-time employees are entitled to a retirement pension
calculated with reference to their basic salaries on retirement and their
length of service in accordance with a government managed pension plan. The
PRC government is responsible for the pension obligations of retired staff.
The Factory is required to make contributions to the state retirement plan
at 15-25% of the monthly salaries of the current full-time employees subject
to local authorities' discretion. Employees are required to make
contributions at 2% of their basic salary. Contract and part-time employees
are not entitled to such benefits. The expense of such arrangements to the
Factory was immaterial for all periods. The Factory is not obligated under
any other post-retirement plans and post-employment benefits are not
material.
9. SEGMENT INFORMATION
The Factory is engaged in one industry segment, the manufacture and sale of
coal products in the PRC where its operations are located. One customer,
Mudanjiang No. 2 Power Plant of Heilongjiang Province, PRC, accounted for
75% of net sales for the nine months ended September 30, 1995.
F-24
SIGNATURE
Pursuant to the requirement of the Securities Exchange Act of 1934,
the registrant certifies that it meets all of the requirements for filing
on Form 20-F and has duly caused this annual report to be signed on its
behalf by undersigned, thereunto duly authorized.
CHINA ENERGY RESOURCES CORPORATION
By: /s/Wang Gongquan
Wang Gongquan
Chairman of the Board and President
Date: July 15, 1998
EXHIBIT INDEX
Exhibit
Number Description of Document
2.1 Long-Term Supply Agreement, dated December 31, 1996, by and among,
QCCF, Quitaihe City Coal Mine and Mudanjiang No. 2 Power Plant.
EXHIBIT 2.1
Long-Term Supply Agreement, dated December 31, 1996, by and among, QCCF,
Qutaihe City Coal Mine and Mudanjiang No. 2 Power Plant.
English Translation
Long-Term Supply Agreement Between QCCF and Mudanjiang No. 2 Power Plant
Parties to the Agreement:
Party A: QCCF and Qitaihe City Coal Mine (Collectively "Party A")
Party B: Mudanjiang Bardar Electric Industrial Co. (a company belonging to
the Mudanjiang No. 2 Power Plant)
In order to meet the demand created by the improvement made by the PRC
government in the existing coal-electrical system which emphasizes on the
direct sales beteween coal suppliers to power plants, this agreement is made
between QCCF and Mudanjiang No. 2 Power Plant ("Mudanjiang"). The purpose of
this agreement is to stabilize the supply and demand relationship between the
parties. This agreement is made because both parties were satisfied with the
previously established co-operative ventures in 1994 and 1995.
1. Term (7 years)
The parties agree that the period of the agreement is from January 1, 1997 to
January 1, 2004.
2. Method of Cooperation
(i) Party A uses its existing factory and coal production facility as
investment.
(ii) Mudanjiang has contributed RMB 2 million on January 1, 1994 and January
1, 1995.
(iii) It is supposed that Mudanjiang will purchase 15 rail transportation
cars.
3. Duties of Party A
(i) Responsible for daily operation and administrative work.
(ii) Supply 900,000 tons of coal to Mudanjiang every year.
(iii) Responsible for arranging rail transportation plan.
(iv) Responsible for repayment of amount owed to Mudanjiang after the
agreement becomes effective on January 1, 1997.
4. Duties o Mudanjiag
(i) Assist Party A to perform administrative work.
(ii) Purchase 900,000 tons of coal (including steam coal) from Party A every
year.
(iii) Obtain adequate funds for the purchase of coal supplied by Party A.
5. Quantity and Quality Requirements
(i) Party A must supply 900,000 tons of coal to Mudanjiang every year.
(ii) The ash content of the coal supplied by Party A cannot exceed 35%
and the caloric value must be above 5,000MJ per kg.
(iii) The quantity and quality of coal shall be determined by the testing
and inspection done by Mudanjiang No. 2 Power Plant.
(iv) The price shall be determined based on the caloric value of the coal.
6. Profit sharing
(i) Mudanjiang is given a rebate of RMB10 per ton which applies up to
560,000 tons every year.
(ii) Any remaining profit is retained by Party A.
(iii) For any increase in the price of coal which is approved by the
Government after 1997, Mudanjiang is responsible for 25% of the price
increase but only with respect to 500,000 tons per year.
(iv) The expenses incurred with respect to Mudanjiang's existing 10 rail
transportation cars with annual capacity of 100,000 tons is borne by
Mudanjiang.
7. Breach of the Agreement
(i) Except for uncontrollable reasons, any party, who does not fulfill the
obligations under the agreement or terminate the agreement without the
consent of the other party, is liable for payment of damages to the other
party. The damages shall equal 30% o the coal value not fulfilled under the
agreement.
(ii) If economic loss is suffered as a result of a breach of agreement, the
breaching party shall pay for the economic loss suffered by the other party
and compensatory damages.
8. Dispute Settlement
(i) In the event of any dispute, the parties should try to resolve them based
on friendly, mutuall concession, otherwise, any dispute will be settled in a
local court of PRC.
9. Any deficiency in this agreement will be discussed and resolved by the
parties.
The agreement will be effective from January 1, 1997.
Party A: QCCF:
Legal representative:
Signature of Mr. Luan Jixiang
Mudanjiang Bardar Electric Industrial Co.
Signature of the Legal representative
December 31, 1996
