-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, C6c6+n8kDU1728I+YGcx5pave9/f2NkT62HNQn+zh9Iucmj+xTB+1ytgSOa/r92e lSLzGkl7nF3hJ3gE2JNIzw== 0000882377-99-000389.txt : 19990716 0000882377-99-000389.hdr.sgml : 19990716 ACCESSION NUMBER: 0000882377-99-000389 CONFORMED SUBMISSION TYPE: 20-F PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990715 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CHINA ENERGY RESOURCES CORP CENTRAL INDEX KEY: 0000925527 STANDARD INDUSTRIAL CLASSIFICATION: BLANK CHECKS [6770] IRS NUMBER: 000000000 STATE OF INCORPORATION: D8 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 20-F SEC ACT: SEC FILE NUMBER: 001-14606 FILM NUMBER: 99664857 BUSINESS ADDRESS: STREET 1: 971 B RUSSELL AVE CITY: GAITHERSBURG STATE: MD ZIP: 20879 BUSINESS PHONE: 3016708880 MAIL ADDRESS: STREET 1: 971 B RUSSELL AVE CITY: GAITHERSBURG STATE: MD ZIP: 20879 FORMER COMPANY: FORMER CONFORMED NAME: JACKSON HOLDING CORP DATE OF NAME CHANGE: 19940617 20-F 1 CHINA ENERGY RESOURCES CORPORATION 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) ------------------------------------ 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 --------------------------------------- ----------------------- Common Stock, par value $0.01 per share American Stock Exchange ------------------------------------ Securities registered or to be registered pursuant to Section 12(g) of the Act. NONE Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act. NONE Indicate the number of outstanding shares of each of the issuer's classes of capital or common stock as of the close of the period covered by the annual report. As of December 31, 1998, 3,248,494 common shares, par value $0.01 per share (the "Common Stock"), were issued and outstanding. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes / / No /X/ Indicate by check mark which financial statement item the registrant has elected to follow. Item 17 / / Item 18 /X/ CERTAIN DEFINITIONS AND SUPPLEMENTAL INFORMATION All references to "China" or "PRC" in this Annual Report are references to The People's Republic of China. Unless otherwise specified, all references in this Annual Report to "U.S. dollars," "dollars," or "$" 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. 1 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 2 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. 3 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 4 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." 5 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:
1996 1997 1998 ---- ---- 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
- -------------------------------------------- *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. 6 QCCF reported the following sales of steam coal for the previous three fiscal years:
1996 1997 1998 ---- ---- Sales volume (in tons) 475,305 396,627 299,086 Average net sales price (per ton)* $15.86 $19.52 $19.31
- --------------------------------------------- * 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 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 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 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. 10 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.
AMOUNT PERCENT TITLE OF CLASS IDENTITY OF PERSON OR GROUP OWNED OF CLASS - -------------- --------------------------- ----- -------- 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%
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.
IDENTITY OF AMOUNT PERCENT OF TITLE OF CLASS PERSON OR GROUP OWNED CLASS - -------------- --------------- ----- ----- 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%
11 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 12 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. 13 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
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: 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%)
(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 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.
Year Ended Year Ended Year Ended 12/31/96 12/31/97 12/31/98 THE COMPANY: ---------------------------------------------------- (expressed in thousands) 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)
Year Ended Year Ended Year Ended 12/31/96 12/31/97 12/31/98 MCCF: ---------------------------------------------------- (expressed in thousands) 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)
16
Year Ended Year Ended Year Ended 12/31/96 12/31/97 12/31/98 QCCF: ---------------------------------------------------- (expressed in thousands) 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
Production Mix and Sales Volume OPERATING COMPANY: ---------------------------------------------------- 1996 1997 1998 ---- ---- ---- (expressed in thousands except average figures) 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
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 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 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 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 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 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 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 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.
Date First Elected Name Position Or Appointed - ---- -------- ------------ 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
(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 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.
Date First Elected Name Position Or Appointed - ---- -------- ------------ Bill H. Zhao (1)(2) President, CEO and Chairman of the Board March 1999
(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.
Date First Elected Name Position Or Appointed - ---- -------- ------------ 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
(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.
Date First Elected Name Position Or Appointed - ---- -------- ------------ Xu Changhai Chief Engineer September 1995
EXECUTIVE OFFICERS AND KEY EMPLOYEES OF QCCF Set forth below is certain information regarding the executive officers and key employees of QCCF:
Date First Elected Name Position Or Appointed - ---- -------- ------------ Luan Jixiang Director September 1995 Yuan Si Xian Director September 1995
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 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 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 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 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 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
CHINA ENERGY RESOURCES CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands except per share amounts) Years ended December 31, 1998 1997 1996 ---- ---- ---- 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 ======= ======= =======
See accompanying notes to consolidated financial statements. F-2
CHINA ENERGY RESOURCES CORPORATION CONSOLIDATED BALANCE SHEETS (Amounts in thousands except share and per share amounts) December 31, 1998 1997 ---- ---- 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 ======== ========
See accompanying notes to consolidated financial statements. F-3
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 ------ ------ ------- --------- ------- ------ 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 ===== ====== ======== ======== ========== ==========
See accompanying notes to consolidated financial statements. F-4
CHINA ENERGY RESOURCES CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands) Years ended December 31, 1998 1997 1996 ---------------------------------------------------- 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
See accompanying notes to consolidated financial statements. F-5 CHINA ENERGY RESOURCES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in thousands except per share amounts) 1. ORGANIZATION AND BASIS OF PRESENTATION China Energy Resources Corporation (the "Company"), a private company incorporated in the British Virgin Islands, was incorporated on March 15, 1996 for the purpose of holding a 100% interest in China Coal Mining (B.V.I.) Co. Ltd. ("China Coal") and to enter into an agreement with Jackson Holding Corp. ("Jackson"), a New York Corporation. On March 15, 1996 the shareholders in China Coal exchanged their shares in China Coal for shares in the Company. The exchange of shares has been accounted for as a reorganization of entities under common control similar to a pooling of interests. The accompanying financial statements include the combined results and operations and financial position of the Company, China Coal and its 80% held subsidiary for all periods presented. On March 22, 1996, pursuant to an agreement and plan of merger between the Company and Jackson, Jackson was merged into the Company and the Company issued 109,850 shares of its common stock to the shareholders of Jackson for the entire issued share capital of Jackson. Jackson had been established in 1994 for the sole purpose of acquiring or merging with an unspecified business, and at the time of 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 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 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 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 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 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 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.
December 31, 1998 1997 ---- ---- 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%
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
December 31, 1998 1997 ---- ---- 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 ======= =======
All long-term bank loans are authorized by the provincial or local governments and are administered by the banks. F-12 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 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 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 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 EX-2.1 2 PLAN OF ACQUISITION, REORGANIZATION, ETC. EXHIBIT 2.1 Stock and Warrant Purchase Agreement, dated December 3, 1998, between America Orient Group, Inc. and China Energy Resources Corporation EXECUTION COPY -------------- STOCK AND WARRANT PURCHASE AGREEMENT BETWEEN CHINA ENERGY RESOURCES CORPORATION AND AMERICA ORIENT GROUP, INC. DECEMBER 3, 1998
TABLE OF CONTENTS 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) (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) (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
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) 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. "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- 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- "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- 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- 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- 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- 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 -8- 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 -9- 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. -10- (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. -11- (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 -12- 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 -13- 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). -14- (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; -15- (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; -16- (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 -17- 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 -18- 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 -19- 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. -20- (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 -21- 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. -22- (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 -23- 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. -24- 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 -25- 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. -26- (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. -27- 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. -28- 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 -29- 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 -30- 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. -31- 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. -32- 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 -33- 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 -34- 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. -35- 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 -36- [EXHIBITS INTENTIONALLY OMITTED] -----END PRIVACY-ENHANCED MESSAGE-----