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, 1998
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)
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BRITISH VIRGIN ISLANDS
(Jurisdiction of incorporation or organization)
Citco Building, Wickhams Cay 971-B Russell Avenue
P.O. Box 662, Road Town Gaithersburg
Tortola, British Virgin Islands Maryland 20879
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
------------------------------------
SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT.
Name of Each Exchange
Title of Each Class on Which Registered
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Common Stock, par value $0.01 per share American Stock Exchange
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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, 1998, 3,248,494 common shares, par value $0.01 per
share (the "Common Stock"), were issued and outstanding.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes / / No /X/
Indicate by check mark which financial statement item the registrant has elected
to follow. Item 17 / / Item 18 /X/
<PAGE>
CERTAIN DEFINITIONS AND SUPPLEMENTAL INFORMATION
All references to "China" or "PRC" in this Annual Report are references to
The People's Republic of China. Unless otherwise specified, all references in
this Annual Report to "U.S. dollars," "dollars," or "$" are to United States
Dollars; all references to "Renminbi" or "Rmb" are to Renminbi, which is the
official currency of China. Unless otherwise specified, for the convenience of
the reader, translation of amounts from Renminbi to U.S. dollars 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 contains "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. Such statements are not guarantees
of future performance and involve a number of substantial risks and
uncertainties that could materially affect the subsidiaries of the Company,
including, without limitation, the subsidiaries' operations, markets and ability
to generate revenue and profits, and, accordingly, the price of the Company's
common stock, par value $.01 per share (the "Common Stock"). 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 (as
defined herein) 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 National Coal Act, increased or more stringent PRC
environmental regulations and the tightening of PRC exchange controls. The
Company has experienced difficulty in generating sufficient cash flow to enable
it to operate all its facilities and develop its Coal Mine Use Rights (as
defined herein). These difficulties have raised substantial doubt about the
Company's ability to continue as a going concern. Management's plans concerning
these matters are described in "Item 1.--Description of Business" and note 3 to
the Financial Statements.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
HISTORICAL BACKGROUND
The Company was incorporated on March 15, 1996, under the International
Business Companies Act of the British Virgin Islands (the "IBC Act"). 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 IBC Act. 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 Sino-foreign
equity joint venture company organized in 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 agreement expires in 2025. 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"). The financial results of the Company have been primarily derived from
the operations of MCCF and QCCF.
In December 1995, the principals of the Company entered into a definitive
agreement for the merger of Jackson Holding Corp. ("JHC") with and into the
Company. JHC was incorporated for the sole purpose of acquiring or merging with
an unspecified operating business.
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In connection with the merger, which was consummated in November 1996, the
Company issued 109,850 shares of Common Stock to the shareholders of JHC in
exchange for all of the issued and outstanding shares of common stock of JHC. At
the time of the merger, JHC had no operating assets.
On April 21, 1997, the Company listed 5,898,436 shares of Common Stock on
the American Stock Exchange, which included 3,248,494 shares outstanding and
2,649,942 shares reserved for issuance.
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.
RECENT DEVELOPMENTS
MANAGEMENT AND OPERATIONAL DIFFICULTIES AT MCCF AND QCCF. During the fiscal
year ended December 31, 1998 ("1998"), the Company experienced significant
management and operational difficulties with MCCF and QCCF.
MCCF. During the fiscal year ended December 31, 1997 ("1997") the Company
terminated the services of the MCCF plant manager for substandard management
performance in general, including substandard collection efforts. However, prior
to his termination, the plant manager improperly signed various documents that
provided collateral to local banks affiliated with the Mishan City Municipal
Government ("Mishan") over MCCF assets. In March 1998, MCCF ceased operations
due to the depletion of its working capital, which was entirely depleted due to
a large amount of uncollected trade receivables and poor operating management.
The situation was exacerbated by the refusal of local banks and raw coal
suppliers to advance further credit. Currently, MCCF only retains a minimum
workforce and incurs minimum expenses to maintain its facility. Total sales by
MCCF to its customers during 1998 amounted to $52,000. In addition, coke
products valued at $659,000 were used to settle debts due to suppliers and coke
valued at $175,000 was used to settle wages due to workers.
In June 1999, the Company entered into a memorandum of understanding with
Mishan whereby the Company agreed to transfer most of MCCF's assets to Mishan in
exchange for cancellation of MCCF's indebtedness to local banks. The memorandum
of understanding was subsequently memorialized in a contract with Mishan dated
July 10, 1999. Pursuant to the memorandum of understanding and subsequent
contract, the Company will retain MCCF's mining rights (the "Coal Mine Use
Rights"), which were granted on June 20, 1995 and continue in force for 100
years. Management intends to seek a third party who would use the Coal Mine Use
Rights in exchange for a negotiated royalty fee. For a discussion of MCCF's
operations, see "--Subsidiary Operations--MCCF."
QCCF. During the third quarter of 1998, it came to the attention of the
Company that QCCF was operating independently from MHXC and the Company and was
under the direction and influence of the local government in the PRC. QCCF
refused to comply with financial and business reporting protocols and disputed
that its operations were under the direction and control of the Company.
However, after a change in the executive management of the Company (as described
below) the Company's independent accountants were able to complete a certified
audit for 1998, and QCCF has subsequently complied with various directives from
the new management. Currently, management is in discussions with QCCF and local
government officials in an effort to fashion long-term solutions to the
operational and management issues. In addition, the Company is negotiating with
QCCF regarding the repayment terms of between $3 million and $4 million in debt
owed to the Operating Company by QCCF. However, final agreements are not
currently in place, and there can be no assurance that the Company and QCCF will
be able to negotiate long-term solutions to such operational and management
issues or that the Company will successfully negotiate the repayment terms of
such $3-4 million debt. For a discussion of QCCF's operations, see "--Subsidiary
Operations--QCCF."
TRANSACTIONS WITH CHINA ORIENT GROUP INDUSTRIES, INC. AND ITS AFFILIATES,
AND RESULTING CHANGE OF EXECUTIVE MANAGEMENT. In response to the management and
operational difficulties at MCCF and QCCF, former management of the Company
began discussions with officers of China Orient Group Industries, Inc., a
private sector conglomerate in the PRC (the "Orient Group"), and its affiliates
regarding an investment by the Orient Group in the Company and a possible change
in the Company's executive management. Such discussions resulted in a change of
executive management of the Company and certain financing agreements which are
described below.
THE STOCK AND WARRANT PURCHASE AGREEMENT. In December 1998, the Company and
America Orient Group, Inc. a Maryland corporation and wholly owned subsidiary of
the Orient Group ("AOG"), executed a stock and warrant
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purchase agreement whereby the Company agreed to sell to AOG 5,000,000 shares of
Common Stock and a warrant to purchase 5,000,000 shares of Common Stock for an
aggregate price of $1.0 million (the "Stock and Warrant Purchase Agreement").
Such warrant is exercisable at any time after the closing of the Stock and
Warrant Purchase Agreement (the "Exercise Date") in the five years following the
Exercise Date, in whole or in part, at the lower of (a) 75% of the average
closing price of the Common Stock for the 30 days immediately prior to such
exercise, or (b) as follows: $0.75 per share in 1999; $1.00 per share in 2000:
$1.50 per share in 2001; $2.00 per share in 2002; and $3.00 per share in 2003
(subject to adjustments for stock splits, stock dividends and similar
transactions). Closing of the Stock and Warrant Purchase Agreement is subject to
several conditions which are further described in the Stock and Warrant Purchase
Agreement. See "Exhibit 2.1"
AOG LOANS TO THE COMPANY. In February 1999, AOG loaned the Company $24,160
at an interest rate of 8% per annum payable on demand for working capital
purposes in exchange for a convertible note (the "AOG Convertible Note") and a
warrant to purchase 120,800 shares of Common Stock at an exercise price of $0.20
per share. Based on a conversion price of $0.20 per share, the AOG Convertible
Note was convertible at the time of issuance into 120,800 shares of Common
Stock. In March 1999, the Company issued a revolving convertible note to AOG of
up to $250,000 at an interest at 8% per annum payable on demand (the "Revolving
Note"). AOG may convert any amounts owed under the Revolving Note to Common
Stock on the same terms as the AOG Convertible Note. In April 1999, the
Revolving Note was increased to up to $1.3 million, and as of July 1999 the
Company had outstanding borrowings under the Revolving Note of approximately
$326,000.
ORIENT FINANCE CO. LOAN TO THE COMPANY. In March 1999, the Company, together
with MHXC, entered into a definitive loan and guarantee agreement with Orient
Finance Co. ("Orient Finance") for a $2.0 million term loan of three years with
a one-year grace period and a 6.625% interest rate per annum (the "Loan
Agreement"). The Loan Agreement provides no conversion features. Orient Finance
is a subsidiary of the Orient Group and, accordingly, an affiliate of AOG. Under
the terms of the Loan Agreement, as amended in July 1999, the $2.0 million will
be disbursed to MHXC no later than July 31, 1999.
JOINT VENTURE AGREEMENT WITH JINZHOU HARBOR (GROUP) CO. LTD. In March 1999,
the Company, through CCM, entered into a definitive agreement (the "Jinzhou
Agreement") with Jinzhou Harbor (Group) Co. Ltd., a majority owned subsidiary of
the Orient Group and affiliate of AOG ("JHG"), to form Jinzhou Port Coal
Terminal Co. Ltd. (the "Jinzhou Terminal"). Under the original Jinzhou
Agreement, CCM was to invest approximately $11 million for a 60% interest in the
Jinzhou Terminal. In order to comply with rules of the Shanghai Stock Exchange,
where JHG shares are traded, the Jinzhou Agreement was amended in July 1999 to
provide for CCM to invest $7.4 million for a 49% interest in the Jinzhou
Terminal. Funding for the $7.4 million investment is expected to be financed by
AOG's exercise of its warrant to purchase 5,000,000 shares of Common Stock under
the Stock and Warrant Purchase Agreement and other purchases of the Common Stock
by AOG or its affiliates. If the Jinzhou Agreement is consummated, the Jinzhou
Terminal is expected to derive revenues primarily from coal and oil and gas port
activity. However, management has not completed its long-term business strategy,
and no assurance can be given that the Jinzhou Agreement will be consummated.
CHANGE IN EXECUTIVE MANAGEMENT. In connection with the Stock and Warrant
Purchase Agreement, the loans from AOG and Orient Finance to the Company and the
Jinzhou Agreement, executive officers from AOG and the Orient Group assumed
control of Company management, which included the resignation of Mr. C.T. Yeh,
the President, Chief Executive Officer and Acting Chairman of the Company, on
March 3, 1999 and the appointment of Mr. Bill H. Zhao, a director and Executive
Vice President of AOG, as President, Chief Executive Officer and Chairman of the
Board of the Company the same day. In April 1999, the Company appointed Guoliang
Guan, a director and Senior Vice President of AOG, as a director of the Company.
In addition, upon closing of the Stock and Warrant Purchase Agreement, the Board
of Directors of the Company (the "Board") will be expanded to include
appointments of AOG so as to give AOG appointees management control of the
Company. Management believes that implementation of its business strategy,
including the continued operation of QCCF, consummation of the Stock and Warrant
Purchase Agreement and the Loan Agreement, will allow the Company to continue as
a going concern; however, there can be no assurance that such business strategy
will be implemented or, if implemented, capable of restoring profitable
operations in the future.
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SUBSIDIARY OPERATIONS
MCCF
When operating, 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
19,880 tons in 1998, accounting for 23% of its production capacity for
metallurgical coke. Improvements to the facility, which cost approximately $3.0
million, were financed through an unsecured loan by a local PRC bank at a fixed
term rate of 15.3% per annum. These improvements enabled MCCF to produce
metallurgical coke and foundry coke which it was unable to do prior to such
improvements. Presently, when operating, the main product of the MCCF plant is
metallurgical coke and low-end metallurgical coke.
On June 20, 1995, the Mishan granted MCCF the Coal Mine Use Rights, which
are exclusive underground rights to mine coal from certain coal reserves located
in Mishan City, within Heilongjiang Province, PRC. 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 $7.9 million to MCCF to
partially finance the acquisition of the Coal Mine Use Rights.
The coal 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 four 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. During 1997 and 1998, MCCF had
been engaged in conducting mine site surveys, clearing the surface of potential
mine entrance sites, performing geological surveys and preparing mining plans.
The Company needs to complete additional work on the survey and mining plans
before the mine is ready for use. During 1998, the Company engaged outside
consultants to assist in this process. The costs associated with mining
preparation work have been capitalized as part of MCCF's Coal Mine Use Rights.
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 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 revenues of $1.3 million.
As discussed above, during 1997 the Company terminated the services of the
MCCF plant manager for substandard management performance in general, including
substandard collection efforts. However, prior to his termination, the plant
manager improperly signed various documents that provided collateral to bank
lenders of MCCF over MCCF assets. In March of 1998, MCCF ceased operations due
to the depletion of working capital, which was entirely depleted due to a large
amount of uncollected trade receivables and poor operating management. The
situation was exacerbated by the refusal of local banks and raw coal suppliers
to advance further credit. At the current stage, MCCF only retains a minimum
workforce and incurs minimum expenses to maintain its facility. Total sales by
MCCF to its customers during 1998 amounted to $52,000. In addition, coke
products valued at $659,000 were used to settle debts due to suppliers and coke
valued at $175,000 was used to settle wages due to workers. Both of these
transactions were recorded as sales in the financial statements of MCCF.
The local government has been assisting the Company to supervise the daily
operations of MCCF. The majority of the workforce was dismissed after the plant
closed with approximately 50 workers remaining on the premises. These workers
spent most of their time defending the MCCF assets from creditors' claims and
dealing with lawsuits brought
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by suppliers. During the third quarter of 1998, the Company was informed by MCCF
that the workers at MCCF had not been paid wages and certain of the workers of
MCCF have petitioned the municipal government in the PRC for aid in being paid.
In February 1999, AOG loaned the Company $24,160, which was used primarily to
pay a portion of the accrued wages to the MCCF's workers. Since such payment,
the workers have stopped petitioning. Although the MCCF factory has been closed
since March 1998, the Company has continued to accrue wages on its financial
statements. The amount of unpaid wages as of December 31, 1998 was approximately
$167,000. The Company has recently entered into an agreement to dispose of all
of the MCCF assets other than the Coal Mine Use Rights. See "--Recent
Developments."
QCCF
QCCF's primary product is steam coal, which is used by thermal power plants.
Historically, a substantial percentage of the sales of QCCF has been to a few
power plants in the nearby region. 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. QCCF sold 475,305 tons, 396,627 tons and 299,086 tons of steam
coal in 1996, 1997 and 1998 respectively. Overall sales volume decreased from
1996 to 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. The transportation
capacity continued to be a major obstacle to sales in 1998 because of the severe
flood problem in the northeast regions of PRC where QCCF's customers are
located. In addition, there was a deceleration in the economic growth in PRC
which resulted in a corresponding decrease in the demand for coal products in
1998. Accordingly, the sales of QCCF's steam coal declined substantially from
$7.7 million in 1997 to $5.8 million in 1998.
BUSINESS STRATEGY
The Company raised net proceeds of approximately $5.4 million through
offerings of convertible notes and warrants in November 1996 and January 1997.
These proceeds were primarily used as follows: $2.0 million for purchase of raw
coal and working capital of MCCF, $648,000 for repayment of bank loans by QCCF,
$1.3 million 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, $286,000 in an unauthorized withdrawal by the former Chairman of the
Company, $832,000 for the Company's administrative and reporting expenses and
$15,000 as cash on hand. Management believes that the proposed transactions with
AOG and its affiliates, if implemented, will provide adequate capital to allow
the Company to continue as a going concern. See "--Recent Developments."
MCCF's working capital was entirely depleted due to a large amount of
uncollected trade receivables and poor operating management. As a result, MCCF
ceased operations in March of 1998 and is not planned to resume production under
the management of the Company. Presently, MCCF only retains a minimum workforce
and incurs minimum expenses to maintain its facility. The Company has entered
into an agreement to transfer most of MCCF's assets to Mishan in exchange for
cancellation of MCCF's indebtedness to local banks. See "--Recent Developments--
Management and Operational Difficulties at MCCF and QCCF--MCCF."
QCCFs business strategy is to obtain the necessary transportation capacity
so that additional products can be marketed and distributed to customers. It is
expected that QCCF will utilize existing cash flow from operations to meet its
operational needs. 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. During 1998, QCCF began operating independently from MHXC
and the Company. However, after a change in the executive management of the
Company, QCCF has subsequently complied with various directives of the new
management. See "--Recent Developments--Management and Operational Difficulties
at MCCF and QCCF-- QCCF."
The Company is planning to expand its business through the formation of the
Jinzhou Terminal. The annual throughput capacity of the Jinzhou Terminal is 1.1
million metric tons of coal products. Management believes the Jinzhou Terminal
provides a strategic advantage for the Company's future development,
particularly if the Company can export QCCF's coal products. However, management
has not completed its long-term business strategy, and no assurance can be given
that the Jinzhou Agreement will be consummated. See "--Recent
Developments--Joint Venture Agreement with Jinzhou Harbor (Group) Co. Ltd."
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Management intends to commence a feasibility study regarding mining the coal
reserves to which MCCF has exclusive mining rights. Management intends to seek a
third party to use the Coal Mine Use Rights for a negotiated royalty fee.
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 $3.0 million to commence such mining operations, including, but not limited
to, purchasing equipment for digging, mining, safety, ventilation and
transportation. The Company expects such construction would take approximately
one year from commencement to completion.
SALES AND MARKETING
MCCF. When operating, 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 1998, 1997 and 1996.
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 focused 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 orders. However, due to poor credit
management and collection efforts by MCCF Management, 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 and production at the
facility was halted in March of 1998.
MCCF reported the following sales of metallurgical coke for the previous
three fiscal years:
<TABLE>
<CAPTION>
1996 1997 1998
---- ----
<S> <C> <C> <C> <C>
Sales volume (in tons) -metallurgical coke 6,758 21,783 19,880
-low-end metallurgical coke - 39,226 25,734
Average net sales price (per ton)* -metallurgical coke $38.32 $41.73 $39.15
-low-end metallurgical coke - $10.30 $4.19
</TABLE>
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*Sales prices indicated are net of discounts and returns.
QCCF. QCCF has entered into various long-term coal supply contracts with its
major electric utility customers to ensure a stable demand for its products
along with a source of working capital. 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.
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QCCF reported the following sales of steam coal for the previous three
fiscal years:
<TABLE>
<CAPTION>
1996 1997 1998
---- ----
<S> <C> <C> <C>
Sales volume (in tons) 475,305 396,627 299,086
Average net sales price (per ton)* $15.86 $19.52 $19.31
</TABLE>
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* Sales prices indicated are net of discounts and returns.
DEPENDENCE ON ONE MAJOR CUSTOMER
Historically, a substantial percentage of the sales of QCCF (and its
predecessor companies) has been to one customer, Mudanjiang No. 2 Power Plant
("Mudanjiang"), in Heilongjiang Province, PRC, which accounted for approximately
82%, 80% and 89% of QCCF's net sales and approximately 78% and 71% and 80% of
the Operating Company's net sales for the years ended December 31, 1996, 1997
and 1998, 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 1996, QCCF sold 390,890 tons 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. 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 and 259,624 tons in 1998. 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.
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 a good harvest in the northeast 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 transportation capacity continued to be a major obstacle to make
sales in 1998 because of the severe flood problem in the northeast regions of
PRC where QCCF's customers are located.
The development of the PRC railway system still lags behind the growth of
the PRC economy as a whole. 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. Because of the Operating Company's ongoing
efforts to develop new customers, the Company expects the number of customers
located in areas other than the PRC's northeast region to 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 in the
foreseeable future based on their current 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 locate alternative
means of transportation that are reliable and cost-efficient.
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. The ash content in the raw coal
is, according to an independent governmental test conducted in Beijing, 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. geological company ("Boyd"), to review and
comment on the availability, reliability and quality of the coking coal reserve
to MCCF (the "Boyd Report"). According to the Boyd Report, 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 latest expansion plans for the
7
<PAGE>
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 an additional 9.4 million recoverable tons of coking coal
reserve base available for expansion and/or continuation of operations. The Boyd
Report recommended that the Company implement various programs to expand the
demonstrated coal reserve base. Due to inadequate working capital, the Company
has not been able to conduct further mine surveys.
TECHNOLOGY
The processing plant at QCCF employs the "air-heavy medium fluid bed" dry
process of coal preparation, which the Company believes is the 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.
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 and the Regulations for the Implementation of the Mineral Resources Law
of the PRC. 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 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, pursuant to the National Coal
Law, require approval by the Heilongjiang Provincial Coke and Coal Bureau. New
rules that may 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, 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") provides 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
8
<PAGE>
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.
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 high caloric value and its low
content of sulfur, phosphorous and ash. 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.
The Operating Company believes that the Jixi City Coal Preparation Plant
("Jixi"), which produces mainly metallurgical coke, is its only major competitor
within the Operating Company's region. 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,
Beijing Coking Chemical Plant and other coking plants in central China. Because
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 the
Operating Company's customers. 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 all of these
other plants produce only limited quantities of foundry coke and there is still
market demand for additional 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. 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 the PRC. 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.
EMPLOYEES
As of December 31, 1998, the Company and CCM each had 1 full-time employee.
As of December 31, 1998, the Operating Company, including its two factories, had
approximately 308 employees, 258 of whom worked for QCCF and 50 of whom worked
for MCCF. During 1998, due to lack of working capital, MCCF ceased operations
and dismissed 500 workers. Although the workers were terminated, the local labor
law stipulated that the Operating Company is still liable for the worker's wages
and benefits. The total amount of unpaid wages and benefits as of December 31,
1998 amounted to approximately $167,000. Of the Operating Company's total number
of employees, approximately 91% were production workers, approximately 7% were
managerial staff and approximately 2% were
9
<PAGE>
engineering and technical staff. QCCF retired 32 workers during 1998 as part of
its cost control program. 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 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 Company has recently entered into an agreement to dispose of all of
the MCCF assets other than the Coal Mine Use Rights. See "Item 1---Description
of Business--Recent Developments."
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 until 2045. 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. 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 $3.0 million 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 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 until 2025. The QCCF factory
has the capacity to produce approximately 750,000 tons of steam coal per year
and was operated at approximately 40% of capacity in 1998.
The MCCF and QCCF factories of the Operating Company are located in Mishan
City and Qitaihe City, respectively, in the PRC. Fire and disaster relief or
assistance in the PRC is far less sophisticated than in the United States. 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. Accordingly, 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. In addition, none of the Company, the Operating Company nor
its factories maintain any business interruption insurance.
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<PAGE>
ITEM 3. 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.
ITEM 4. CONTROL OF REGISTRANT
The following table sets forth certain information regarding ownership of
the Company's shares of Common Stock as of December 31, 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.
<TABLE>
<CAPTION>
AMOUNT PERCENT
TITLE OF CLASS IDENTITY OF 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 - 0%
</TABLE>
The Company issued a total of 52,000 options to a consulting firm, the
Equity Group, in July 1997 and January 1998, 32,000 of which are fully vested
with an exercise price of $5.00 per share, and 20,000 of which are fully vested
with an exercise price of $3.50 or at a lower price at which the Company issued
additional equity or warrants between January 22, 1998 and January 21, 1999.
Such options expire in 2002 and 2003, respectively.
On September 2, 1998 the Company entered into an employment agreement with
Mr. C.T. Yeh, the former Acting Chairman, President and Chief Executive Officer
of the Company (the "Employment Agreement"). Under the Employment Agreement,
among other things, Mr. Yeh received 15,000 shares as part of his compensation
for the 1998 fiscal year. In addition, Mr. Yeh received a total of 120,000
options to subscribe for and purchase shares of the Common Stock at $1.00 per
share. At December 31, 1998, 50,000 of these options were unrestricted, the
remainder will cease to be restricted on December 31, 1999 or upon the
occurrence of certain specified events described in the Employment Agreement.
Such options are exercisable within five years from the date of issuance.
As of January 25, 1999, there were 3,263,494 shares of Common Stock issued
and outstanding. In the event that the holders of the outstanding Convertible
Notes in the principal amount of $3,237,500 (the "Convertible Notes") exercise
their rights to convert the Convertible Notes at the floor price of $3.50 per
share (resulting in the issuance of an additional 1,082,250 shares of Common
Stock), (ii) AOG purchased 5,241,600 shares of Common Stock, (iii) AOG exercises
its right to convert, the AOG Convertible Notes, at the conversion price of $.20
per share (resulting in the issuance of an additional 120,800 shares of Common
Stock) and (iv) all the holders of warrants and options of the Company exercise
their purchase rights (resulting in the issuance of an additional 7,428,543
shares of Common Stock), the Company would have a total of 17,136,687 shares of
Common Stock issued and outstanding. Dilution to the existing shareholders would
be approximately 81%.
Assuming full conversion (in the case of the Convertible Notes and the AOG
Convertible Notes) or exercise in the case of warrants and options of the
Company) of the outstanding Convertible Notes, the AOG Convertible Notes,
warrants and options of the Company, 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>
IDENTITY OF AMOUNT PERCENT OF
TITLE OF CLASS PERSON OR GROUP OWNED CLASS
- -------------- --------------- ----- -----
<S> <C> <C> <C>
Common Stock Hualong Holding Co. Ltd. 1,250,000 7%
Common Stock Rana Energy Investment Ltd. 734,444 4%
Common Stock All officers and directors as a group - 0%
Common Stock AOG 5,241,600 31%
</TABLE>
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<PAGE>
ITEM 5. NATURE OF TRADING
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."
The high and low sales prices for shares of the Common Stock on the AMEX for
the period indicated were as follows:
HIGH LOW
1997 Second Quarter $6.0000 $4.5625
1997 Third Quarter 5.1250 3.1250
1997 Fourth Quarter 3.8750 1.6250
1998 First Quarter 2.9375 1.5000
1998 Second Quarter 2.1250 1.5000
1998 Third Quarter 1.3750 0.3750
1998 Fourth Quarter 1.3750 0.3125
As of December 31, 1998, there were 3,248,494 shares of Common Stock issued
and outstanding, 1,467,694 of which were held of record by approximately 290
holders with addresses in the United States.
ITEM 6. EXCHANGE CONTROLS AND OTHER LIMITATIONS AFFECTING SECURITY
HOLDERS
CURRENCY CONTROLS - PEOPLES' REPUBLIC OF CHINA
The Operating Company receives almost all of its revenues in Renminbi, which
is not freely convertible into foreign currency. 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
currency 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 currency 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
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<PAGE>
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 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 residents 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 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 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: (i) transact 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 situated 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) maintain a banking or trust
business, unless it is licensed under the BVI Banks and Trusts Companies Act of
1990; (iv) transact business as an insurance or a reinsurance company, insurance
agency or insurance broker, unless it is licensed under an enactment authorizing
it to transact that business; (v) maintain the business of company management
unless it is licensed under the BVI Company Management Act, 1990; or (vi)
maintain 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.
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<PAGE>
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. 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 (non-BVI)
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.
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 included in this Annual Report. The Company prepares
its financial statements in accordance with U.S. GAAP.
The Company holds 100% of the capital stock of CCM. The Operating Company is
a Sino-foreign equity joint venture company which owns and operates two
production factories, MCCF and QCCF. The figures below primarily reflect the
financial operating results of MCCF and QCCF.
14
<PAGE>
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
12/31/96(2) 12/31/97(2) 12/31/98(2)
THE COMPANY: ---------------------------------------------------------
(amounts in thousands, except per share data)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
<S> <C> <C> <C>
Net sales .............................................................. $ 7,801 $ 9,053 $ 6,660
Subcontracting income .................................................. 723 362 --
Cost of sales .......................................................... (5,584) (5,516) (4,835)
-------- -------- --------
Gross profit ........................................................... 2,940 3,899 1,825
Selling, general and administrative expenses ........................... (961) (4,921) (2,634)
Write off of advances to related parties ............................... -- (1,768) --
-------- -------- --------
Operating income/(loss) ................................................ 1,979 (2,790) (809)
Interest expense ...................................................... (422) (1,056) (1,339)
Other income/(expenses) ................................................ 46 (190) (79)
-------- -------- --------
Income (loss) before income taxes and minority interest ................ 1,603 (4,036) (2,227)
Income tax ............................................................. -- -- --
-------- -------- --------
Income (loss) before minority interest ................................. 1,603 (4,036) (2,227)
Minority interest ...................................................... (345) 494 196
-------- -------- --------
Net income (loss) ...................................................... $ 1,258 $ (3,542) $ (2,031)
Earnings (loss) per share (1) .......................................... $ 0.66 $ (1.18) $ (0.63)
Dividends per share .................................................... -- --
Weighted average number of shares outstanding (1) ...................... 1,918 2,994 3,248
CONSOLIDATED BALANCE SHEET DATA (AT PERIOD END):
Working capital ........................................................ $ 1,804 $ (4,421) $ (6,956)
Total assets ........................................................... 28,833 27,393 24,077
Total long-term debt ................................................... 5,369 4,761 5,348
Minority interest ...................................................... 2,377 1,739 1,543
Shareholders' equity ................................................... 12,156 7,608 4,434
CONSOLIDATED CASH FLOW STATEMENT DATA:
Net cash provided by/(used in) operating activities .................... 1,960 (3,493) 1,282
Net cash used in investment activities ................................. (1,028) (1,250) (372)
Net cash provided by/(used in) financing activities .................... (3,795) 562 (1,595)
Additions to property, plant and equipment ............................. 1,028 997 442
Depreciation ........................................................... 863 643 858
STATISTICAL DATA:
Gross margin ........................................................... 28.4% 39.1% 27.4%
Operating margin ....................................................... 16.1% (30.8)% (12.1%)
</TABLE>
(1) The calculation of actual earnings per share of Common Stock for 1998, 1997
and 1996 are based on the weighted average number of shares outstanding
during the years ended December 31, 1998, 1997 and 1996.
(2) See Consolidated Statement of Operations of the Company for the years ended
December 31, 1998, 1997 and 1996.
15
<PAGE>
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>
<CAPTION>
Year Ended Year Ended Year Ended
12/31/96 12/31/97 12/31/98
THE COMPANY: ----------------------------------------------------
(expressed in thousands)
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA (UNCONSOLIDATED)
Net sales .............................................................. $ -- $ -- $ --
Cost of sales .......................................................... -- -- --
------- ------- -------
Gross profit ........................................................... -- -- --
Selling, general and administrative expenses
(96) (953) (619)
------- ------- -------
Operating loss ......................................................... (96) (953) (619)
Interest expense ....................................................... (47) (483) (454)
Other expenses ......................................................... -- (199) (102)
------- ------- -------
Loss before income taxes and minority interest ......................... (143) (1,635) (1,175)
Income tax ............................................................. -- -- --
Loss before minority interest .......................................... (143) (1,635) (1,175)
Minority interest ...................................................... -- -- --
Net loss ............................................................... -- -- --
------- ------- -------
$ (143) $(1,635) $(1,175)
</TABLE>
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
12/31/96 12/31/97 12/31/98
MCCF: ----------------------------------------------------
(expressed in thousands)
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA (UNCONSOLIDATED)
Net sales .............................................................. $ 259 $ 1,313 $ 886
Subcontracting income .................................................. 723 362 --
Cost of sales .......................................................... (684) (1,559) (1,183)
------- ------- -------
Gross profit (loss) .................................................... 298 116 (297)
Selling, general and administrative expenses ........................... (309) (2,116) (265)
------- ------- -------
Operating loss ......................................................... (11) (2,000) (562)
Interest expense ....................................................... (127) (433) (640)
Other expenses ......................................................... -- 24 --
Loss before income taxes and minority interest ......................... (138) (2,409) (1,202)
Income tax ............................................................. -- -- --
Loss before minority interest .......................................... (138) (2,409) (1,202)
Minority interest ...................................................... 28 495 226
------- ------- -------
Net loss ............................................................... $ (110) $(1,914) $ (976)
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
12/31/96 12/31/97 12/31/98
QCCF: ----------------------------------------------------
(expressed in thousands)
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA (UNCONSOLIDATED)
Net sales..................................................
$ 7,542 $ 7,740 $ 5,774
Cost of sales.............................................. (4,900) (3,957) (3,652)
------- ------- -------
Gross profit............................................... 2,642 3,783 2,122
Selling, general and administrative expenses............... (556) (1,852) (1,750)
Write off advances to related parties...................... -- (1,768) --
------- ------- -------
Operating income........................................... 2,086 163 372
Interest expense........................................... (248) (140) (245)
Other income/(expenses).................................... 46 (15) 23
------- ------- -------
Income before income taxes and minority interest........... 1,884 8 150
Income tax................................................. -- -- --
------- ------- -------
Income before minority interest............................ 1,884 8 150
Minority interest.......................................... (373) (1) (30)
------- ------- -------
Net income................................................. $ 1,511 $ 7 $ 120
</TABLE>
<TABLE>
<CAPTION>
Production Mix and Sales Volume
OPERATING COMPANY: ----------------------------------------------------
1996 1997 1998
---- ---- ----
(expressed in thousands except average figures)
<S> <C> <C> <C>
Metallurgical coke:
Sales volume........................................... 6,758 21,783 19,880
Average sales price per ton............................ $ 38.32 $ 41.73 $ 39.15
Average production cost per ton........................ $ 101.21 $ 55.86 $ 50.39
Low-end metallurgical coke:
Sales volume........................................... -- 39,226 25,734
Average sales price per ton............................ -- $ 10.30 $ 4.19
Average production cost per ton........................ -- $ 8.72 $ 7.03
Steam coal:
Sales volume........................................... 475,305 396,627 299,086
Average sales price per ton............................ $ 15.86 $ 19.52 $ 19.31
Average production cost per ton........................ $ 10.31 $ 9.98 $ 12.21
</TABLE>
EXCHANGE RATE INFORMATION
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:
Period Ended Exchange Rate
------------ -------------
December 31, 1996 US$1.00 = Rmb8.2982
December 31, 1997 US$1.00 = Rmb8.2798
December 31, 1998 US$1.00 = Rmb8.2787
17
<PAGE>
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 1998, 1997 and 1996 are to
the consolidated results of CCM and the 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
When operating, 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
19,880 tons in 1998, accounting for 23% of its production capacity for
metallurgical coke. Improvements to the facility, which cost approximately $3.0
million, were financed through an unsecured loan by a local PRC bank at a fixed
term rate of 15.3% per annum. These improvements enabled MCCF to produce
metallurgical coke and foundry coke which it was unable to do prior to such
improvements. Presently, when operating, the main product of the MCCF plant is
metallurgical coke and low-end metallurgical coke.
On June 20, 1995, the Mishan granted MCCF the Coal Mine Use Rights,
which are exclusive underground rights to mine coal from certain coal reserves
located in Mishan City, within Heilongjiang Province, PRC. The Coal Mine Use
Rights were granted on June 20, 1995 and continue in force for 100 years. See
"Item 1--Description of Business--Government Regulation." Upon the formation of
the Operating Company, the PRC joint venture partner made an interest free loan
in the amount of $7.9 million to MCCF to partially finance the acquisition of
the 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
40% of capacity in 1998.
18
<PAGE>
COMPARISON OF OPERATING RESULTS FOR THE FISCAL YEARS ENDED DECEMBER 31, 1998 AND
1997.
NET SALES. Net sales are recorded as gross sales less returns and
discounts. Net sales decreased from $9.1 million in 1997 to $6.7 million in
1998.
MCCF's sales during the first quarter of 1998 consisted of sales
totaling $52,000 to the customers and coke products valued at $834,000 which
were used to settle wage and coal supplier claims. The sales price for coke
products used to settle wages and creditor claims was determined by the local
court in the PRC and was lower than the market price. Such amount was based on a
physical counting of the inventory, and was based on the actual tonnage removed
from the MCCF facility. MCCF's sales to customers decreased 96% from $1.3
million in 1997 to $52,000 in 1998 primarily because the factory was not able to
produce and operate due to a depletion of working capital in 1998.
QCCF's sales of steam coal decreased 25% from $7.7 million in 1997 to
$5.8 million in 1998. Coal sales volume decreased 25% from 396,627 tons in 1997
to 299,086 tons in 1998. The decline in sales volume was primarily due to (1) a
deceleration in the economic growth rate which resulted in a corresponding slow
down in the demand for coal products, (2) an inability to obtain transportation
capacity in the fourth quarter of 1998 which is the peak season for the steam
coal business, and (3) a reduction in sales volume caused by pressure from the
local government which requested power plants to purchase coal products from
state-owned producers as part of the government's effort to support state-owned
enterprises.
MCCF received a subcontracting fee of $362,000 in 1997 as a result of a
subcontracting agreement with a company under the control of PRC's Ministry of
Coal.
This agreement expired in March 1997 and MCCF did not receive any
subcontracting income in 1998.
COST OF SALES. The cost of coal sales includes the cost of raw
material, direct labor and benefits, depreciation, transportation and
manufacturing overhead. Cost of sales decreased from $5.5 million in 1997 to
$4.8 million 1998.
MCCF's average unit cost of producing metallurgical coke decreased due
to (1) a decline in direct labor as a result of the dismissal of approximately
520 workers and (2) a decrease in the price of raw coal.
QCCF's average unit cost for steam coal increased by 22% as a result of
the lack of economies of scale for certain production costs such as
depreciation, direct labor and other manufacturing overhead. Also, the price for
raw coal decreased slightly due to poor demand.
GROSS PROFIT. Gross profit decreased 53% from $3.9 million in 1997 to
$1.8 million in 1998. The decrease was primarily attributable to the decline in
sales in both factories, including QCCF's sales decrease of 25% and the
termination of operations at MCCF in March 1998. Furthermore, MCCF did not
receive any subcontracting income in 1998.
SELLING, GENERAL AND ADMINISTRATION EXPENSES. Selling, general and
administrative expenses decreased 46% to $2.6 million in 1998 from $4.9 million
in 1997. The decease of $2.3 million is mainly attributable to the following
factors: (1) MCCF's decrease in salary expenses due to its termination of
operations in March 1998; (2) MCCF's decrease in salary expenses due to the
dismissal of approximately 500 workers; (3) MCCF's elimination of the bad debt
provision, which in 1997 totalled $1.6 million; (4) QCCF's termination of
workers due to reduced sales which reduced salary and benefit expenses by
$107,000; (5) QCCF's reduction in other general and administrative expenses by
$507,000 due to tighter control of expenditures for all departments by the
management; and (6) the Company's reduction in general and administrative
expenses by closing the Harbin office in 1998 and exercising tighter control
over administrative expenses.
INTEREST EXPENSE. Interest expense was reported net of interest income.
Interest expense increased by 27% from $1.1 million in 1997 to $1.3
million in 1998. The increase of $283,000 was attributable to an increase in
MCCF's interest expense by $150,000. This increase was attributable to the
expiration of the agreement between the local government and MCCF which
obligated the local government to share one-half of the interest expense on
certain loans. In addition, MCCF incurred $57,000 in penalties in 1998 due to
its default on the
19
<PAGE>
payments of all of its outstanding loans with local banks. QCCF's interest
expense increased by $105,000 due to increase in loan borrowings.
Interest expense in the amount of $386,000 was imputed for the year
ended December 31, 1998 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
funds in the amount of $286,000 from the MHXC without the authority of the
Company. The Chairman died in October 1997 and the Company has been seeking to
recover the amount from his estate and family. The Company wrote off $184,000
and $102,000 in 1997 and 1998 respectively.
INCOME TAXES. Substantially all of the Company's current profits
accrued 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 payment
of income taxes 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 1998.
NET LOSS. Net loss decreased from $3.5 million in 1997 to $2.0 million
in 1998. The decrease in net loss by $1.5 million was due to: (1) a decrease in
salary and benefit expenses of MCCF and QCCF by $227,000 due to the dismissal of
workers; (2) a decrease in bad debt provision of $1,630,000 in MCCF; (3) a
decrease in the Company's general and administrative expenses of $334,000 by
closing the Harbin office and exercising tighter controls in overall
administrative expenses; and (4) the lack of write offs of advances to related
parties. The decrease in net loss was partially offset by (1) a decrease in
gross profit of $2.1 million in MCCF and QCCF and (2) an increase in the selling
expenses of $463,000 in QCCF.
COMPARISON OF OPERATING RESULTS FOR THE FISCAL YEARS ENDED DECEMBER 31, 1997 AND
1996.
NET SALES. Net sales are recorded as gross sales less returns and
discounts. Net sales increased from $7.8 million in 1996 to $9.1 million in
1997.
MCCF's sales increased 407% from $259,000 in 1996 to $1.3 million 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 of the increase in
production improved the quality of the product. MCCF entered into a
subcontracting agreement with a third party in June 1996. 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
MCCF a subcontracting fee of $723,000 in 1996 and $362,000 in 1997. MCCF was not
able to collect the $362,000 in 1997 due to the death of Chairman of the
Company. Upon the receipt of working capital in March of 1997, MCCF terminated
the subcontracting agreement and 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.
QCCF's sales of steam coal increased 2.6% from $7.5 million in 1996 to
$7.7 million 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 due
primarily 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 in the area 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 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 compared to 390,890 tons in 1996. Such decrease was due to a
shortage of transportation capacity.
20
<PAGE>
COST OF SALES. The cost of coal sales includes the cost of raw
materials, direct labor and benefits, depreciation, transportation and
manufacturing overhead. Cost of sales decreased from $5.6 million in 1996 to
$5.5 million in 1997.
MCCF's average unit cost of producing metallurgical coke decreased 45%
from $101.21 in 1996 to $55.86 in 1997 due to economies 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 $2.9 million in 1996 to
$3.9 million in 1997. The increase was primarily attributable to an increase in
MCCF's gross profit on sales of coke products by 42% and an increase in QCCF's
gross profit by 43% due to an 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 $4.9 million in 1997 from $961,000 in
1996. The increase of $4.0 million is mainly attributable to the following
factors:
(1) In 1997, MCCF increased its write-off of trade receivables and
subcontracting income in the amount of $1.6 million due to poor credit
management and collection efforts. Salaries and selling expenses increased by
$416,000 due to an increase in selling efforts in 1997. (2) QCCF increased its
$311,000 write off of trade and other receivables, and 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 opened a representative office in
Heilongjiang in 1997 which increased the office expenses by $337,000 in 1997
compared to 1996. (4) In addition, the Company incurred approximately $432,000
in professional and administrative expenses associated with its reporting
obligations as a public entity. There was an additional amortization of issuance
cost totaling $88,000 when compared to 1996 due to additional financing which
closed in 1997.
WRITE OFF OF ADVANCES TO RELATED PARTIES. In 1997 advances totaling
$1.8 million 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. The terms of the repayment of the
advances became unclear with the death of the Company's former Chairman.
Accordingly, management wrote off such costs in 1997.
INTEREST EXPENSE. Interest expense was reported net of interest income.
Interest income increased by $44,000 from $11,000 in 1996 compared to
$55,000 in 1997.
Interest expense increased 157% from $433,000 in 1996 to $1.1 million
in 1997. The increase of $678,000 was attributable to the following factors: (1)
The Company incurred an additional $480,000 in interest expense on the
convertible notes in the principal amount of $6.1 million; (2) an increase in
MCCF's interest expense of $306,000 due to the loss of a waiver of interest
expense from a local bank and another lender in 1997 compared to 1996. Such
increase was offset by a decrease in QCCF interest expense of $108,000 as the
average borrowing rate decreased from 18% in 1996 to 9.5% in 1997 and QCCF
repaid a loan of $648,000 on March 31, 1997. 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, Mishan 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 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
funds in an amount totaling $285,562 from MHXC without authority from the
Company. The Chairman died in October 1997 and the Company recorded an expense
of $184,000 in "other expense" representing the amounts not recovered.
21
<PAGE>
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 the payment of
income taxes 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.
Accordingly, there was no provision for income tax for the year ended December
31, 1997 and 1996.
NET INCOME. The Company incurred a net loss of ($3.5 million) in 1997
as compared to a net income of $1.2 million in 1996. The decrease in earnings of
$4.8 million was mainly attributable to: (1) the increase in the write off of
uncollectible receivables and other assets of $2.0 million; (2) an increase in
net interest expense of $634,000; (3) an increase in selling, general and
administration expenses of $857,000 attributable to the additional Heilongjiang
representative office, additional professional expenses related to public
reporting requirements and additional financing activities; (4) an increase in
selling expenses, salary and benefits in the Operating Company of $1.0 million;
(5) additional expenses due to the unauthorized withdrawal by the deceased
Chairman in the amount of $184,000; (6) additional writeoffs of $1.8 million
made to the former owner of QCCF; and (7) a 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 1.3 million and a decrease in minority interest of
$839,000.
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 offerings of securities. The Company believes that such sources of cash
flow, including the transactions pending with AOG and its affiliates, are
sufficient to fund its current operating expenses. See "--Financing Activities."
Since the completion of the offerings in early 1997, the Company has
applied $2.0 million of the net proceeds of $5.4 million to MCCF primarily for
its working capital needs. MCCF purchased raw coal and applied its other working
capital needs to ramp sales and production during the months of April and
November of 1997. Unfortunately, due to poor credit management, MCCF was not
able to collect $1.6 million 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 days in 1996 to 313 days in
1997. As a result of the unwillingness of 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 the 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 73 days in 1997 to 122 days in
1998 as a result of deceleration in economic growth in PRC and Heilongjiang
Province. As of December 31, 1998, QCCF had $3.1 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 $442,000 in 1998, 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 expenditures in 1999.
FINANCING ACTIVITIES
In November 1996, the Company raised net proceeds of approximately $4.5
million through an offering of convertible notes and warrants. Subsequently, in
January 1997, the Company raised net proceeds of approximately $900,000 in a
follow-up offering of convertible notes and warrants on the same terms as the
November 1996 offering. The convertible notes and the warrants are referred to
hereinafter as the "Notes" and the "Warrants" respectively. The aggregate
principal amount of the Notes issued in the November 1996 and January 1997
offerings was $6.1 million.
22
<PAGE>
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 a Warrant 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 December 31,
1998, Notes in the aggregate principal amount of $3.2 million remained
outstanding and Warrants to purchase an aggregate of 1,894,150 shares of Common
Stock remained outstanding (with an 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 were used primarily as follows: $2.0
million for purchase of raw coal and working capital of MCCF, $648,000 for bank
loan repayment in QCCF, $1.3 million for loan to the former owner of QCCF,
$337,000 for the expenses of the representative office in Heilongjiang, an
unauthorized withdrawal of $286,000 by the former Chairman, and $832,000 for the
Company's administrative and reporting expenses with the remaining $15,000 as
cash on hand.
TRANSACTIONS WITH CHINA ORIENT GROUP INDUSTRIES, INC. AND ITS
AFFILIATES. In response to the management and operational difficulties of MCCF
and QCCF, former management of the Company began discussions with officers of
China Orient Group Industries, Inc., a private sector conglomerate in the PRC
(the "Orient Group"), and its affiliates regarding an investment by the Orient
Group in the Company and a possible change in the Company's executive
management. Such discussions resulted in a change of executive management of the
Company and certain financing agreements which are described below.
THE STOCK AND WARRANT PURCHASE AGREEMENT. In December 1998, the Company
and America Orient Group, Inc. a Maryland corporation and wholly owned
subsidiary of the Orient Group ("AOG"), executed a stock and warrant purchase
agreement whereby the Company agreed to sell to AOG 5,000,000 shares of Common
Stock and a warrant to purchase 5,000,000 shares of Common Stock for an
aggregate price of $1.0 million (the "Stock and Warrant Purchase Agreement").
Such warrant is exercisable at any time after the closing of the Stock and
Warrant Purchase Agreement (the "Exercise Date") in the five years following the
Exercise Date, in whole or in part, at the lower of (a) 75% of the average
closing price of the Common Stock for the 30 days immediately prior to such
exercise, or (b) as follows: $0.75 per share in 1999; $1.00 per share in 2000:
$1.50 per share in 2001; $2.00 per share in 2002; and $3.00 per share in 2003
(subject to adjustments for stock splits, stock dividends and similar
transactions). Closing of the Stock and Warrant Purchase Agreement is subject to
several conditions which are further described in the Stock and Warrant Purchase
Agreement. See "Exhibit 2.1"
AOG LOANS TO THE COMPANY. In February 1999, AOG loaned the Company
$24,160 at an interest rate of 8% per annum payable on demand for working
capital purposes in exchange for a convertible note (the "AOG Convertible Note")
and a warrant to purchase 120,800 shares of Common Stock at an exercise price of
$0.20 per share. Based on a conversion price of $0.20 per share, the AOG
Convertible Note was convertible at the time of issuance into 120,800 shares of
Common Stock. In March 1999, the Company issued a revolving convertible note to
AOG of up to $250,000 at an interest at 8% per annum payable on demand (the
"Revolving Note"). AOG may convert any amounts owed under the Revolving Note to
Common Stock on the same terms as the AOG Convertible Note. In April 1999, the
Revolving Note was increased to up to $1.3 million, and as of July 1999 the
Company had outstanding borrowings under the Revolving Note of approximately
$326,000.
ORIENT FINANCE CO. LOAN TO THE COMPANY. In March 1999, the Company,
together with MHXC, entered into a definitive loan and guarantee agreement with
Orient Finance Co. ("Orient Finance") for a $2.0 million term loan of three
years with a one-year grace period and a 6.625% interest rate per annum (the
"Loan Agreement"). The Loan Agreement provides no conversion features. Orient
Finance is a subsidiary of the Orient Group and, accordingly, an affiliate of
AOG. Under the terms of the Loan Agreement, as amended in July 1999, the $2.0
million will be disbursed to MHXC no later than July 31, 1999.
23
<PAGE>
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 8.2787 on December 31, 1998.
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
Set forth below is certain information regarding the directors and
executive officers of the Company.
<TABLE>
<CAPTION>
Date First Elected
Name Position Or Appointed
- ---- -------- ------------
<S> <C> <C>
Bill H. Zhao (1)(2) President, CEO and Chairman of the Board March 1999
Weixing Zhang Vice President March 1999
Ming Wong Vice President and Chief Financial Officer March 1999
Jianmin Xin Vice President - MCCF March 1999
Guoliang Guan Director April 1999
Luan Jixiang Director April 1997
Wu Chunlai (1) Director April 1997
Zhang Geng Xin (1) Director April 1998
</TABLE>
(1) Member of Audit Committee.
(2) Mr. Zhao succeeded C.T. Yeh, who resigned from his positions as
President, CEO and Acting Chairman of the Company in March 1999. Mr. Yeh
succeeded Wang Gongquan, who resigned from his positions as President and
Chairman of the Board of the Company in August 1998 to devote more time to his
investment company.
24
<PAGE>
DIRECTORS AND EXECUTIVE OFFICERS OF CCM
Set forth below is certain information regarding the directors and
executive officers of CCM, a wholly-owned subsidiary of the Company.
<TABLE>
<CAPTION>
Date First Elected
Name Position Or Appointed
- ---- -------- ------------
<S> <C> <C>
Bill H. Zhao (1)(2) President, CEO and Chairman of the Board March 1999
</TABLE>
(1) Member of Audit Committee.
(2) Mr. Zhao succeeded C.T. Yeh, who resigned from his positions as
President, CEO and Acting Chairman of CCM in March 1999. Mr. Yeh succeeded Wang
Gongquan, who resigned from his positions as President and Chairman of the Board
of CCM in August 1998 to devote more time to his investment company.
DIRECTORS AND EXECUTIVE OFFICERS OF THE OPERATING COMPANY
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.
<TABLE>
<CAPTION>
Date First Elected
Name Position Or Appointed
- ---- -------- ------------
<S> <C> <C>
Bill H. Zhao (1)(2) Chairman of the Board and Legal Representative March 1999
Weixing Zhang President and CEO March 1999
Yabin Yin Vice President and CFO March 1999
Fangping Yao Vice President and Chief Engineer March 1999
Luan Jixiang Director September 1995
Xu Changhai Director September 1995
Yuan Si Xian Director September 1995
Wu Chunlai Director September 1995
</TABLE>
(1) Member of Audit Committee.
(2) Mr. Zhao succeeded C.T. Yeh, who resigned from his positions as
Chairman of the Board and Legal Representative of the Operating Company in March
1999. Mr. Yeh succeeded Wang Gongquan, who resigned from his positions as
Chairman of the Board and Legal Representative of the Operating Company in
August 1998 to devote more time to his investment company.
EXECUTIVE OFFICERS AND KEY EMPLOYEES OF MCCF
Set forth below is certain information regarding the executive officers
and key employees of MCCF.
<TABLE>
<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
Set forth below is certain information regarding the executive officers
and key employees of QCCF:
<TABLE>
<CAPTION>
Date First Elected
Name Position Or Appointed
- ---- -------- ------------
<S> <C> <C>
Luan Jixiang Director September 1995
Yuan Si Xian Director 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.
25
<PAGE>
ITEM 11. COMPENSATION OF DIRECTORS AND OFFICERS
For the year ended December 31, 1998, 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 $47,500 which includes $25,000 paid to Mr. Wang in his capacity as
President and Chairman of the Board of the Company, from which he resigned in
August 1998. 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.
On September 2, 1998 the Company entered into an employment agreement
with Mr. C.T. Yeh, the Chairman, President and Chief Executive Officer of the
Company at that time. Under the agreement, among other matters, Mr. Yeh received
15,000 shares at a fair market value of $8,000 which has been recognized as
compensation expense. These shares were issued in January 1999.
ITEM 12. OPTIONS TO PURCHASE SECURITIES FROM REGISTRANT OR SUBSIDIARIES
In November 1996, the Company raised net proceeds of approximately $4.5
million through an offering of Notes and Warrants. 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.
The aggregate principal amount of Notes issued in the November 1996 and January
1997 offerings was $6.1 million. 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.
26
<PAGE>
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 of the 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 issued new equity or warrants between January 22, 1998 and January 21,
1999. Such options expire in 2002 and 2003, respectively.
During 1997, holders of Notes converted principal and accrued interest
in the amount of $2.9 million into 848,644 shares of Common Stock. As of
December 31, 1998, Notes in the aggregate principal amount of $3.2 million
remained outstanding and Warrants to purchase an aggregate of 1,894,150 shares
of Common Stock remained outstanding.
On September 2, 1998 the Company entered into an employment agreement
with Mr. C.T. Yeh, the Acting Chairman, President and Chief Executive Officer of
the Company at that time. Under the agreement, among other things, Mr. Yeh
received 15,000 shares as his compensation for 1998. In addition, he received a
total of 120,000 options to subscribe for and purchase shares of the Common
Stock at $1.00 per share. At December 31, 1998, 50,000 options were unrestricted
and the remainder will cease to be restricted December 31, 1999 or upon the
earlier occurrence of certain specified transactions listed in his employment
agreement. Such options are exercisable within five years from the date of
issuance.
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, CHANGES IN SECURITY FOR REGISTERED
SECURITIES AND USE OF PROCEEDS
None.
PART IV
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.
27
<PAGE>
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, 1998, 1997 and 1996.............................................F-2
Consolidated balance sheets at December 31, 1998 and 1997....................F-3
Consolidated statements of stockholders' equity for the years ended
December 31, 1998, 1997 and 1996.............................................F-4
Consolidated statements of cash flows for the years ended
December 31, 1998, 1997 and 1996.............................................F-5
Notes to consolidated financial statements...................................F-6
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.
(b) Exhibits.
Exhibit 2.1 -- Stock and Warrant Purchase Agreement, dated December 3,
1998, between America Orient Group, Inc. and China Energy Resources Corporation.
28
<PAGE>
SIGNATURE
Pursuant to the requirements 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
the undersigned, thereunto duly authorized.
CHINA ENERGY RESOURCES CORPORATION
By: /s/ Bill H. Zhao
---------------------------------------
Bill H. Zhao
President, Chief Executive Officer
and Chairman of the Board
Date: July 14, 1999
29
<PAGE>
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
subsidiaries as of December 31, 1998 and 1997 and the related consolidated
statements of operations and cash flows for the three years in the period ended
December 31, 1998. 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 audits provide 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 subsidiaries as of December 31, 1998 and 1997 and
the results of their operations and their cash flows for the three years in the
period ended December 31, 1998 in conformity with accounting principles
generally accepted in the United States of America.
/s/ Deloitte Touche Tohmatsu
Deloitte Touche Tohmatsu
Hong Kong
March 29, 1999, except for note 3 as to which is dated July 10, 1999
F-1
<PAGE>
<TABLE>
<CAPTION>
CHINA ENERGY RESOURCES CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands except per share amounts)
Years ended December 31,
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net sales..................................................... $ 6,660 $ 9,053 $ 7,801
Subcontracting income (note 1)................................ - 362 723
Cost of sales................................................. (4,835) (5,516) (5,584)
------- ------- -------
Gross profit.................................................. 1,825 3,899 2,940
Selling, general and administrative expenses.................. (2,634) (4,921) (961)
Write-off of advances to related parties (note 12)............ - (1,768) -
------- ------- -------
Operating (loss) income....................................... (809) (2,790) 1,979
Interest expense.............................................. (1,339) (1,056) (422)
Other (expense) income (note 12).............................. (79) (190) 46
------- ------- -------
(Loss) income before minority interests....................... (2,227) (4,036) 1,603
Minority interest............................................. 196 494 (345)
------- ------- -------
Net (loss) income............................................. $(2,031) $(3,542) $ 1,258
======= ======= =======
(Loss) earnings per share
- - Basic....................................................... $ (0.63) $ (1.18) $ 0.66
======= ======= =======
- - Fully-diluted............................................... $ (0.63) $ (1.18) $ 0.57
======= ======= =======
Weighted average number of shares outstanding
- - Basic....................................................... 3,248 2,994 1,918
======= ======= =======
- - Fully-diluted............................................... 3,248 2,994 2,314
======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<PAGE>
<TABLE>
<CAPTION>
CHINA ENERGY RESOURCES CORPORATION
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except share and per share amounts)
December 31,
1998 1997
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................... $ 82 $ 767
Accounts receivable, net of allowance for doubtful
accounts of $1,571 (1997:$1,576)..................... 1,472 2,346
Prepayments, prepaid expenses, and other assets............. 1,222 1,615
Inventories (note 6)........................................ 3,020 4,136
-------- --------
Total current assets................................ 5,796 8,864
Property, plant and equipment, net (note 7)................. 17,916 18,002
Value added taxes receivable (note 8)....................... 81 140
Other assets................................................ 284 387
-------- --------
Total assets......................................... $ 24,077 $ 27,393
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities:
Short-term borrowings (note 9).............................. $ 4,625 $ 5,057
Current portion of long-term debt (note 10)................. 1,812 1,812
Accounts payable............................................ 796 1,629
Customer deposits........................................... 225 87
Other payables.............................................. 2,078 2,392
Plant construction payables................................. 7 77
Accrued payroll and employee benefits....................... 385 474
Accrued interest............................................ 2,495 1,596
Other accrued liabilities................................... 329 161
-------- --------
Total current liabilities............................ 12,752 13,285
Long-term debt (note 10)
Related parties............................................ 2,800 2,414
Convertible notes (note 11)................................. 2,548 2,347
Minority interests.......................................... 1,543 1,739
Commitments and contingencies (note 14)
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 (1997:3,248,494) shares
issued and outstanding............................... 32 32
Additional paid-in capital.................................. 11,808 11,788
Deficit..................................................... (3,971) (1,940)
Advances receivable from related parties (note 12).......... (3,435) (2,272)
-------- --------
Total stockholders' equity........................... 4,434 7,608
-------- --------
Total liabilities and stockholders' equity........... 24,077 27,393
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
<TABLE>
<CAPTION>
CHINA ENERGY RESOURCES CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Amounts in thousands)
Common Stock
------------
Advances
Additional Retained receivable Total
paid-in earnings from related stockholders'
Shares Amount capital (deficit) parties equity
------ ------ ------- --------- ------- ------
<S> <C> <C> <C> <C> <C> <C>
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
Stock compensation expense (note 13)............. - - 26 - - 26
Net loss......................................... - - - (3,542) - (3,542)
Advances to related parties...................... - - - - (2,272) (2,272)
----- ------ -------- -------- ---------- ----------
Balance at December 31, 1997 .................... 3,248 32 11,788 (1,940) (2,272) 7,608
Stock compensation expense (note 13)............. - - 20 - - 20
Net loss......................................... - - - (2,031) - (2,031)
Advances to related parties...................... - - - - (1,163) (1,163)
----- ------ -------- -------- ---------- ----------
Balance at December 31, 1998 .................... 3,248 $ 32 $ 11,808 $ (3,971) $ (3,435) $ 4,434
===== ====== ======== ======== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
<TABLE>
<CAPTION>
CHINA ENERGY RESOURCES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
Years ended December 31,
1998 1997 1996
----------------------------------------------------
<S> <C> <C> <C>
Cash flow from operating activities:
Net (loss) income ............................................................... $ (2,031) $ (3,542) $ 1,258
Adjustments to reconcile net (loss) income to
net cash provided by (used in) operating activities:
Minority interest........................................................... (196) (494) 345
Loss on disposal of property, plant and equipment........................... 19 152 -
Depreciation................................................................ 858 643 863
Bad debt provisions......................................................... - 1,365 15
Imputed interest on convertible notes....................................... 201 211 7
Write-off of prepaid expenses............................................... - 289 -
Value added tax on opening debit balance utilized........................... 59 27 53
Stock compensation expense.................................................. 20 26 -
Changes in assets and liabilities:
Accounts receivable......................................................... 874 (2,467) 1,456
Inventories................................................................. 1,116 (1,064) (105)
Prepayments, prepaid expenses, and other assets............................. 393 (433) (427)
Accounts payable............................................................ (833) 577 (581)
Customer deposits........................................................... 138 (81) (82)
Other payables.............................................................. (314) 563 288
Amount due to PRC joint venture partner..................................... - (278) (525)
Accrued payroll and employee benefits....................................... (89) 165 7
Accrued interest............................................................ 899 695 (580)
Other accrued liabilities................................................... 168 153 (32)
-------- -------- -------
Net cash provided by (used in) operating activities.............................. 1,282 (3,493) 1,960
-------- -------- -------
Cash flow from investing activities:
Sales proceeds of property, plant and equipment............................. 70 129 -
Purchase of property, plant and equipment................................... (442) (997) (1,028)
Addition of other assets.................................................... - (382) -
-------- -------- -------
Net cash used in investing activities............................................ (372) (1,250) (1,028)
-------- -------- -------
Cash flow from financing activities:
Advances to related parties................................................. (1,639) (2,272) -
Prepayments from related parties............................................ 476 - -
Repayment of long-term debt from related parties............................ - - (1,266)
Repayment to minority interests............................................. - (144) (83)
Increase in short-term borrowings - net .................................... (432) 1,949 140
Issuance of convertible notes............................................... - - 2,340
Issuance of common stock.................................................... - 1,029 2,619
Cash and cash equivalents acquired on merger with Jackson................... - - 45
-------- -------- -------
Net cash (used by) provided by financing activities.............................. (1,595) 562 (3,795)
-------- -------- -------
(Decrease) increase in cash and cash equivalents................................. (685) (4,181) 4,727
Cash and cash equivalents at beginning of year................................... 767 4,948 221
-------- -------- -------
Cash and cash equivalents at end of year......................................... $ 82 $ 767 $ 4,948
======== ======== =======
Supplementary disclosures of cash information
Cash paid during the year for:
Interest......................................................................... $ 247 $ 405 $ 1,202
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
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 the 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
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).
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:
F-6
<PAGE>
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands except per share amounts)
o Adjustment to record the coal mine use right and interest
free loan at estimated fair value.
o Adjustment to depreciation expense for property, plant and
equipment to reflect more accurately the economic useful life
of the assets;
o Adjustment to recognize interest expense on the accruals
basis.
o Adjustment to recognize sales and cost of sales upon shipment
to customers.
The preparation of financial statements in conformity with U.S. 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 SUBSEQUENT EVENTS
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 1998 and 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, 1998 the gross assets of MCCF
were $7,266. Until March 1999, it had been the Company's intention to
operate the plant on obtaining additional financing. However, on July
10, 1999, the Company completed negotiations to transfer the facilities
back to the Mishan Government.
MHXC also owns the rights to use the coal mine, which at December 31,
1998 are stated at $7,562 and which are located in Mishan and are
planned to supply coking coal for use in MCCF. During 1998 and 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.
Additional work on the survey and mining plans is necessary before the
mine is ready for use. During 1998 the Company engaged outside
consultants to assist in this process. In 1998, 1997 and 1996 the
Company capitalized interest amounting to $386, $341 and $458,
respectively, in the coal mine use right. No provision for impairment
has been made as it is the Company's intention to develop, license or
sell the rights on completion of the additional work.
The Company incurred losses of $2,031 in 1998 and $3,542 in 1997 and is
continuing to operate at a loss subsequent to the balance sheet date
and at December 31, 1998 the Company had net current liabilities of
$6,956, 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 indicated that the Company may not be able to continue as a
going concern for a reasonable period of time. Management's actions to
obtain the necessary financing to address the situation are set out as
follows:
On December 3, 1998 the Company and America Orient Group, Inc ("AOG"),
a Maryland corporation and a wholly-owned subsidiary of China Orient
Group Industries, Inc. ("COG"), a private sector conglomerate in the
PRC, executed a Stock and Warrant Purchase Agreement (the "Stock
Purchase Agreement") in which the Company agreed to sell to AOG
5,000,000 shares of the Company's common stock, and a warrant to
purchase 5,000,000 shares of the Company's common stock for $1,000. The
Stock Purchase Agreement provides that AOG will purchase the shares and
the warrant from the Company for an aggregate purchase price of $1,000.
The warrant is exercisable at any time after the later of the closing
date or January 1, 1999 (the "Exercise Date") in the five years
following the Exercise Date, in whole or in part, at the lower of (a)
75% of the average closing price of the Common Stock for the 30 days
immediately prior to such exercise, or (b) as follows: $0.75 per share
in 1999; $1.00 per share in 2000: $1.50 per share in 2001; $2.00 per
share in 2002; and $3.00 per share in 2003 (subject to adjustments for
stock splits, stock dividends or similar transactions).
F-7
<PAGE>
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands except per share amounts)
On February 13, 1999, AOG loaned the Company $24 for working capital
purposes in exchange for a convertible note (the "AOG Convertible
Note") and a warrant to purchase 120,800 shares of Common Stock at an
exercise price of $0.20 per share. Based on a conversion price of $0.20
per share, the AOG Convertible Note was convertible at the time of
issuance into 120,800 shares of Common Stock.
On March 3, 1999, the then acting Chairman, President and Chief
Executive Officer of the Company resigned from his positions and on the
same day, the Board appointed Bill H. Zhao as Chairman, President and
Chief Executive Officer of the Company, Chairman and Director of China
Coal Mining (B.V.I.) Co. Ltd., and Legal Representative, Chairman and
Director of Mishan Hua Xing Coke Limited. Mr. Zhao is a Director and
Executive Vice President of AOG and a Director of COG.
On March 24, 1999, MHXC entered into an agreement ("Loan Agreement")
with Orient Finance Company, an affiliate of AOG, to provide a loan of
$2,000 for a period of three years, with a one-year grace period at an
annual interest rate of 6.625%. The Company has pledged as security its
interest in MHXC. Under the terms of the Loan Agreement, as amended in
July 1999, the $2,000 will be disbursed to MHXC no later than July 31,
1999.
On March 29, 1999 the Company issued a revolving convertible note
("Revolving Note") to AOG of up to $250 bearing interest of 8% per
annum repayable on demand. A shareholder of the Company has granted AOG
a continuing lien and first priority security interest in certain
securities owned by the shareholder. AOG has the right prior to the
payment in full of all principal of and interest on the Revolving Note
to convert any outstanding and unpaid principal portion into fully paid
shares of the Company's common stock at a conversion price of $0.20 per
share. In April 1999, the Revolving Note was increased to up to $1,250
and as of July 9, 1999, the Company had outstanding borrowings under
the Revolving Note of $326.
On March 29, 1999, the Company appointed three new officers and on the
same date, MHXC made four new officer appointments.
On March 29, 1999, the Company, through China Coal, entered into a
definitive agreement (the "Jinzhou Agreement") with Jinzhou Harbor
(Group) Co. Ltd., a majority owned subsidiary of the Orient Group and
affiliate of AOG ("JHG"), to form Jinzhou Port Coal Terminal Co. Ltd.
(the "Jinzhou Terminal"). Under the original Jinzhou Agreement, China
Coal was to invest $10,843 for a 60% interest in the Jinzhou Terminal.
In order to comply with rules of the Shanghai Stock Exchange, where JHG
shares are traded, the Jinzhou Agreement was amended in July 1999 to
provide for China Coal to invest $7,350 for a 49% interest in the
Jinzhou Terminal. Funding for the $7,350 investment is expected to be
financed by AOG's exercise of its warrant to purchase 5,000,000 shares
of Common Stock under the Stock Purchase Agreement and other purchases
of the Common Stock by AOG or its affiliates. The closing is subject to
obtaining the required PRC government approvals and may also be
affected by development of the long-term business plan of the Company.
On July 10, 1999, the Company and MHXC entered into an agreement with
the Mishan City Government for the Mishan City Government to assume the
liabilities relating to MCCF and the long-term debt owed to it, and in
exchange the Mishan City Government will take back all the facilities
and assets of MCCF. The Mishan City Government will also give up its
20% interest in MHXC. The resulting gain to the Company of between
$3,000 and $4,000 will be credited to the coal mine use right, which is
being retained, as an adjustment of the original price MHXC originally
paid to the government entity.
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.
F-8
<PAGE>
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands except per share amounts)
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
installments as follows:
Land use rights........................................... 30-50 years
Buildings................................................. 8-45 years
Plant and machinery....................................... 5-20 years
Transportation vehicles................................... 5-10 years
Railway................................................... 50 years
COAL MINE USE RIGHT - Coal mine use right is stated at estimated fair
value at the 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 necessary to get the mine ready
for its intended mining operations are in progress. In 1998, 1997 and
1996 interest capitalized amounted to $386, $341 and $458,
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 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.
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 nil in 1998, $1,365 in
1997 and $15 in 1996.
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 $62 in 1998, $47 in 1997 and $42
in 1996.
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 basis of
F-9
<PAGE>
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands except per share amounts)
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 1998 and 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:
Weighted average
Earnings number of shares
-------- ----------------
Basic............................ $ 1,258 1,918
Effect of convertible debt....... 53 396
--------- -----
$ 1,311 2,314
========= =====
NEW ACCOUNTING STANDARDS ADOPTED - in 1998, the Company adopted three
new disclosure standards. Results of operations, financial disclosures
were 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. As the Company did not have any items of other
comprehensive income for the years reported, the net (loss) income
reported in the statement of operations is equivalent to total
comprehensive income (loss).
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. SFAS No. 131 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.
SFAS No. 132, Employers' Disclosures about Pensions and Other
Postretirement Benefits, which amends the disclosure requirements for
pension and other postretirement benefits.
NEW ACCOUNTING STANDARD NOT YET ADOPTED - The Financial Accounting
Standards Board has issued a new standard SFAS No. 133 "Derivative
Instruments and Hedging Activities". Management has not yet completed
the analysis of the impact this would have on the financial statements
of the Company.
5. INCOME TAXES
Income is subject to taxation in the various countries in which the
Company and its subsidiaries operate. The Company is not taxed in the
British Virgin Islands where it is incorporated. The Company's
operations are all in China.
F-10
<PAGE>
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands except per share amounts)
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. The
subsidiary also has a 50% exemption from Chinese income tax for the
subsequent three years. The exemptions applicable to this subsidiary
will expire in 1999. At December 31, 1998 the Company and its
subsidiaries have no available tax losses.
6. INVENTORIES
December 31,
1998 1997
---- ----
Raw materials.................. $ 2,446 $ 3,203
Finished goods................. 79 724
Consumables.................... 495 209
------- -------
Total $ 3,020 $ 4,136
======= =======
The amount of work-in-progress is insignificant due to the short
production cycle of the manufacturing process.
7. PROPERTY, PLANT AND EQUIPMENT
December 31,
1998 1997
---- ----
Coal mine use right............ $ 7,562 $ 7,176
Land use rights................ 1,789 1,789
Buildings...................... 6,630 6,427
Plant and machinery............ 2,287 2,213
Transportation vehicles........ 797 727
Railway........................ 1,438 1,442
------- -------
Total 20,503 19,774
Less: Accumulated depreciation. (2,594) (1,778)
Construction in progress....... 7 6
------- -------
Total $17,916 $18,002
======= =======
The coal mine use right is stated at estimated fair value at the 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).
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, 1994 (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 $59, $ 27 and $53 were utilized in
1998, 1997 and 1996, respectively
F-11
<PAGE>
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands except per share amounts)
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,
1998 1997
---- ----
<S> <C> <C>
Short-term borrowings at the end of the year.......................... $ 4,625 $ 5,057
Weighted average interest rate on borrowings at end of year........... 12% 13%
</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, 1998, short-term borrowings of $1,256 and long-term
bank loans of $1,812 were secured over property, plant and equipment
with a net book value of $5,882.
10. LONG-TERM DEBT
<TABLE>
<CAPTION>
December 31,
1998 1997
---- ----
<S> <C> <C>
Long-term debt consists of:
Bank loans at a fixed interest rate
(14.04% at December 31, 1998)
Due in 1998.................................................... $ -- $ 1,086
Due in 1999.................................................... 1,328 242
Due in 2000.................................................... 242 242
Due in 2001.................................................... 242 242
------- -------
1,812 1,812
Interest free loan from PRC joint venture partner
Due in 2002.................................................... 1,334 1,334
Due in 2003.................................................... 1,334 1,334
Due in 2004.................................................... 1,335 1,335
Due in 2005.................................................... 1,335 1,335
Due in 2006.................................................... 1,335 1,335
------- -------
6,673 6,673
Less: notional interest....................................... 3,873 4,259
------- -------
2,800 2,414
Total........................................ 4,612 4,226
------- -------
Current portion of long-term debt.............................. 1,812 1,812
------- -------
Long-term debt, less current portion........................... $ 2,800 $ 2,414
======= =======
</TABLE>
All long-term bank loans are authorized by the provincial or local governments
and are administered by the banks.
F-12
<PAGE>
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands except per share amounts)
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 installment 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 and $197 in 1996. 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 1998 and 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.
11. CONVERTIBLE NOTES
At December 31, 1998 the Company had outstanding convertible notes with
detachable warrants amounting to $2,548 which were issued in 1996.
These notes carry interest at 8% 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%
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 certain events happening as 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
F-13
<PAGE>
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands except per share amounts)
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.
12. RELATED PARTY TRANSACTIONS
In 1997 advances totaling $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 1998 and 1997, the Company advanced $1,639 and $2,272, respectively,
to the bank of the former owner of QCCF to settle loans and interest
owed by the former owner of QCCF to the bank. In 1998, repayments of
$476 were received. The receivable at December 31, 1998 of $3,435 is
repayable on demand and is interest free.
In 1997 the former Chairman of the Company withdrew amounts totaling
$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 in 1998
and 1997 of $102 and $184, respectively, in other (expense) income
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. STOCK OPTIONS AND COMPENSATION
On September 2, 1998 the Company entered into an employment agreement
with Mr. C.T. Yeh, the acting Chairman, President and Chief Executive
Officer of the Company at that time. Under the agreement, among other
matters, Mr.
F-14
<PAGE>
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands except per share amounts)
Yeh received 15,000 shares at a fair value of $8 which has been
recognized as compensation expense and credited to additional paid-in
capital. These shares were issued in January 1999.
In addition he was issued options to acquire 120,000 shares of the
Company's common stock at $1.00 per share. At December 31, 1998, 50,000
options were unrestricted and the remainder will cease to be restricted
by December 31, 1999 or on the earlier occurrence of certain specified
transactions. The options are exercisable within five years from the
date of issuance.
The Company accounts for stock options issued to employees pursuant to
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued
to Employees. Accordingly, no compensation expense has been recognized
in connection with the issue of these stock options. The fair value of
these stock options as calculated under SFAS No. 123, Accounting for
Stock Based Compensation, would be insignificant and, accordingly, the
pro forma information required by SFAS No. 123 has not been shown.
In 1997, the Company issued options to a Consultant, in respect of the
provision of public relations services, to acquire 32,000 shares of the
Company's common stock at an exercise price of $5.00 per share. In 1998
the Company issued options to the same party to acquire an additional
20,000 shares for services rendered at an exercise price of $3.50 per
share. All such options have vested. The options expire in 2002 and
2003, respectively. The Company recognized expense of $12 in 1998 and
$26 in 1997 in respect of these options.
14. COMMITMENTS AND CONTINGENCIES
At December 31, 1998, 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.
15. 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, 1998 was US$1 = Rmb8.2787.
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
<PAGE>
CHINA ENERGY RESOURCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands except per share amounts)
16. 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.
17. 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, 1998 because of the relatively short
maturities of these investments. At December 31, 1998 the fair value of
the bank loans and the interest free loan from the PRC joint venture
partner were approximately $1,812 and $2,800, respectively, estimated
based on the discount rate the seller would pay to a credit- worthy
third party to assume its obligation.
18. EMPLOYEE RETIREMENT BENEFITS
All the PRC's 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.
19. 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 78% of net
sales in 1998, 71% in 1997, and 80% in 1996.
F-16
EXHIBIT 2.1
Stock and Warrant Purchase Agreement, dated December 3, 1998, between
America Orient Group, Inc. and China Energy Resources Corporation
<PAGE>
EXECUTION COPY
--------------
STOCK AND WARRANT PURCHASE AGREEMENT
BETWEEN
CHINA ENERGY RESOURCES CORPORATION
AND
AMERICA ORIENT GROUP, INC.
DECEMBER 3, 1998
<PAGE>
<TABLE>
<CAPTION>
TABLE OF CONTENTS
<S> <C> <C>
1. Definitions..............................................................................................1
2. Purchase and Sale of the Shares and Warrants.............................................................5
(a) Basic Transaction...............................................................................5
(b) Purchase Price..................................................................................5
(c) The Closing.....................................................................................5
(d) Deliveries at the Closing.......................................................................5
3. Representations and Warranties Concerning the Transaction................................................6
(a) Representations and Warranties of the Buyer.....................................................6
4. Representations and Warranties Concerning the Company and Its Subsidiaries...............................8
(a) Organization, Qualification, and Corporate Power................................................8
(b) Capitalization..................................................................................8
(c) Noncontravention................................................................................9
(d) Brokers' Fees...................................................................................9
(e) Title to Assets.................................................................................9
(f) Subsidiaries....................................................................................9
(g) Financial Statements...........................................................................10
(h) Events Subsequent to Most Recent Fiscal Year End...............................................10
(i) Undisclosed Liabilities........................................................................12
(j) Legal Compliance...............................................................................12
(k) Tax Matters....................................................................................12
(l) Real Property..................................................................................15
(m) Intellectual Property..........................................................................17
(n) Tangible Assets................................................................................19
(o) Inventory......................................................................................19
(p) Contracts......................................................................................20
(q) Notes and Accounts Receivable..................................................................20
(r) Powers of Attorney.............................................................................20
(s) Insurance......................................................................................20
(t) Litigation.....................................................................................21
(u) Product Warranty...............................................................................21
(v) Product Liability..............................................................................22
(w) Employees......................................................................................22
(x) Employee Benefits..............................................................................22
(y) Guaranties.....................................................................................22
(z) Environmental, Health and Safety...............................................................22
(aa) Certain Business Relationships with the Company or Its Subsidiaries............................23
(bb) Disclosure.....................................................................................23
5. Pre-Closing Covenants...................................................................................23
(a) General........................................................................................23
(i)
<PAGE>
(b) Notices and Consents...........................................................................23
(c) Operation of Business..........................................................................23
(d) Preservation of Business.......................................................................24
(e) Full Access....................................................................................24
(f) Notice of Developments.........................................................................24
(g) Exclusivity....................................................................................24
(h) Intentionally Omitted..........................................................................24
(i) Listing of Shares and Approval by the Company's Shareholders...................................24
(j) Management of the Subsidiaries.................................................................24
6. Post-Closing Covenants..................................................................................25
(a) General........................................................................................25
(b) Litigation Support.............................................................................25
(c) Debt in Default................................................................................25
(d) Capital Expansion..............................................................................25
(e) Office.........................................................................................25
(f) Confidentiality................................................................................25
7. Conditions to Obligation to Close.......................................................................26
(a) Conditions to Obligation of the Buyer..........................................................26
(b) Conditions to Obligation of the Company........................................................28
8. Remedies for Breaches of This Agreement.................................................................29
(a) Survival of Representations and Warranties.....................................................29
(b) Indemnification Provisions for Benefit of the Buyer............................................29
(c) Indemnification Provisions for Benefit of the Company..........................................29
(d) Matters Involving Third Parties................................................................30
(e) Determination of Adverse Consequences..........................................................31
(f) Other Indemnification Provisions...............................................................31
9. Tax Matters.............................................................................................31
(a) Tax Sharing Agreements.........................................................................31
(b) Certain Taxes..................................................................................31
10. Termination.............................................................................................32
(a) Termination of Agreement.......................................................................32
(b) Effect of Termination..........................................................................32
(c) Termination Fee................................................................................32
11. Miscellaneous...........................................................................................33
(a) Press Releases and Public Announcements........................................................33
(b) No Third Party Beneficiaries...................................................................33
(c) Entire Agreement...............................................................................33
(d) Succession and Assignment......................................................................33
(e) Counterparts...................................................................................33
(ii)
<PAGE>
(f) Headings.......................................................................................33
(g) Notices........................................................................................33
(h) Governing Law..................................................................................34
(i) Amendments and Waivers.........................................................................34
(j) Severability...................................................................................34
(k) Expenses.......................................................................................34
(l) Construction...................................................................................35
(m) Incorporation of Exhibits, Annexes and Schedules...............................................35
(n) Specific Performance...........................................................................35
(o) Submission to Jurisdiction.....................................................................35
</TABLE>
Exhibit A--Form of Warrant
Exhibit B--Form of Registration Rights Agreement
Exhibit C--Historical Financial Statements
Exhibit D--Holders of Convertible Notes and Terms of Amendment of the
Convertible Notes
Exhibit E--Forms of Side Agreements
Exhibit F--Form of Opinion of Counsel to the Company
Disclosure Schedule--Exceptions to Representations and Warranties Concerning the
Company and Its Subsidiaries
(iii)
<PAGE>
STOCK AND WARRANT PURCHASE AGREEMENT
This STOCK and WARRANT PURCHASE AGREEMENT (this "Agreement") is made
and entered into on December 3, 1998, between America Orient Group, Inc., a
Maryland corporation, or its designee (the "Buyer"), and China Energy Resources
Corporation, a corporation organized under the International Business Companies
Act of the British Virgin Islands (the "Company"). The Buyer and the Company are
referred to together herein as the "Parties".
The Company is offering for sale 5,000,000 shares of its common stock
(the "Common Stock") par value $0.01 per share (the "Shares") and a warrant to
purchase 5,000,000 shares of Common Stock in the form attached hereto as Exhibit
A (the "Warrant," together with the Common Stock, the "Securities").
This Agreement contemplates a transaction in which the Buyer will
purchase from the Company, and the Company will issue and sell to the Buyer, the
Securities.
Now, therefore, in consideration of the premises and the mutual
promises herein made, and in consideration of the representations, warranties,
and covenants herein contained, the Parties agree as follows.
1. DEFINITIONS.
"ACCREDITED INVESTOR" has the meaning set forth in Regulation D
promulgated under the Securities Act.
"ADVERSE CONSEQUENCES" means material actions, suits, proceedings,
hearings, investigations, charges, complaints, claims, demands, injunctions,
judgments, orders, decrees, rulings, damages, dues, penalties, fines, costs,
amounts paid in settlement, Liabilities, obligations, Taxes, liens, losses,
expenses, and fees, including court costs and reasonable attorneys' fees and
expenses arising from the foregoing.
"AFFILIATE" has the meaning set forth in Rule 12b-2 of the regulations
promulgated under the Securities Exchange Act.
"AFFILIATED GROUP" means any affiliated group within the meaning of
Code ss.1504 or any similar group defined under a similar provision of state,
local or foreign law.
"AMEX" has the meaning set forth in Section ss.7(a) below.
"APPLICABLE RATE" means the corporate base rate of interest announced
from time to time by Citibank N.A. plus 2% per annum.
"BASIS" means any past or present fact, situation, circumstance,
status, condition, activity, practice, plan, occurrence, event, incident,
action, failure to act, or transaction that forms or could form the basis for
any specified consequence.
<PAGE>
"BUYER" has the meaning set forth in the preface above.
"CLOSING" has the meaning set forth in ss.2(c) below.
"CLOSING DATE" has the meaning set forth in ss.2(c) below.
"CODE" means the United States Internal Revenue Code of 1986, as
amended.
"COMMON STOCK" has the meaning set forth in the preface above.
"COMPANY" has the meaning set forth in the preface above.
"CONFIDENTIAL INFORMATION" means any information concerning the
businesses and affairs of the Company and its Subsidiaries that is not already
generally available to the public.
"CONTROLLED GROUP OF CORPORATIONS" has the meaning set forth in Code
ss.1563 or any similar provision of any tax law of any other jurisdiction.
"CONVERTIBLE NOTES" has the meaning set forth in ss.7(a).
"DEFINITIVE AGREEMENTS" means this Agreement, the Warrant and the
Registration Rights Agreement.
"DEFERRED INTERCOMPANY TRANSACTION" has the meaning set forth in Treas.
Reg. ss.1.1502-13 or any similar provision of any tax law of any other
jurisdiction.
"DISCLOSURE SCHEDULE" has the meaning set forth in ss.4 below.
"EMPLOYEE BENEFIT PLAN" means any (a) nonqualified deferred
compensation or retirement plan or arrangement which is an Employee Pension
Benefit Plan, (b) qualified defined contribution retirement plan or arrangement
which is an Employee Pension Benefit Plan, (c) qualified defined benefit
retirement plan or arrangement which is an Employee Pension Benefit Plan, (d)
Employee Welfare Benefit Plan or material fringe benefit plan or program, or (e)
any Multiemployer Plan.
"EMPLOYEE PENSION BENEFIT PLAN" has the meaning set forth in ERISA
ss.3(2).
"EMPLOYEE WELFARE BENEFIT PLAN" has the meaning set forth in ERISA
ss.3(1).
"ENVIRONMENTAL, HEALTH AND SAFETY LAWS" means all laws (including
rules, regulations, codes, plans, injunctions, judgments, orders, decrees,
rulings, and charges thereunder) of federal, state, local, and foreign
governments (and all agencies thereof) concerning pollution or protection of the
environment, public health and safety, or employee health and safety, including
laws relating to emissions, discharges, releases, or threatened releases of
pollutants, contaminants, or chemical, industrial, hazardous, or toxic materials
or wastes into ambient air, surface water, ground water, or lands or otherwise
relating to the manufacture, processing, distribution, use, treatment, storage,
-2-
<PAGE>
disposal, transport, or handling of pollutants, contaminants, or chemical,
industrial, hazardous, or toxic materials or wastes.
"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended.
"EXCESS LOSS ACCOUNT" has the meaning set forth in Treas. Reg.
ss.1.1502-19 or any similar provision of any tax law of any other jurisdiction.
"FIDUCIARY" has the meaning set forth in ERISA ss.3(21).
"FINANCIAL STATEMENT" has the meaning set forth in ss.4(g) below.
"GAAP" means United States generally accepted accounting principles as
in effect from time to time.
"INDEMNIFIED PARTY" has the meaning set forth in ss.8(d) below.
"INDEMNIFYING PARTY" has the meaning set forth in ss.8(d) below.
"INTELLECTUAL PROPERTY" means (a) all inventions (whether patentable or
unpatentable and whether or not reduced to practice), all improvements thereto,
and all patents, patent applications, and patent disclosures, together with all
reissuances, continuations, continuations-in-part, revisions, extensions, and
reexaminations thereof, (b) all trademarks, service marks, trade dress, logos,
trade names, and corporate names, together with all translations, adaptations,
derivations, and combinations thereof and including all goodwill associated
therewith, and all applications, registrations, and renewals in connection
therewith, (c) all copyrightable works, all copyrights, and all applications,
registrations, and renewals in connection therewith, (d) all mask works and all
applications, registrations, and renewals in connection therewith, (e) all trade
secrets and confidential business information (including ideas, research and
development, know-how, formulas, compositions, manufacturing and production
processes and techniques, technical data, designs, drawings, specifications,
customer and supplier lists, pricing and cost information, and business and
marketing plans and proposals), (f) all computer software (including data and
related documentation), (g) all other proprietary rights, and (h) all copies and
tangible embodiments thereof (in whatever form or medium).
"KNOWLEDGE" means actual knowledge after reasonable investigation.
"LETTER OF INTENT" means the Letter Agreement, dated November 23, 1998,
between the Buyer and the Company.
"LIABILITY" means any material liability (whether known or unknown,
whether asserted or unasserted, whether absolute or contingent, whether accrued
or unaccrued, whether liquidated or unliquidated, and whether due or to become
due), including any liability for Taxes.
-3-
<PAGE>
"MOST RECENT BALANCE SHEET" means the balance sheet contained within
the Most Recent Financial Statements.
"MOST RECENT FINANCIAL STATEMENTS" has the meaning set forth in ss.4(g)
below.
"MOST RECENT FISCAL MONTH END" has the meaning set forth in ss.4(g)
below.
"MOST RECENT FISCAL YEAR END" has the meaning set forth in ss.4(g)
below.
"MULTIEMPLOYER PLAN" has the meaning set forth in ERISA ss.3(37).
"ORDINARY COURSE OF BUSINESS" means the ordinary course of business
consistent with past custom and practice (including with respect to quantity and
frequency).
"PARTY" has the meaning set forth in the preface above.
"PERSON" means an individual, a partnership, a corporation, an
association, a joint stock company, a trust, a joint venture, an unincorporated
organization, or a governmental entity (or any department, agency, or political
subdivision thereof).
"PROHIBITED TRANSACTION" has the meaning set forth in ERISA ss.406 and
Code ss.4975 or any similar provision of any tax law of any other jurisdiction.
"PURCHASE PRICE" has the meaning set forth in ss.2(b) below.
"REGISTRATION RIGHTS AGREEMENT" means the Registration Rights Agreement
between the Company and the Buyer in the form attached as Exhibit B.
"RESALE RESTRICTION TERMINATION DATE" has the meaning set forth in
ss.3(a) below.
"SEC" means the Securities and Exchange Commission.
"SECURITIES" means the Common Stock and the Warrant.
"SECURITIES ACT" means the Securities Act of 1933, as amended.
"SECURITIES EXCHANGE ACT" means the Securities Exchange Act of 1934, as
amended.
"SECURITY INTEREST" means any mortgage, pledge, lien, encumbrance,
charge, or other security interest, other than (a) mechanic's, materialmen's,
and similar liens, (b) liens for Taxes not yet due and payable or for Taxes that
the taxpayer is contesting in good faith through appropriate proceedings, (c)
purchase money liens and liens securing rental payments under capital lease
-4-
<PAGE>
arrangements, and (d) other liens arising in the Ordinary Course of Business and
not incurred in connection with the borrowing of money.
"SHARES" has the meaning set forth in the preface above.
"SUBSIDIARY" means any corporation with respect to which a specified
Person (or a Subsidiary thereof) owns a majority of the common stock or has the
power to vote or direct the voting of sufficient securities to elect a majority
of the directors.
"TAX" means any British Virgin Islands or other federal, state, local,
or foreign income, gross receipts, license, payroll, employment, excise,
severance, stamp, occupation, premium, windfall profits, environmental
(including taxes under Code ss.59A) (or any similar provision of any tax law of
any other jurisdiction), customs duties, capital stock, franchise, profits,
withholding, social security (or similar), unemployment, disability, real
property, personal property, sales, use, transfer, registration, value added,
alternative or add-on minimum, estimated, or other tax of any kind whatsoever,
including any interest, penalty, or addition thereto, whether disputed or not.
"TAX RETURN" means any return, declaration, report, claim for refund,
or information return or statement relating to Taxes, including any schedule or
attachment thereto, and including any amendment thereof.
"TERMINATION DATE" means the date on which either Party provides the
other Party with written notice that this Agreement is terminated.
"THIRD PARTY CLAIM" has the meaning set forth in ss.8(d) below.
"WARRANT" has the meaning set forth in the preface above.
2. PURCHASE AND SALE OF THE SHARES AND WARRANTS.
(a) BASIC TRANSACTION. On and subject to the terms and conditions of
this Agreement, the Buyer agrees to purchase from the Company, and the Company
agrees to sell to the Buyer, the Securities for the consideration specified
below in this ss.2.
(b) PURCHASE PRICE. The Buyer agrees to pay to the Company at the
Closing $1,000,000 (the "Purchase Price") by delivery of cash payable by wire
transfer or delivery of other immediately available funds.
(c) THE CLOSING. The closing of the transactions contemplated by this
Agreement (the "Closing") shall take place at the offices of Thacher Proffitt &
Wood in New York, New York, commencing by no later than January 23, 1999, or
such other date as the parties may mutually determine (the "Closing Date").
(d) DELIVERIES AT THE CLOSING. At the Closing, (i) the Company will
deliver to the Buyer the various certificates, instruments, and documents
referred to in ss.7(a) below, (ii) the Buyer will
-5-
<PAGE>
deliver to the Company the various certificates, instruments, and documents
referred to in ss.7(b) below, (iii) the Company will deliver to the Buyer stock
certificates and a warrant representing all of the Securities and (iv) the Buyer
will deliver to the Company the consideration specified in ss.2(b) above.
3. REPRESENTATIONS AND WARRANTIES CONCERNING THE TRANSACTION.
(a) REPRESENTATIONS AND WARRANTIES OF THE BUYER. The Buyer represents
and warrants to the Company that the statements contained in this ss.3(a) are
correct and complete as of the date of this Agreement and will be correct and
complete as of the Closing Date (as though made then and as though the Closing
Date were substituted for the date of this Agreement throughout this ss.3(a)).
(i) ORGANIZATION OF THE BUYER. The Buyer is a corporation duly
organized, validly existing, and in good standing under the laws of the
jurisdiction of its incorporation.
(ii) AUTHORIZATION OF TRANSACTION. The Buyer has full power
and authority (including full corporate power and authority) to execute
and deliver this Agreement and to perform its obligations hereunder.
This Agreement constitutes the valid and legally binding obligation of
the Buyer, enforceable in accordance with its terms and conditions. The
Buyer need not give any notice to, make any filing with, or obtain any
authorization, consent, or approval of any government or governmental
agency in order to consummate the transactions contemplated by this
Agreement.
(iii) NONCONTRAVENTION. Neither the execution and the delivery
of this Agreement, nor the consummation of the transactions
contemplated hereby, will (A) violate any constitution, statute,
regulation, rule, injunction, judgment, order, decree, ruling, charge,
or other restriction of any government, governmental agency, or court
to which the Buyer is subject or any provision of its charter or bylaws
or (B) conflict with, result in a breach of, constitute a default
under, result in the acceleration of, create in any party the right to
accelerate, terminate, modify, or cancel, or require any notice under
any agreement, contract, lease, license, instrument, or other
arrangement to which the Buyer is a party or by which it is bound or to
which any of its assets is subject.
(iv) BROKERS' FEES. The Buyer has no Liability or obligation
to pay any fees or commissions to any broker, finder, or agent with
respect to the transactions contemplated by this Agreement for which
the Company could become liable or obligated.
(v) REGISTRATION OF SECURITIES. The Buyer understands that the
Securities have not been registered under the Securities Act or any
other applicable securities laws, and that the sale provided for in
this Agreement is being made pursuant to the exemption provided in
Section 4(2) of the Securities Act and that the reliance of the Company
on such exemption is predicated in part on the Buyer's representations
set forth herein, and none of the Securities may be offered, sold,
pledged or otherwise transferred except in compliance with the
registration requirements of the Securities Act and other applicable
securities laws, pursuant
-6-
<PAGE>
to an exemption therefrom or in a transaction not subject thereto and,
in each case, in compliance with the conditions for transfer set forth
in ss.3(a)(vii) below.
(vi) ACCREDITED INVESTOR. The Buyer is not, and has not been,
an "affiliate" (as defined in Rule 144 under the Securities Act) of the
Company or acting on behalf of the Company, and the Buyer is an
Accredited Investor.
(vii) INVESTMENT. The Buyer is acquiring the Securities for
the Buyer's own account, for investment, and not with a view to, or for
offer or sale in connection with, any distribution thereof in violation
of the Securities Act or other applicable securities laws, subject to
any requirement of law that the disposition of its property be at all
times within its control and subject to its ability to resell such
Securities pursuant to an effective registration statement under the
Securities Act or any exemption from registration available under the
Securities Act; and it agrees on its own behalf, and each subsequent
holder of the Securities by its acceptance thereof will be deemed to
agree, to offer, sell or otherwise transfer such Securities prior to
the date which is two years after the later of the original issuance
date thereof and the last date on which the Company or any "affiliate"
of the Company was the owner of such Securities (the "Resale
Restriction Termination Date") only (a) to the Company, (b) pursuant to
a registration statement which has been declared effective under the
Securities Act, or (c) pursuant to any other available exemption from
the registration requirements of the Securities Act, subject in each of
the foregoing cases to any requirement of law that the disposition of
its property be at all times within its control and to compliance with
any applicable state securities laws; it being understood further that
the Company reserves the right prior to any offer, sale or other
transfer prior to the Resale Restriction Termination Date pursuant to
clause (c) above to require the delivery of an opinion of counsel,
certifications and other information satisfactory to the Company. The
Buyer acknowledges that any certificate evidencing the Securities will
contain a legend substantially to the following effect:
THE SECURITIES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE
"SECURITIES ACT") OR ANY STATE SECURITIES LAWS OR ANY OTHER
APPLICABLE SECURITIES LAW. NEITHER THE SECURITIES EVIDENCED
HEREBY NOR ANY INTEREST OR PARTICIPATION HEREIN MAY BE
REOFFERED, SOLD, ASSIGNED, TRANSFERRED, PLEDGED, ENCUMBERED OR
OTHERWISE DISPOSED OF IN THE ABSENCE OF SUCH REGISTRATION OR
UNLESS SUCH TRANSACTION IS EXEMPT FROM, OR NOT SUBJECT TO,
SUCH REGISTRATION.
(viii) RULE 144. The Buyer understands that the Securities may
not be sold, transferred or otherwise disposed of without registration
under the Securities Act or an exemption therefrom and that in the
absence of an effective registration statement covering the Securities
or an available exemption from registration under the Securities Act,
the Securities must be held indefinitely. The benefits of Rule 144
promulgated under the
-7-
<PAGE>
Securities Act are not presently available to the Buyer and the Company
has not covenanted to make the benefits of such rule available.
4. REPRESENTATIONS AND WARRANTIES CONCERNING THE COMPANY AND ITS
SUBSIDIARIES. The Company represents and warrants to the Buyer that the
statements contained in this ss.4 are correct and complete as of the date of
this Agreement and will be correct and complete as of the Closing Date (as
though made then and as though the Closing Date were substituted for the date of
this Agreement throughout this ss.4), except as set forth in the disclosure
schedule delivered by the Company to the Buyer on the date hereof and initialed
by the Parties (the "Disclosure Schedule"). Nothing in the Disclosure Schedule
shall be deemed adequate to disclose an exception to a representation or
warranty made herein, unless the Disclosure Schedule identifies the exception
with reasonable particularity and describes the relevant facts in reasonable
detail. Without limiting the generality of the foregoing, with the exception of
the Company's Form 20F and 6K filings with the SEC dated July 15, 1998 and
September 29, 1998, respectively, the mere listing (or inclusion of a copy) of a
document or other item shall not be deemed adequate to disclose an exception to
a representation or warranty made herein (unless the representation or warranty
has to do with the existence of the document or other item itself). The
Disclosure Schedule will be arranged in paragraphs corresponding to the lettered
and numbered paragraphs contained in this ss.4.
(a) ORGANIZATION, QUALIFICATION, AND CORPORATE POWER. Each of the
Company and its Subsidiaries is a corporation or an equity joint venture company
duly organized, validly existing, and in good standing under the laws of the
jurisdiction of its formation. Each of the Company and its Subsidiaries is duly
authorized to conduct business and is in good standing under the laws of each
jurisdiction where such qualification is required. Each of the Company and its
Subsidiaries has full corporate or equity joint venture power and authority and
all licenses, permits, and authorizations necessary to carry on the businesses
in which it is engaged and in which it presently proposes to engage and to own
and use the properties owned and used by it. ss.4(a) of the Disclosure Schedule
lists the directors and officers of each of the Company and its Subsidiaries.
The Company has delivered to the Buyer correct and complete copies of the
charter and bylaws of each of the Company and its Subsidiaries (as amended to
date). The minute books (containing the records of meetings of the stockholders,
the board of directors, and any committees of the board of directors), the stock
certificate books, and the stock record books of each of the Company and its
Subsidiaries are correct and complete. None of the Company or its Subsidiaries
is in default under or in violation of any provision of its charter or bylaws.
(b) CAPITALIZATION. The entire authorized capital stock of the Company
consists of 50,000,000 shares of Common Stock, of which 3,248,494 shares of
Common Stock are issued and outstanding and no shares of Common Stock are held
in treasury and 2,000,000 shares of preferred stock, of which no shares of
preferred stock are issued and outstanding. All of the issued and outstanding
shares have been duly authorized, are validly issued, fully paid, and
nonassessable, and are held of record by the respective holders as set forth in
ss.4(b) of the Disclosure Schedule. There are no outstanding or authorized
options, warrants, purchase rights, subscription rights, conversion rights,
exchange rights, or other contracts or commitments that could require the
Company to issue, sell, or otherwise cause to become outstanding any of its
capital stock. There are no outstanding or authorized stock appreciation,
phantom stock, profit participation, or similar rights with respect to
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the Company. There are no voting trusts, proxies, or other agreements or
understandings with respect to the voting of the capital stock of the Company.
(c) NONCONTRAVENTION. Neither the execution and the delivery of this
Agreement, nor the consummation of the transactions contemplated hereby, will
(i) violate any constitution, statute, regulation, rule, injunction, judgment,
order, decree, ruling, charge, or other restriction of any government,
governmental agency, or court to which any of the Company and its Subsidiaries
is subject or any provision of the articles of association or memorandum of
association of any of the Company or joint venture agreements of its
Subsidiaries or (ii) conflict with, result in a breach of, constitute a default
under, result in the acceleration of, create in any party the right to
accelerate, terminate, modify, or cancel, or require any notice under any
agreement, contract, lease, license, instrument, or other arrangement to which
any of the Company or its Subsidiaries is a party or by which they are bound or
to which their assets are subject (or result in the imposition of any Security
Interest upon any of their assets). None of the Company and the Subsidiaries
needs to give any notice to, make any filing with, (except for filings with the
SEC or AMEX) or obtain any authorization, consent, or approval of any government
or governmental agency in order for the Parties to consummate the transactions
contemplated by this Agreement.
(d) BROKERS' FEES. None of the Company and Subsidiaries has any
Liability or obligation to pay any fees or commissions to any broker, finder, or
agent with respect to the transactions contemplated by this Agreement.
(e) TITLE TO ASSETS. The Company and its Subsidiaries have valid and
legal title to, or a valid leasehold interest in, the properties and assets used
by them, located on their premises, or shown on the Most Recent Balance Sheet or
acquired after the date thereof, free and clear of all Security Interests,
except for properties and assets disposed of in the Ordinary Course of Business
since the date of the Most Recent Balance Sheet.
(f) SUBSIDIARIES. ss.4(f) of the Disclosure Schedule sets forth for
each Subsidiary of the Company (i) its name and jurisdiction of formation, (ii)
the number of shares of authorized capital stock of each class of its capital
stock, (iii) the number of issued and outstanding shares of each class of its
capital stock, the names of the holders thereof, and the number of shares held
by each such holder, and (iv) the number of shares of its capital stock held in
treasury. All of the issued and outstanding shares of capital stock of each
Subsidiary of the Company have been duly authorized and are validly issued,
fully paid, and nonassessable. One of the Company and its Subsidiaries holds of
record and owns beneficially all of the outstanding shares of each Subsidiary of
the Company, free and clear of any restrictions on transfer (other than
restrictions under the Securities Act and state securities laws), Taxes,
Security Interests, options, warrants, purchase rights, contracts, commitments,
equities, claims, and demands. There are no outstanding or authorized options,
warrants, purchase rights, conversion rights, exchange rights, or other
contracts or commitments that could require any of the Company and its
Subsidiaries to sell, transfer, or otherwise dispose of any capital stock of any
of its Subsidiaries or that could require any Subsidiary of the Company to
issue, sell, or otherwise cause to become outstanding any of its own capital
stock. There are no outstanding
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stock appreciation, phantom stock, profit participation, or similar rights with
respect to any Subsidiary of the Company. There are no voting trusts, proxies,
or other agreements or understandings with respect to the voting of any capital
stock of any Subsidiary of the Company. None of the Company and its Subsidiaries
controls directly or indirectly or has any direct or indirect equity
participation in any corporation, partnership, trust, or other business
association which is not a Subsidiary of the Company.
(g) FINANCIAL STATEMENTS. Attached hereto as Exhibit C are the
following financial statements (collectively the "Financial Statements"): (i)
audited consolidated and unaudited consolidating balance sheets and statements
of income, changes in stockholders' equity, and cash flow as of and for the
fiscal years ended December 31, 1996 and 1997(the "Most Recent Fiscal Year End")
for the Company and its Subsidiaries; and (ii) unaudited consolidated and
consolidating balance sheets and statements of income, changes in stockholders'
equity, and cash flow (the "Most Recent Financial Statements") as of and for the
9 months ended September 30, 1998 (the "Most Recent Fiscal Month End") for the
Company and its Subsidiaries. The Financial Statements (including the notes
thereto) have been prepared in accordance with GAAP applied on a consistent
basis throughout the periods covered thereby, present fairly the financial
condition of the Company and its Subsidiaries as of such dates and the results
of operations of the Company and its Subsidiaries for such periods, are correct
and complete, and are consistent with the books and records of the Company and
its Subsidiaries (which books and records are correct and complete), PROVIDED,
HOWEVER, that the Most Recent Financial Statements are subject to normal
year-end adjustments (which will not be material individually or in the
aggregate) and lack footnotes and other presentation items.
(h) EVENTS SUBSEQUENT TO MOST RECENT FISCAL YEAR END. Since the Most
Recent Fiscal Year End, there has not been any adverse change in the business,
financial condition, operations, results of operations, or future prospects of
any of the Company and its Subsidiaries. Without limiting the generality of the
foregoing, since that date:
(i) None of the Company and its Subsidiaries has sold, leased,
transferred, or assigned any of its assets, tangible or intangible,
other than for a fair consideration in the Ordinary Course of Business.
(ii) None of the Company and its Subsidiaries has entered into
any agreement, contract, lease, or license (or series of related
agreements, contracts, leases, and licenses) either involving more than
$50,000 or outside the Ordinary Course of Business.
(iii) No party (including any of the Company and its
Subsidiaries) has accelerated, terminated, modified, or cancelled any
agreement, contract, lease, or license (or series of related
agreements, contracts, leases, and licenses) involving more than
$50,000 to which any of the Company and its Subsidiaries is a party or
by which any of them is bound.
(iv) None of the Company and its Subsidiaries has imposed any
Security Interest upon any of its assets, tangible or intangible.
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(v) None of the Company and its Subsidiaries has made any
capital expenditure (or series of related capital expenditures) either
involving more than $50,000 or outside the Ordinary Course of Business.
(vi) None of the Company and its Subsidiaries has made any
capital investment in, any loan to, or any acquisition of the
securities or assets of, any other Person (or series of related capital
investments, loans, and acquisitions) either involving more than
$50,000 or outside the Ordinary Course of Business.
(vii) None of the Company and its Subsidiaries has issued any
note, bond, or other debt security or created, incurred, assumed, or
guaranteed any indebtedness for borrowed money or capitalized lease
obligation either involving more than $10,000 singly or $50,000 in the
aggregate.
(viii) None of the Company and its Subsidiaries has delayed or
postponed the payment of accounts payable and other Liabilities outside
the Ordinary Course of Business.
(ix) None of the Company and its Subsidiaries has cancelled,
compromised, waived, or released any right or claim (or series of
related rights and claims) either involving more than $50,000 or
outside the Ordinary Course of Business.
(x) None of the Company and its Subsidiaries has granted any
license or sublicense of any rights under or with respect to any
material Intellectual Property.
(xi) There has been no change made or authorized in the
charter or bylaws of any of the Company and its Subsidiaries.
(xii) None of the Company and its Subsidiaries has issued,
sold, or otherwise disposed of any of its capital stock, or granted any
options, warrants, or other rights to purchase or obtain (including
upon conversion, exchange, or exercise) any of its capital stock.
(xiii) None of the Company and its Subsidiaries has declared,
set aside, or paid any dividend or made any distribution with respect
to its capital stock (whether in cash or in kind) or redeemed,
purchased, or otherwise acquired any of its capital stock.
(xiv) None of the Company and its Subsidiaries has experienced
any material damage, destruction, or loss (whether or not covered by
insurance) to its material property.
(xv) None of the Company and its Subsidiaries has made any
loan to, or entered into any other transaction with, any of its
directors, officers, and employees outside the Ordinary Course of
Business.
(xvi) None of the Company and its Subsidiaries has entered
into any employment contract or collective bargaining agreement,
written or oral, or modified the terms of any existing such contract or
agreement.
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(xvii) None of the Company and its Subsidiaries has granted
any increase in the base compensation of any of its directors,
officers, and employees outside the Ordinary Course of Business.
(xviii) None of the Company and its Subsidiaries has adopted,
amended, modified, or terminated any bonus, profit-sharing, incentive,
severance, or other plan, contract, or commitment for the benefit of
any of its directors, officers, and employees (or taken any such action
with respect to any other Employee Benefit Plan).
(xix) None of the Company and its Subsidiaries has made any
other change in employment terms for any of its directors, officers,
and employees outside the Ordinary Course of Business.
(xx) None of the Company and its Subsidiaries has made or
pledged to make any charitable or other capital contribution outside
the Ordinary Course of Business.
(xxi) There has not been any other material occurrence, event,
incident, action, failure to act, or transaction outside the Ordinary
Course of Business involving any of the Company and its Subsidiaries.
(xxii) None of the Company and its Subsidiaries has committed
to any of the foregoing.
(i) UNDISCLOSED LIABILITIES. None of the Company and its Subsidiaries
has any Liability (and there is no Basis for any present or future action, suit,
proceeding, hearing, investigation, charge, complaint, claim, or demand against
any of them giving rise to any Liability), except for (i) Liabilities set forth
on the face of the Most Recent Balance Sheet (rather than in any notes thereto)
and (ii) Liabilities (limited to the Knowledge of the Company with respect to
the Subsidiaries) which have arisen after the Most Recent Fiscal Month End in
the Ordinary Course of Business (none of which results from, arises out of,
relates to, is in the nature of, or was caused by any breach of contract, breach
of warranty, tort, infringement, or violation of law).
(j) LEGAL COMPLIANCE. Each of the Company, its Subsidiaries, and their
respective predecessors and Affiliates has complied with all applicable laws
(including rules, regulations, codes, plans, injunctions, judgments, orders,
decrees, rulings, and charges thereunder) of federal, state, local, and foreign
governments (and all agencies thereof) if any, and no action, suit, proceeding,
hearing, investigation, charge, complaint, claim, demand, or notice has been
filed or commenced against any of them alleging any failure so to comply.
(k) TAX MATTERS.
(i) Each of the Company and its Subsidiaries has filed all Tax
Returns that it was required to file. All such Tax Returns were correct
and complete in all respects. All Taxes owed by any of the Company and
its Subsidiaries (whether or not shown on any Tax Return) have been
paid (except as described in ss.4(k)(vii) below). None of the Company
and its
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Subsidiaries currently is the beneficiary of any extension of time
within which to file any Tax Return. No claim has ever been made by an
authority in a jurisdiction where any of the Company and its
Subsidiaries does not file Tax Returns that any of it or its
Subsidiaries is or may be subject to taxation by that jurisdiction.
There are no Security Interests on any of the assets of any of the
Company and its Subsidiaries that arose in connection with any failure
(or alleged failure) to pay any Tax.
(ii) Each of the Company and its Subsidiaries has withheld and
paid all Taxes required to have been withheld and paid in connection
with amounts paid or owing to any employee, independent contractor,
creditor, stockholder, or other third party.
(iii) Neither the Company or its Subsidiaries expects any
authority to assess any additional Taxes for any period for which Tax
Returns have been filed. There is no dispute or claim concerning any
Taxes of any of the Company and its Subsidiaries either (A) claimed or
raised by any authority in writing or (B) as to which any of the
Company and its Subsidiaries has Knowledge based upon personal contact
with any agent of such authority. ss.4(k) of the Disclosure Schedule
lists all British Virgin Islands or other federal, state, local, and
foreign income Tax Returns filed with respect to any of the Company and
its Subsidiaries for taxable periods ended on or after December 31,
1991, indicates those Tax Returns that have been audited, and indicates
those Tax Returns that currently are the subject of audit. The Company
has delivered to the Buyer correct and complete copies of all British
Virgin Islands or other federal income Tax Returns, examination
reports, and statements of deficiencies assessed against or agreed to
by any of the Company and its Subsidiaries since December 31, 1996.
(iv) None of the Company and its Subsidiaries has waived any
statute of limitations in respect of Taxes or agreed to any extension
of time with respect to a Tax assessment or deficiency.
(v) None of the Company and its Subsidiaries has filed a
consent under Code ss.341(f) concerning collapsible corporations (or
any similar provision of British Virgin Islands or other federal,
state, local, or foreign law). None of the Company and its Subsidiaries
has made any payments, is obligated to make any payments, or is a party
to any agreement that under certain circumstances could obligate it to
make any payments that will not be deductible under Code ss.280G (or
any similar provision of state, local, or foreign law). None of the
Company and its Subsidiaries has been a United States real property
holding corporation within the meaning of Code ss.897(c)(2) during the
applicable period specified in Code ss.897(c)(1)(A)(ii). Each of the
Company and its Subsidiaries has disclosed on its British Virgin
Islands or other federal (or similar) income Tax Returns all positions
taken therein that could give rise to a substantial understatement of
federal income Tax within the meaning of Code ss.6662 (or any similar
provision of British Virgin Islands or other federal, state, local, or
foreign law). None of the Company and its Subsidiaries is a party to
any Tax allocation or sharing agreement. None of the Company and its
Subsidiaries (A) has been a
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member of an Affiliated Group filing a consolidated federal income Tax
Return (other than a group the common parent of which was the Company)
or (B) has any Liability for the Taxes of any Person (other than any of
the Company and its Subsidiaries) under Treas. Reg. ss.1.1502-6 (or any
similar provision of British Virgin Islands or other federal, state,
local, or foreign law), as a transferee or successor, by contract, or
otherwise.
(vi) ss.4(k) of the Disclosure Schedule sets forth the
following information with respect to each of the Company and its
Subsidiaries (or, in the case of clause (B) below, with respect to each
of the Subsidiaries) as of the most recent practicable date (as well as
on an estimated pro forma basis as of the Closing giving effect to the
consummation of the transactions contemplated hereby): (A) the basis of
the Company or Subsidiary in its assets; (B) the basis of the
stockholder(s) of the Subsidiary in its stock (or the amount of any
Excess Loss Account); (C) the amount of any net operating loss, net
capital loss, unused investment or other credit, unused foreign tax,
excess charitable contribution, excess loss account, or earnings and
profits allocable to the Company or Subsidiary, as well as the methods
of accounting of each of the Company and its Subsidiaries; (D) the
amount of any deferred gain or loss allocable to the Company or
Subsidiary arising out of any Deferred Intercompany Transaction and the
amount of overall foreign losses of the Affiliated Group filing a
consolidated return of which the Company is the common parent allocable
to the Company and its Subsidiaries under Treas. Reg. ss. 1.1502-9 (or
any similar provision of British Virgin Islands or other federal,
state, local, or foreign law) and subject to recapture; and (E) the
amount of investment tax credit of the Company and its Subsidiaries
subject to recapture and the aggregate amount of ordinary losses on
"section 1231(b) property" (in each case under the Code or similar
British Virgin Islands or other federal, state, local, or foreign law)
that has been deducted by the Company and the Subsidiaries.
(vii) The unpaid Taxes of the Company and its Subsidiaries (A)
did not, as of the Most Recent Fiscal Month End, exceed the reserve for
Taxes owed (rather than any reserve for deferred Taxes established to
reflect timing differences between book and Tax income) set forth on
the face of the Most Recent Balance Sheet (rather than in any notes
thereto, and prepared in accordance with the generally accepted
accounting principles of the jurisdiction imposing the tax) and (B) do
not exceed that reserve as adjusted for the passage of time through the
Closing Date in accordance with the past custom and practice of the
Company and its Subsidiaries in filing their Tax Returns.
(viii) All elections with respect to Taxes affecting the
Company and its Subsidiaries as of the date hereof are set forth on
ss.4(k) of the Disclosure Schedule. Except as set forth on ss.4(k) of
the Disclosure Schedule, neither the Company nor its Subsidiaries has
made an election, and none are required, to treat any asset of the
Company or its Subsidiaries as owned by another person or as
"tax-exempt bond financed property" or "tax-exempt use property" within
the meaning of section 168 of the Code (or any similar provision of
British Virgin Islands or other federal, state, local, or foreign law).
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(ix) Except as set forth on ss.4(k) of the Disclosure
Schedule, none of the Company and its Subsidiaries has made or will
make a deemed dividend election under Treas. Reg. ss.1.1502-32(f)(2)
(or any similar provision of British Virgin Islands or other federal,
state, local, or foreign law), or a consent dividend election under
section 565 of the Code (or any similar provision of British Virgin
Islands or other federal, state, local, or foreign law).
(x) None of the Company and its Subsidiaries has agreed, or is
required, to make any adjustment under section 481(a) of the Code (or
any similar provision of British Virgin Islands or other federal,
state, local, or foreign law), by reason of a change in accounting
method or otherwise.
(xi) None of the Company and its Subsidiaries is a party to
any joint venture, partnership, or other arrangement or contract which
has been treated as a partnership for United States federal income tax
purposes (or any similar provision of British Virgin Islands or other
federal, state, local or foreign laws).
(xii) None of the Company and its Subsidiaries is subject to
any Tax imposed on net income in any jurisdiction or by any taxing
authority other than as set forth on ss.4(k) of the Disclosure
Schedule.
(xiii) None of the Company and its Subsidiaries has engaged
in, participated in or otherwise cooperated with any boycott
transactions or received boycott requests, as described in section 999
of the Code (or any similar provision of British Virgin Islands or
other federal, state, local, or foreign law).
(xiv) None of the Company and its Subsidiaries has ever had
any "subpart F income" within the meaning of section 952 of the Code,
or income that would be "subpart F income" if any of the Company or it
Subsidiaries were "controlled foreign corporations" within the meaning
of section 957 of the Code, other than as set forth on ss.4(k) of the
Disclosure Schedule.
(l) REAL PROPERTY.
(i) ss.4(l)(i) of the Disclosure Schedule lists and describes
briefly all real property for which any of the Company and its
Subsidiaries owns land use rights. With respect to each such parcel of
real property:
(A) the identified owner has valid and legal title to
the land use rights, free and clear of any Security Interest,
and other restrictions which do not impair the current use,
occupancy or value of the property subject thereto;
(B) there are no pending or, to the Knowledge of the
Company and its Subsidiaries threatened condemnation
proceedings, lawsuits, or administrative actions relating to
the property or other matters affecting materially and
adversely the current use, occupancy, or value thereof;
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(C) all facilities have received all approvals of
governmental authorities (including licenses and permits)
required in connection with the operation thereof and have
been operated and maintained in accordance with applicable
laws, rules, and regulations;
(D) there are no leases, subleases, licenses,
concessions, or other agreements, written or oral, granting to
any party or parties the right of use or occupancy of any
portion of such property; and
(E) all facilities located on the parcel of real
property are supplied with utilities and other services
necessary for the operation of such facilities, including gas,
electricity, water, telephone, sanitary sewer, and storm
sewer, all of which services are adequate in accordance with
all applicable laws, ordinances, rules, and regulations and
are provided via public roads or via permanent, irrevocable,
appurtenant easements benefitting the parcel of real property.
(ii) ss.4(l)(ii) of the Disclosure Schedule lists and
describes briefly all real property for which the land use rights have
been leased or subleased to any of the Company and its Subsidiaries.
The Company has delivered to the Buyer correct and complete copies of
the leases and subleases listed in ss.4(l)(ii) of the Disclosure
Schedule (as amended to date). With respect to each lease and sublease
listed in ss.4(l)(ii) of the Disclosure Schedule:
(A) the lease or sublease is legal, valid, binding,
enforceable, and in full force and effect;
(B) the lease or sublease will continue to be legal,
valid, binding, enforceable, and in full force and effect on
identical terms following the consummation of the transactions
contemplated hereby;
(C) no party to the lease or sublease is in breach or
default, and no event has occurred which, with notice or lapse
of time, would constitute a breach or default or permit
termination, modification, or acceleration thereunder;
(D) no party to the lease or sublease has repudiated
any provision thereof;
(E) there are no disputes, oral agreements, or
forbearance programs in effect as to the lease or sublease;
(F) with respect to each sublease, the
representations and warranties set forth in subsections (A)
through (E) above are true and correct with respect to the
underlying lease;
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(G) none of the Company and its Subsidiaries has
assigned, transferred, conveyed, mortgaged, deeded in trust,
or, to the Knowledge of the Company and its Subsidiaries,
encumbered any interest in the leasehold or subleasehold;
(H) all facilities leased or subleased thereunder
have received all approvals of governmental authorities
(including licenses and permits) required in connection with
the operation thereof and have been operated and maintained in
accordance with applicable laws, rules, and regulations;
(I) all facilities leased or subleased thereunder are
supplied with utilities and other services necessary for the
operation of said facilities; and
(J) the owner of the facility leased or subleased has
valid and legal title to the parcel of real property, free and
clear of any Security Interest, and other restrictions which
do not impair the current use, occupancy, or value of the
property subject thereto.
(m) INTELLECTUAL PROPERTY.
(i) The Company and to its Knowledge, its Subsidiaries own or
have the right to use pursuant to license, sublicense, agreement, or
permission all Intellectual Property necessary or desirable for the
operation of the businesses of the Company and its Subsidiaries as
presently conducted. To the Knowledge of the Company, each item of
Intellectual Property owned or used by any of the Company and its
Subsidiaries immediately prior to the Closing hereunder will be owned
or available for use by the Company or the Subsidiary on identical
terms and conditions immediately subsequent to the Closing hereunder.
Each of the Company and its Subsidiaries has taken all necessary and
desirable action to maintain and protect each item of Intellectual
Property that it owns or uses.
(ii) None of the Company and to its Knowledge, its
Subsidiaries has interfered with, infringed upon, misappropriated, or
otherwise come into conflict with any Intellectual Property rights of
third parties, and none of the Company and the directors and officers
(and employees with responsibility for Intellectual Property matters)
of the Company and its Subsidiaries has ever received any charge,
complaint, claim, demand, or notice alleging any such interference,
infringement, misappropriation, or violation (including any claim that
any of the Company and its Subsidiaries must license or refrain from
using any Intellectual Property rights of any third party). To the
Knowledge of any of the Company and its Subsidiaries, no third party
has interfered with, infringed upon, misappropriated, or otherwise come
into conflict with any Intellectual Property rights of any of the
Company and its Subsidiaries.
(iii) ss.4(m)(iii) of the Disclosure Schedule identifies each
patent or registration which has been issued to any of the Company and
its Subsidiaries with respect to any of its Intellectual Property,
identifies each pending patent application or application for
registration
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which any of the Company and its Subsidiaries has made with respect to
any of its Intellectual Property, and identifies each license,
agreement, or other permission which any of the Company and its
Subsidiaries has granted to any third party with respect to any of its
Intellectual Property (together with any exceptions). The Company have
delivered to the Buyer correct and complete copies of all such patents,
registrations, applications, licenses, agreements, and permissions (as
amended to date) and have made available to the Buyer correct and
complete copies of all other written documentation evidencing ownership
and prosecution (if applicable) of each such item. ss.4(m)(iii) of the
Disclosure Schedule also identifies each trade name or unregistered
trademark used by any of the Company and its Subsidiaries in connection
with any of its businesses. With respect to each item of Intellectual
Property required to be identified in ss.4(l)(iii) of the Disclosure
Schedule:
(A) the Company and its Subsidiaries possess all
right, title, and interest in and to the item, free and clear
of any Security Interest, license, or other restriction;
(B) the item is not subject to any outstanding
injunction, judgment, order, decree, ruling, or charge;
(C) no action, suit, proceeding, hearing,
investigation, charge, complaint, claim, or demand is pending
or, to the Knowledge of any of the Company and the directors
and officers (and employees with responsibility for
Intellectual Property matters) of the Company and its
Subsidiaries, is threatened which challenges the legality,
validity, enforceability, use, or ownership of the item; and
(D) none of the Company and its Subsidiaries has ever
agreed to indemnify any Person for or against any
interference, infringement, misappropriation, or other
conflict with respect to the item.
(iv) ss.4(m)(iv) of the Disclosure Schedule identifies, with
the exception of computer software, each item that any third party owns
and that any of the Company and its Subsidiaries uses pursuant to
license, sublicense, agreement, or permission. The Company have
delivered to the Buyer correct and complete copies of all such
licenses, sublicenses, agreements, and permissions (as amended to
date). With respect to each item of Intellectual Property required to
be identified in ss.4(m)(iv) of the Disclosure Schedule:
(A) the license, sublicense, agreement, or permission
covering the item is legal, valid, binding, enforceable, and
in full force and effect;
(B) the license, sublicense, agreement, or permission
will continue to be legal, valid, binding, enforceable, and in
full force and effect on identical terms following the
Closing;
(C) no party to the license, sublicense, agreement,
or permission is in breach or default, and no event has
occurred which with notice or lapse of time
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would constitute a breach or default or permit termination,
modification, or acceleration thereunder;
(D) no party to the license, sublicense, agreement,
or permission has repudiated any provision thereof;
(E) with respect to each sublicense, the
representations and warranties set forth in subsections (A)
through (D) above are true and correct with respect to the
underlying license;
(F) the underlying item of Intellectual Property is
not subject to any outstanding injunction, judgment, order,
decree, ruling, or charge;
(G) no action, suit, proceeding, hearing,
investigation, charge, complaint, claim, or demand is pending
or, to the Knowledge of the Company and the directors and
officers (and employees with responsibility for Intellectual
Property matters) of the Company and its subsidiaries, is
threatened which challenges the legality, validity, or
enforceability of the underlying item of Intellectual
Property; and
(H) none of the Company and its Subsidiaries has
granted any sublicense or similar right with respect to the
license, sublicense, agreement, or permission.
(v) To the Knowledge of the Company, the Company and its
Subsidiaries will not interfere with, infringe upon, misappropriate, or
otherwise come into conflict with, any Intellectual Property rights of
third parties as a result of the continued operation of its business as
presently conducted and as presently proposed to be conducted.
(vi) None of the Company and its Subsidiaries has any
Knowledge of any new products, inventions, procedures, or methods of
manufacturing or processing that any competitors or other third parties
have developed which reasonably could be expected to supersede or make
obsolete any product or process of any of the Company and its
Subsidiaries.
(n) TANGIBLE ASSETS. The Company and its Subsidiaries own or lease all
buildings, machinery, equipment, and other tangible assets necessary for the
conduct of their businesses as presently conducted and as presently proposed to
be conducted). Each such tangible asset is free from defects (patent and
latent), has been maintained in accordance with normal industry practice, is in
good operating condition and repair (subject to normal wear and tear), and is
suitable for the purposes for which it presently is used and presently is
proposed to be used. The fair market value of all tangible assets owned by the
Company located in the United States, which consists solely of certain computer
equipment and software, does not exceed $20,000.
(o) INVENTORY. The inventory of the Company and its Subsidiaries
consists of raw materials and supplies, manufactured and purchased parts, goods
in process, and finished goods, all of which is merchantable and fit for the
purpose for which it was procured or manufactured, and
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none of which is slow-moving, obsolete, damaged, or defective, subject only to
the reserve for inventory writedown set forth on the face of the Most Recent
Balance Sheet (rather than in any notes thereto) as adjusted for the passage of
time through the Closing Date in accordance with the past custom and practice of
the Company and its Subsidiaries.
(p) CONTRACTS. ss.4(p) of the Disclosure Schedule lists the contracts
and other agreements (i) executed by the Company and (ii) executed by the
Subsidiaries and in the possession of the Company.
The Company will deliver to the Buyer by December 4, 1998, a correct
and complete copy of each written agreement either (i) executed by the Company
or (ii) in the possession of the Company, which is listed in ss.4(p) of the
Disclosure Schedule and a written summary setting forth the terms and conditions
of each oral agreement of the Company. The Company will use its best efforts to
deliver to the Buyer a correct and complete copy of each written agreement
executed by its Subsidiaries but not in the Company's possession and a written
summary setting forth the terms and conditions of each oral agreement of its
Subsidiaries. With respect to each such agreement: (A) the agreement is legal,
valid, binding, enforceable, and in full force and effect; (B) the agreement
will continue to be legal, valid, binding, enforceable, and in full force and
effect on identical terms following the consummation of the transactions
contemplated hereby; (C) no party is in breach or default, and no event has
occurred which with notice or lapse of time would constitute a breach or
default, or permit termination, modification, or acceleration, under the
agreement; (D) no party has repudiated any provision of the agreement and (E)
none of such agreements individually or in the aggregate provides for
compensation or other payments that are non-deductible under ss.280G of the
Code.
(q) NOTES AND ACCOUNTS RECEIVABLE. All notes and accounts receivable of
the Company and its Subsidiaries are reflected properly on their books and
records, are valid receivables subject to no setoffs or counterclaims, are
current and collectible, and will be collected in accordance with their terms at
their recorded amounts, subject only to the reserve for bad debts set forth on
the face of the Most Recent Balance Sheet (rather than in any notes thereto) as
adjusted for the passage of time through the Closing Date in accordance with the
past custom and practice of the Company and its Subsidiaries.
(r) POWERS OF ATTORNEY. There are no outstanding powers of attorney
executed on behalf of any of the Company and its Subsidiaries.
(s) INSURANCE. ss.4(s) of the Disclosure Schedule sets forth the
following information with respect to each insurance policy (including policies
providing property, casualty, liability, and workers' compensation coverage and
bond and surety arrangements) to which any of the Company and its Subsidiaries
has been a party, a named insured, or otherwise the beneficiary of coverage at
any time within the past 10 years:
(i) The name, address, and telephone number of the agent.
(ii) The name of the insurer, the name of the policyholder,
and the name of each covered insured.
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(iii) The policy number and the period of coverage.
(iv) The scope (including an indication of whether the
coverage was on a claims made, occurrence, or other basis) and amount
(including a description of how deductibles and ceilings are calculated
and operate) of coverage.
(v) A description of any retroactive premium adjustments or
other loss-sharing arrangements.
With respect to each such insurance policy: (A) the policy is legal, valid,
binding, enforceable, and in full force and effect; (B) the policy will continue
to be legal, valid, binding, enforceable, and in full force and effect on
identical terms following the consummation of the transactions contemplated
hereby; (C) neither any of the Company and its Subsidiaries nor any other party
to the policy is in breach or default (including with respect to the payment of
premiums or the giving of notices), and no event has occurred which, with notice
or the lapse of time, would constitute such a breach or default, or permit
termination, modification, or acceleration, under the policy; and (D) no party
to the policy has repudiated any provision thereof. Each of the Company and its
Subsidiaries has been covered during the past 2 years by insurance in scope and
amount customary and reasonable for the businesses in which it has engaged
during the aforementioned period. ss.4(s) of the Disclosure Schedule describes
any self-insurance arrangements affecting any of the Company and its
Subsidiaries.
(t) LITIGATION. ss.4(t) of the Disclosure Schedule sets forth each
instance in which any of the Company and its Subsidiaries (i) is subject to any
outstanding injunction, judgment, order, decree, ruling, or charge or (ii) is a
party or, to the Knowledge of the Company and its Subsidiaries is threatened to
be made a party to any action, suit, proceeding, hearing, or investigation of,
in, or before any court or quasi-judicial or administrative agency of any
federal, state, local, or foreign jurisdiction or before any arbitrator. None of
the actions, suits, proceedings, hearings, and investigations set forth in
ss.4(t) of the Disclosure Schedule could result in any adverse change in the
business, financial condition, operations, results of operations, or future
prospects of any of the Company and its Subsidiaries. None of the Company and
its Subsidiaries has any reason to believe that any such action, suit,
proceeding, hearing, or investigation may be brought or threatened against any
of the Company and its Subsidiaries.
(u) PRODUCT WARRANTY. Each product manufactured, sold, leased, or
delivered by any of the Company and its Subsidiaries has been in conformity with
all applicable contractual commitments and all express and implied warranties,
and none of the Company and its Subsidiaries has any Liability (and there is no
Basis for any present or future action, suit, proceeding, hearing,
investigation, charge, complaint, claim, or demand against any of them giving
rise to any Liability) for replacement or repair thereof or other damages in
connection therewith, subject only to the reserve for product warranty claims
set forth on the face of the Most Recent Balance Sheet (rather than in any notes
thereto) as adjusted for the passage of time through the Closing Date in
accordance with the past custom and practice of the Company and its
Subsidiaries. No product manufactured, sold, leased, or delivered by any of the
Company and its Subsidiaries is subject to any guaranty, warranty, or other
indemnity beyond the applicable standard terms and conditions of sale or lease.
ss.4(u) of the Disclosure Schedule includes copies of the standard terms and
conditions of sale or lease
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for each of the Company and its Subsidiaries (containing applicable guaranty,
warranty, and indemnity provisions).
(v) PRODUCT LIABILITY. None of the Company and its Subsidiaries has any
Liability (and there is no Basis for any present or future action, suit,
proceeding, hearing, investigation, charge, complaint, claim, or demand against
any of them giving rise to any Liability) arising out of any injury to
individuals or property as a result of the ownership, possession, or use of any
product manufactured, sold, leased, or delivered by any of the Company and its
Subsidiaries.
(w) EMPLOYEES. To the Knowledge of any of the Company and its
Subsidiaries, no executive, key employee, or group of employees has any plans to
terminate employment with any of the Company and its Subsidiaries. None of the
Company and its Subsidiaries is a party to or bound by any collective bargaining
agreement, nor has any of them experienced any strikes, grievances, claims of
unfair labor practices, or other collective bargaining disputes. None of the
Company and its Subsidiaries has committed any unfair labor practice. None of
the Company and its Subsidiaries has any Knowledge of any organizational effort
presently being made or threatened by or on behalf of any labor union with
respect to employees of any of the Company and its Subsidiaries. The Company and
its Subsidiaries have only one employee in the United States and have never had
more than one employee working in the United States in the past.
(x) EMPLOYEE BENEFITS. ss.4(x) of the Disclosure Schedule lists each
Employee Benefit Plan that any of the Company and its Subsidiaries maintains or
to which any of the Company and its Subsidiaries contributes. The Company and
its Subsidiaries do not have any Employee Benefit Plan for the benefit of the
Company's sole employee in the United States.
None of the Company, its Subsidiaries, and the other members of the
Controlled Group of Corporations that includes the Company and its Subsidiaries
contributes to, ever has contributed to, or ever has been required to contribute
to any Multiemployer Plan or has any Liability (including withdrawal Liability)
under any Multiemployer Plan.
(y) GUARANTIES. None of the Company and its Subsidiaries is a guarantor
or otherwise is liable for any Liability or obligation (including indebtedness)
of any other Person.
(z) ENVIRONMENTAL, HEALTH AND SAFETY.
(i) Each of the Company, its Subsidiaries, and their
respective predecessors and Affiliates has complied with all
Environmental, Health and Safety Laws, and no action, suit, proceeding,
hearing, investigation, charge, complaint, claim, demand, or notice has
been filed or commenced against any of them alleging any failure so to
comply. Without limiting the generality of the preceding sentence, each
of the Company, its Subsidiaries, and their respective predecessors and
Affiliates has obtained and been in compliance with all of the terms
and conditions of all permits, licenses, and other authorizations which
are required under, and has complied with all other limitations,
restrictions, conditions, standards, prohibitions, requirements,
obligations, schedules, and timetables which are contained in, all
Environmental, Health and Safety Laws.
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(ii) None of the Company and its Subsidiaries has any
Liability (and none of the Company, its Subsidiaries, and their
respective predecessors and Affiliates has handled or disposed of any
substance, arranged for the disposal of any substance, exposed any
employee or other individual to any substance or condition, or owned or
operated any property or facility in any manner that could form the
Basis for any present or future action, suit, proceeding, hearing,
investigation, charge, complaint, claim, or demand against any of the
Company and its Subsidiaries giving rise to any Liability) for damage
to any site, location, or body of water (surface or subsurface), for
any illness of or personal injury to any employee or other individual,
or for any reason under any Environmental, Health and Safety Law.
(iii) All properties and equipment used in the business of the
Company, its Subsidiaries, and their respective predecessors and
Affiliates have been free of asbestos, PCB's, methylene chloride,
trichloroethylene, 1,2-trans-dichloroethylene, dioxins, and
dibenzofurans.
(aa) CERTAIN BUSINESS RELATIONSHIPS WITH THE COMPANY OR ITS
SUBSIDIARIES. None of the stockholders of the Company or their Affiliates has
been involved in any business arrangement or relationship with any of the
Company and its Subsidiaries within the past 12 months, and none of the
stockholders of the Company or their Affiliates owns any asset, tangible or
intangible, which is used in the business of any of the Company or its
Subsidiaries.
(bb) DISCLOSURE. The representations and warranties contained in this
ss.4 do not contain any untrue statement of a material fact or omit to state any
material fact necessary in order to make the statements and information
contained in this ss.4 not misleading.
5. PRE-CLOSING COVENANTS. The Parties agree as follows with respect to
the period between the execution of this Agreement and the Closing.
(a) GENERAL. Each of the Parties will use its reasonable best efforts
to take all action and to do all things necessary, proper, or advisable in order
to consummate and make effective the transactions contemplated by this Agreement
(including satisfaction, but not waiver, of the closing conditions set forth in
ss.7 below).
(b) NOTICES AND CONSENTS. The Company will and will use its best
efforts to cause its Subsidiaries to give any notices to third parties, and the
Company will cause each of the Company and its Subsidiaries to use its
reasonable best efforts to obtain any third party consents, that the Buyer
reasonably may request in connection with the matters referred to in ss.4(c)
above. Each of the Parties will give any notices to, make any filings with, and
use its reasonable best efforts to obtain any authorizations, consents, and
approvals of governments and governmental agencies in connection with the
matters referred to in ss.3(a)(ii) and ss.4(c) above.
(c) OPERATION OF BUSINESS. The Company will not, and will use its best
efforts to cause its Subsidiaries to not engage in any practice, take any
action, or enter into any transaction outside the Ordinary Course of Business.
Without limiting the generality of the foregoing, the Company and
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the Subsidiaries will not (i) declare, set aside, or pay any dividend or make
any distribution with respect to its capital stock or redeem, purchase, or
otherwise acquire any of its capital stock, or (ii) otherwise engage in any
practice, take any action, or enter into any transaction of the sort described
in ss.4(h) above. The Company shall provide the Buyer a copy of all payments,
complete with documentation of the reason for such payments made by the Company
to third parties. The Company shall have received in writing approval from the
Buyer of all payments in excess of $2,000.
(d) PRESERVATION OF BUSINESS. The Company and its Subsidiaries will
keep its business and properties substantially intact, including its present
operations, physical facilities, working conditions, and relationships with
lessors, licensors, suppliers, customers, and employees.
(e) FULL ACCESS. The Company will permit, and the Company will use its
best efforts to cause each of its Subsidiaries to permit, representatives of the
Buyer to have full access to all premises, properties, personnel, books, records
(including Tax records), contracts, and documents of or pertaining to each of
the Company and its Subsidiaries.
(f) NOTICE OF DEVELOPMENTS. The Company will give prompt written notice
to the Buyer of any material adverse development causing a breach of any of the
representations and warranties in ss.4 above. The Buyer will give prompt written
notice to the Company of any material adverse development causing a breach of
any of its own representations and warranties in ss.3 above. No disclosure by
any Party pursuant to this ss.5(f), however, shall be deemed to amend or
supplement the Disclosure Schedule or to prevent or cure any misrepresentation,
breach of warranty, or breach of covenant.
(g) EXCLUSIVITY. Until the later of the Closing Date or the Termination
Date, the Company will (and the Company will use its best efforts to cause or
permit any of its Subsidiaries not to, directly or indirectly, through any
representative or otherwise,) (i) solicit, initiate, or encourage the submission
of any proposal or offer from any Person relating to the acquisition of any
capital stock or other voting securities, or any portion of the assets of, any
of the Company and its Subsidiaries (including any acquisition structured as a
merger, consolidation, or share exchange) or (ii) participate in any discussions
or negotiations regarding, furnish any information with respect to, assist or
participate in, or facilitate in any other manner any effort or attempt by any
Person to do or seek any of the foregoing. The Company will notify the Buyer
immediately if any Person makes any proposal, offer, inquiry, or contact with
respect to any of the foregoing.
(h) INTENTIONALLY OMITTED.
(i) LISTING OF SHARES AND APPROVAL BY THE COMPANY'S SHAREHOLDERS. The
Company will take or cause to be taken all action necessary to obtain the
listing of the Shares on the AMEX and the approval by the Company's Shareholders
to the issuance of the Securities.
(j) MANAGEMENT OF THE SUBSIDIARIES. The Company will take or cause to
be taken all corporate and joint venture actions necessary to enable the Buyer's
designees to assume management of the Company's Subsidiaries.
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6. POST-CLOSING COVENANTS. The Parties agree as follows with respect to
the period following the Closing.
(a) GENERAL. In case at any time after the Closing any further action
is necessary or desirable to carry out the purposes of this Agreement, each of
the Parties will take such further action (including the execution and delivery
of such further instruments and documents) as any other Party reasonably may
request, all at the sole cost and expense of the requesting Party (unless the
requesting Party is entitled to indemnification therefor under ss.8 below). The
Company acknowledges and agrees that from and after the Closing the Buyer will
be entitled to possession of all documents, books, records (including Tax
records), agreements, and financial data of any sort relating to the Company and
its Subsidiaries.
(b) LITIGATION SUPPORT. In the event and for so long as any Party
actively is contesting or defending against any action, suit, proceeding,
hearing, investigation, charge, complaint, claim, or demand in connection with
(i) any transaction contemplated under this Agreement or (ii) any fact,
situation, circumstance, status, condition, activity, practice, plan,
occurrence, event, incident, action, failure to act, or transaction on or prior
to the Closing Date involving any of the Company and its Subsidiaries, the other
Party will cooperate with it and its counsel in the contest or defense, make
available their personnel, and provide such testimony and access to their books
and records as shall be necessary in connection with the contest or defense, all
at the sole cost and expense of the contesting or defending Party (unless the
contesting or defending Party is entitled to indemnification therefor under ss.8
below).
(c) DEBT IN DEFAULT. The Buyer will use its best efforts to restructure
the $1.8 million currently in default on loans made to the Subsidiaries.
(d) CAPITAL EXPANSION. The Buyer will use its best efforts to increase
the Company's assets by at least (i) $5 million in 1999 and (ii) an additional
$10 million in 2000 through equity and/or debt financing, which will include the
Buyer exercising its rights pursuant to the Warrants to the extent necessary to
bolster the capital base of the Company.
(e) OFFICE. As soon as practical after the Closing Date, the Company's
representative office will be relocated to the Buyer's primary office place at
971-B Russell Avenue, Gaithersburg, Maryland. The Company will compensate the
Buyer at market rates for office space and office support and supplies provided
by the Buyer.
(f) CONFIDENTIALITY. Except as and to the extent required by law, the
Buyer will not disclose or use, and will direct its representatives not to
disclose or use to the detriment of the Company and its Subsidiaries, any
Confidential Information (as defined below) with respect to the Company and its
Subsidiaries furnished, or to be furnished, by the Company and its Subsidiaries
or their respective representatives to the Buyer or its representatives at any
time or in any manner other than in connection with its evaluation of the
transactions contemplated in this Agreement. For purposes of this paragraph,
"Confidential Information" means any information about the Company and its
Subsidiaries stamped "confidential" or identified in writing as such to the
Buyer by the Company promptly following its disclosure, unless (a) such
information is already known to the
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Buyer or its representatives or to others not bound by a duty of confidentiality
or such information becomes publicly available through no fault of the Buyer or
its representatives (b) the use of such information is necessary or appropriate
in making any filing or obtaining any consent or approval required for the
consummation of the transaction contemplated by the Agreement, or (c) the
furnishing or use of such information is required by or necessary or appropriate
n connection with legal proceedings. Upon the written request of the Company,
the Buyer will either promptly return to the Company such Confidential
Information or destroy any Confidential Information in its possession and
certify in writing to the Company that it has done so.
7. CONDITIONS TO OBLIGATION TO CLOSE.
(a) CONDITIONS TO OBLIGATION OF THE BUYER. The obligation of the Buyer
to consummate the transactions to be performed by it in connection with the
Closing is subject to satisfaction of the following conditions:
(i) The representations and warranties set forth in ss.3(a)
and ss.4 above shall be true and correct in all material respects at
and as of the Closing Date.
(ii) The Company shall have performed and complied with all of
its covenants hereunder in all material respects through the Closing.
(iii) The Company and its Subsidiaries shall have procured all
of the third party consents specified in ss.5(b) above.
(iv) No action, suit, or proceeding shall be pending or, to
the Company's Knowledge, threatened before any court or quasi-judicial
or administrative agency of any federal, state, local, or foreign
jurisdiction or before any arbitrator wherein an unfavorable
injunction, judgment, order, decree, ruling, or charge would (A)
prevent consummation of any of the transactions contemplated by this
Agreement, (B) cause any of the transactions contemplated by this
Agreement to be rescinded following consummation, (C) affect adversely
the right of the Buyer to own the Company Shares and to control the
Company and its Subsidiaries, or (D) affect adversely the right of any
of the Company and its Subsidiaries to own its assets and to operate
its businesses (and no such injunction, judgment, order, decree,
ruling, or charge shall be in effect).
(v) The Company shall have delivered to the Buyer a
certificate to the effect that each of the conditions specified above
in ss.7(a)(i)-(iv) is satisfied in all respects.
(vi) The Buyer shall have completed a satisfactory due
diligence examination of the Company.
(vii) The Company shall have continued to operate in the
normal and ordinary course of business until the Closing Date,
including, maintaining its listing on the American Stock Exchange
("AMEX"); AMEX officials shall not have notified the Company of their
determination to delist the Company from AMEX.
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(viii) The holders of the Convertible Notes as set forth in
Exhibit D (the "Convertible Notes") attached hereto shall have agreed
to amend the terms of the Convertible Notes as set forth in Exhibit D.
(ix) The Company's cash position on the Closing Date shall be
at least $1.00, free and clear of any fees, bills, invoices outstanding
and unpaid, unless the Buyer waives this condition in writing on or
before the Closing Date.
(x) The Company shall have provided to the Buyer a copy of all
payments, complete with documentation of the reason for such payments,
made by the Company to third parties. The Company shall have received
in writing approval from the Buyer of all payments in excess of $2,000.
(xi) The Company and its Subsidiaries shall have received all
other authorizations, consents, and approvals of governments and
governmental agencies referred to in ss.3(a)(ii) and ss.4(c) above.
(xii) The relevant parties shall have entered into side
agreements in form and substance as set forth in Exhibits E-1 through
E-2 attached hereto and the same shall be in full force and effect.
(xiii) The Buyer shall have received the resignations,
effective as of the Closing, of each director and officer of the
Company and its Subsidiaries other than those whom the Buyer shall have
specified in writing at least five business days prior to the Closing
and the Buyer's 3 director nominees shall have been appointed to the
board of directors of the Company.
(xiv) The Buyer shall have received a copy of a letter from
Cornerstone Financial Corporation addressed to the Company that none of
the Company or its Subsidiaries is obligated to pay a fee to
Cornerstone Financial Corporation in connection with the transactions
contemplated by this Agreement.
(xv) The Company shall have furnished to the Buyer a favorable
opinion of Pavia & Harcourt dated the Closing Date substantially in the
form attached as Exhibit F hereto, as well as opinions from BVI counsel
to the Company and counsel in China for the Subsidiaries in form and
scope satisfactory to the Buyer and from counsel acceptable to Buyer.
(xvi) All actions to be taken by the Company in connection
with consummation of the transactions contemplated hereby and all
certificates, opinions, instruments, and other documents required to
effect the transactions contemplated hereby will be satisfactory in
form and substance to the Buyer.
(xvii) The Company shall have listed the Shares and the shares
of Common Stock to be issued upon exercise of the Warrant on the AMEX.
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The Buyer may waive any condition specified in this ss.7(a) if it executes a
writing so stating at or prior to the Closing.
(b) CONDITIONS TO OBLIGATION OF THE COMPANY. The obligation of the
Company to consummate the transactions to be performed by them in connection
with the Closing is subject to satisfaction of the following conditions:
(i) The representations and warranties set forth in ss.4 above
shall be true and correct in all material respects at and as of the
Closing Date.
(ii) The Buyer shall have performed and complied with all of
its covenants hereunder in all material respects through the Closing.
(iii) No action, suit, or proceeding shall be pending or
threatened before any court or quasi-judicial or administrative agency
of any federal, state, local, or foreign jurisdiction or before any
arbitrator wherein an unfavorable injunction, judgment, order, decree,
ruling, or charge would (A) prevent consummation of any of the
transactions contemplated by this Agreement or (B) cause any of the
transactions contemplated by this Agreement to be rescinded following
consummation (and no such injunction, judgment, order, decree, ruling,
or charge shall be in effect).
(iv) The Buyer shall have delivered to the Company a
certificate to the effect that each of the conditions specified above
in ss.7(b)(i)-(iii) is satisfied in all respects
(v) The Company and its Subsidiaries shall have received all
other authorizations, consents, and approvals of governments and
governmental agencies referred to in ss.3(a)(ii) and ss.4(c) above.
(vi) The relevant parties shall have entered into side
agreements in form and substance as set forth in Exhibits E-1 and E-2
and the same shall be in full force and effect.
(vii) All actions to be taken by the Buyer in connection with
consummation of the transactions contemplated hereby and all
certificates, opinions, instruments, and other documents required to
effect the transactions contemplated hereby will be reasonably
satisfactory in form and substance to the Company.
(viii) Approval of the transactions contemplated herein by the
Company's board of directors and shareholders.
The Company may waive any condition specified in this ss.7(b), except
ss.7(b)(viii), if the Company executes a writing so stating at or prior to the
Closing.
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8. REMEDIES FOR BREACHES OF THIS AGREEMENT.
(a) SURVIVAL OF REPRESENTATIONS AND WARRANTIES.
All of the representations and warranties of the Parties
contained in this Agreement shall survive the Closing hereunder (even
if the damaged Party knew or had reason to know of any
misrepresentation or breach of warranty at the time of Closing) and
continue in full force and effect forever thereafter (subject to any
applicable statutes of limitations).
(b) INDEMNIFICATION PROVISIONS FOR BENEFIT OF THE BUYER.
(i) In the event the Company breaches (or in the event any
third party alleges facts that, if true, would mean the Company has
breached) any of its representations, warranties, and covenants
contained herein (other than the covenants in ss.2(a) above and the
representations and warranties in ss.3(a) above), and, if there is an
applicable survival period pursuant to ss.8(a) above, provided that the
Buyer makes a written claim for indemnification against the Company
pursuant to ss.11(h) below within such survival period, then the
Company agrees to indemnity the Buyer from and against the entirety of
any Adverse Consequences the Buyer may suffer through and after the
date of the claim for indemnification (including any Adverse
Consequences the Buyer may suffer after the end of any applicable
survival period) resulting from, arising out of, relating to, in the
nature of, or caused by the breach (or the alleged breach).
(ii) The Company agrees to indemnify the Buyer from and
against the entirety of any Adverse Consequences the Buyer may suffer
resulting from, arising out of, relating to, in the nature of, or
caused by any Liability of any of the Company and its Subsidiaries (x)
for any Taxes of the Company and its Subsidiaries with respect to any
Tax year or portion thereof ending on or before the Closing Date (or
for any Tax year beginning before and ending after the Closing Date to
the extent allocable (determined in a manner consistent with ss.9(c))
to the portion of such period beginning before and ending on the
Closing Date): to the extent such Taxes are not reflected in the
reserve for Taxes owed (rather than any reserve for deferred Taxes
established to reflect timing differences between book and Tax income)
shown on the face of the Most Recent Balance Sheet (rather than in any
notes thereto, and prepared in accordance with the generally accepted
accounting principles of the jurisdiction imposing the tax), as such
reserve is adjusted for the passage of time through the Closing Date in
accordance with the past custom and practice of the Company and its
Subsidiaries in filing their Tax Returns.
(iii) The Company agrees to indemnify the Buyer from and
against the entirety of any Adverse Consequences the Buyer may suffer
resulting from, arising out of, relating to, in the nature of, or
caused by the purchase by the Buyer of the Securities.
(c) INDEMNIFICATION PROVISIONS FOR BENEFIT OF THE COMPANY. In the event
the Buyer breaches (or in the event any third party alleges facts that, if true,
would mean the Buyer has
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breached) any of its representations, warranties, and covenants contained
herein, and, if there is an applicable survival period pursuant to ss.8(a)
above, provided that any of the Company makes a written claim for
indemnification against the Buyer within such survival period, then the Buyer
agrees to indemnify each of the Company from and against the entirety of any
Adverse Consequences the Company may suffer through and after the date of the
claim for indemnification (including any Adverse Consequences the Company may
suffer after the end of any applicable survival period) resulting from, arising
out of, relating to, in the nature of, or caused by the breach (or the alleged
breach).
(d) MATTERS INVOLVING THIRD PARTIES.
(i) If any third party shall notify any Party (the
"Indemnified Party") with respect to any matter (a "Third Party Claim")
which may give rise to a claim for indemnification against any other
Party (the "Indemnifying Party") under this ss.8, then the Indemnified
Party shall promptly notify each Indemnifying Party thereof in writing;
PROVIDED, HOWEVER, that no delay on the part of the Indemnified Party
in notifying any indemnifying Party shall relieve the Indemnifying
Party from any obligation hereunder unless (and then solely to the
extent) the Indemnifying Party thereby is prejudiced.
(ii) Any Indemnifying Party will have the right to defend the
Indemnified Party against the Third Party Claim with counsel of its
choice reasonably satisfactory to the Indemnified Party so long as (A)
the Indemnifying Party notifies the Indemnified Party in writing within
15 days after the Indemnified Party has given notice of the Third Party
Claim that the Indemnifying Party will indemnify the Indemnified Party
from and against the entirety of any Adverse Consequences the
Indemnified Party may suffer resulting from, arising out of, relating
to, in the nature of, or caused by the Third Party Claim, (B) the
Indemnifying Party provides the Indemnified Party with evidence
reasonably acceptable to the Indemnified Party that the indemnifying
Party will have the financial resources to defend against the Third
Party Claim and fulfill its indemnification obligations hereunder, (C)
the Third Party Claim involves only money damages and does not seek an
injunction or other equitable relief, (D) settlement of, or an adverse
judgment with respect to, the Third Party Claim is not, in the good
faith judgment of the Indemnified Party, likely to establish a
precedential custom or practice materially adverse to the continuing
business interests of the Indemnified Party, and (E) the Indemnifying
Party conducts the defense of the Third Party Claim actively and
diligently.
(iii) So long as the Indemnifying Party is conducting the
defense of the Third Party Claim in accordance with ss.8(d)(ii) above,
(A) the Indemnified Party may retain separate co-counsel at its sole
cost and expense and participate in the defense of the Third Party
Claim, (B) the Indemnified Party will not consent to the entry of any
judgment or enter into any settlement with respect to the Third Party
Claim without the prior written consent of the Indemnifying Party (not
to be withheld unreasonably), and (C) the Indemnifying Party will not
consent to the entry of any judgment or enter into any settlement with
respect to the
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Third Party Claim without the prior written consent of the Indemnified
Party (not to be withheld unreasonably).
(iv) In the event any of the conditions in ss.8(d)(ii) above
is or becomes unsatisfied, however, (A) the Indemnified Party may
defend against, and consent to the entry of any judgment or enter into
any settlement with respect to, the Third Party Claim in any manner it
reasonably may deem appropriate (and the Indemnified Party need not
consult with, or obtain any consent from, any Indemnifying Party in
connection therewith), (B) the Indemnifying Parties will reimburse the
Indemnified Party promptly and periodically for the costs of defending
against the Third Party Claim (including reasonable attorneys' fees and
expenses), and (C) the Indemnifying Parties will remain responsible for
any Adverse Consequences the Indemnified Party may suffer resulting
from, arising out of, relating to, in the nature of, or caused by the
Third Party Claim to the fullest extent provided in this ss.8.
(e) DETERMINATION OF ADVERSE CONSEQUENCES. The Parties shall take into
account the true cost of money (using the Applicable Rate as the discount rate)
in determining Adverse Consequences for purposes of this Section 8. All
indemnification payments under this Section 8 shall be deemed adjustments to the
Purchase Price.
(f) OTHER INDEMNIFICATION PROVISIONS. The foregoing indemnification
provisions are in addition to, and not in derogation of, any statutory,
equitable, or common law remedy any Party may have for breach of representation,
warranty, or covenant; PROVIDED, HOWEVER, that Buyer shall not institute any
action against the Acting Chairman of the Company personally based upon any such
breach, so long as the Acting Chairman did not have any actual knowledge of the
facts or circumstances giving rise to the breach and did not commit any fraud.
9. TAX MATTERS. The following provisions shall govern the allocation to
the Company for certain tax matters following the Closing Date:
(a) TAX SHARING AGREEMENTS. All tax sharing agreements or similar
agreements with respect to or involving the Company and its Subsidiaries shall
be terminated as of the Closing Date and, after the Closing Date, the Company
and its Subsidiaries shall not be bound thereby or have any liability
thereunder.
(b) CERTAIN TAXES. All transfer, documentary, sales, use, stamp,
registration and other such Taxes and fees (including any penalties and
interest) incurred in connection with this Agreement, shall be paid by the
Company when due, and the Company will, at their own expense, file all necessary
Tax Returns and other documentation with respect to all such transfer,
documentary, sales, use, stamp, registration and other Taxes and fees, and, if
required by applicable law, Buyer will, and will cause its affiliates to, join
in the execution of any such Tax Returns and other documentation.
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10. TERMINATION.
(a) TERMINATION OF AGREEMENT. The Parties may terminate this Agreement
as provided below:
(i) The Buyer and the Company may terminate this Agreement by
mutual written consent at any time prior to the Closing.
(ii) The Buyer may terminate this Agreement by giving written
notice to the Company on or before the close of the 61st day following
the date of this Agreement if the Buyer is not satisfied with the
results of its continuing business, legal, and accounting due diligence
regarding the Company and its Subsidiaries; (A) in the event the
Company has breached any material representation, warranty, or covenant
contained in this Agreement in any material respect, the Buyer has
notified the Company of the breach, and the breach has continued
without cure for a period of 30 days after the notice of breach or (B)
if the Closing shall not have occurred on or before June 1, 1999, by
reason of the failure of any condition precedent under ss.7(a) hereof
(unless the failure results primarily from the Buyer itself breaching
any representation, warranty, or covenant contained in this Agreement).
(iii) The Company may terminate this Agreement by giving
written notice to the Buyer on or before the close of the 61st day
following the date of this Agreement (A) in the event the Buyer has
breached any material representation, warranty, or covenant contained
in this Agreement in any material respect, of the Company has notified
the Buyer of the breach, and the breach has continued without cure for
a period of 30 days after the notice of breach or (B) if the Closing
shall not have occurred on or before June 1, 1999, by reason of the
failure of any condition precedent under ss.7(b) hereof (unless the
failure results primarily from the Company itself breaching any
representation, warranty, or covenant contained in this Agreement).
(b) EFFECT OF TERMINATION. If any Party terminates this Agreement
pursuant to ss.10(a) above, all rights and obligations of the Parties hereunder
shall terminate without any Liability of any Party to any other Party (except
for any Liability of any Party then in breach).
(c) TERMINATION FEE. If (a) the Company breaches Section 2 of Part Two
of the Letter of Intent or the Company provides the Buyer with written notice
that negotiations toward the Definitive Agreements are terminated, and (b)
within six months after the date of such breach or the date of delivery of such
written notice, as the case may be, the Company or any of its Subsidiaries signs
a letter of intent or other agreement relating to the acquisition of a material
portion of the Common Stock or of the Company or its Subsidiaries, their assets,
or businesses, in whole or in part, whether directly or indirectly, through
purchase, merger, consolidation or otherwise (other than sales of inventory or
immaterial portion of the Company or its Subsidiaries; assets in the ordinary
course) and such transaction is ultimately consummated, then, immediately upon
the closing of such transaction, the Company will pay, or cause its Subsidiaries
to pay, to the Buyer the sum of $100,000. This fee will not serve as the
exclusive remedy to the Buyer under this Agreement in the event of a breach by
the Company of Section 5(g), and the Buyer will be entitled to all other rights
and remedies provided by law or in equity.
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11. MISCELLANEOUS.
(a) PRESS RELEASES AND PUBLIC ANNOUNCEMENTS. No Party shall issue any
press release or make any public announcement relating to the subject matter of
this Agreement prior to the Closing without the prior written approval of the
other Party; PROVIDED, HOWEVER, that any Party may make any public disclosure it
believes in good faith is required by applicable law or any listing or trading
agreement concerning its publicly-traded securities (in which case the
disclosing Party will use its best efforts to advise the other Party prior to
making the disclosure).
(b) NO THIRD PARTY BENEFICIARIES. This Agreement shall not confer any
rights or remedies upon any Person other than the Parties and their respective
successors and permitted assigns.
(c) ENTIRE AGREEMENT. This Agreement (including the documents referred
to herein) constitutes the entire agreement among the Parties and supersedes any
prior understandings, agreements, or representations by or among the Parties,
written or oral, to the extent they related in any way to the subject matter
hereof.
(d) SUCCESSION AND ASSIGNMENT. This Agreement shall be binding upon and
inure to the benefit of the Parties named herein and their respective successors
and permitted assigns. No Party may assign either this Agreement or any of his
or its rights, interests, or obligations hereunder without the prior written
approval of the other Party; PROVIDED, HOWEVER, that the Buyer may (i) assign
any or all of its rights and interests hereunder to one or more of its
Affiliates and (ii) designate one or more of its Affiliates to perform its
obligations hereunder (in any or all of which cases the Buyer nonetheless shall
remain responsible for the performance of all of its obligations hereunder).
(e) COUNTERPARTS. This Agreement may be executed in one or more
counterparts, each of which shall be deemed an original but all of which
together will constitute one and the same instrument.
(f) HEADINGS. The section headings contained in this Agreement are
inserted for convenience only and shall not affect in any way the meaning or
interpretation of this Agreement.
(g) NOTICES. All notices, requests, demands, claims, and other
communications hereunder will be in writing. Any notice, request, demand, claim,
or other communication hereunder shall be deemed duly given if (and then two
business days after) it is sent by registered or certified mail, return receipt
requested, postage prepaid, and addressed to the intended recipient as set forth
below:
If to the Company: Copy to:
----------------- -------
C.T. Yeh Nicolas J. Puro, Esq.
c/o Nicolas J. Puro, Esq. Pavia & Harcourt
Pavia & Harcourt 600 Madison Avenue
600 Madison Avenue New York, New York 10022
New York, New York 10022 Phone: (212) 980-3500
Fax: (212) 980-3185
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and
Howard H. Jiang,Esq.
Morgan, Lewis & Bockius
101 Park Avenue
New York, New York 10148
Phone: (212) 309-7078
Fax: (212) 309-6273
If to the Buyer: Copy to:
Bill Zhao Kofi Appenteng, Esq.
America Orient Group, Inc. Thacher Proffitt & Wood
971-B Russell Avenue Two World Trade Center
Russell Office Park New York, New York 10048
Gaithersburg, Maryland 20879 Phone: (212) 912-7418
Phone: (301) 670-8880 Fax: (212) 912-7751
Fax: (301) 670-4721
Any Party may send any notice, request, demand, claim, or other communication
hereunder to the intended recipient at the address set forth above using any
other means (including personal delivery, expedited courier, messenger service,
telecopy, telex, ordinary mail, or electronic mail), but no such notice,
request, demand, claim, or other communication shall be deemed to have been duly
given unless and until it actually is received by the intended recipient. Any
Party may change the address to which notices, requests, demands, claims, and
other communications hereunder are to be delivered by giving the other Parties
notice in the manner herein set forth.
(h) GOVERNING LAW. This Agreement shall be governed by and construed in
accordance with the domestic laws of the State of New York without giving effect
to any choice or conflict of law provision or rule (whether of the State of New
York or any other jurisdiction) that would cause the application of the laws of
any jurisdiction other than the State of New York.
(i) AMENDMENTS AND WAIVERS. No amendment of any provision of this
Agreement shall be valid unless the same shall be in writing and signed by the
Buyer and the Company. No waiver by any Party of any default, misrepresentation,
or breach of warranty or covenant hereunder, whether intentional or not, shall
be deemed to extend to any prior or subsequent default, misrepresentation, or
breach of warranty or covenant hereunder or affect in any way any rights arising
by virtue of any prior or subsequent such occurrence.
(j) SEVERABILITY. Any term or provision of this Agreement that is
invalid or unenforceable in any situation in any jurisdiction shall not affect
the validity or enforceability of the remaining terms and provisions hereof or
the validity or enforceability of the offending term or provision in any other
situation or in any other jurisdiction.
(k) EXPENSES. The Company will bear its own costs and expenses
(including legal fees and expenses and broker's or finder's fees and the
expenses of its representatives) and the Buyer's costs and expenses (including
legal fees and expenses and broker's or finder's fees and the expenses
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of its representatives) incurred at any time in connection with this Agreement
and the transactions contemplated hereby; PROVIDED, HOWEVER, prior to Closing,
if this Agreement is terminated pursuant to ss.10 above prior to Closing, each
Party shall bear all of their own costs and expenses.
(l) CONSTRUCTION. The Parties have participated jointly in the
negotiation and drafting of this Agreement. In the event an ambiguity or
question of intent or interpretation arises, this Agreement shall be construed
as if drafted jointly by the Parties and no presumption or burden of proof shall
arise favoring or disfavoring any Party by virtue of the authorship of any of
the provisions of this Agreement. Any reference to any federal, state, local, or
foreign statute or law shall be deemed also to refer to all rules and
regulations promulgated thereunder, unless the context requires otherwise. The
word "including" shall mean including without limitation. The Parties intend
that each representation, warranty, and covenant contained herein shall have
independent significance. If any Party has breached any representation,
warranty, or covenant contained herein in any respect, the fact that there
exists another representation, warranty, or covenant relating to the same
subject matter (regardless of the relative levels of specificity) which the
Party has not breached shall not detract from or mitigate the fact that the
Party is in breach of the first representation, warranty, or covenant.
(m) INCORPORATION OF EXHIBITS, ANNEXES AND SCHEDULES. The Exhibits,
Annexes, and Schedules identified in this Agreement are incorporated herein by
reference and made a part hereof.
(n) SPECIFIC PERFORMANCE. Each of the Parties acknowledges and agrees
that the other Parties would be damaged irreparably in the event any of the
provisions of this Agreement are not performed in accordance with their specific
terms or otherwise are breached. Accordingly, each of the Parties agrees that
the other Parties shall be entitled to an injunction or injunctions to prevent
breaches of the provisions of this Agreement and to enforce specifically this
Agreement and the terms and provisions hereof in any action instituted in any
court of the United States or any state thereof having jurisdiction over the
Parties and the matter (subject to the provisions set forth in ss.10(o) below),
in addition to any other remedy to which they may be entitled, at law or in
equity.
(o) SUBMISSION TO JURISDICTION. Each of the Parties submits to the
jurisdiction of any state or federal court sitting in New York, New York, in any
action or proceeding arising out of or relating to this Agreement and agrees
that all claims in respect of the action or proceeding may be heard and
determined in any such court. Each Party also agrees not to bring any action or
proceeding arising out of or relating to this Agreement in any other court. Each
of the Parties waives any defense of inconvenient forum to the maintenance of
any action or proceeding so brought and waives any bond, surety, or other
security that might be required of any other Party with respect thereto. Any
Party may make service on any other Party by sending or delivering a copy of the
process to the Party to be served at the address and in the manner provided for
the giving of notices in ss.10(h) above. Nothing in this ss.10(o), however,
shall affect the right of any Party to bring any action or proceeding arising
out of or relating to this Agreement in any other court or to serve legal
process in any other manner permitted by law or at equity. Each Party agrees
that a final judgment in any action or proceeding so brought shall be conclusive
and may be enforced by suit on the judgment or in any other manner provided by
law or at equity.
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IN WITNESS WHEREOF, the Parties hereto have executed this Agreement on
December 3, 1998.
AMERICA ORIENT GROUP, INC.
By: /s/ Guoliang Guan
--------------------------------------
Name: Guoliang Guan
Title: Senior Vice President
CHINA ENERGY RESOURCES
CORPORATION
By: /s/ C.T. Yeh
--------------------------------------
Name: C.T. Yeh
Title: President, Chief Executive Officer
and Acting Chairman
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[EXHIBITS INTENTIONALLY OMITTED]
